In an October speech, Reddy noted that there is “a subsisting interest in influential policy circles to keep a window for round-tripping” open.
Note: You will find below excerpts from the Mahesh Buch Memorial Lecture delivered by former Reserve Bank of India governor Y.V. Reddy at Bhopal on October 5, 2016. In his speech, Reddy takes us through his experiences in dealing with black money and the shadow economy in India. In light of the Modi government’s decision to demonetise Rs 500 and Rs 1000 notes in its fight against corruption and black money, we have published, with permission, excerpts from Reddy’s lecture. We believe it is a useful read as it details the failure of the Indian state to historically and holistically combat the problem of unaccounted money and tax evasion.
First experiences in tackling black money
My interest in black money goes back to 1960. I was registering for PhD I wanted to take the subject black money in India for my thesis. My would be guide, Professor V.V. Ramanadham said that it would not be an appropriate subject for a PhD degree; there was no data available. I, therefore, changed the subject to monopoly and concentration of economic power in India. I worked for three years on the subject and I had to change that subject also for a variety of reasons.
At a policy level, I came into contact with the issue of black money when we were going through the balance of payment crisis in 1991. India development bonds were floated to obtain foreign exchange from non-residents to help us tide over their crisis. At that time, there was a consensus and control systems that were prevalent before 1991 would be dismantled. It was the general understanding that there would be a regime shift in the policies away from a system that provided incentives to accumulate wealth outside India. The country was also desperately in need of foreign exchange to get over the crisis. Amnesty was granted under some conditions.
General understanding at that time was that this dispensation of Amnesty was an extraordinary and one time measure. The IMF team which was negotiating with us its support was not confident that the bond issue will succeed even with amnesty, because at that time one of the reasons of the crisis was withdrawal of NRI deposits. We felt that NRIs confidence in our economy will be restored with reforms initiated, and they will put in money without waiting for formal upgrade by rating agencies. The returns for them were attractive but not excessive.
We succeeded in racing the foreign exchange from NRI bonds, soon after balance of payment crisis in 1991, with elements of amnesty.
I was hoping that it will remain one off measure. It did not.
In 1997, there was a Voluntary Disclosure Scheme which did not have any relationship with a foreign exchange crisis or a regime shift in policy. However, there was an assurance of changes in policy, giving one last chance to come clean. By then I was a deputy governor. I express my reservations about its desirability, for well known reasons; i.e. moral hazard and global experiences. Some people criticised saying that “coming clean” became more attractive than paying taxes on current incomes also.
This had no link with forex or a crisis, but facilitated conversion of some of the stock of black money to non-black money channels.
I am not aware of evaluation of its performance in terms of original objectives.
On failure to curb ’round-tripping’
In 1998, consequent upon imposition of sanctions by USA as a reaction to our nuclear explosion, many observers felt that we had to mobilise extraordinary financing for balance of payments support. I was closely involved in the design of the Resurgent India bonds. There was a strong feeling within government that amnesty should be given. My position was that it would set a bad precedent and, in any case, inadvisable on grounds of theory, empirical evidence and our experience. My input during discussions was that we should be prepared to pay higher interest costs rather than extend the amnesty. Governor Jalan and minister Sinha resisted the pressures and temptation to follow the precedent, and decided on the proposal not involving amnesty.
Simply stated, we proved that amnesty was not needed if their intention was to raise money from NRIs since an attractive rate was enough. It was not addressing issue of black money or money illegally stashed abroad.
In September 2003, I took over as governor. By then we had faced the Ketan Parekh scam, and the parliamentary committee that enquired into the subject made a reference to the role of overseas corporate bodies and participatory notes in this scam.
There were enough grounds to believe that these two mechanisms were being used for round tripping, that is, illegally taking money out from India and bringing it back to invest in India. Concealed incomes, untaxed, go out and earn incomes that are not taxed.
OCBs were permitted to disinvest and repatriate, but they were not permitted to make new investments. These amounted to a ban on inflow from them. One of the two big windows of round tripping of money was thus closed.
There was a second route for round tripping called participatory notes (PNs) which were serving a similar purpose. I had spoken to chairman SEBI and he promised to ban PNs immediately after my action against OCBs in 2003. Later he mentioned that the SEBI board did not approve and that the government was not supportive of the measure. I took up the matter with the government without much success.
In November 2005, an expert group (chairman Dr. Lahiri) appointed by government gave a report encouraging FII flows. It was in favour of a liberal approach to PNs but with safeguards put in by SEBI. The representatives of the Reserve Bank of India in an unusual gesture appended a Note of Dissent. The RBI asserted that nothing short of banning of participatory notes would be appropriate.
Clearly, there is a subsisting interest in influential policy circles to keep a window for round-tripping open.
On usefulness of tax amnesty
First, black money often described as parallel economy is not exactly parallel with white money since there is continuous mingling of the two. Let me illustrate. Many building are constructed by real estate developers with a significant share of black money. The developer may be paying wages to the construction workers in the evening out of his black money. For the construction worker, however, it is white money earned for hard work, and when he spends to buy the groceries in the evening, it is pure white money transactions. However, when the owner of the grocery shop has to pay protection money to the mafia in the night, it becomes black money with the mafia. At the same time, when the grocery shop pays electricity bill or pays municipal tax, they are all white money transactions. In brief, the black and white components keep changing through the transactions, and all moneys are fungible.
Second, experience with tax amnesty to convert black money into white has not helped in curbing generation of black money and amounts of black money mobilised through amnesty is a very small part of the estimated stock. In fact, such amnesty has led people to argue that yesterday’s black money can become todays white money in the policy of the government changes. In other words, the stigma attached to the black money and the differentiation on ethical grounds between black and white money, lose their significance with recourse to amnesty by the government. Both in theory and in practice, both in India and globally, tax amnesty proved to be counter-productive.
High taxes, more black?
Firstly, when we started with the reform process, we assumed that high level of taxation encouraged generation of black money. As of now, income tax rates for the higher income earners in India are, perhaps, among the lowest taxed in major economies of the world. Similarly, India is one of the few that does not have inheritance tax and no wealth tax, and substantively no gift tax. Even after the taxes have been brought down to this level, the record of compliance with tax law is dismal.
Both, the generation of black money and cross border movement of black money are not explained by current level of taxation.
Asking different questions
Most important lesson from a review of experience is that our policies relating to curbing black money or bringing back the stock of money illegally parked overseas have been less than successful. There is no reason to believe that more of the same will work better. We do not seem to know what might work better. Perhaps, we should ask different or right questions in order to understand the issues relating to black money.
Benami Transaction (Prohibition) Act was enacted in 1988. For some reason or the other, no regulations were issued under the Act. In other words, it remained unimplemented for more than 25 years. The president who seemed unconcerned about implementation. The parliament was indifferent. The executive had no compulsion to explain. The judiciary did not consider it a matter of public interest to dwell on that. However, an amendment Bill was introduced in Lok Sabha in May, 2015. It has been passed in August, 2016. What explains the lack of enthusiasm among all wings of public policy to do what is universally accepted as very critical to issue black money?
We are proceeding on the assumption that government agencies should be empowered to punish the citizens who generate black money. At the same time, the Supreme Court wants to make sure that such powers are not used selectively by the executive as illustrated by the work of SIT. Implicitly, Supreme Court does not trust the executive to discharge its executive functions unless the court takes over the supervisory functions. Is it possible that generation, circulation and multiplication of black money are a symptom of lawlessness in the system: all pervading lawlessness? Is lawlessness defined as respect for contracts, explicit or implicit, prevalent both in dealings by the government and the citizens?