What could be the connection between Underground Money and Foreign Direct Investment.

One has the potential of unlocking the economic power of the country, and the other an immediate palliative with negative after-effects.

Another disclosure scheme for ‘unaccounted’ money, or ‘black’ money has been announced. A very small percentage of that money will be declared, and the rest will literally continue to remain underground.

[Update: 30 September 2016 has passed and the amount declared under the Income Declaration Scheme is Rs 65,250 crores disclosed by 64,275 declarants, or Rs 1.015 crore per declarant. Rs 10,000 crores more is expected once tabulation is complete, which would bring it to Rs 1.170 crore per declarant. My suggested model would have brought in much, much, more.]

[Update: 29 November 2016. A demonetisation scheme was announced on 8 November 2016, whereby currency notes with a face value of Rs 500 and 1,000, ceased to be legal tender from that date. From all reports the move does not seem to have achieved the objectives it was announced for, and according to assessment by economists the world over, will have an extremely negative effect on the Indian economy as a whole.]

These schemes do not work because in the whole scenario, the most important factor has been missed out, the human factor. A retributive scheme of taxation has never worked from the time that a system of taxation came into being, a few thousand years ago. What he have today is a carried over colonial system of taxation, which successive governments have tinkered with since 1947. Not once has any government applied their mind as to whether the money extracting system of the East India Company, or the British Raj was suited for an independent India.

No one has ever thought of the principles enunciated in the Arthashastra. These excerpts are extremely relevant today.

Ideally, the government should collect taxes like a honeybee that sucks just the right amount of honey from the flower so that both can survive. [Has this ever been followed?]

the taxing power of the state should be limited, tax should not be felt to be heavy or excessive, tax hikes should be introduced gradually, tax should be levied in the proper place, time and form, and tax level should be equitable and reasonable. [The taxation system over the last few decades has been unreasonable and inequitable].

The root of wealth is economic activity and lack of it brings material distress. In the absence of fruitful economic activity, both current prosperity and future growth are in danger of destruction. The King shall populate the countryside by creating new villages on virgin lands or reviving abandoned village sites. [The thrust on mindless urbanization, has had its consequent results of overcrowded cities, with a large percentage of the city populations living in slums. Villages need to be made self-sustaining so that villagers do not have to come to the city for work]

Economics works well with resource management, efficient administration, a fair judicial system, knowledgeable people with integrity capable of taking up high positions. [How many governments have measured up to these words of Kautilya].

For Kautilya, good governance was paramount. He suggested built-in checks and balances in systems and procedures for the containment of malpractices. Many postulates of Kautilya’s philosophy of political economy are applicable to contemporary times.

Economics is all encompassing, and not confined to an economists neat graphs, charts, equations, trends, and treating a human being as a data point. Human beings act on their feelings and emotions, and when that is neglected, one has a chaotic economy, with an unbalanced taxation system, and a country lands up with an underground economy. The strongest human emotions over the centuries have been linked to money and assets exemplified by Zar (wealth), Zameen (land), Zan (woman). [In a historical and cultural context, a woman, was equated as a possession, and still continues to be so in many societies]. Governments tread on very dangerous ground when they levy taxes without considering the human consequences. It is not an arithmetical exercise, and never will be. Governments who understand this will always have strong economies.

To come back to where we started.

India has an immense amount of underground money. According to an NIFP report, the size of the parallel economy is around 75% of the GDP. Now whether we take the nominal GDP value of 2.308 trillion dollars or 8.027 trillion dollars by Purchasing Power Parity, 75% is a fairly large amount. (October 2015 figures)

This money, which if brought into the banking system, would obviate the need for foreign direct investment to a very large extent. Without getting into the morality of naming, shaming, exposing, penalties, we need to focus on what the country requires today. Here’s an approach which I have proposed before, modified in the light of present day requirements, as a solution.

  • Issue bearer bonds with a face value of 1 crore, 10 crores, and 100 crores.
  • The bonds would bear an interest of 2.5% per annum, and be redeemable after 10 years. [Redeemed money is not to be treated as income. The income from its investment into economic activity can then be taxed].
  • No forms to be filled, no questions to be asked. Designated bank branches would receive the money, check the received amount for fake notes, count the money, and issue the bonds. [Banks would deduct a 10% handling charge to cover their costs. Identities will automatically come to the fore when the bonds come for redemption].
  • [If black money can become holy by landing up in a holy place’s coffers, it can surely become ‘white’ when it lands up in a bank vault. Money is money and has no colour].

The money so received in the banking system would be advanced to:

  • Farmers, Women Entrepreneurs, Artisans, Weavers, Self-Help Groups, Tribals, Micro-enterprises, Village-level Industries and Facilities like cold storages, food and dairy processing, animal husbandry, biomass to energy plants, health-care centres, organic farming, and so on, with an interest rate of 4% per annum, with a cap on the borrowing. To put things in perspective, money is borrowed at 2%–5% per day by vegetable and fruit vendors. [This would boost up the farm sector, the rural economy and the so-called unorganized sector. The cap would be decided by groups of people familiar with the problems in these sectors. No bureaucrat or politician should be associated with these groups. The condition is that the government cannot change the recommendations — since governments exist to carry out the will of the people].
  • Small Enterprises at an interest rate of 6% per annum, including localised renewable energy projects not exceeding 2 Megawatts.

Legislation should be brought in so that banks and micro-lending institutions can lend at these rates.

None of the money received by the banks on this account will be available to medium and large enterprises, who will use normal banking or institutional channels for their credit needs.

Have touched on this before. Nothing in an economic system works in isolation. Every activity is interconnected. To make the system work we also need to implement measures like:

  • No personal income tax, which would mean that the long list of deductions would also be scrapped. There are other ways of replacing the revenue received from personal income tax.
  • Remove service tax. [This is an unnecessary tax and has only increased the cost of services to consumers without any benefit accruing to them. The poor and the rich are affected equally].
  • Corporate income tax to be capped at 15%. [This would encourage a lot of companies to set up base in India, and provide an alternative to Hong Kong, and Singapore. Ireland functions with a tax rate of 12.5%].
  • Along with this would be required lifting the controls on foreign exchange. [Indians will not need to set up offshore companies, and a lot of those set up outside will be encouraged to come back to India].
  • GST (whenever it comes) to be capped at 5%, with no extra levies.
  • No multiple taxation.
  • Plugging of leakages in government expenditure. [The Aam Aadmi Party government in Delhi has shown that leakages can be plugged, and the positive benefits for citizens due to this — lower cost of infrastructure, supply of basic services at an affordable cost, free healthcare, good school infrastructure. All in line with the Arthashastra].

There are a lot of supporting regulations and systems which will need to be set up and refined to support these main reforms, to reach a Singapore/Hong Kong level of efficiency, which I’m not covering here.

Have just focussed on the main points, which if set right would really make India an economic superpower and improve social conditions of all the citizens.

Request that comments be in the directions of improving on the solutions suggested, and not why these things can’t be done. We have had enough of that. Let us have people-guided solutions instead of government directed solutions.