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Dirty Money Is Not Just Black


(From my column at Yahoo!)

We complain about black money. For most of us, black money is money in suitcases, printed notes of currency. We imagine that there are huge stashes of currency in politicians’ houses, that industrialists are, quite literally, rolling in the stuff. Our new-age yoga enhanced civil society members even demand that we should stop the use of Rs. 500 and Rs. 1000 notes because they help corruption.

And I say that at a macro level, we should be more worried about white money.

Because RBI’s statistics — they release this every week — say that the total amount of rupees in notes printed is about Rs. 10 lakh crores. Our GDP is about 80 lakh crores. Even if 30% of the total money printed was being hoarded as black money, it’s about 4% of GDP. This is not small; but I argue that this is not big enough. I mean there is much more illegal money out there than 4% of GDP. And that also means the black money is being laundered into white money quite easily.

From doctors to lawyers to small hotels to vegetable vendors, there is a large amount of cash exchanged.  Some of these merchants keep the money in cash, and refuse to declare them, thus creating black money. Many buy property, transferring money to the uber-rich, who can now launder the money.

At the really big money level, laundering money isn’t very difficult. First, the cash generated is sent out of the country through hawala, which involves calling someone who says give cash to person X and we’ll deliver dollars to person Y. Once it’s offshore, it’s brought back in, in various ways. Since Switzerland, till recently, didn’t ask too many questions, a lot of money went into Swiss banks (and banks in Dubai and other not-so-cooperative countries).

Then some of it was channeled back to India as "FII" —a foreign institutional investor – money, back into the Indian equity markets. There are then numerous ways to use that money to pump up the stock price or otherwise distribute the money in the "white" channel. In 2007, when SEBI and the RBI expressed their desire to curb such investments by demanding more details of the eventual source, the markets tanked 10% and hit the lower circuit the next day. SEBI clarified that the restrictions would apply only after 18 months and everything went back on track.

Why does equity investing become attractive? Equity investing is tax free if you hold the money for over a year. Also, for short term money,  FIIs also use the Mauritius route to come into India, and because of a Double Taxation Avoidance Treaty, India doesn’t tax such entities — and it turns out that Mauritius doesn’t either. No tax means a great opportunity to launder money; the only problem with black money is that no tax is paid on it.

(If a minister is paid the highest ever rental for any commercial property at the time, that seems to be ok. Because he’ll pay tax on it. Or so it seems.)

Special Economic Zones (SEZs) for instance, pay no tax. So all one has to do is set up an SEZ in India, and then send money in from abroad against an invoice. When software exports were tax-free, money was laundered there. Now with the Minimum Alternate Tax (MAT) reaching 20%, this avenue is less useful.

Agricultural income is tax free, so within some limits, there is "income" generated there. You can’t really question a farmer about why he ended up selling SO many coconuts, can you? But this avenue is not open to most of us anymore, especially not to film-stars.

The answer isn’t to ban high denomination notes. The answer is to take serious action against the laundering of black money. We need to question the source of any money coming to India, especially FII money — if they’re not willing to reveal details, tell them to go away.

We also need to remove all tax-free concepts, including agricultural income, SEZs and Equity investing (the last one is going away next year). NGOs that get income tax exemptions need to be monitored very closely; they are another way to turn taxable income into "tax-free" money.

Since this will inconvenience actual users or farmers, introduce an upper limit — say 10 lakhs a year of profit — below which the tax-free rules continue to apply. There is absolutely no need to keep things tax-free after you’ve crossed a certain profit limit, even if you wanted to encourage industry. (Stop when it’s encouraged!)

We must absolutely bring back the illegal wealth stashed abroad; but it’s complicated to figure out how. Does Swiss bank money of people who are now abroad not be brought back? Does a person of Italian origin, who can move money to family in Italy, then qualify as not having black money? Does one give legitimate income — from investing in India through FIIs — thumbs up, simply because we aren’t able to prove that the original money, years back, was really black money? Or do we go to the other extreme, and say that all money is black unless proved to be white? The "proof" will take years of court process to prove, no one will get access to the money, except the people in power.

But we don’t have an alternative right now — set up a mechanism to query every single account that has money owned by Indian residents, and question their sources. In fact, find out who have recently transferred OUT their money out of fear of such an investigation, and question them even more.

We need to pick up enforcement of laws against the conversion of black money to white. I have no doubt that we are generating far more than 4% of our GDP in black money — but the figures show that the money doesn’t stay black; there is an efficient, functioning system that helps launder the money. We can get to that system and arrest the kingpins — it’s an open secret now — but we simply choose not to. Our fight against corruption must open this can of worms.

Banning the Rs. 500 note will only create problem for small businesses like vegetable vendors who have to carry cash around to buy things. It will create no problems for corruption — because the corrupt will still use cash and quickly convert that cash to white money. Banning such notes is the equivalent of the security theater we see in malls, where it seems the terrorist code of conduct is that you hide your bombs only in the boot or under the car’s hood, nowhere else. Effectively a Rs. 500 note ban does nothing to deter corruption, but inconveniences normal people. In fact, it’s better to probe every real estate sale in the last three years — there is surely more cash exchanged illegally there than in any other transaction. The money trail will reveal, in double-quick time, that the money gets whitened very fast.

We’re enraged about the colour of money, but the area is, in the most unfortunate pun ever intended, grey.

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