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Why any claim that demonetisation was a failure is totally misplaced

Earlier this week, there were some claims that demonetisation could be declared a failure as apparently there was enough data on the table to conclude it. These claims were made on the basis of current loan-waiver costs that the government has to incur, which was, rather speciously, linked to demonetisation and identified as ‘cost’ of demonetisation. This was further juxtaposed with the ‘benefits’, data for which is by no means conclusive, for not even three full quarters have passed since the announcement.

It was argued that the farmers were not getting good prices for their produce because the intermediary markets were mostly cash driven and the demonetisation after-effects were still not over. This argument, in my view, is far-fetched as well as reductionist. The prices of agricultural goods are a factor of production more than liquidity, and a ‘good’ harvest following a good monsoon ironically gets ‘bad’ prices for the farmers.

The issues with farming and agriculture financing are far more complex and badly need solutions, and it will do no one a justice if we take a reductionist approach and blame it all on demonetisation.

Nonetheless, scope of my article is about demonetisation, not about farming, and I strongly believe that any statement declaring demonetisation a failure, when not even 9 months have passed since the step was announced, is not just premature, but even ill-conceived.

Demonetisation was a disruptive step in true sense, having far reaching impacts on various facets of our economy and consumption habits. A little over eight months is too short a period to pronounce judgments or take up any meaningful ‘cost-benefit’ analysis.

To truly understand the benefits, we will have to understand the objectives of demonetisation and see whether those objectives have been met and the kind of benefits they are expected to bring.

Broadly, there were three objectives behind demonetisation:

  • Track and tax “black money” in the system
  • Bring more people into the formal economy and/or tax base
  • Encourage digital payments leading to “less cash economy”

Let us take each objective separately and see what was planned in short and long term and how did Modi government perform.

Track and tax “black money” in the system:

How do you quantify/track and bring to tax something which you only had an estimate of? In this paper titled “White Paper on Black Money” [pdf] published by the Ministry of Finance, GOI, various estimates and methods are provided to quantify “Black Money”. At best these were only estimates. One surest thing that happened after demonetisation is that every piece of currency paper now has an address.

Let us rewind a little.

First: while accepting deposits during the demonetisation drive, IDs were collected and proper forms were filled by citizens. Second: the deposit limits were also set. Third: Bank accounts with no proper KYC were debarred from accepting cash deposits. All this ensured that only accounts which could be traced back to an individual/firm were allowed to deposit cash.

The result:

During Budget Speech this year, Finance Minister Arun Jaitley revealed that during the period from 8th November to 30th December 2016, deposits between Rs 2 lakh and Rs 80 lakh were made in about 1.09 crore accounts with an average deposit size of Rs 5.03 lakh. Deposits of more than Rs 80 lakh were made in 1.48 lakh accounts with average deposit size of Rs 3.31 crore.

I don’t intend to say that all cash is “black money” or everything in bank is white, but it is pertinent to note that 31% of the total deposits that were made into banks were by individuals with an average of Rs 80 lakhs and above. This data is goldmine for tax administration. I have a simple query: who keeps on an average Rs 3.31 Cr in cash?

If it is legitimate cash, there should be no problems in replying to Income Tax notices. This tracking and reset of the currency flow is one of the successes of demonetisation.

You can’t put a number to it to undertake any meaningful cost-benefit analysis. This is more like a hard reset of the system so that future functioning is smooth. However, there still are some numbers that need to be accounted.

Let us take an example: Suppose an individual deposited Rs 20 lakhs in his account. After receipt of a notice from the income tax department, he replies that he had provided certain service to another person. Here, the effect is that the government gets to claim service tax on this amount.

Furthermore, they can ask him to provide full details of the service recipient and even question him over the source, thus establishing the full source of this amount. Plus, this individual will now have to file returns year after year and all his declarations shall be open to scrutiny every single time. Will he try to be too clever and conceal his sources of income? Not only the current black money is detected, even future generation of black money is discouraged as a result.

On this, some express the concern of “tax terrorism”, but the demonetisation actually made sure that tax authorities did not become too powerful. Arbitrary powers to charge penalty on evasion were removed and replaced with a fixed amount; this ensured that no cases got “settled” outside the system. Of course, final assessments will take time. The persons have a right to defend themselves and go in appeals hence it is difficult to quantify the tax gains as of now.

At this stage, it is important to note that demonetisation is one of the part of series of decisions taken since Day 1 by Modi government to eliminate corruption, black money, counterfeit currency, and terror funding. Hence not an end in itself but means to an end. In this fight, such data as highlighted by the finance minister is invaluable.

Bring more people into the formal economy:

On 14th December 2016, CBDT issued a press release stating that only in certain cases revised returns can be filed by Assessee. The fact that this came into notice highlights that this method was being used by persons to manipulate income figures, cash-in-hand, profits, etc. and were attempting to launder unaccounted money.

So what happens when you plug one loophole? People try and find some other way. The government added 9.1 million new taxpayers in 2016-17. This was an 80% increase over the normal yearly growth in tax base each year. Income tax collection till 15 June has risen by 26.2% compared to last year.

