200 Per Cent Tax On Unexplained Deposits Is Daft Economics; Best To Have A New IDS

The Finance Ministry has needlessly tied itself in knots by suggesting that cash amounts above Rs 10 lakh that are deposited in bank accounts, if found to be not in line with declared incomes, will be treated as evasion and attract a penalty of 200 per cent of the tax payable – which means over 90 per cent will be taxed, since there are cesses payable above the top tax rate.

This is silly, and works against the main purpose of demonetisation, which is to bring more money into the banking system and then tax amounts that may have evaded tax. The government should be happy about the amounts coming into the system and collect a reasonable amount of tax on it, albeit with a penalty added. But if it makes the tax rates confiscatory or extortionate, it will inevitably lead to bad consequences: more tax terrorism and a fresh lease of life to black money.

Rogue taxmen will be collecting bribes from hapless people trying to escape harassment, and those who lost money anyway will renew efforts to generate more black money to compensate for their losses. Bribes may actually spike.

The only logical way to deal with any abnormal surges in deposits is to bring the Income Declaration Scheme (IDS) back, in a modified form. The IDS closed on 30 September with declarations of over Rs 65,000 crore and potential tax collections of nearly Rs 30,000 crore. The new IDS should be modified, and can even have a gross 50 per cent tax, in order to not reward those who skipped the previous scheme. But 90 per cent plus makes no sense. Psychologically, any taxation that goes beyond 50 per cent is a deterrent to compliance. In the 2015 disclosure scheme for foreign incomes and assets, where the tax element was 60 per cent, declarations were barely over Rs 4,000 crore.

In the next round of IDS, the attempt must be to spread the net to smaller fish too. And this net must be made easy to comply with, and not draconian. The tax should be collected painlessly, and largely without actual interaction with the taxman.

Kaushik Basu, chief economist at the World Bank and former chief economic adviser to the Finance Ministry during the UPA regime, wrote a paper in 2011 proposing that for small bribes, the bribe-giver should be given immunity so that he is comfortable squealing on the bribe-taker.

In a paper titled ‘Why, for a class of bribes, the act of giving a bribe should be treated as legal’, Basu pointed out that most small bribes are forced out of the hapless bribe-giver. “Harassment bribery is widespread in India and it plays a large role in breeding inefficiency and has a corrosive effect on civil society. The central message of this paper is that we should declare the act of giving a bribe in all such cases as legitimate activity. In other words, the giver of a harassment bribe should have full immunity from any punitive action by the state… This will cause a sharp decline in the incidence of bribery. The reasoning is that once the law is altered in this manner, after the act of bribery is committed, the interests of the bribe giver and the bribe taker will be at divergence. The bribe giver will be willing to cooperate in getting the bribe taker caught. Knowing that this will happen, the bribe taker will be deterred from taking a bribe.”

Actually, he is only partly right. If you want to end bribery, you also have to enable the bribe-taker to come clean. In India’s all-pervasive system of everyday bribery, the non-bribe taker is shunted out and frequently transferred to keep him away from areas where bribes are big business.

The only logical way to deal with low-level systemic corruption is to give small bribe-takers the same option the Narendra Modi government gave to large holders of black money till September.

Far from going after every bank account which has seen a sudden surge in cash deposits pre- or post-demonetisation, all such account holders should be offered a simple deal: a tax deduction of 50 per cent of amounts credited above Rs 50,000 without PAN cards, and the same for other accounts that saw inflows of over Rs 2.5 lakh, which is the tax-free level for individuals. Trying to tax these accounts with 200 per cent (ie, a penal tax rate of 60 per cent over and above the 30 per cent top tax rate), may not only be illegal, but will end up driving more of the new notes being printed underground. Losers will want more bribes to compensate for this confiscation. It will be more economically damaging that demonetisation itself.

Letting the taxman loose on millions of Indians will unleash tax terrorism and offer more opportunities for black money creation. Only this time it will be the taxman himself who will be the cause of this creation.

The logical prelude to demonetisation was the IDS. A modified IDS with slightly higher tax will be a good epilogue to demonetisation and the fight against black money. Prime Minister Modi should be practical, not extreme, in the way he fights black money.

Taxmen are already scratching their heads on how to implement the 200 per cent penalty; they should be given a new IDS before their palms start itching.