When Prime Minister Narendra Modi announced the government’s decision to invalidate the old Rs 5000 and Rs 1000 currency notes on November 8, one of the ostensible goals was to attack the existing stock of black money held in cash. The burden of this task will fall on India’s tax administration system, which seems ill-equipped. Experts behind the government’s currency exchange decision had argued that an estimated Rs 2.5 lakh crore may not return to the system. This potential windfall, they argued, will lead to massive gains for the state, with Reserve Bank of India’s liabilities significantly reduced. The government may use this money to improve its fiscal situation and provide income tax relief/loan waivers, recapitalise banks and kick-start lending. In other words, the success of demonetisation will depend on the value of old notes that have not returned to the system. There is no official data available, but the consensus seems to be that most of the invalidated notes have come back into the banking system. This significantly reduces the prospect of any windfall gains accruing to the government arising from of a portion of the old currency remaining outside the banking system. Nonetheless, votaries of the government have now changed their tune and argue that merely depositing money into a bank account does not turn black money into white. It was a point Union Finance Minister Arun Jaitley had alluded to in his Facebook post on Sunday. Tax authorities will now be able to trace the transactions and tax black money hoarders since all that money has entered the formal banking system, they argue. It now seems entirely possible that many tax evaders have found a way to launder their illicit wealth—posing a serious challenge to India’s tax administration system. Besides constant changes to withdrawal limits, the fact that most of the invalidated notes have reportedly made their way back to banking system indicates poor implementation on the government’s part. Beyond demonetisation, however, the return of vast volumes of cash also points to some glaring drawbacks in our system that makes detection of black money difficult. Reports on Wednesday indicate that the Income Tax Department has been asked to scrutinise details and send notices to depositors of Rs 3-4 lakh crore on which tax could have been evaded. The challenges before the taxman are massive.
From a purely operational perspective, officials in the tax department will now need to scrutinise a huge volume of data to ascertain those accounts that have been used to deposit illicit cash. Besides contending with a substantial increase in workload, authorities will have to build water-tight cases in the event of litigation. Scrutinising accounts is only half the job. As per a recent report in Mint, a leading business daily, approximately 3.9 lakh cases are pending across various forums. In fact, the report goes into the recommendations made by the tax department’s internal committee, one of which includes paying more attention to litigation management and reducing scrutiny. The tax department will also need to ensure that the entire exercise does not cause unnecessary discomfort to honest taxpayers. Arvind Panagariya, the vice chairperson of NITI Aayog, has reportedly written a letter to the Prime Minister citing similar concerns. In his letter, Panagariya highlighted the need to codify tax rules to ensure that citizens, especially women, are not unduly harassed for depositing old notes in the stipulated period. Is the system capable of tracking all these deposits? Even in a country where merely 4 per cent of the population filed income tax returns in 2014-15, the task of scrutinising these accounts is a mammoth task. “Modern-day fiat money isn’t born illegitimate; illegal transactions and tax evasion make it so. Indeed, it is the political executive’s poor design of tax policies and shoddy implementation of laws and compliance that create unaccounted income. Even after the ongoing disruptive exercise, the government will rely on the same army of tax officials for filtering the misreporting, or lack of reporting, of undisclosed income which earlier couldn’t be relied on up to do a credible job,” writes Rajiv Malik, a senior economist with a private firm. Simply put, the existing capability and infrastructure of the tax department will now be put to a severe test. Massive tax evasion is only part of the problem. What the government will have to work on is how to enhance the system’s capabilities to tackle this scourge more effectively. Going by the Prime Minister’s claim of only about 2.4 million people in the country declaring income over Rs10 lakh, the tax administration system has thus far done a rather shoddy job.
What could hinder the government’s efforts is the shortage of human resources. Reports indicate that there’s 35 per cent shortfall at staff level in the IT, and an acute shortage at deputy and assistant commissioner and assessment officer levels. Will the IT department be able to scrutinise crores of accounts? Allied with plugging the gap in its workforce, the department will also have to employ big data analytics—the process of examining large data sets to identify data patterns that may not otherwise be discernible to human analysts. For example, data generated by the consumption patterns of individuals to identify tax evasion can be used. What’s more, its officers will need to upgrade their skills to use the latest technology available. More than administrative measures, a lot of due diligence will need to go into revamping complex laws and regulations that are mainly responsible for the generation of black money. Simplifying these regulations and lowering tax rates where possible, could go a long way towards improving compliance among potential taxpayers. Structural changes to tax administration have always been a major gateway towards reducing the generation of black money. The government must now make the best out of a bad situation, and inculcate some of these changes.