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Book Extract: Black Income
Are a high tax rate and a high degree of regulation responsible for the generation of black money?
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Some analysts have suggested that the low salaries of bureaucrats, the police, the judiciary and other law-and-order and regulatory authorities lead to the generation of black incomes. It is thought that because these people are ill paid, there is a drive to make extra money and that leads them to use their position to demand and get bribes. That is certainly the case, but the black income generated because of this is not large. Of the black incomes generated through committing an illegality, bribes often are in the range of 5 to 15 per cent.
The thought underlying this idea is that there is a demonstration effect from the developed nations. Those in power want a lifestyle comparable to that enjoyed by their counterparts in advanced economies. In order to enable this their salaries, it is argued, should be much higher. This does not make sense. How can employees in these sectors be given salaries comparable to those paid in an advanced country when India’s per capita income is not even 5 per cent of that in the advanced countries? If even 5 per cent of the population in India is given a salary comparable to that available in the advanced countries, there will be nothing left for the rest of the population. The origin of the problem can be traced to growing consumerism in India.
Further, the salaries currently paid to the bureaucracy and the police are a multiple of India’s per capita income, hence they cannot be called low. They are low only in comparison with the salaries of their counterparts in advanced countries. There is another reason why the bureaucracy or the police feel dissatisfied. In any society, there is an income ladder which is historically given and traditionally accepted. Economic theory suggests that when this changes rapidly, disaffection rises. In India, the business class has rapidly increased its income relative to all others and that has led to disaffection. Much of this income is believed by many to be based on committing illegalities of some kind and is resented by those who are left behind. For all the foregoing reasons it would be incorrect to blame low salaries (in absolute terms or in comparison to those in the advanced countries) as a cause of the generation of black incomes.
What about the theory that inflation and speculation lead to black income generation? Inflation and speculation result in higher incomes for businesses, but that cannot by itself be a cause of black income generation. Even after paying taxes honestly, more is left from the higher income earned through speculation than the lower income these people were getting earlier. So, in itself, this cannot be the cause of black income generation.
Extreme speculation, by flouting government regulations, when there are shortages, does result in black income generation since it is associated with an illegality. The cause then is illegality and not speculation. Worthy of more serious consideration are the hypotheses that the high tax rate and a high degree of regulation are responsible for the generation of black income.
The idea underlying this hypothesis is an obvious one — people do not pay their taxes fully because they find them to be high. The real question to be asked is, what is a high tax rate? This is not easily defined. In some countries like Sweden, in 1985, the highest tax rate was 85 per cent but people did not evade taxes; the black economy there was estimated to be only 1 per cent of GDP.
By and large, around the world, responsible citizens understand that they are being taxed so that these revenues can be used to provide goods and services to society. Of course, there is an administration which enables these goods and services to be made available to the public and therefore there are administrative costs. This expenditure is said to be unproductive but without it the delivery of these public goods is not feasible. It can be more or less efficient and one must strive to move towards greater efficiency. But the cost of administration is an essential cost which cannot be escaped. It is to be found not just in the public sector but in the private sector as well. Witness the massive expenditures incurred by corporate executives to fuel extravagant lifestyles — swanky corporate offices, airplanes, seven-star luxury living and so on. This has become the style in both the public and the private sectors.
Taxes are recycled to the public in the form of public goods and services. In the developed world, which functions more efficiently for the most part, the citizenry feels that it is getting a good return for its taxes as public goods and services work efficiently. In order to pay for this, citizens pay taxes voluntarily and the size of the black economy remains small, as in the case of the Scandinavian economies. A vast majority of the citizens there feel that the high tax they pay comes back to them in the form of quality education, healthcare, clean environment, infrastructure and so on—all the things that enable them to lead a civilized existence.
In developing countries, tax-paying citizens often feel cheated because they see others getting away with paying little or no taxes. Those earning a fixed income see businessmen and self-employed professionals getting away with paying little taxes. Further, they see money wasted by governments and negligible benefits accruing to them. They see the government and corporates squandering money. They hear of corruption in high and low places and feel aggrieved. This results in a widespread sense of social injustice and that weakens the commitment to paying taxes. The problem then is not high or low taxes, but the citizen’s sense of belonging to society.
