Demonetization… The Good, the Bad and the Ugly – Part 3

Part -3: The Segments of Black Cash Economy

Continued from Part -2: Breaking the Status Quo

Question: How Cash-less transactions will help this sector? This sector is only comprised of about 40% of the overall economy.
Answer is simple. If this shop is forced to accept Checks or Credit/Debit Cards or Mobile/Electronic Funds transfers, then all these transactions would be accounted. All the funds received have to be accounted and recorded as sales and hence, all the tax collected by the shop from the customer on behalf of the government must be deposited in Govt. accounts and he has to declare the profits he has made on the business and pay Income Tax on that profits. All these years, he has been avoiding and evading this tax which accounts to those 60% of non-Taxpaying population of the country.

Question: Well we have not talked about the rest of 25% of non-Tax Paying population. Who are they and how they can be brought under tax net?
Answer: Do you know any professional providing you services without a proper establishment or business? Let me give you some pointers: Your kids are probably going to a teacher for tuitions or coaching which is usually imparted in his/her house and you pay the fee in cash. Or, maybe you visit a doctor whenever you are sick who runs his private practice and you pay his consultation in cash. Or, do you get food delivered to you which is prepared by someone at home and it is usually paid in cash. Or, do you hire some help to paint your house, fix your taps, electrical fittings, small repairs and usually these helps are paid in cash. Or, have you ever taken help from a Lawyer, Chartered Accountant, Tax Lawyer, Investment Consultant, etc. and paid his fee in Cash. Or, for a wedding, you booked the Band, Caterer, farm house venue and paid these costs in cash. If the answer to any or all of above is Yes, then very likely all these transactions have never been accounted for Income Calculation and hence for Taxation purposes. Since all these transactions goes under the radar being small value of Rs. 500-5,000 ech never getting any attention from us or the authorities. Sometimes these transactions value as much as few lakhs and still we pay them in cash. If you look carefully, then you would realize that all these services are taxable under Service Tax Act or lately under GST and the service provider should be collecting this tax from you and depositing it with the authorities. But most likely, you have never received any invoice or Receipt for these transactions and hence, NO Tax ever gets accounted or paid. These transactions add to the overall income of the professional providing you these services and since he does not intend to pay tax on it, he keeps these transactions as cash and all this Cash is untaxed. Now we know, if there are any transactions that is supposed to be taxed and is NOT… then such money is “Black Money”.

How not paying in cash would help the Government? Imagine you visit your favorite doctor and you insist on paying using Debit/Credit Card or Check, the Doctor then would be obliged to issue you a receipt, showing the services provided and tax collected on these services. When he issues these receipts, all these transactions will be accounted and will be added to his overall income from such services. All such incomes will be subject to Income Tax and hence it will add to the overall tax collection for the Government. Such services contribute to almost 18-20% of non-taxed transactions.

What about the rest…!!! Well that is anybody’s guess. How do you think all the illegal business of drugs, gold smuggling, prostitution, arms and ammunition, betting, Bribes, paid for carrying out riots, terrorism, etc. are conducted? Do you believe anyone issuing invoices for such transactions? All these transactions are carried in Cash. Large volumes of Cash. When we say Large volumes, such volumes are only possible in Large Denominations. Imagine you need to transact a 10 Crore Rupees in 1000 Rs. Denomination… you would need about 1 lakh notes of Rs.1000 each which is about 1000 packets of 100 notes each. Possible right? Now imagine such volume of cash has to be kept in Rs.100 denomination. Multiply everything by 10 and now you need 10,000 Packets of 100 notes each consisted of Rs.100 notes. A lot more (10 times) trouble than with larger 1000 Rs. denomination. These are the real culprits and all these transactions are absolutely illegal and conducted using Black Money. This is where large volumes of cash are involved and these transactions and cash volumes MUST be eliminated for a peaceful and fair society.

