Campaign donations are one source.

Where to Find India's Black Money

Dhiraj Nayyar is a journalist in New Delhi. Trained as an economist, he has worked at the Financial Express, India Today and Firstpost.com. He is editor of "Surviving the Storm: India and the Global Financial Crisis."
Read More.
a | A

Like all politicians, Narendra Modi promised more than he could deliver while campaigning to become India's prime minister. Critics are now making him pay. Earlier this week, a furor erupted after Modi acknowledged a setback in efforts to recover the billions in illicit, untaxed "black money" stashed abroad in foreign bank accounts. After lambasting the previous Congress-led government for failing to make public a list of Indian account holders in Liechtenstein's LGT Bank, he admitted he couldn't do so either because of confidentiality requirements in an existing agreement with Germany.

While Modi's promise was foolish, the black-money campaign is more so. Not only is identifying the holders of those overseas accounts going to be harder than the prime minister imagined. The fact remains that the real mountain of illicit cash is sitting at home in India, not in some Swiss bank.

There is no official estimate of the size of India's parallel economy. Unofficial calculations, such as one by the Washington-based think tank Global Financial Integrity, estimate that $460 billion has been stashed in foreign bank accounts, equivalent to around a quarter of India's gross domestic product. But that is a one-time stock figure calculated over a 60-year period between 1947 and 2008. India's annual GDP is a flow. And by some estimates, including leaked reports of a study commissioned by the government, an amount equal to 70 percent of India's $2 trillion GDP -- about $1.4 trillion -- is hiding out in India itself.

Of course, as long as that money is spent or invested at home rather than hidden abroad, it boosts economic activity and so doesn't represent a deadweight loss for the economy. But it does impose a cost on the government in terms of lost tax revenues -- something the exchequer can ill afford given its persistent fiscal deficit and huge spending needs. At India's current tax-to-GDP ratio of just over 10 percent, an additional $1.4 trillion of GDP would yield taxes worth $140 billion. That would wipe out the deficit -- currently around $100 billion.

If he really wants to eliminate the pool of black money, Modi could adopt three obvious policy measures without running afoul of bank secrecy laws or foreign governments. Each would address one of the root causes of the problem: campaign finance, real estate and tax law.

First, Modi should fight to require all political parties to declare the source of any donation more than a rupee. This might sound ludicrously low, but in India, which has neither public financing for campaigns nor effective campaign finance laws, the need for political funds is one of the main drivers of official corruption. Current regulations require parties to name donors for any amounts over Rs. 20,000, or about $300. Curiously, most parties claim that over 80 percent of their donations are made in increments less than that.

Second, the government must close the gap between so-called circle rates for property -- the minimum valuation set by the government -- and market rates. Transactions are usually listed at the former, while the actual sale price is much higher; the difference is invisible to tax authorities. In a market economy, there's no need for the government to set an official price for real estate at all. There should be only one -- taxable -- market rate.

Third, Modi must fulfill his promise to implement a long-overdue goods and services tax (GST). He's set a deadline of six months from now to roll out the measure. How the tax is finally implemented matters greatly. Crucially, the government must ensure that no goods or services receive exemptions and that the rate is reasonably low, cutting out avenues and incentives for evasion.

Presumably, even the black money stashed abroad has to be generated in India. Better that Modi bring it out of the shadows here, before it has a chance to flee beyond the government's reach.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Dhiraj Nayyar at dhiraj.nayyar@gmail.com

To contact the editor on this story:
Nisid Hajari at nhajari@bloomberg.net