Demonetization

Authored by jain and govil - astute political observers

Modinomics is yet to deliver – was the Op-ed written by the Editorial Board of Financial Times published from London -(https://twitter.com/ft/status/1069894756929585152. They have raised the following issues in the article.

• Modinomics yet to deliver to many (https://steemit.com/financialtimes/@ajain/ft-rebuttal-part-1-assessing-how-modinomics-has-reached-the-poor)
• Failed infrastructure overhaul (https://steemit.com/india/@ajain/ft-rebuttal-part-2-assessing-failed-infrastructure-overhaul)
• Failed attempt to turn country into a manufacturing powerhouse (https://steemit.com/india/@ajain/ft-rebuttal-part-3-assessing-make-in-india)
• Demonetisation ineffective
• Economic growth squandered away on symbolic projects (Statue of Unity)
• Fudging statistics
• NPA’s (Non-Performing Assets of Banks)
• RBI Fracas (Reserve Bank of India)

We have initiated a series of eight articles where each issue raised in the Financial Times Op-ed as listed above, will be taken up and put under the microscope of facts and data to critically test the validity of the statements made.

Much has been said about Demonetization that was carried out by government of India in November 2016. More of it has been said in negative than positive. The financial world is only too eager to condemn and bury it as a failed initiative of the government. And of course, haul Modi personally over coal for putting the country through this ordeal. Those with black money, who are worst hit, are the ones shouting the loudest. The best example was a write up appearing in one of the leading magazines of India (Reproduced below). See the last two lines. The magazine was quick to acknowledge the honesty of the distressed family. But they failed to condemn the audacity and inhuman act of the owner of the black money who had no qualms in making an attempt to use the family under distress to try to launder his illegal wealth.

“………….But soon after the PM's demonetization announcement, the family is flooded with calls from the rich willing to fund Sumana's treatment. But with a rider - they will have to accept the money in their account and must return it in due course only for a tiny amount in return. Shocked and hurt, the family has refused point blank. Her parents say they are willing to sacrifice their daughter's life but will not accept black money for her treatment".

(Source:https://www.indiatoday.in/india/story/demonetisation-good-bad-impact-note-ban-354650-2016-11-29)

Such is the ecosystem that the current government is trying to fight. And, not just fight, but to overtime, bring it productively back into the mainstream economy as a responsible individual or a responsible corporate citizen. Not a very easy task. The strength of the government no doubt, is the common man at large, who is yearning for a clean and honest system. No wonder, despite all provocation and allurement by the corrupt and mighty, the average person in the country refused to fall for their antics and stood resolutely behind the government during the trails and tribulations of Demonetization.

Having said that, we move to the trail of data to see how ineffective (or effective) has the exercise of Demonetization been.

The esteemed Editorial Board has reached the conclusion that Demonetization was a failure because almost the entire currency of the country was deposited back. And very little penal taxes were collected. This data is no doubt true. But does this tell the whole story? The answer is a big ‘No’.

Let’s begin with taking some basic data points.

1. India’s Tax Base - Post Demonetization

The number of people filing their returns has gone up substantially. One of the fundamental negatives of the Indian economy over so many decades has been the extremely low penetration rate in terms of taxpayers. We see how the tax base has expanded on various fronts.

A) Direct Taxes (Income Tax)

The data for Income Tax will be analyzed on the following parameters:
(i) Number of people filing their Income Tax Returns (ITR’s)
(ii) Massive Rise in ITR’s in the Presumptive Tax Category
(iii) Increase in number of Indirect Tax account holders

(i) Number of people filing their Income Tax Returns

The data on Income Tax reveals that the number of people filing their income tax returns has been going up since the Modi government has come to power. However, what is significant is the fact that this number jumped significantly since the Demonetization (November 2016 – FY 16:17). We can see from the chart below that the growth from the year 2016-17 to 2017 -18 is almost 22%. (50% higher growth rate - from 14.46% growth in the year of demonetization to 21.67% growth in the year after). In other words, India expanded its tax base by 22% in a single year. This would be an extraordinary spurt in compliance for any tax regime globally.

(ii) Massive Increase in ITR’s under ‘Presumptive Tax Category’

We saw in point two above how the tax base for direct taxes has expanded in India in a big way. The number of ITR's filed has gone up substantially. The devil is however in the detail. It is just that it is ‘no devil' but rather ‘an angel' in the context of Demonetisation. The ITR's increased by a massive number. The increase in ITR comes about on two accounts. The salaried class and the nonsalaried class – the set of individuals filing ITR's in the ‘Presumptive Tax' category. While there has been a 54% increase in ITR's for the salaried class, there has been a 700%, yes seven hundred percent, increase in ITR's for the Presumptive Tax Category. The number of ITR's in the latter category has gone up from 1.5 million to 11.7 million

(Source:https://www.incometaxindia.gov.in/Lists/Press%20Releases/Attachments/729/Press-Release-Filing-Income-Tax-Returns-registers-upsurge-71-31st-August-2018-01-09-2018.pdf).

Before we go on to analyze who are these people who filed ITR's in ‘Presumptive Tax Category', a slight digression is essential. For the benefit of an average reader, we would like to explain what is Presumptive Tax. Under this provision of Income Tax Act, certain categories of professionals doing business with a turnover up to $ 71,500 (INR 50 lacs) will be entitled to claim 50% of their turnover as their expense regardless of their actual expenditure. Which in turn means that their annual income will be only 50% of what they actually earn and they will have to pay tax accordingly. We now analyze what this means and who are these people who opted to file ITRs in Presumptive Tax Category. It is a very logical conclusion to make that a person will not opt for this scheme if he does not see a benefit for himself. So how do the dynamics work?