Question: If large denomination helps in above illegal trade and activities then how a Rs.2000 denomination note would help curb such transactions and activities. In fact, a higher denomination is only going help such activities?
Answer: Absolutely right. In principle, all these transactions would be helped a lot with a Rs.2000 denomination note. But I am sure Government think tanks have thought about that too. How is it going to curb such activities? My understanding is that, since all new currency notes are issued from the banks and government bodies only like Post offices… Government has control on who receives these notes. One side government wants to target these illegal activities at the same time there are millions of legitimate populations holding 500 and 1000 Rs. Notes which needs to be changed. So, Government mandates that you can exchange your old currency only from those outlets that are under the Government control that is the Banks (Highly regulated) and post offices (Govt. regulated again). Although these outlets may not be most efficient but Government knows that these institutes are accountable to government directly or indirectly and they will be able to track any large volumes of cash exchange that may happen. Few illustrations will help here:

  1. Case -1: A is a common man holding few notes of 1000/500 Rs. Denominations. He is an honest tax paying common man who has a bank account, pays tax and has nothing to hide. He is also not worried about getting caught due to the cash he has in his possession. Government has allowed such people to deposit any amount of such notes in their bank accounts. No limit helps them get rid of their old currency in a single shot without the hassles of multiple trips to the bank. Once the money is in the account, Mr. A can use his ATM Debit card to pay for purchases as well as withdraw cash from a Bank or ATM for petty expenses. Each note that is dispensed is accounted and can be traced to the recipient.
  2. Case -2: B, is a common man, holding few hundred of these 1000 Rs. Denomination… he has accumulated these notes from his business, shop, services, etc. and he has not paid tax on these sums. Now, his problem is two folds… he cannot deposit all the cash in his account as it will be flagged and he may have to pay tax on all this cash plus the penalties and maybe prosecution. Secondly, he has to somehow exchange these old notes with new ones. So, he goes to bank and based on his calculations, he deposits as much as he viably can to his account and then stands in the queue for notes exchange. Here he has been limited to Rs.4,000 value per transaction and he feels that he has to make quite a few trips to the bank in order to exchange all the notes. He is also made aware that for every such conversion he has to disclose his ID and PAN which would eventually be totaled up for all the conversions he has made and may get into trouble. He is in problem again and then Mr. B ends up hiring agents, helpers, mules or other people who work for him to stand in the queues and willing to use their ID/PAN and exchange these old notes with new ones and he is willing to pay some commission to these people for their help. Here, the government has made it difficult for Mr. B to carry on with his Cash transactions. It is a lesson for him that Cash in Inconvenient and expensive as he would be paying these helps/mules/agents a big cut for the exchange of the notes. He may get away without being tried for tax evasion this time but he has his lesson learnt about Cash hoarding.
  3. Case -3: X has about 1 crore of black money in cash in form of 1000 notes. If govt issues new Rs.1000 notes then, he will be able to circumvent the Banking system. He will go to bank on day 1 with Rs.1000 x 250 notes (2.5 lakh Rupees) and deposits in his account. Next day morning, he withdraws this 2.5 Lakh Rupees in new 1000 notes. He puts that cash in the locker and now in the evening goes to bank again and deposits his old Rs.1000×250 notes again, duly filling the deposit slip with correct denomination. Then next morning he goes to bank and withdraws the Rs. 2.5 Lakh again in new notes of Rs 1000 each and put them in the locker again. He repeats this cycle for  40 days and is now able to convert all his old 10,000 notes with new notes. He has a simple explanation to the Taxman that he has been depositing and withdrawing the same 2.5 lakh rupees each day and depositing it back as the need was no longer valid. No matter how illogical it may sound, but technically it will be plausible. There is no tax upto 2.5 lakhs and while Mr. X Still has only 2.5 Lakh in his account he has successfully converted all his 1 Crore in new currency.
  4. Case -4: There is Mr. X who has been doing illegal trade activities and now he has this huge pile of Cash with him that would become worthless after 50 days. He will lose the opportunity to convert these large holds of 1000 Rs. Notes which had made him a rich guy with all the money to buy anything he wished. Now, he has very few options with respect to the exchange of these notes. Either he puts that money in donation boxes of Temples, Churches, or drains them in the river or hires bigger agents and dealers who are willing to take the risk of conversion of these large volumes of cash through a bigger network of people willing to stand in the queue. He also, tries to find those influential bankers and officials who may have access to large volumes of New notes and would bribe them to facilitate the conversion. Here, the official risks his job, reputations and jail if he facilitates such an exchange. Since all old currency notes conversion required ID and PAN cards, the official or banker would be responsible for furnishing these details and it won’t be easy for him to achieve that. There would be few such officials who would risk for the huge rewards but again, as I said earlier, all new notes can be tracked based on their series and where these notes were sent and hence, such large transactions would be easily traced. It is estimated that almost 3.5 Lakh Crores of Rupees is the volume of such Dirty money and wealth. Until the demonetization, the Government has been under obligation to honor these notes irrespective of the nature or origin of such wealth. But with demonetization, if such wealth goes out of circulation (destroyed, buried, burnt) then that is the volume of wealth Government will gain and it can now issue new notes for such value that will be the fresh Liquidity in the market.
  5. Case -5: Now there is a cartel OrgX which has access to Currency printing Technology. As for the old currency, this OrgX was able to print and circulate a large volume of fake currency into the economy which was primarily funding the Terroristic and other anti-national activities. With the new Currency Technology, which happens to be Non-Transferable, suddenly the Govt. has destroyed the whole Cartel OrgX along with its distribution channels and beneficiaries. No more money for funding and Arming Terror outfits from outside or inside the country.

