Introduction
In the shadows of India’s economy, a hidden world thrives: the realm of black money. This wealth lurks beneath the surface, enriching criminals and crippling the nation. But where do these dark shadows originate? Delve into the story of high taxes, a cunning underworld, and the fight to bring light to India’s financial landscape.
Indian Tax System & the Underworld Economy
To understand the root cause of the black money problem, we need to delve into the history of India’s tax structure. In the 1970s, during the Indira Gandhi era, India’s tax rates were staggeringly high, reaching up to 93.5% for the highest income bracket. The government’s rationale was to tax the rich heavily and use the revenue for welfare schemes to empower the poor. However, this well-intentioned plan backfired, as it inadvertently contributed to the massive rise of black money, which became an instrument of wealth for the underworld.
Let’s consider a hypothetical example to illustrate this dynamic. Imagine a wealthy businessman, Jamnadas, who wanted to sell his apartment in South Bombay for 5 lakh rupees. However, with the 93.5% tax rate on income above 2 lakh rupees, Jamnadas sought to avoid this hefty tax burden. Meanwhile, the notorious D-Company leader, D. Ibrahim, had amassed 50 lakh rupees through his illegal activities and wanted to legitimize his money. The two met and devised a scheme: Jamnadas would underreport the sale value of the apartment to 1 lakh rupees, and D. Ibrahim would pay the official 1 lakh rupees, along with an additional 4 lakh rupees in cash directly to Jamnadas.
This arrangement benefited both parties. Jamnadas avoided the 93.5% tax bracket, paying taxes only on the reported 1 lakh rupees, while D. Ibrahim successfully converted his illegal income into a legitimate asset that would further appreciate in value. The loser in this transaction was the Government of India, which lost out on both income tax and stamp duty revenue
High taxes in India may have backfired, creating a loophole for the wealthy to avoid them through deals with the underworld. This allowed criminals to launder money and grow their power, hindering the government’s ability to collect taxes.
How India’s Tax System Fuels Black Markets
The problem of black money has now extended to the Indian stock market, where a practice known as “dabba trading” has become a thriving black market. Dabba trading refers to an illegal practice of trading that takes place outside the purview of stock exchanges, essentially functioning as a form of gambling.
Let’s consider the case of Auro, a successful trader who operates in the futures and options market with a capital of 10 lakh rupees. Through multiple rotations, Auro is able to achieve a daily turnover of 1 crore rupees. However, the various taxes, fees, and brokerage charges he has to pay on each trade, including the security transaction tax, can amount to 2,000 to 2,500 rupees per day. This means that out of the 5 lakh rupees he generates in profit at the end of the year, he is left with only 1 lakh rupees, as the majority of his earnings go towards these mandatory payments.
To avoid these burdensome taxes and fees, Auro turns to the black market, where he contacts a “dabba trading” agent. In this system, the agent executes the trade outside the official market, without placing any actual orders on the exchange. Auro simply bets on the price movement of the stock, and the profits or losses are settled directly with the agent, without any official transactions or taxes involved.
This black market trading system, estimated to have a daily turnover of 70,000 crore rupees, highlights the significant impact of high taxes and charges on the financial system. As the government increases the security transaction tax and other levies, it inadvertently drives investors and traders towards the black market, further fueling the growth of the parallel economy.
Reaganomics: Trickle Down’s Promise & Peril
The story of the United States’ economic transformation under the Reagan administration, known as “Reaganomics,” provides valuable insights into the potential benefits and pitfalls of tax reforms. In the early 1980s, the US economy was struggling with high inflation, unemployment, and sluggish growth. Reagan’s bold move to significantly reduce income tax rates, from 70% to 28% at the highest bracket, as well as corporate tax from 48% to 34%, aimed to stimulate economic activity and boost investment.
The underlying theory behind Reaganomics was the “trickle-down effect,” where lower taxes would incentivize companies to reinvest their savings, leading to job creation, increased consumer spending, and overall economic growth. This strategy proved successful, as the US economy experienced a period of sustained growth, with GDP, employment, and inflation all improving during the 1980s.
However, Reaganomics also had its critics, who pointed to the increased income inequality and rising national debt as potential downsides. The lesson for India is that while lower taxes can indeed spur economic activity and reduce the incentive for black money generation, the government must carefully balance the reduction in tax revenue with policies that ensure the wealth trickles down to the broader population, rather than further concentrating it in the hands of the rich.
Practical Strategies to Eradicate Black Money in India
Based on the insights from the Reaganomics experience and the analysis of the Indian black money problem, here are some practical strategies the Indian government can consider to tackle the issue:
1. **Rationalize the tax structure:** Gradually reduce the highest marginal tax rates to a more reasonable level, striking a balance between revenue generation and incentivizing economic activity.
2. **Implement targeted tax cuts:** Selectively reduce taxes on high-demand products, such as gold, to curb smuggling and the growth of the black market.
3. **Promote wealth trickle-down:** Complement tax reforms with policies that ensure the benefits of lower taxes are passed on to the broader population, such as increased investment in infrastructure, education, and social welfare programs.
4. **Strengthen enforcement and monitoring:** Enhance the government’s ability to detect and crackdown on illegal activities, such as the black stock market and counterfeit currency, through improved technology and inter-agency coordination.
5. **Encourage voluntary compliance:** Simplify the tax system and enhance transparency to build trust and encourage voluntary tax compliance among citizens and businesses.
Conclusion
Eradicating black money is a complex and multifaceted challenge, but by addressing the root causes, such as the link between high taxes and the growth of the underworld, and learning from the successes and failures of Reaganomics, the Indian government can develop a comprehensive and effective strategy to tackle this persistent problem.
References:
https://en.m.wikipedia.org/wiki/Reaganomics#:
Link to my other case study:
https://geocrit.com/Japan’s-lost-decade