Answered: “The demonetisation drive focused on cornering tax evaders and, through legislative amendments, forcing deposits of unreported incomes to pay higher penal rates.” Critically examine.

The recent demonetization drive led to withdrawal of Rs. 500 and Rs. 1000 bank notes as legal tender, removing 86% of the total currency (by value) from circulation.

The move, along with other measures, helped as:

  1. It turned the cash hoarded as black money into plain paper without any value, since almost the entire cash hoard is in Rs. 500 and Rs. 1000 bank notes.
  2. Most of the black money begotten by evading tax or not disclosing legitimate income is invested in real estate and gold. Benami Transactions (Amendment) Act, Foreign assets declaration Act, amendment of Double Tax Avoidance Agreement with Mauritius and Singapore etc. have blocked the avenues for tax evaders, cornering them.
  3. Amendment to the IT Act introduced the PM Garib Kalyan Yojana (PMGKY), wherein the person disclosing income has to pay tax, 33% surcharge, 10% penalty as well as deposit 25% of the sum with RBI without interest for 4 years. The quantum of penalties has been successively increasing since the launch of the first Income Declaration Scheme.
  4. The subsequent push towards cashless transactions will further lead to curbing of the parallel economy and lead to establishment of verifiable paper-trails of all transactions, curbing tax evasion.

However, this drive may have limited success and adverse consequences due to:

  1. Understaffed Income Tax offices and no mechanism to discern genuine savings (say, a housewife saved Rs. 2 lakh over 10 years) from laundered money (say, a businessman giving Rs. 2 lakh to a woman to temporarily deposit in her account).
  2. Disruption in day-to-day businesses of MSME industries and loss of jobs in the informal sector, which has hurt the bottom quintile the most. GDP growth might slump to 7% from 7.6% earlier.
  3. Studies in UK have shown that one-time penalties have no effect on tax evasion. Behavioural changes with respect to paying taxes have shown progress and need to be encouraged instead of such radical drives.
  4. Collusion and involvement of RBI officials and bank officials in laundering black money defeat the purpose of the drive.
  5. Cooperative banks are a very large loophole in this entire process and have been used for large scale laundering of stashed undisclosed money.
  6. There is lack of infrastructure for cashless transactions, leaving a large chunk of population, especially the rural population in a quandary.

Demonetization was not an isolated step but the next logical step for curbing the parallel black economy and reducing the menace of counterfeit currency. However, a holistic approach consisting of plugging the loopholes in the system, widening the tax base, and engendering behavioural change in the taxpayer is essential for obtaining the desired results.


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