Law of Black Money: If left uncontrolled it will continue to grow in size
Once again the annual budget has ignored this ground reality. The government’s reluctance to mention “black money” in the economic survey or the budget is natural but that does not prevent the government from taking corrective measures to stop generation of black money.
In the absence of reliable methodology, we do not have an agreed estimate of the size of black money in India. This problem exists in the United States too. Different organizations have made different estimates of the size of black money in India, ranging between les than 20% of GDP and 75% of GDP. A related and important question is, how much black money is in cash with public?
Estimates of Black Money and cash with public in India in 2022-23
For calculation, GDP in 2022- 23 has been taken ₹286.23 crore (estimate in the economic survey 2022-23, $3.5 trillion at budget day’s exchange rate) and, , it is assumed that 9% of black money is held by public in cash (as estimated by a committee appointed in 2011 by the Central Board of Direct Taxes). (91% kept invested in assets.)
Such wild guesses are of little use to the policymakers. However, before coming to any conclusion, let us have a look at the total amount quantum of cash – sum total of white and black – available with public as per the RBI.
If you consider the estimate of the NIPFP and cash available to the public in October 2022, it would appear that more than 50% of cash with public is black. This may or may not be true but even the lowest estimate of black money available with public is enough to play havoc with the economy, country’s security and society.
Table 2 also indicates that despite quantum jump in digital transactions since demonetisation, there is significant increase in cash with public.
Why is so much cash with public despite quantum jump in digital transactions?
The two main reasons are (a) ease of transaction in cash and (b) increase in black money. People have to keep cash for day-to-day expenses. Most of the agricultural commodities are sold in cash. Even in the urban areas, poor and middle-class people are not comfortable with digital transactions unless mandatory.
Cash is needed for transactions in criminal activities. In the open world, it is generated by corruption and tax evasion. I am not aware of any research to ascertain whether black money is generated more by bribery or by tax evasion. Corruption in our country is more widespread and deep rooted than generally believed. If it is paid at the higher levels for getting contracts and at the lower levels common people have to pay bribes for most of the services, from birth certificates to death certificates. The high rate of GST is also making even honest people dishonest.
We do not have reliable data to know the contribution of different factors to the sum total of black money. However, the biggest culprits are believed to be the real estate, film industry, education and mining, all in the private sector.
In the present write up, the main area of concern is the real estate sector which presently contributes more than 7% of the GDP at current prices.
In the real estate sector, the use of black money (in most of the cases) starts from the purchase of land. For example, in certain areas of Delhi, the market price of land used for residential purposes is three times more than the official circle rate. Every builder, big or small, and every common individual have to pay bribe for getting the building plan approved, water supply, electricity connection for construction, storage of building materials, and completion certificate. The “leeches” visit house builders at their sweet will. That is not all. A new policeman or a new employee of DMC or Delhi JAL board comes to demand his share on the ground that those who came earlier were from different offices! A quick cost-benefit analysis shows that paying bribe is the only cost-effective option The construction work would be hassle-free if there is a central pool to which every builder contributes and each “leech “collects” his share according to a mutual agreement! Unfortunately, it is a utopian thought.
Builders are no less guilty. They use low quality material and pocket the difference. We often hear the news of collapse of buildings under construction. The reputed builders too use low quality materials to earn part of profit in black. Several builders collect a part of sale price in cash. Small builders constructing flats on small plots almost invariably demand part of sale price in cash. In a sellers’ market, buyers have little choice.
The use of cash in purchase of house from a previous owner is very common. According to a survey conducted by Local Circles, a community platform, 70% of the persons interviewed said they paid a component (i.e. an unspecified part) of the purchase price in cash while about 16% said they paid over half of the amount in cash. Some went to the extent of admitting that property registration takes place at a fraction of the total value paid thereby evading taxes. I have heard of properties being registered in Delhi at 10% of the actual cost. From what I hear from the people, my assessment is that payment of 20%-25% in cash is quite common.
Since April 2015 Income Tax Act has provisions to prevent cash transactions. Section 269SS of the Act forbids seller from accepting ₹20,000 or more in cash. Section 269T prohibits refund of advance in cash (₹20,000 or more) if the deal is cancelled. According to section 271D, anyone found accepting ₹20,000 or more in cash will have to pay penalty equal to what has been received in cash. In other words, the cash portion of sale price is confiscated by the government. There were penal provisions earlier also but such stringent measures were introduced in 2015.
However, the ground reality is that the penal provisions have little impact. Several lakh residential and commercial properties are sold every year. Buyers and sellers know that the income tax department does not have resources to monitor all transactions taking place behind closed doors. Most of the income tax returns are accepted without scrutiny. The probability of being caught is very little unless the cash portion is quite large and the department has definite information about it.