Be that as it may, what has the situation been in India? Are Indian taxes high? Indeed, in 1971, when Mrs Gandhi was the prime minister and the finance minister, the highest tax rate was 97.5 per cent. For incomes above Rs 15 lakh the tax rate became 102 per cent since there was also a wealth tax. As a result, no one could have an annual income above Rs 15 lakh. At that time the Wanchoo Committee had estimated the size of the black economy to be 7 per cent of GDP. Tax rates since then have come down systematically and are now at 30 per cent (plus some surcharges) but the size of the black economy has gone up to 62 per cent.
From the mid-1970s to the mid-1990s, the sum that India used to collect from direct taxes was between 2.5 per cent and 2.7 per cent of GDP. This was in spite of the lowering of income tax rates. This figure started rising when new schemes (called, one for five and one for six) were introduced to bring more people into the tax net. These schemes required one to file a tax return if one belonged to one of the five or six categories (if one went abroad or was a member of a club and so on).
Roughly one per cent of Indians used to pay income tax till the end of the 1990s. Today, the direct tax-GDP ratio has risen to about 5.5 per cent. The number of people in the tax net has gone up to about 52 million from around 12 million in the late 1990s. Has this success been the result of the lowering of tax rates? Not really.
What has happened is that the government’s policies are based on ‘growth at any cost’. As a result, inequalities have risen dramatically from the end of the 1990s.
Thus, those in the higher tax brackets are earning a lot more and, therefore, paying more taxes on their declared incomes. But they are also generating a lot of black income. For instance, after 1992, when the cap on managerial salaries at Rs 3,12,000 was removed, salaries soared and by the 2000s there were many top executives earning crores of rupees. At the same time, the minimum daily wage was Rs 35 in the 1990s; this had risen to 105 by the mid-2000s. So, the minimum wage rose by a factor of 3 while managerial salaries jumped by a factor of 100. Corporate profits also soared, but because compliance did not improve, more black incomes were generated rather than less.
A 2007 Alternative Economic Survey article showed that the rise in the direct tax to GDP ratio was a result of increase in inequality and not better compliance. A 2016 Economic and Political Weekly article shows that even though the number of people in the direct tax net has risen to 52 million in 2012-2013, the latest year for which the data was released (from 1999 to 2015 the government did not release this data), the effective number of taxpayers was approximately 15 million or just about 1.2 per cent of the population. Thus, the tax base has not broadened effectively in spite of lower tax rates.
Similarly, in the case of indirect taxes, the rates have come down, especially after 1991. The peak customs duties used to be 320 per cent and the average used to be around 150 per cent. These have come down to an average of 15 per cent. Yet, black income generation and the flight of capital via under- and over-invoicing not only continues but has grown.
A National Institute of Public Finance and Policy (NIPFP) 1985 publication showed that in the case of the sugar industry, even though excise duties changed between 1962 and 1980, there was no correlation between this and the black incomes generated in this industry. In the case of sales tax, the government offered a low tax (about 2 per cent of their income) to the traders to make them come into the tax net, but this scheme did not meet with any success. So, in spite of lowering of indirect tax rates, compliance in these taxes did not improve.
In brief, the evasion of taxes, whether direct or indirect, is not linked to the rates of taxes alone.
Controls: Can a law be its own cause of violation? It has been argued that the licence-permit-quota raj or the inspector raj has been one of the important causes for black income generation by businesses. It is argued that the officialdom in charge of the implementation of laws pertaining to businesses makes an extra buck by allowing businesses to flout the relevant laws. For instance, if labour laws, like safety precautions, are flouted, then an extra income can be generated by the business. Similarly, if a food-processing concern on the banks of a river discharges its effluents directly into the river without treatment, it is able to save costs and thereby increase its income. To commit these illegalities, all the management needs to do is to bribe the inspector who comes to check. The cause then is neither the inspectors coming to check the proper implementation of laws nor the laws themselves which they are supposed to enforce.
Controls and regulations have a history. They come up in response to social needs. For instance, as mentioned earlier, during World War II, rents soared and people could not afford them. In response to the situation, rent control was imposed. This continued on the statute books long after the situation normalized. Once a law is passed, it is often difficult to repeal it since vested interests build around it. Certain laws need to be repealed when they are no longer required; however, there cannot be a general prescription that all controls and regulations be removed.