Politicians and those with hangers-on always find a way around the law, as reports suggest. In one instance, a politician in Karnataka despatched his cronies with Rs 1 lakh to Rs 2 lakh in cash of Rs 500 and Rs 1,000 denominations to get them exchanged and thus “laundered” clean white. These were the kind of people former RBI governor Raghuram Rajan was referring to when he said demonetisation had been considered in the past but not thought to be effective.
“My sense is the clever find ways around it. They find ways to divide up their hoard into many smaller pieces,” he had said at an interaction after delivering the Lalit Doshi Memorial lecture in August 2014. An audience member had asked a question about RBI’s proposal to phase out old notes that do not have the year printed on them, and Rajan had said that demonetisation had been considered as an option to get rid of black money but he didn’t think it would work.
He reasoned that the need of the hour was to focus the incentives that generate and retain black money. Adding that most of the black money might be stocked in the form of gold, which would make it harder for the administration to track or catch.
Stressing on the need to implement a better tax system, Rajan said India’s taxes were among the lowest and therefore there was no reason why people should not pay their dues. In such a situation, better data tracking mechanism and tax administration will go a long way in keeping track of where money is not being declared, he said. “I think it is very hard in this modern economy to hide your money that easily,” he added.
Here is the extract of Rajan’s interaction where he spoke about demonetization.
Question: RBI’s proposal to phase out old notes which do not have the year printed. Suggestion – a: Replacing old currency notes under a new series. b: Also consider adding new series of Notes with Rabindranath Tagore, Homi Bhabha, et al.
Response: I am not quite sure if what you meant is demonetise the old notes and introduce new notes instead. In the past demonetisation has been thought off as a way of getting black money out of circulation. Because people then have to come and say “how do I have this ten crores in cash sitting in my safe” and they have to explain where they got the money from. It is often cited as a solution.
Unfortunately, my sense is the clever find ways around it. They find ways to divide up their hoard in to many smaller pieces. You do find that people who haven’t thought of a way to convert black to white, throw it into the Hundi in some temples. I think there are ways around demonetization. It is not that easy to flush out the black money. Of course, a fair amount may be in the form of gold, therefore even harder to catch.
I would focus more on the incentives to generate and retain black money. A lot of the incentives are on taxes. My sense is the current tax rate in this country is for the most part reasonable. We have a reasonable tax regime, for example, the maximum tax rate on high-incomes is 33%, in the US it is already 39% plus State taxes, etc., it takes it to near 50. We are actually lower than many industrial countries.
Given that, there is no reason why everybody who should pay taxes is not paying taxes. I would focus more on tracking data and better tax administration to get at where money is not being declared. I think it is very hard in this modern economy to hide your money that easily.
Interactive Session with Dr. Raghuram Rajan, Governor, Reserve Bank of India