The Presumptive Tax category is applicable for the professionals in the following fields – Legal, Medical, Engineering, Architecture, Accountancy, Technical Consultancy, and Interior Decoration. These are normally self-employed professionals under the above-mentioned fields. It is highly unlikely that the expenses these people incur on running their professional service set up would be 50% of their turnover. So obviously an allowance of 50% towards expenses is very attractive to them. And that explains the massive jump (700% as we have seen above) in their numbers. So where is the catch? The catch is that they were probably showing doctored expenses to bring down their Tax incidence, and, some of them may not even be filing their ITRs also. Going forward all this has got streamlined and these people are not only having smoother business operations but are also participating in the mainstream economic activity paying their regular dues.

(iii) Indirect tax – numbers go up

There has been a 50% plus increase in the number of taxpayers in the indirect taxpayer category. The number has gone up from 6.4 million tax payers to 9.8 million tax payers as of December 2017. These figures are as per Economic Survey 2017- 2018 (released in Jan 2018). It is important to understand who are these people. These are predominantly the small businesses who were outside the tax net so far or bulk / major part of their operations remained outside the formal economy. Demonetization coupled with GST has induced/forced these business entities to mainstream their operations and comply with the Tax regime (Data source: Economic Survey 2018)

The big question then is – so what if the ‘Tax Base’ has gone up for Direct as well as Indirect Taxes? Let’s see. Whatever benefits accrued in terms of increased tax revenue is just one part. A more important point is that these people will remain into the tax ecosystem going forward and would be contributors to the tax yield of India year after year after year. The benefits would continue to be reaped by India even when Demonetization would be a forgotten thing of the past. Across the globe, most of us have heard a story – The Goose That Laid Golden Eggs. Modi has identified the Goose and is nurturing them towards mainstream so that golden eggs keep coming India’s way year after year.
Whether the ‘golden egg' is being delivered or not, let us see in the next section.

Tax Amount Collected

We analyze the tax collections for Direct and Indirect Taxes under this section.

(i)Direct Tax Collection

There has been a clear jump in the Direct Tax collection figures. The rate of growth in tax collections was extremely impressive post demonetization. The growth rate immediately preceding the year in which demonetization took place was 6.6% (From FY 14-15 to FY 15-16). This grew to 14.5% in the year of demonetization (From FY 15-16 to FY 16-17). And to 18% in the year thereafter (FY 16-17 to FY 17-18). A similar trend continues in the current financial year (FY 18 – 19: the second year after Demonetization). As per data released by the Income Tax department, the tax collection has increased by 14.1% in this financial year as of 31st December 2018. It goes to show that the buoyancy has been maintained in the current financial year. Year wise Direct tax collection figures since FY 2013 -14 are as below:

(ii) Indirect Tax Collection

The chart below presents the Indirect Tax Collection data since the year of Demonetisation. The Indirect Tax collection has shown a healthy growth and this coupled with the increased number of business entities going in for GST registration augurs well for the country from future tax collection perspective.

What constitutes black money?

Finally, the third point. Here we come back to the very point on which the conclusion is based. Black money by definition is money that remains outside the system. No one knows who owns it, how it is used, and of course being out of the system, there is no question of any taxes being paid on it. Isn’t it then a huge success that almost 99% of the money has returned into the system. We now know who owns the money and going forward how it will be used. Isn’t that elimination of black money in one single swoop.

As for the taxes, the govt. is taking up the forensic audit of the ITRs and upon discovering anomalies in the same, tax recovery procedures are being instituted against the evaders and recoveries are being made on an on-going basis. Please bear in mind though that these evaders, while being fully responsible for their past misdeeds are now into the Tax net and are paying their taxes as per the law of the land. As per reports, the Income Tax department has identified almost 80,000 accounts where people deposited $ 15,000 (INR 10 lacs) or above but have either not filed any ITRs or have no profile of theirs with Income Tax office. Investigations and reconciliations of these accounts are going on and recoveries as per the provisions of the law are being made. Post demonetization about 1000 properties have also been identified for further action. Government officials are taking action under ‘Benami Transactions Act’. Some 475 properties out of this have been attached.

As would be very evident that there was a stark difference between the approach of the Modi government and that the influence peddlers who are often also the spokespersons for the corrupt and mighty. While the latter has been busy declaring demonetization as a colossal failure on the single most fact that all legal currency virtually got turned in to the bank accounts. Their narrative is that since all money has come no ‘black money' has been found out and hence it is a failure. On the other hand, Modi governments approach has been to plug the black money generation going forward by drafting the people into the mainstream legitimate economy. And they have been extremely successful in it also. The past will sort out in due course through assessments of suspect cases, penalties, reconciliations, and assessment deals. Keep in mind that India has got on to a track of generating almost $ 30 billion tax revenue per month (Direct as well as Indirect Taxes) which works out to almost $360 billion per annum. In the context of that whether a sum of $40 billion black money got missed out at the time of demonetization when all currency returned, pales into insignificance. As mentioned above in the article, one might remember the story - Goose that lays a golden egg. Whether you want to nurture the goose and get a golden egg every day on an on-going basis or you want to be the greedy farmer wanting all eggs in one go. Modi chose not to be the greedy farmer and it has paid rich dividends for the country.

The Op-ed sums up the point about demonetization by stating - Unfortunately, the poor have tasted the bitter medicine disproportionately. Now that is conjecture. No dispute the people at large went through huge inconvenience. But while the physical inconvenience of the poor people was short lived and they took the blow on their chin smilingly, the bitter medicine of demonetization is troubling the mighty and rich no end. Ask anyone of them and you will know as they go into a spiel of their narrative. They are having sleepless nights for their past deeds and are forced to become compliant with the tax regime going forward. It is a change of mindset and behavior for them. Hence the hardship and discomfort for the mighty and the rich.

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