by Meera Sanyal
56 lakh of the Prime Minister: ‘The Prime Minister’s speech referred to the increase in number of e-filed Personal Income Tax Returns filed from 1 April 2017 to 5 August 2017 over the ITR filed in corresponding period of earlier years. The data maintained by the IT Department shows that during 1 April 2017 to 5 August 2017, 2.79 crore e-returns of individual tax payers were received as against 2.23 crore e-returns received during 1st April 2016 to 5th August 2016. Thus, the additional ITR received in 2017 works out to be 56 lakh. During the same period of 2015, 2.00 crore e-returns were received, meaning thereby, that in 2016, only 22 lakh (rounded off) additional e-returns were received by the due date of filing.’
Given that the Prime Minister had clearly talked of new tax payers and not e-returns, this too did not reflect well on the authorities. In any case, given that the filing of e-returns has been mandatory since AY 2013–14,36 this clarification in itself made little sense.
Furthermore, on 22 April 2016, the Central Board of Direct Taxes (CBDT) released circular F No 309/11/2016-OT, defining the terms ‘New Tax Base’, ‘New Taxpayer added’ and ‘Tax Payer’ and recommended ‘these standard definitions be adopted for the purpose of generating relevant statistics, as also for reporting to Parliamentary Committees and various outside agencies.’ It is a mystery why the government did not use these guidelines, which could have saved both the Finance Minister and the Prime Minister needless embarrassment.
So, what was the real number of new tax payers added as a result of demonetization? The Economic Survey is undoubtedly the most reliable estimate, namely 5.4 lakh new tax payers. The comments in the Economic Survey are even more revealing than the number itself:
Para 1.86 of the survey states, ‘The growth of tax payers post-demonetization amounted to about 5.4 lakh tax payers or one per cent of all individual tax payers in just a few months. The addition to the reported taxable income (of these new payers) was about `10,600 crore. So, the tax base did expand after demonetization. It is, however, interesting that the average income reported of the new tax payers – `2.7 lakh – was not far above the tax threshold of `2.5 lakh, so the immediate impact on tax collections was muted.’
The Economic Survey makes an important distinction between the number of new tax payers and increased tax collections. Clearly, in addition to more tax payers, collecting more taxes is important. So, the next question we must answer is, did demonetization result in higher tax realizations?
There is, of course, a natural growth in taxes collected. As the economy grows, incomes grow and taxes grow. So, what we need to assess is, if demonetization caused a sudden spurt in taxes.
Every quarter, the MoF shares data on actual tax collections. When we compare the data for the period of demonetization to the corresponding period in the previous year, we see an interesting result.
On 9 August 2017, the MoF press release stated, ‘The Direct Tax collections up to July, 2017 (for the period April 17–July 17) in the Current FY 2017–18, net of refunds, stands at `1.90 lakh crore which is 19.1 per cent higher than the net collections for the corresponding period of last year.’
This seems like a healthy growth. However, when compared to the previous year the growth in taxes has actually declined! On 9 August 2016, a similar MoF press release stated: ‘The figures for direct tax collections up to July, 2016 (for the period April 16 to July 16) show that net revenue collections are at `1.59 lakh crore which is 24.01 per cent more than the net collections for the corresponding period last year.’
What this shows is that before demonetization, the growth in direct tax collections was higher (24.01 per cent) than after it (19.1 per cent). When one thinks about it, this is not surprising – slower economic growth, job losses and lower incomes, led naturally to lower tax collections as well.
What did, however, happen after demonetization was that a massive amount of data on people and companies who were purportedly avoiding tax, became available to the tax authorities.
Finance Minister Jaitley stated in May 2017 that the Income Tax Department had identified 1.8 million persons whose cash deposits during the demonetization period were not in line with their tax profile, and had sent them tax notices asking for explanations. Transactions of over 3,00,000 registered companies were investigated and ‘more than 37,000 shell companies which were engaged in hiding black money and hawala transactions’ were identified.
The assets seized and undisclosed income detected as a consequence of these actions by the Income Tax department was shared in response to a question in the Rajya Sabha, in December 2017, and are summarized in the following table:
Table 13: Assets Seized and Income Detected Post-Demonetization
Dates IT Searches and Surveys Assets Seized
(` Cr) Income Detected
(` Cr)
November 2016–March 2017 9,139 900 14,706
April 2017–October 2017 3,463 573 10,285
Total 12,602 1,473 24,991
Source: Minister of State for Finance, P. Radhakrishnan in a written reply to the Rajya Sabha, on 19 December 2017.
This implies that of the 1.8 million individuals and 3,00,000 companies identified, surveys and searches were carried out on only 12,000, leading to an income disclosure of an average of `2 crore per entity – a paltry amount by any stretch of imagination. It is hard to understand why the authorities have been so slow to mine the data they have collected and not taken tangible steps to bring more evaders into the tax net.
