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Mainstream, VOL LVI No 10 New Delhi February 24, 2018

India’s Income Inequality Woes are Compounded by its Black Economy

Friday 23 February 2018, by Arun Kumar


True income disparity cannot be captured by the World Inequality Report because the impact of the black economy is not taken into account.

The World Inequality Report (WIR) released last week shows that “India’s top one per cent earners received 22 per cent of the national income in 2014”. Simultaneously, the latest data on direct taxes released by the Central Board of Direct Taxes (CBDT) shows that 9690 individuals paid tax exceeding Rs 1 crore. Only one individual paid tax exceeding Rs 100 crores —about Rs 238 crores.

According to the WIR report, the top 0.01 per cent of the earners numbered at about 78,000 people with an average income of about Rs 5.5 crores. At a 30 per cent tax rate, they should have paid a tax of about Rs 1.56 crore each. The two facts juxtaposed against each other suggest that while the top income-earners in the economy are earning a large part of the national income, they are not paying commensurate taxes. This is, at the very least, one indication of the large amount of black incomes that are earned by the rich in India.

While this is an indication, it does not come anywhere close to the reality of the situation. The database of the WIR does not take into account the black economy and is based on the white economy data alone. The difficulty with trying to understand income distribution is that the Government of India does not carry out income surveys. Some private surveys have been carried out from time to time but they have a rather small sample size and are not particularly reliable. These have been used in the WIR.

Surveys in India have often proved to be rather unreliable. For instance, in 1976 when the National Council of Applied Economic Research (NCAER) carried out an income survey based on a rather large sample, the total national income obtained from the survey was 45 per cent less than the national income total for that year. This could only be because not only did people not report their black incomes, they also understated their white incomes.

Surveys are also unreliable because respon-dents have various motives for giving incorrect replies, or the surveyors do not take the trouble of doing a proper job or the government expects an immediate response which results in shortcuts.

While surveying the sugarcane-growing areas of Maharashtra, this author found that the farmers under-reported incomes believing that I was a government official and if they reported lower incomes they could get some government aid. In another instance, one official who regularly did data work for the Rajasthan Government in the 1990s told this author that very often they had to produce data on certain variables within a week. So, they simply marked up the previous years’ data by a certain percentage and sent it to the government.

Error in data becomes evident when it shows that people with very low incomes buy consumer durables that they should not be able to afford. The obvious answer to this puzzle is that such apparently poor people are not poor but under-report their incomes. They hide their white incomes and naturally do not reveal their black incomes.

According to this author’s estimate, the black economy was 62 per cent of the GDP in 2012-13. Assume that this statistic has remained unchanged since then, this black income is earned largely by the top income-earners. While some small fish also earn a little bit of black incomes, the bulk is concentrated in the hands of three per cent of the top income-earners. They are the ones with high incomes and want to hide their incomes either because of the illegality involved in their activity or because of the desire to pay lower taxes. Usually, it is a mix of both.

The database of the World Inequality Report does not take into account the black economy and is based on the white economy data alone. Credit: Reuters

The implication is that if the government declares national income to be ‘100’, it is actually ‘162’. Based on data in the WIR, the top three per cent would earn about 40 per cent of the national income. This is from white incomes. The black incomes are on top of this; so that on the actual national income of 162, these people have an income of 102. In other words, these three per cent have an income share of 62.5 per cent of the actual incomes. The WIR also shows that the bottom 50 per cent of earners have roughly a 15 per cent income-share. This is only on the white incomes. Since they do not have any black incomes, their share of the true national income becomes 9.4 per cent. Thus, the ratio of average incomes of the top three per cent earners and the bottom 50 per cent would be 44 in the white economy but when the black economy is taken into account it becomes 113. So, the black economy accentuates the inequality in society.

The above also explains why the data on income tax collected is not of much use to calculate the true income disparities in India. The detailed data on income tax shows that in 2014-15, six crore people were in the tax net either as filing returns or paying tax or both. Of this, a vast majority declare a very low income so that they either pay no tax or very little tax. Effectively only about 17 million pay most of the income taxes, that is, about 1.4 per cent of the Indian population. This percentage has not changed much since 1997.

What has happened because of various changes in the laws is that the number of people in the tax net has increased several fold from around 10 million to about 60 million, but the number of effective taxpayers has not shown a corresponding increase. This is an indication of the growing share of black incomes in the economy and rising inequality.

If the black economy could be brought into the tax net, at least four per cent of the income-earners in India would be in the tax net. Currently the government collects 16.5 per cent of the GDP as taxes. But of the actual income (black and white) it is about 10 per cent—one of the lowest in the world. If the black economy could be brought into the tax net (that is, eliminated) the ratio would rise to about 25.6 per cent which would be a respectable amount. This would end the shortage of resources for public education, public health, power, roads and so on. As a result, the rate of growth of the economy would rise substantially. Currently, the black economy results in massive waste of resources and that lowers the rate of growth further. Thus, tackling the black economy is necessary to raise the rate of growth of the economy.

In brief, in India because data on income distribution is officially not collected and the impact of the black economy is not taken into account, the true income disparity is not captured in the WIR. Tax data cannot be used to proxy for income distribution because the tax base is not only very narrow but it does not even capture the income distribution of the well-off sections since they generate large black incomes. So, not only is the income distribution skewed, it is far more skewed than what the WIR suggests.

The author is the Malcolm Adiseshiah Chair Professor at the Institute of Social Sciences, New Delhi. His latest book, Demonetisation and the Black Economy, has just been published by Penguin (India).

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