Economy

What Arun Jaitley's Defence of Demonetisation Conveniently Ignores

The Wire breaks down the finance minister's statement and examines the changes in goalposts, the obfuscations and what the 2016 note-ban actually achieved.

New Delhi: Finance minister Arun Jaitley on Thursday mounted a defence of the Narendra Modi government’s decision to ban Rs 500 and Rs 1,000 notes two years ago, quoting bullish digital transactions and tax-related data.

A closer look at Jaitley’s arguments shows that the truth is more nuanced and, in some cases, quite ambiguous due to a lack of data.

The Wire breaks it down and examines the changes in goalposts, the obfuscations and what the 2016 note-ban actually achieved.

The finance minister starts his blogpost by explaining that demonetisation was merely one step in a “chain of important decisions taken by the government to formalise the economy”.

He writes:

The Government first targeted the black money outside India. Asset holders were asked to bring this money back on payment of penal tax. Those who failed to do so are being prosecuted under the Black Money Act. Details of all accounts and assets abroad which have reached the Government, resulted in action against the violators.

The first thing to note is that Jaitley cites no numbers or data: how many asset holders were asked to bring back black money from abroad through the payment of a penal tax? How many people who failed to do so were prosecuted under the Black Money Act? Every now and then, a media report comes out on the subject but offers no evidence. Put simply, we don’t know and Jaitley offers nothing new on this front.

Also read: Time to Own Up to Damage Done by Note Ban, Says Opposition As Govt Calls Move a Success

The only publicly available data so far we have on prosecution in tax evasion and black money is that there were 2,226 prosecution complaints filed in FY 2017-18 (upto the end of November 2017) when compared to 784 for the corresponding period in the preceding year. With no data on the quantum of evaded tax, this doesn’t appear impressive.

Secondly, during the first two years of the Modi government, tax treaties with a number of countries (most importantly Mauritius and Singapore) were furiously worked out and signed. These tax agreements were offered up as proof of the Centre’s commitment to fight black money.

While both treaties were useful, it did not stop the practice of round-tripping, and just plugged one leaky hole. As The Wire has reported, the Netherlands is quickly becoming the new “Mauritius route”, with over 80% of the investment flows that came from Netherlands in 2017 being ‘routed’ and not ‘direct’.

The Modi government’s attempt at cracking down on Switzerland also is only delayed action: while India will get access to Swiss account data from 2019, as whistleblower Rudolf Elmer told The Wire, by that time, the biggest fish would have moved onwards to other tax-evasion havens like Hong Kong.

Cash, cash and cash

At another point, Jaitley offers up one statistic while talking about the cash that came back after demonetisation:

Demonetisation compelled holders of cash to deposit the same in the banks.  The enormity of cash deposited and identified with the owner resulted in suspected 17.42 lakh account holders from whom the response has been received online through non-invasive method. The violators faced punitive actions.

Again here, the wording is confusing. Apparently 17.42 lakh account holders were “suspected” as a result of the cash they deposited and asked to give a response. The violators then faced “punitive action” – but how many out of 17.42 lakh account holders weren’t able to explain the cash they deposited? And what was the quantum of black money detected? Jaitley offers no specific data. What he leaves out is the poor performance of Pradhan Mantri Garib Kalyan Yojana (PMGKY) programme, which was launched to unearth black money.

Under the PMGKY scheme, those people whose deposits did not match their income were given a chance to come clean by March 31, 2017 and convert the black money into white by paying penal taxes. The scheme, however, wasn’t a success as just Rs 2,300 crore was collected by the income-tax department as penal tax under the amnesty scheme.

Formalisation of savings

Jaitley also touches on the benefits of higher bank deposits and formalisation of financial savings:

Larger deposits in banks improved lending capacity for the banks. A lot of this money was diverted to the Mutual Funds for further investments. It became a part of the formal system.

While this is true, the finance minister leaves out other contributing factors as well as a few other important developments that were a consequence of demonetisation-induced formalisation. Firstly, while the mutual fund industry received a handsome bump in the months after demonetisation, in recent times it has benefited greatly from people being put off small savings schemes.  

Also read: Two Years after Demonetisation, the Nightmare Continues for India’s Informal Economy

Secondly, it’s clear that Indians are now keeping more cash reserves at home than they did before the note-ban decision. And despite this, the household savings rate has fallen. An India Ratings report noted that the savings rate of the household sector plummeted 153 basis points on a year-on-year basis in FY’17 as a result of demonetisation and GST.