However, going forward, individuals and companies who deposited significant amount of cash during demonetization will probably have to declare similar levels of cash receipts and income in the future, as they are now on the radar of the tax authorities. One hopes that this leads to higher direct tax receipts in the future, yielding at least some future benefits from a hugely expensive and destructive demonetization exercise.
To Integrate the Informal Economy into the Formal Sector and Create a ‘Larger and Cleaner’ GDP37
By using the word ‘cleaner’ in this objective, the Finance Minister, perhaps inadvertently, seemed to insinuate that the informal sector was ‘dirty’ or undesirable.
Perhaps he held this view because those working in the informal sector don’t pay tax, ignoring the basic fact that millions of people working in the informal sector are not in the taxable bracket and, therefore, do not have to pay tax in the first place.
His statement also indicates a fundamental misunderstanding of the Indian economy. It portrays the informal and formal sectors as being clearly distinct and unrelated, when in fact they are closely integrated. The informal sector and people working in it are an integral part of the supply chain providing goods and services to those paying tax in the formal sector. They are also consumers of goods and services provided by the formal sector.
For example, consider a ‘pakoda seller’.38 He buys provisions from a grocery store, uses a gas cylinder, and sells fresh pakodas to office-goers who pass his stall every day. While he himself operates in the informal economy without any job security, he is buying provisions and gas from agencies in the formal economy (and presumably paying GST on these) and selling to customers, several of whom could be salaried employees within the formal economy.
The truth is that India’s informal sector, far from being ‘dirty’ or ‘undesirable’, is actually the backbone of our economy. The Indian economy is overwhelmingly ‘informal’. Rather than being a ‘residual sector’ of the economy, the informal sector is the dominant sector, both in terms of employment and in the value it adds to our GDP.
Before proceeding, it is probably a good idea to define what we mean by the terms ‘formal’ and ‘informal’ sectors. The Economic Survey, presented in January 2018 by the CEA, for the first time provided a definition of the formal and informal sector, and an indication of the size of each.
The survey said that there are many different definitions of formal and informal sectors. The most common ones are:
Whether a worker has a form
al contract;
Whether a worker is a regular/salaried worker (as opposed to self-employed or casual);
Whether a firm is registered with any branch of the government;
Whether the firm pays taxes; and
Whether a worker receives social security.
Estimating the size of each sector, the survey stated:
Formal Sector: ‘About 0.6 per cent of firms, accounting for 38 per cent of total turnover, 87 per cent of exports, and 63 per cent of GST liability are what might be called in the “hard core” formal sector in the sense of being both in the tax and social security net.’
Informal Sector: ‘At the other end, 87 per cent of firms, representing 21 per cent of total turnover, are purely informal, outside both the tax and social security nets.’
From these definitions, it is clear that in terms of the number of firms, the informal sector dominates the formal sector, though, in terms of turnover, the picture appears different. This is probably because the turnover of the majority of these small firms is neither recorded nor captured in the formal statistics, something that will hopefully be remedied as increasingly micro and small firms register under the GST framework.39
An article by Neelkanth Misra,40 of Credit Suisse, shares a perspective on the contribution of the informal sector to India’s GDP.
…ninety per cent workforce is engaged in the informal economy (that is, not in companies). About half of India’s GDP is informal (that is, not generated by incorporated enterprises) among the highest ratios in the world… Productivity growth has been the most dramatic in the informal side of the economy… But this doesn’t show up in the current GDP statistics because we don’t measure it.
The Report by the Committee on Unorganized Sector Statistics re-emphasizes the fact that the informal economy makes a considerable contribution to the economy. In addition to generating jobs (albeit low-paying jobs), this report estimates that the informal sector produces up to two-thirds of the country’s GDP. In addition, the formal economy benefits from the informal economy, becoming more cost competitive through subcontracting and sourcing of cheaper products and services.
Data from the National Sample Survey Office (NSSO)41 validates the contribution of the informal sector to employment generation. The NSSO 2011–12 estimates that 84.7 per cent of the 473 million jobs in the Indian economy are in the informal or unorganized sector. The India Labour Market Update (2016) by ILO estimates that over 90 per cent of the employment in the agricultural sector and 70 per cent in the non-agricultural sector (mainly in manufacturing, construction and trade), are informal.
Thus, by any estimate, it is clear that the informal sector provides employment to most of India. More than 400 million workers and their families depend on the informal sector. The problem is that these workers have low wages, little job security, and few of the protections guaranteed to workers under different labour laws in the formal sector.
While demonetization struck at the heart of the informal economy, it did nothing to create a larger and cleaner GDP. Instead of making the informal sector more formal, it pushed more workers into the informal sector. A six-month field study undertaken by the Centre for New Economic Studies at O.P. Jindal Global University concluded that while destroying informal markets, demonetization also led to rising informalization.42
The study observed, ‘Demonetization had hardly any impact in formalising the regulatory process of cash-based transactions across the identified market arrangements. On the contrary, the short- to medium-term impact of the announcement caused a massive drop in market activity, affecting the economic livelihoods of most trading merchants. As a radical economic reform intended to curb the black economy, demonetization can be seen as a major epistemic failure.’