I have so far not explained how Rs.2000 Denomination will curb such large accumulation of wealth. Well, it is a bit more farfetched and complex to understand. I will still try to explain. Remember that initially all the new notes are issued under strict control. So, at least for once the system will be wiped out of Dirty money. However, Cash will remain in circulation and it will again channelize through the cash transactions route to fund such Illegal activities. Again, there will be few who would amass such huge wealth through illegitimate business. First of all, Such would take some time to happen. I would say not less than few or couple of years at best while such dirty wealth is accumulated. Now comes the Second Jolt… I would rather call it a Lightning Bolt. Government announces a second demonetization of new Rs.2000 notes and this time, it is no surprise but a fair amount of time is given to people. Further, Government may mandate that such notes will not be exchanged with new notes but only deposited to the bank accounts of holder of such notes. Now in the meanwhile (2 years at most), all or most legitimate and common people would have opened their bank accounts and have got their debit/credit cards and all the big and small shops, merchants have got their accounts in order, got the Payment terminals to accept Debit/Credit Cards or accept Electronic/Mobile payments. Now, less and less people would have hoarded large number of these Rs.2000 Notes (lesson learnt earlier) as they all have bank accounts to keep and save their money instead of hiding it under their pillows. All the common man would not need to exchange their now old Rs.2000 notes as they have only few of them and whatever is there can be easily deposited in the account and withdrawn as new notes. While all those people who have again accumulated the Dirty wealth are big time screwed as they cannot get to lose everything and cannot enjoy their wealth.

But, the question remains… why a Rs.2000 note… not a Rs.100 or 500 note. The answer is in simple math to answer the large economic question. It costs about Rs.45 for the Government to print a Rs.1000 or 2000 Note. This cost is marginally higher or lower for other denominations. As per the initial estimates, the total value of Rs.500 and 1000 notes is approx 13.5 lakh crores. Which means that there are about 1,350 crore notes each of Rs.1000 would be needed to replace all old Rs.1000 Notes. That would cost the Government a whole lot of money to print and distribute and to destroy old notes. To handle the initial volume and rush and ease on costs and logistics, the government issues Rs.2000 notes which cuts the printing costs to half and logistics costs to half as well. And the new Rs.2000 Notes are machine readable/verifiable and can be effectively traced/tracked using the electronic machines that counts and validates these notes. Also, at a later stage, during the second wave of demonetization, government has to handle a lot less volumes of Rs. 2000 notes in order to curb dirty money resulting in less notes to account, collect carry and destroy.

Consider the Rs.2000 notes as an interim stop gap arrangement before the final solution is in place. Considering the above logistical challenges and costs and the temporary nature of these new notes, it only makes sense to bring a larger denomination note to ease out the challenges.

Hopefully we answered the big question of How to Break this vicious Cash Cycle. Few more questions before we close are:

  1. What about black money in Gold, real estate, foreign exchange, etc. ?
  2. How more and more earning population is brought under tax?
  3. How, Tax gets rationalized
  4. How the tax money is utilized
  5. And how it helps the economy…


A Lot of questions remains to be answered  and more math to be done, and we will focus on the these questions in next Part -4. Stay tuned.

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About Rajeev

Known as "Guru" the author has a wide and broad interests from Food, Technology, Health, LifeStyle and Spiritual Yoga. As an Energy Professional with extensive Technology Experience specializing in Program Management, Business Transformation and Strategic Management. Likes to simplify Technology that can be used in everyday life without needing to be a whiz.

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