Digital future

On how demonetisation pushed India forward on the online payments front, Jaitley writes:

The Unified Payment Interface (UPI) was launched in 2016 involving real time payments between two sets of mobile holders. Its transactions have grown from Rs. 0.5 billion in October, 2016 to Rs. 598 billion in September, 2018. The Bharat Interface for Money (BHIM) is an App developed by NPCI for quick payment transactions using UPI. It is currently used by 1.25 Crore people. The value of BHIM transactions has gone up from Rs. 0.02 billion in September, 2016 to Rs. 70.6 billion in September, 2018. The share of BHIM transactions in overall UPI transactions is at about 48% in June, 2017.

The finance minister is largely correct on this: UPI, launched as late as it was, is a demonetisation bright-spot, although its rapid growth slowed a few months after the note-ban and has looked a little shaky after various cash-back schemes were withdrawn by the Centre.

It’s also unclear how well India’s retailers and merchants are taking to this payment option: the great majority of UPI transactions are still person-to-person, indicating that they may have replaced more onerous and formal net banking channels.

Also read: Despite the Spin, Demonetisation Simply Wasn’t Worth the Time or Effort

What Jaitley leaves out is that demonetisation didn’t erase the love that Indians have for cash. Before demonetisation, India’s currency-to-GDP ratio was a little over 12%. After November 2016, it fell to a little over 6% and has since then risen back to 11.3% of GDP, with no signs of stopping.

While government-affiliated economists point to the fact that currency-in-circulation (CIC) must be viewed differently – namely what would it be if demonetisation hadn’t happened – it’s also clear that a new permanently lower equilibrium has not been found and that the rate of CIC growth has not been stunted as a result of the note-ban.

Higher revenue argument

Finally, Jaitley re-traces a defence that India’s income-tax department has consistently tried to make over the last two years; that the formalisation that came about as a result of demonetisation has led to more people paying taxes.

The finance minister writes:

The impact of Demonetisation has been felt on collection of personal income tax. Its collections were higher in Financial Year 2018-19 (till 31-10-2018) compared to the previous year by 20.2%. Even in the corporate tax the collections are 19.5% higher. From two years prior to Demonetisation, direct tax collections have increased 6.6% and 9% respectively. In the next two years, post-demonetisation, the increase by 14.6% (part of the year before impact of Demonetisation in 2016-17) and an increase of 18% in the year 2017-18.

Similarly, in the year 2017-18, the tax returns filed reached 6.86 crore, an increase of 25% over the previous year. This year, as on 31-10-2018, already 5.99 crore returns have been filed which is an increase of 54.33% compared to the previous year till this date. The new filers added this year are 86.35 lakh.

In May, 2014, when the present Government was elected the total number of the filers of income tax returns was 3.8 crore. In the first four years of this Government, it has increased to 6.86 crore. By the time the first five years of this Government are over, we will be close to doubling the assessee base.

While true, the numbers need to be viewed in the appropriate context. While India’s direct tax collections are up, the country’s direct tax-GDP ratio has not seen a significant rise, as The Wire has pointed out, with the highest ratio in recent times being seen in 2006-2007 (6.3%).

Since demonetisation, the Centre has also regularly reported the increase in number of new tax filers. What it leaves out, as many have noted, is that a good bunch of these new I-T return filers are people with very little taxable income, leading to very little increases in revenue for the government.

Also read: Modi’s Minimum Raj: Jaitley Forwarded Anonymous Note to Flag Key Matter to PMO

Lastly, as Mahesh Vyas, head of the Centre for Monitoring Indian Economy (CMIE) has noted, there’s no glory to be obtained in a quest for a generally higher tax-to-GDP ratio.

Economic Survey 2016-17 had argued that after controlling for the level of economic development, India neither under-taxes nor under-spends. So, there is no argument in favour of raising the tax-to-GDP ratio… Since the GST accounts for most of the indirect taxes and almost a third of all taxes in 2018-19, its eventual decline should see the tax-GDP ratio fall in due course,” Vyas wrote earlier this year.

The Wire has fact-checked several statements made by Arun Jaitley before. Read them here: 

Fact Check on Jaitley the Fact-Checker Paints Unflattering Picture of Economy

Fact Check: Demonetisation’s Effect on Increase in Direct Taxes and Income Tax Base

Jaitley’s ’15 Questions’ Only Reinforce the Murky Nature of Modi’s Rafale Deal

Tall Claims on Demonetisation’s Success Carry Over Into Jaitley’s Budget 2018 Speech

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