Jaitley Hails India's Tax-Free, Job-Rich Informal Economy

India Finance Minister Arun Jaitley Interview

Arun Jaitley, India's finance minister.

Photographer: Prashanth Vishwanathan/Bloomberg
  • Opposes IMF recommendation to widen tax net among population
  • Wants to put more money in pockets of `neo-middle class'

India’s underground economy is booming, and Finance Minister Arun Jaitley wants to keep it that way.

The informal sector is estimated at $780 billion, or about 40 percent of India’s official gross domestic product. It employs more than 90 percent of India’s workforce, according to the government.

“I’m a great supporter of this informal sector," Jaitley said in an interview on Monday. “The informal sector generates more jobs than the organized industry."

The approach goes against the advice of many economists, including those at the International Monetary Fund, which recommends widening the tax net to alleviate India’s chronic shortfalls in fiscal revenue. Indian governments often need to slash infrastructure spending to meet deficit targets that are still among Asia’s highest.

India ranks among the world’s top employers in the informal sector, according to the International Labour Organisation. It puts to work about 400 million people -- more than the entire U.S. population.

In India, it’s nearly impossible to avoid. Retail stores offer discounts for customers if they pay cash, and landlords often take a portion of the monthly rent in stacks of 1,000-rupee notes. Back-alley hawalas transfer billions of dollars around the globe with no questions asked, and thousands of unregistered and underpaid chauffeurs and housemaids don’t file annual income declarations.

“The black economy is growing faster than the white economy and everybody is involved -- the entire country," said Arun Kumar, author of “The Black Economy in India," who came up with the $780 billion estimate by looking at wages, under-the-table transactions and cash-based real estate sales. “This isn’t just a problem among the wealthy -- almost everyone with disposable income participates in the black economy and it’s accepted."

Total corporate and personal income tax payers in India amount to about 40 million -- roughly 3 percent of the country’s 1.2 billion people. To expand that, a Finance Ministry-created panel suggested putting levies on farmers in the untaxed rural sector who make more than 5 million rupees ($76,000) per year -- an approach backed by the IMF.

“We think there’s scope to bring the fiscal deficit down in particular with the revenue side," said Thomas Richardson, the resident representative of the IMF in India. “It’s really a task of widening the tax net -- not raising rates, but bringing more people into the tax net."

“Neo-Middle Class"

Jaitley, for one, rejects that idea. Most farmers don’t make much money anyway, he said, and the rest could use the extra cash.

“We need to strengthen the neo-middle class and put more money in their pockets," Jaitley said. “So bringing tax violators into the tax net, yes, but bringing people with marginal incomes into the tax net -- I’m not so excited about it at all."

Instead, Jaitley wants to finance them. This year the government started a program to boost lending to small entrepreneurs like shopkeepers, fruits and vegetable vendors and artisans. Government-run banks have so far disbursed nearly $6 billion in increments of as much as about $15,000.

Part of the problem is India’s strict labor laws for companies with more than 100 employees. They incentivize businesses to stay small, leaving workers with few rights. The government so far has tweaked only a few minor labor laws, and it’s unclear when they will push for more changes.

While Jaitley this year is again struggling to raise revenue, he’s confident he’ll hit his deficit target of 3.9 percent of GDP without slashing funds for roads, bridges and ports. Shortfalls in direct taxes and state assets sales will be compensated by higher-than-expected indirect taxes -- including payments on services and exports.

Jaitley’s support for the informal sector is "practical and pragmatic" as there’s a trade-off between tax revenues that the government can spend and leaving more cash in the hands of the consumer, according to Anand Rathi Financial Services Ltd.

"The cost of collecting the last rupee from the informal sector in terms of tax isn’t cost efficient as earnings are low," economist Sujan Hajra said by phone from Mumbai. "Instead, you derive an indirect benefit by not taxing them in terms of the consumption push."

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