Further, for April-December 2016 period, indirect tax collections grew at 25% to Rs 6.3 trillion, central excise was up by 43% to Rs 2.79 trillion, service tax grew at 23.9% to Rs 1.83 trillion, and customs by 4.1% to Rs 1.67 trillion. Direct tax collections were also up by 12.01% to Rs 5.53 trillion in the nine-month period. (source)

Demonetisation critics stress that holding cash isn’t illegal, I agree, it is not but they should also understand that merely depositing cash into bank accounts does not convert black money into white! Ignoring facts like expansion in tax base and deposits being tracked shows how facts are being ignored to arrive at inferences they have already concluded. Any process under Income Tax Act has various steps and stages. A long-term analysis is being written off in a very short term.

Now these new taxpayers will have to file returns on a year to year basis. How do we quantify this incremental benefit? The tax collections figures should be an indicator. During demonetisation, searches, seizures, and raids were conducted across the nation. In a reply to the Rajya Sabha, the Finance Minister informed the House that under Operation Clean Money, the Income Tax Department had issued 18 lakh notices to persons whose cash deposits were not matching with their income profiles. Against this, they received 12 lakh responses from 8.38 lakh distinct PAN/persons. The process is far from over.

Further implementation of Goods and Services Tax (GST) will widen the formal economy leading to a wider tax base. Raids, searches, notices and government responses every day to plug loopholes (during demonetisation) sent a strong message to tax evaders who now probably have a sense of fear in their minds. You cannot quantify these benefits.

Move to a less-cash economy:

In November last year, I had written why a move to less-cash economy comes with its own benefits. Cost of transactions goes down, time and cost of accounting goes down, and of course, costs of printing currency goes down. Compliance is better as there is better documentation. Better documentation and compliance plugs loopholes in public distribution system. And there is better tax monitoring, and better revenue collections. As you can see, not everything among these can be quantified, but these objectives are being met.

RBI data shows that India is adopting digital means of payments. Cash has made a comeback but clearly there is a change in mindset and behaviour. Launch of BHIM app, Aadhaar Pay, and incentives for online transactions are few instances to promote digital payments. There is surely much more that’s needed to be done as behavioural change takes time, but there is no doubt that we have taken important first steps towards a less-cash economy.

Finally, demonetisation is not a standalone project:

Regardless of the horizon that we choose to undertake a cost-benefit analysis – and that horizon definitely can not be less than 9 months – we have to keep in mind that demonetisation is no standalone project. It is a key and crucial part of a series of steps taken to tackle black money problem.

Here are few of those steps:

  • Constitution of the Special Investigation Team (SIT) on Black Money under Chairmanship and Vice-Chairmanship of two former Judges of Hon’ble Supreme Court
  • Enactment of a comprehensive law – ‘The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015’ to specifically deal with black money stashed away abroad,
  • Constitution of Multi-Agency Group (MAG) for investigation of revelations in Panama paper leaks,
  • Proactively engaging with foreign governments to facilitate and enhance the exchange of information under tax treaties
  • Renegotiation of tax treaties to bring the Article on Exchange of Information to International Standards and expanding India’s treaty network by signing tax treaties with many jurisdictions to facilitate the exchange of information and to bring transparency
  • Proactively furthering global efforts to facilitate automatic exchange of information and
  • Enabling attachment and confiscation of property equivalent in value held within the country where the property/proceeds of crime is taken or held outside the country by amending the Prevention of Money-laundering Act, 2002 through the Finance Act, 2015
  • The Benami prohibition law which remained in-operative for last 28 years was made operational through a comprehensive amendment with effect from November, 2016.
  • Cash deposit limits and cash transactions limits plus streamlined penalty provisions
  • Aadhaar linking with bank accounts and PAN for better tracking of money to stop accumulation of unaccounted money

From May 2014 till February 2017, 23064 searches/surveys were conducted (Income Tax 17525; Customs 2509; Central Excise 1913; Service Tax 1120); more than Rs. 1.37 lakh crore of undisclosed income/tax evasion was detected (Income Tax 69434; Customs 11405; Central Excise 13952; Service Tax 42727). Simultaneously, criminal prosecutions were launched in 2814 cases (Income Tax 1966; Customs 526; Central Excise 293; Service Tax 29) and 3893 persons were placed under arrest (Customs 3782; Central Excise 47; Service Tax 64)

Post demonetisation, during the period 9th November 2016 to 10th January 2017, more than 1100 search and survey were conducted by the ITD, apart from issuing more than 5100 verification notices in the cases of suspicious high value cash deposits or related activities. These actions led to seizure of valuables of more than Rs. 610 crore which includes cash of Rs. 513 crore. Seizure of cash in new currency notes was about Rs 110 crore. The undisclosed income detected in these actions was more than Rs. 5400 crore. (source)

If you analyse demonetisation (a long-term activity) on a short-term basis or ignore all the above mentioned steps and their outcomes/benefits, it is unjustified and unfair on the entire exercise. As can be seen, some short-term benefits have materialized, but the long-term benefits can be seen only in the long run. But data points to the fact that we are heading in the right direction.

Looking at the data available and the trends, I can say with confidence that demonetisation was not just a political success, but an economic one too.

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