Modi derecognises notes; US recognises Trump

Two epochal events occurred last week, with long-term consequences.

Much like Cinderella’s carriage turning into a pumpkin at the stroke of midnight, high-value (₹500 and ₹1,000) currency notes turned into mush at the stroke of midnight on Tuesday. Anyone is free to deposit them in banks, but deposits of over ₹2.5 lakh would be subject to both tax and a 200 per cent penalty, if unexplainable. This means that anyone who cannot explain the money would not deposit the money, preferring to lose 100 per cent than to pay over 200 per cent.

The demonetisation was a bold, and necessary step against black money, but more needs to be done, and likely will. The high value notes together account for ₹14 lakh crore, or 86 per cent of currency in circulation. To the extent that part of this money is tax-paid money, it would be deposited and would enter the mainstream. To the extent that it is undeclared money and cannot find a way to cleanse itself, it would either be subjected to tax and may be penalty, or be lost. According to a presentation by broking firm Anand Rathi, the potential tax collection could be ₹5 lakh crore, equivalent to the budget deficit!

States, however, still retain a lot of discretionary powers, leading to corruption. Especially the Municipal Corporations, in things such as building permits or road contracts (witness the potholes in city roads thanks to unending corruption). The sooner these are made less discretionary and more transparent, the more effective will be the ending of the problem of black money.

Simultaneously, agricultural income must be taxed. This column has been suggesting that farmers be given a generous tax-free allowance, say 10 times that of non-farmers, but any farm income above that should be taxed. If Modi is really serious about striking at black money, he should do this, even though it would affect politicians/bureaucrats/businessmen close to him.

RN Bhaskar provides a context of the scale of this problem, in his article ‘India’s biggest laundromat’. In 2011, 6.5 lakh assessees declared ₹2,000 lakh crore as agricultural income! If taxed at even 20 per cent this would fetch the Exchequer ₹500 lakh crore. Or 100 times the amount of tax estimated from the demonetisation move.

Put simply, 1.2 billion people pay tax, directly or indirectly, because 6.5 lakh assessees don’t.

It is this kind of iniquitous treatment that created the anti-privileged angst which allowed Donald Trump to win.

The short-term impact of the demonetisation would be felt deeply in sectors which have a large cash component, e.g., real estate. Political parties who have stored cash with which to buy votes in coming elections, would also be affected.

The demonetisation is a good reform step. Another step is to ensure sanctity of contract. In the case of the Noida Toll Bridge Company, a listed company with around 80,000 shareholders, the Allahabad High Court has dishonoured the sanctity of contract and has stopped the concessionaire from collecting further toll, on a plea that the toll collected thus far has provided an adequate return.

If India wants foreign investors, (and reforms such as demonetisation to help), then we must also respect privity of contract.

(The writer is India Head, EuroMoney Conferences. The views are personal.)