Denominator Neglect: Accounting for Hidden Money

04.10.2016 • The Economy

From Vivek Kaul – Vivek Kaul’s Diary (India) –

Human beings have a habit of looking at absolute values and ignoring the denominator. Economists refer to this tendency as the denominator neglect.

The denominator neglect has been at full show in case of the Income Declaration Scheme which came to a close on September 30, 2016. The scheme had been in operation since June 1,2016. It offered people who had black money within the country to declare it to the government, pay a tax of 45 per cent on it and become a part of the system.

Black money or unaccounted or hidden wealth, is essentially income that has been earned over the years, but on which taxes have not been paid.

The government of India got declarations of Rs 65,250 crore of black money under the scheme This money will be taxed at the rate of 45 per cent. It means collections of Rs 29,362 crore for the government.

The scheme has been declared to be a huge success by the government as well as the media. The government press release announcing the black money declarations said that there has been “a tremendous response from the general public, especially in the last two months”.

 

The media led by The Times of India went to town saying that the collections had been three times bigger than the collections of the Voluntary Disclosure of Income Scheme (VDIS) of 1997, the last black money declaration scheme that the government had launched.

The total amount of black money declared in VDIS 1997 had stood at Rs 33,000 crore. The corporates had to pay a tax of 35 per cent on the black money declared whereas others (primarily individuals) had to pay a tax of 30 per cent. This led to a collection of around Rs 10,000 crore for the government.

The collections in the Income Declaration Scheme of 2016 are expected to be Rs29,362 crore or around Rs 30,000 crore. This is three times bigger than the 1997 number or so the media seems to have concluded.

The trouble is this is wrong. What the media hasn’t taken into account is the denominator or the size of the Indian economy, which has grown significantly bigger in the last two decades. The nominal gross domestic product (GDP) at current prices, a measure of the size of the economy, in 1996-1997 (the financial year before the VDIS 1997 scheme) was Rs 13.02 lakh crore. The total tax collected by the government in VDIS 1997 amounted to around Rs 10,000 crore. This was 0.77 per cent of the GDP.

The nominal GDP at current prices in 2015-2016 (the financial year before the Income Declaration Scheme of 2016) was Rs 135.76 lakh crore. This is 10.4 times more than the GDP in 1996-1997. Hence, the size of the economy is 10.4 times bigger, though the tax collected has grown only three times.

The tax the government expects to collect from the Income Declaration Scheme of 2016, is Rs 29,362 crore. This amounts to 0.22 per cent of the 2015-2016 GDP.

This is significantly lower than the tax collected in VDIS 1997. The media obviously did not take the size of the Indian economy into account before going to town about the success of the scheme. The denominator neglect was at play.

One reason for lower collections in the 2016 scheme lies in the fact that the rate of tax to be paid is 45 per cent. In the VDIS of 1997, it was 30 per cent or 35 per cent. Of course, more people are likely to declare black money at a lower rate of tax. But even after taking this into account, the difference between 0.77 per cent of the GDP and 0.22 per cent of the GDP, is fairly significant.

In fact, if the idea was to ignore the size of the Indian economy, then the media could have come up with an even better result. Instead of taking the VDIS of 1997 and saying that the tax collected in the Income Declaration Scheme of 2016, will be three times bigger, it could have taken the Voluntary Disclosure Scheme of 1975.

The total black money disclosure in case of this scheme was Rs 738 crore and the total tax collected stood at Rs 241 crore. The total tax expected to be collected under the Income Declaration Scheme of 2016 is Rs 29,362 crore, which is 122 times bigger.

The point being that even though the government has managed to collect some reasonable amount of tax under the Income Declaration Scheme of 2016, it is nowhere as significant as it is being made out to be.

Postscript: The Business Standard reports only 15% of black money declarants came in on their own. If the remaining 85% were forced to declare black money, why is there the need for amnesty schemes like the Income Declaration Scheme?

This also tells us that the IT department knows who the black money wallahs are. Business Standard reports that the IT department sent letters to 7 lakh possible evaders asking them to avail of the Income Disclosure Scheme. Why is there a need for amnesty schemes to do something like this? Why can’t such things be done during the normal course of things? Of course, this is benefit of hindsight. But there are lessons to be learnt here.

-Read more at https://www.equitymaster.com/diary/ (English)-

Related Posts

Comments are closed.

« »