The law does provide some incentives to sellers. There is no income tax if the long-term capital gains is utilised to buy a new residential property (changes proposed in the Finance Bill 2023 discussed later in the article).
After recovery from COVID-19 effect, the size of the real market is increasing at a fast rate and is expected to increase in the future at a faster rate. Considering the expected growth of the real estate market and assuming that 20% of the payment is made in cash, Table 3 summarises the future scenario compared to what it was in 2017.
The future scenario – only one sector of the economy generating as much as ₹16.4 lakh crore black money in 2030 – is quite frightening. Even half of it is frightening because black money is generated in the other sectors too. If buyers and sellers fearlessly get the property registered at 10% of the actual cost, the penal provisions and incentives given in the Income Tax Act have limited impact.
Need to think of out of box policy measures to curb this monster
Remember, black money reproduces more black money. If left uncontrolled, it will continue to grow. Larger the share of black money in the market, greater the number of transactions in black money.
We need to think out of box to prepare an effective road map to rein the increasing threat to the economy.
The biggest culprit is high transaction cost. Seller has to pay 20% of the capital gains as tax if the property is held for 2 years or more and at the marginal rate of tax which may be as high as 30% + cess + surcharge if the property has been held for a lesser period. Buyer has to pay stamp duty plus registration fee of 5% or more of the sale price depending on the state in which the transaction text place and whether the purchaser is a man or a woman or it is jointly purchased by a man and a woman. In addition, there is registration fee of 1%.
Real estate market has become so dirty, so murky that more often than not at least one party wants a part of transaction to be paid or received in cash. I have made 3 calculations to ascertain cost and benefit to the government and buyers/sellers. The common assumptions are that a residential property is sold for ₹4 cr. and the long-term capital gain is ₹1cr. The calculations have been made assuming the existing costs of transaction and lower costs of transaction, with as well as without the cash component ( 20% of the sale price i.e. ₹80 lakh).
(A) Income tax on long term capital gains 20% +cess (the existing rate) and stamp duty plus cost of registration (total 6% of sale price). The result is as follows:
(B) Income tax on long term capital gains @10% +cess and stamp duty plus cost of registration 3% of the sale price. The result is as follows:
(C) Income tax on long term capital gains @ 5% +cess and stamp duty plus cost of registration @ 1% of the sale price. The result is as follows:
At the lower tax rate, there will be very little incentive to receive cash for purchase of properties. The incentive will be much less for the buyer unless his main source of “income” is in black, say the bribe money collected by him.
The million dollar question is, will any government be ready to sacrifice, say ₹15 lakh how to stop generation of ₹80 lakh of black money (this is only by way of illustration)? The policy makers believe in “carrot and stick”, give incentives (like investment in a new property and penalty when caught, the chances of which are little. All the investigating agencies together have not touched even tip of the iceberg.
Demonetisation of high currency notes as done in November 2016 and on a limited scale earlier may be as cited a corrective measure. Let me make it clear. The main objective of the demonetization in November 2016 was not mopping of black money. The main objective was to destroy illegally printed high denomination currency notes. In any case, no government will have courage to resort it again in foreseeable future unless the situation goes completely out of control.
As far as I know, no study has been carried out to decide the optimum rate of income tax and the optimum stamp duty plus registration fee which will not give any attractive incentive for part of transaction in cash. However, it would not be unreasonable to expect that the reduction in taxes and duties will significantly reduce the use of cash. At least part of the loss of revenue will be compensated by more transactions in white money and saving the economy and society from the evil consequences of black money.
Unfortunately, as of now, there is no hope of any such policy decision. The proposed amendment of section 54 of the Income Tax Act limits exemption to ₹10 cr. The memorandum explaining the provisions in the Finance Bill 2023 has given the reason: “The primary objective of the sections 54 and section 54F of the Act was to mitigate the acute shortage of housing, and to give impetus to house building activity. However, it has been observed that claims of huge deductions by high-net-worth assessees are being made under these provisions, by purchasing very expensive residential houses. It is defeating the very purpose of these sections.”
The government may have its own justification for prescribing the exemption limit but the policy makers have ignored the ground reality. The new provision will encourage generation of black money. The capital gains of say, ₹12 cr. can easily be reduced by taking ₹2.95 cr. in cash. Moreover, the government’s policy is contradictory. On the one hand, luxury housing projects are being approved on a large scale and on the other, the government is discouraging purchase of such houses. I do not think the proposed amendment will make a large scale difference. On the contrary, it may encourage more use of black money.
No one can claim that tax evasion could be fully stopped by reducing income tax rates. However, serious measures have to be taken if we do not want several lakhs of crores of rupees in black floating around.
February 4, 2023