In a thoughtful article in May 2017, titled ‘Is Informal the New Formal’, Prof. Himanshu43 summarized the problem:
One of the issues that continue to haunt the Modi government after three years of rule at the Centre is the problem of job creation. By all estimates, the economy has seen a deceleration in the pace of employment creation with actual employment generation in the economy not even a fraction of the estimated 20 million jobs that need to be created every year as per government’s own commitment… Between 2004–05 and 2011–12, net addition to jobs in the economy was 14 million, the bulk of which was in the informal sector… So, how should one deal with the large informal sector, without killing the golden goose? The best way is to recognize that the informal sector is the new normal… what is needed is to upgrade the skills of those who are already in the informal sector with government support through easier access to credit, technology and availability of markets.
So, while it is clear that demonetization did not succeed in meeting the Finance Minister’s objective of ‘Integrating the informal economy into the formal sector and creating a “larger and cleaner” GDP’, the question that arises is, was this even a desirable objective?
Instead of focussing on making the life of those working in the informal sector easier, better, and more secure – the ‘Achhe Din’ promised by the Prime Minister – demonetization brutally targeted the informal sector, destroying livelihoods and causing untold misery.
By not understanding how closely integrated the informal and formal economies were, the architects of demonetization dealt a fatal blow to supply chains across the Indian economy, destroyed precious working capital, dented business confidence, and set back economic activity everywhere in the country. In and of itself, this was a completely misdirected objective, which failed spectacularly, at great cost to both the informal and formal sectors of the Indian economy.
To Lower Interest Rates by Forcing ‘Idle’ Savings into the Banking System
As a stated goal of demonetization, this was quite Kafkaesque. On 7 December 2016, the Secretary, Economic Affairs claimed, ‘demonetization had been carried out to force Indians to put domestic savings lying idle at home into the banking system, so that banks can use that money to give loans at lower interest rates.’44 Undoubtedly, demonetization did succeed in forcing all of India to put money into the banking system, though it is questionable whether forcing people to deposit their money into a bank is a desirable or an ethical objective, or indeed, whether 86.9 per cent of the country’s Cash in Circulation can be called ‘idle savings’ lying at home.
Quite apart from the ethical questions around forcibly impounding the nation’s cash and/or savings, there are several concerns with this objective such as:
What impact did these artificially lower interest rates have on depositors (especially on pensioners and senior citizens) who had their life savings in fixed deposits in banks? (62 per cent of Indian household savings are held in banks.)
What effect did this move have on the profitability of banks? Did they benefit from the sudden influx of deposits?
What effect did the upsurge in bank liquidity have on the RBI’s liquidity management operations, and at what cost? (Note: RBI’s domestic earnings declined as it had to pay interest of `17,426 crore after it mopped up excess liquidity in the banking system following demonetization. The previous year, the central bank had earned interest of `506 crore in its liquidity management operations.)
It is also true that, as a consequence of the huge inflows into the banking system, interest rates did drop, but the question is, did this lead to more lending by banks (and therefore more productive investment and a virtuous cycle of economic growth) which is presumably what the government wished to achieve? We have addressed the impact of demonetization on savings and investment in an earlier chapter, but for the purposes of this Report Card, the data45 by which we can judge this objective is as follows:
Increase in Bank Deposits: Aggregate deposits during the demonetization period increased by `6,720 billion.46
Decrease in Fixed Deposit rates: The incremental deposits into banks were mostly current accounts (on which no interest is paid) and savings accounts (on which most banks pay 3–4 per cent). As a conseq
uence, Indian banks were flush with low-cost funds, and lowered their domestic term deposit rates. The median-term deposit rates of scheduled commercial banks declined by 38 basis points (bps)47 during the period November 2016–February 2017.
Decrease in Lending Rates: The combination of lower fixed deposit rates and the sharp increase in low-cost current and savings accounts (CASA), allowed banks to reduce their lending rates. The WALR of banks in respect of fresh rupee loans declined by 56 bps during the period November 2016–January 2017. The Median Reduction in both Deposit and Lending Rates – post-demonetization (up to 7 March 2017) is summarized in the table below.
Table 14: Decrease in Bank Rates Post Demonetization
(basis points)
Bank GroupMCLR
(Median)Term Deposit Rates
(Median)
1 yearUp to 1 year1 to 3 yearsAll Tenors
Public Sector Banks 85 26 35 28
Private Sector Banks 65 50 48 50
Foreign Banks 40 8 34 6
Scheduled Commercial Banks 70 31 40 38
Source: RBI Report on Macroeconomic Impact of Demonetization, 10 March 2017.
Impact on Lending: Despite the fact that banks were flush with funds and interest rates had fallen, lending and credit declined instead of increasing. Data excerpts from the Economic Review section of the RBI’s 2017 Annual Report show how drastic the decline was: