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Why cash will remain king despite tax raids, strictures: View

Posted by: Uma Shashikant on Aug 21, 2017, 11.49 AM IST

The darkest side of the Indian economy is its informal black market that deals in cash and hides from the taxman. For many of us who are salaried and are paying taxes at source, it hurts that so many who are financially so much better off, evade taxes. A society that does not impose the rule of law uniformly, is simply unjust. Why is it so tough to deal with this scourge?

Let's consider a simple man who decides to set up a business. We shall call him Ram, for the sake of simplicity. Ram decides to set up a shop that would source and sell groceries and make a small profit by meeting the regular demand of local customers.

Ram must find the initial capital to set up his shop. He does so by dipping into what he already has, perhaps land or gold. However, at every stage of his venture he has to deal with those who charge a fee, preferably in cash, to enable his shop to come up. He must bribe the officials to give him a licence; he must bribe the local politicians who own or control most rentable or buyable property; he must bribe policemen and government inspectors so his shop can function smoothly. When he opens for business, he is already in a place where he has paid a huge amount of “tax” and has to earn enough cash to keep going.

Ram will not be able to make any of these payments that are essential to keep his business afloat from his formal books of accounts. He has no tax-deductible head of expense that can be used to pay off excise inspectors, government officials, local politicians and policemen. This chain of bribe seekers represents the network that feeds the politicians, from the grassroot municipal level to the higher level of members of Parliament. Ram needs them because they are the ones who will help him get the required approvals, find a place to rent and to live, get his children admitted in school and ensure basic safety for a migrant in a large city. Ram must cultivate this network, whose needs are defined in black cash.

Ram does not mind this, if he has enough margins to keep himself going. The network that parasitically feeds on him knows his revenues and his margins, and is exploitative enough to extract its fee, leaving him with a modest income. Ram has two choices: he remains the marginal player who pays his dues and keeps a modest business, or grows his business aggressively to become part of the network, acquiring political powers for himself, as a large funder of political activity. In either case, his business and the cash economy are intertwined.

Ram has no intention of opening a bank account. He fears that the amount of revenue he earns will then be known to someone he believes is an arm of the government. If he chooses to have a current account, and avail of an overdraft facility, he will be able to get working capital for his business that is far cheaper than the loans he manages from his informal networks, at usurious rates. But his informal network is faster, efficient, and importantly asks few questions. Money is available to Ram when he needs it, as the informal lender has his musclemen to recover dues. There is no paperwork involved.

Ram also becomes a part of the group of traders and businessmen like himself, who will lend and borrow among one another, or run a private chit fund that will help them tide over the need for capital. Ram has no need for financial investments in the formal sector. He buys gold when he can, since it is easy to pawn gold when needed, and buy it back when times are good. The informal system he is part of recognises that revenues in the business can move up and down, and is aligned to this reality. The formal banking system expects him to pay a steady amount each month, or has product structures that do not fit well with his business.

There are thus millions of traders, businessmen and service providers who rely on the informal networks to set up and run their business. They have no need for a formal system, and see no benefit in obtaining a PAN card, opening a bank account, taking a formal loan, or making financial investments. They find it cumbersome to stand in line to deposit money and complete paperwork to access their own money. They also do not have the expertise to maintain formal books of accounts, file income tax returns, and remain compliant. There is no tangible benefit to them from doing any of this.

What happens when businesses like Ram's become big? They invariably tilt towards acquisition of power to wield authority over other smaller businesses. They use money to remain at the top. They know the power structure too well, about what needs oiling and managing and how. The more enterprising ones become politicians themselves, while most end up funding candidates for their own business benefits. The nexus is deep and well entrenched. It takes just one round of rioting, street fights and closure to get an entire street of shopkeepers to fall in line. Those who play the game know how to move the coins.

It is not very different in agriculture, the other large segment that pays no taxes, but operates in the tight exploitative network of a class of cash-rich farmers and politicians. The marginal farmers borrow from the exploitative lenders, only because money is available immediately, on terms that align with sowing and harvesting cycles. They end up selling their produce to exploitative middlemen, since they cannot wait with the perishable harvest. There is a large network operating in the black and informal cash economy that keeps the marginal farmer poor, while keeping the costs for the consuming public high.

The government cannot hope to destroy this exploitative parallel economy by resorting to raids, closures and strictures. That only fosters the inspection raj system, which will soon feed on the network of cash payments to let someone off the hook. The demon to slay is the political system that seeks cash to win elections. The reform to bring is the uniform application of the rule of law. Without these two deep, pervasive and tough measures, the government will not make much progress with its drive to slay the cash economy.

The author is Chairperson, Centre for Investment Education and Learning.

Disclaimer: The facts and opinions written in this column are those of the author and do not reflect the views of economictimes.com. This article appeared in Economic Times dated Aug 21, 2017, 11.49 AM IST