It’s time to reintroduce an unconventional scheme to bring back black money

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India’s central budget is around the corner and the government is weighing various options to reduce the budget deficit. Because the previous government creatively passed on some expenditure items, the deficit is larger than the projected 4.1% and the finance minister will come under pressure to contain the gap.

Arun Jaitley, the new finance minister, has a huge task before him. Any decision that he takes to increase tax revenue or cut subsidies will be decried as being against the common man. So how does he raise revenues and maintain growth without increasing taxation, and create momentum that raises investment?

He might resort to an unconventional measure that the previous government weighed trying just before their term came to an end. For former finance minister P. Chidambaram, it would have amounted to pulling an old trick from under his hat. In 1997, when Chidambaram was finance minister, the government floated an initiative known as the voluntary disclosure of income scheme, or VDIS. It was open for a period of seven months. Anybody could submit a declaration to the Income Tax department, pay the requisite tax and walk away, no questions asked. The source of the income needn’t be disclosed, and disclosures under the scheme would be immune to prosecution under laws such as the IT Act, Foreign Exchange Act, and others.

The response was phenomenal. Some 3.5 lakh individuals and companies declared hitherto undeclared wealth, or black money, amounting to some Rs33,000 crore ($5.4 billion today).

The current government is said to be mulling a similar amnesty scheme. The objective is to attract close to Rs100,000 crore in assets that are stashed abroad. These are funds earned by an Indian individual (either at home or overseas) and not declared as income and tax paid on it in India. The most obvious method of sending such funds abroad is over invoicing imports, especially in diamonds. Or under invoice exports and collect part of the money abroad. It is easier to do it in case of diamonds because the value and cost is certified by buyer, cargo is not bulky and multiple transactions can happen on the same cargo as it is not easy differentiate between one batch of diamonds from another. Taxmen refer to this practice as roundtripping of diamonds.

A lot of Indian citizens also park their funds abroad by conducting transactions abroad, and not bringing the funds within Indian tax jurisdiction. Everybody who has money overseas is not a money launderer or a tax evader. They need to adequately be incentivized to move that money to India and invest in productive instruments here so that they are available for the country’s development.

Indians dominating the real estate market in tony quarters of London, such as Mayfair, is sign that Indian money overseas is searching for investment options. Parking money in banks overseas is a poor deal due to low interest rates.

Almost every large Indian business family has now set up family offices to manage their wealth. These offices are headed by former investment bankers and private equity professionals. While moving HNI money around, they seek to minimize the overall tax component.

So in the new, changed circumstances, where Indian money has plenty of competing destinations to deploy, any amnesty scheme should be more sophisticated in its approach. A tiered three-year approach could be an option. Tax free or nominal tax for the first year, 15% tax for the second year and a 30% tax for the third year. This will attract a lot of money parked overseas to be brought into India within a year.

These funds will not add anything to the tax receipts in the first year, but they will add to the investment flow to the country. This money will come looking for investments, either in stock markets, real estate or bonds. The inflow of these funds could be timed with a series of bond issues for the infrastructure sector that could soak in this investment. In this way these funds would turn into productive assets that would add to the growth of the country.

Such amnesty schemes raise moral and ethical questions. And the VDIS of 1997 was criticised by the Comptroller and Auditor General for shortchanging the regular, honest tax payer and for widespread abuse of the scheme. And by allowing in money whose sources are unknown into the mainstream economy and banking system, it is true that a certain amount of what economists call moral hazard is created—people will be encourage to evade taxes in expectation of the next round of amnesty.

These are perhaps the reasons why the previous government eventually shied away from it. But as a nation, we are at a stage where we must embrace pragmatism. Unless these funds come back to the country and come into the mainstream, they cannot be used for productive purposes. Therefore, the government must consider a carefully calibrated scheme that encourages people to declare their undeclared assets, bring it to India and invest in productive instruments.