Impact of the Black Economy in India: Brief Report of a Seminar

by Arun Kumar, Sunil Dharan and Astha Ahuja

The Sukhamoy Chakravarty Chair, CESP, JNU, in collaboration with Tax Justice Network, London organized a seminar on ‘Black Economy in India, its Global Dimensions and Impact on Policies’ at Jawaharlal Nehru University on June 26, 2015. In all 13 papers were presented in the day-long seminar which was spread over four sessions.

In his opening remarks, Arun Kumar, Sukhamoy Chakravarty Chair Professor at the CESP, JNU, pointed out that the black economy is the missing dimension of policy making in India. It affects all variables—macro and micro—yet, it is neither taken into account in policy makingnor in empirical analysis. The Government, the Planning Commission (now closed) and the RBI do not take it into account while making policies. The result is widespread policy failure.

He emphasised that it is important to identify the correct cause of the growing black economy, otherwise, actions to curb it would not succeed. Many committees have looked into the problem and made a plethora of suggestions. In spite of many of them being implemented the problem continues to grow. Since the black economy is over 50 per cent of the GDP, it has to be ‘systematic and systemic’. In his view, the real cause is the triad consisting of corrupt business-men, corrupt politicians and corrupt executive. This triad has strengthened because of the political weakness of our democracy and is referred to as ‘crony capitalism’.

The recent steps initiated by the present government are unlikely to succeed. Steps like, making payment in cheque mandatory, the bill for bringing back assets and income abroad and setting up of SIT, are unlikely to succeed because they do not dismantle the Triad. Finally, since all political parties are tainted there is a need to build people’s movements against this menace.

Seminars like these, he hoped, would bring together individual experts who are otherwise working in isolation on different aspects of the black economy. Such mutual interaction would help in building a body of knowledge and perhaps lead to a movement against black economy.

The first session on Judiciary, Law and Electoral Issues was chaired by Prof Sunanda Sen, Retired Professor, JNU. The first paper of the session was on Impact of Black Money in Elections and Political Activities by Sushmita Samaddar, Lakshmi Bargavi Sriram, Nilesh Ekka and Jagdeep Chhokar of the Association for Democratic Reforms (ADR). The paper pointed to the hiatus between the estimates of actual expenditure on elections and what candidates spend. The official spending by the Election Commission of India (ECI) and the Government of India is small compared to what the candidates spend.

For example, in the 2014 general elections, estimates suggest that the candidates may have spent about Rs 30,000 crores while the official machinery spent around Rs 7000 crores. Thus the total expenditure was not even half a per cent of the GDP of 2014. In these elections, the average declared election expenditure of the candidates, was 59 per cent of the election expenditure limit! Unfortunately, the ECI does not take into account the expenditure by the political parties.

It was pointed out that there was a rapid increase in the assets of MPs who got re-elected. 165 MPs saw their assets increase by 137 per cent between 2009 and 2014. Of these, the assets of 32 MPs went up by more than Rs 10 crores in these five years. The number of crorepatis increased from 58 per cent in 2009 to 82 per cent in 2014. The sources of income are not disclosed by the candidates.

The paper argued for better scrutiny of affidavits and election expenditure statements of candidates. Candidates often undervalue their assets in their statements.Further, political parties do not disclose the details of their donors. 80 per cent of their incomes are shown in the below Rs 20,000 category so that they do not have to reveal the details of the donors. Political parties also get funds from bogus companies. It was emphasised that there is need to bring political parties within the ambit of the RTI act.

The second paper of the session was on Extant Laws to Deal with International Black Money: Inadequacies and How to Tackle the Situation by Bishwajit Bhattacharya, former Additional Solicitor General of India. According to the speaker, there are three legislations to deal with black money in India—the Foreign Exchange Management Act (FEMA), the Prevention of Money Laundering Act (PMLA) and the recently brought in Undisclosed Foreign Income and Assets Bill.

Under FEMA it is no longer a criminal offence to hold an account in a Swiss Bank. A person resident in India can hold, own, invest and transfer foreign assets outside India. The teeth of the law have been knocked out and not even one dollar has come to India under this Act. PMLA is also ineffective. It has scheduled offences which are themselves self-contained legislations, be it the Arms Act, the Prevention of Corruption Act or the Immoral Trafficking Act. Foreign exchange violation is not a scheduled offence under this act.

The Undisclosed Foreign Income and Assets Act also does not have any provisionto bring black money back to the country. It only attempts to impose tax and penalty on foreign bank accounts and assets and that too only in Indian Rupee. In his view, this would encourage people to generate additional black money in India. Interestingly, the entire amount of black money held abroad is outside the purview of the Income Tax Act and entire domestic Black Money is outside the purview of the Undisclosed Foreign Income and Assets Act. Moreover, all residents have to declare foreign assets and income in their tax returns beginning April 1, 2016 only. This would give people enough time to evade the law. He concluded by saying that it is time to shift attention from international black money to domestic black money.

In the final paper of the session, Rule of Law, the Underlying Principle in the Approach of the Supreme Court towards Black Money, Ashok Panda, Advocate at the Supreme Court, looked at the changes in the Supreme Court’s approach towards black money.He argued that prior to the McDowell case (1985) the Supreme Court took a lenient view towards tax avoidance. In the McDowell case the Supreme Court departed from this approach and emphasised on the harmful effects of tax avoidance. He cited the Jain Havala case and other cases on black money in the Supreme Court. He concluded that the only hope of the citizens lies in an independent judiciary which is free from extraneous pressures.

The topic of the second session was Fiscal Issues and Estimation of Black Incomes. It was chaired by Anil Divan, Senior Advocate. In the first paper titled Minimising Selection Failure and Measuring Tax Gap: An Empirical Modelling, the authors Sudhanshu Kumar and Kavita Rao, both at the National Institute of Public Finance and Policy (NIPFP), presented an empirical model to estimate tax gap based on the scrutiny of tax returns. The tax gap or tax evasion would be zero if the tax department could audit all returns filed by the taxpayers and validate the information provided by them. But that is neither possible nor desirable. So the department has to confine its exercise to a sample of the filed returns. But here there is possibility of selection failure. While selecting the cases,the department could make two kinds of errors. It could be that the department selects an honest filer. In this case it would invite complaints of taxpayer harassment while no additional revenue would be forthcoming. The second kind of error would be that the sample leaves out the dishonest taxpayer which would result in a tax gap, i.e., what could have been collected but was not. The paper developed a model which would minimize selection failures and reduce tax gap in the case of corporate taxes.

The next paper was on Effects of Scams on National Accounts Statistics by R.K. Biswas and Meghna Sharma, researchers at the CESP, JNU. The paper examined scams between 2005 and 2008 in India and tried to assess their impact on estimation of National Income. The paper shows that, contrary to popular perception, scams, depending on their nature, do affect national income. The paper classifies scams into twelve categories based on i) their private or public sector character, ii) whether the income generated is factor or transfer income, iii) whether the black income generated is via showing lower revenue or higher cost (or both) and finally, whether the scam leads to overestimation or underestimation of national income or leaves it unchanged.

The paper presents a number of case studies. For instance, in the Kidney scam the kidney donors were paid paltry amounts by the scamsters while they sold the kidneys at exorbitant rates. Here, the black income generated leads to underestimation of the national income. Of the 144 scams which the authors studied,108 cases showed revenue reduction and 36 cases showed over invoicing of costs so that 121 cases resulted in under-estimation of national income whereas the remaining had no impact on national income.

The last paper was, Estimation of the Size of the Black Economy by Arun Kumar. He began by highlighting the importance of studying the size of the black economy.If it is large, it cannot be ignored.Even though data availability is sketchy, efforts have to be made to estimate it. Further, even if data are poor it cannot be ignored theoretically. The government is not keen to estimate the size of the black economy lest it has to answer awkward questions like, what led to its growth and why it could not be checked earlier. Even the RBI does not take the black economy seriously despite its known effects on monetary policy variables.

The paper highlights the definitional aspects, namely, black incomes are factor incomes property incomes that are not reported to the direct tax authorities. In the case of illegal activities, the entire incomes generated in them are black incomes. Black incomes are largely concentrated in the services sector and are absent in the agricultural sector because there is no income tax there. Mis-invoicing of foreign trade and capital flight are important aspects of generation of black incomes.

Kumar used the fiscal approach for estimating black incomes in India. The other approaches lead to multiple counting of black incomes or count transfer incomes also, giving inflated figures. Using the linkage of black incomes with services sector, illegality (represented by crime data) and international trade, the author presented a model for estimating the black economy from 1952 to 2012. For 2012 theestimate was 62 per cent of the GDP. In the period after 2000, it was shown to have grown at around 20 per cent per annum, much faster than the white economy.

The third session was on Social Sector, Natural Resources and Institutional Aspects and was chaired by Prof Amit Bhaduri, Emeritus Professor, CESP, JNU. In the first paper, Ashok, faculty member at the CESP, analysed Corruption in Education in India. The focus of his paper was on higher education. He pointed out that higher education is a quasi-public and a merit good. The root cause of corruption in this sector, in his view, is that while the private sector is allowed to run educational institutions in this country, legally they cannot make profits. They, therefore, try to make money through various means aided by the prevalence of asymmetric information in this sector. He pointed to more than 15 different forms of corruption in the public sector and more than 8 forms in the private sector. This has brought down the quality of higher educational institutions in the country with a majority getting a grade of C in the NAAC Accreditation in the year 2009. The number of legal cases with the UGC against educational institutions has been growing over the years. He concluded by stating that the regulators have failed miserably in checking the malpractices in this sector.

The next paper was by Vivekananda Mukherjee, who is teaching in Jadavpur University. He presented a paper, co-authored with his student, titled Does Introduction of Bureaucratic Competition Reduce Corruption in Public Service Delivery? The paper considered a hypothetical situation where different public service providers compete among themselves to provide service to the citizens. If the citizens are not satisfied with one service provider they have the option of approaching another one. He makes a distinction between corruption tolerant economy and corruption reliant economy. In the former, firms are victims of corruption while in the latter, they gain from corruption. Using a theoretical model he showed that introduction of bureaucratic competition is likely to increase corruption in the corruption tolerant economies but its impact on corruption reliant economies are uncertain. The former, according to him,are developing economies and the latter the developed economies.

The next presentation was by Paranjoy Guha Thakurta, an independent journalist. He spoke on Natural Resources and Crony Capitalism in India. According to him, an important feature of the major scams in the recent period is that they are all linked to natural resources. This is true of the 2G Spectrum scam, Coalgate, gas pricing and the iron ore mining scam. The land acquisition bill is also under scrutiny and is again about another important and scarce natural resource. Cronyism refers to a situation where the rules of the game are bent to ensure that a chosen few got hold of the natural resources. Free market allocation was not resorted to in these cases.

In the case of 2G spectrum, the market for it doubled each year at the height of the boom and yet, the concerned minister decided to allocate in on a first come first served basis at very low prices. In the case of gas production from the Krishna Godavari basin, the Production Sharing Contract did not have provisions to prevent gold plating. The concerned company was promised assured returns in the form of cost recovery. There were allegations of deliberate production suppression in anticipation of higher prices in the future. The company produced only one-eighth of the gas it was supposed to produce according to the contract and explored only 10 per cent of the area it had control over. The company attributed this to natural factors.

In some cases the accused have been brought to book. For example, the Bellary brothers were put behind bars in the iron-ore mining scam. The Supreme Court cancelled the licenses in the 2G scam and the coal blocks in the coal scam. But the damage had already been done. According to the author, in the name of economic liberalization the system is being subverted resulting in institutionalised corruption due to the emergence of a Triad and cronyism.

He argued that natural resources belong to the people of the country. He expressed optimism that with an alert civil society, vigilant judiciary and government organs like, the CAG and the CVC the worst may be behind us.

In the next presentation, Prafulla Prusty, Commissioner, Income Tax Department examined why the department lost some of the recent cases that it had initiated against tax evaders. Using a number of case studies, heargued in his presentation titled ‘Failure of Some Recent Income Tax Cases: Deliberate or Genuine?’ that even though the Income Tax Act 1961 has provisions to curb tax evasion, they have either been misused or not properly enforced to check tax evasion. The Search and Seizure provision in the Income Tax Act is a draconian provision but it has been found that, in spite of it, the assesses escape by taking recourse to the appellate window provided in the act. For instance, in the Hasan Ali Khan cross border money laundering case, the IT department had initially put up a demand of over Rupees One lakh crore but now only a very small proportion of this is likely to be realized even if the department manages to get a judgment in its favour, which itself seems unlikely. This, according to him, is because of the long time involved in pursuing the case which helped the accused to wipe out all evidence and due to faulty investigation. The Finance Ministry has almost concluded that the cases against Hassan Ali Khan group will not stand the test of judicial scrutiny.

Similarly, in another case of Today Homes and Infrastructure Private Limited, in which the company was generating black income through shell companies, the company managed to get away by going to Income Tax Settlement Commission. The very existence of this Commission, according to him, shows the pro-business tilt of policies and the operation of the invisible Triad.

The final session of the seminar ‘Business Fraud and its Global Dimensions’ was chaired by Ashok Bhattacharya, Editor, Business Standard. In the first paper of this session, Prasana K. Dash, Election Commission of India, spoke on Political Finance and Corruption. India is the largest functional democracy in the world and has remained so despite all odds. Conducting elections in this country is a herculean task.While the country has done it successfully over the years it has been the root cause of corruption. The main causes of corruption have been mobilizing money for elections, where it is spent and the quid pro quo associated with it. The Constitution does not dwell adequately on financing of election. The Representation of Peoples Act 1951 is the only place where the term political party appears in the Constitution. Under Section 29B of the Act, any registered party may accept any amount of contribution voluntarily offered to it by any person or company other than a government company or from foreign sources.

Many parties are being used as conduits to convert black money to white. But the Election Commission does not have the power to de-register political parties. The Election Commission under article 324 of constitution only manages and conducts free and fair election. Election Commission is not a regulator of political parties and has no power to deregister them.

Making points similar to the ones made by ADR, he argued that ceilings on expenditures are violated openly to such an extent that the EC is in a dilemma whether to have the ceilings or not.Building public awareness could deal with this problem to a large extent. But without appropriate legislation doing away with this menace is difficult.

The next paper was, Decentralisation of Corruption and its Effect on Local Public Service Delivery: An Experience from Nepal by Krishna Raj Panta, a social activist from Nepal. Proponents of decentralization maintain that it leads to more efficient local public service delivery. Based on his field work, he showed that this has not been the case in Nepal. He found out that 45 per cent of the respondents observed elite capture in project selection-mostly by political parties, 33 per cent of the respondents said that corruption was a major obstacle for local development,local users and political leadersblamedeach other for corruption, 35 per cent were dissatisfied with the services provided by VDC, 29 per cent were not satisfied with the change in quality of public services. Corruption and elite capture at the local level have resulted in lack of transparency and lack of accountability. He argued that along with decentralisation of authority and resources there has been decentralisation of corruption as well.

In the final paper of the seminar, Saumen Chattopadhyay of the JNU presented his estimate of capital flight from India during the period 1948-2013. The paper Estimation of Capital Flight from India: 1948-2013 defines capital flight as capital that is taken out of the country in the form of foreign exchange illegally. This can be for two reasons—to evade taxes and to escape detection, if the income is illegal. The global financial system is adversely affected by global flows of dirty money as one-fifth of all financial deposits in the world are held off-shore. Flight of capital results in loss of capital for the domestic economy with employment and multiplier generated abroad and not in India, investment and savings cease to be related, the rate of growth of the economy declines compared to the potential rate of growth the economy that could have been achieved in the absence of the black economy.

The paper improves upon the World Bank methodology for estimating capital flight, which has a number of shortcomings. Its coverage is inadequate as it takes into account trade misinvoicing only. Trade in services is not included. Also smuggling and other illegal activities are left out. Based on the improved methodology, the paper estimates that the total illicit financial outflow from the country during the period 1948-2013 is around $ 416 billion whereas as per the World Bank methodology it is around $ 210 billion. However, its opportunity cost is around $ 2 trillion.

In conclusion, the papers presented highlight the impact of the black economy on elections, politics, international trade, taxation, corporates, local bodies and allocation of the nation’s resources. It is also pointed out that the laws have been toothless in tackling the growing black economy because of the existence of the Triad (crony capitalism) which is in power and does not wish to check its growing incomes. The papers also point to the increasing number of scams and the growing amount of funds misappropriated in them and consequently, the growth in the size of the black economy in the country and also to the rising amount of capital illegally going out of India. It becomes clear that the black economy effects every aspect of the nation’s lifeand without political will no amount of laws and measures can check the menace of the black economy in India.It was highlighted that people have to be alert and movements are necessary to check this menace.

Prof Arun Kumar is a retired Sukhamoy Chakravarty Chair Professor, Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. Sunil Dharan is a Lecturer in Motilal Nehru (M) College, University of Delhi. Asha Ahuja is a Lecturer is Arya Bhatt College, University of Delhi. Prof Arun Kumar is a retired Sukhamoy Chakravarty Chair Professor, Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. Sunil Dharan is a Lecturer in Motilal Nehru (M) College, University of Delhi. Asha Ahuja is a Lecturer is Arya Bhatt College, University of Delhi.