Convertibility of Black Money: Indian Case

Topics: Underground economy, Money laundering, Tax evasion Pages: 8 (2280 words) Published: September 3, 2008
1. What is black money?
Black money is essentially the currency used in ‘black economy’. Black, shadow, underground, unobserved, unofficial, subterranean, unrecorded, informal, irregular, second, twilight, parallel – are all the synonyms used for the ‘shadow economy’. The shadow economy basically consists of legal and illegal activities outside the reach of the government. Smith (1985, p.18) provides a very broad definition of the shadow economy as ‘market based production of goods and services, whether legal or illegal, that escape detection in the official estimates of GDP’. Table 1 gives a better view of what a reasonable definition of underground economy includes. Underground economic activities are all illegal actions that fit the characteristics of classical crime transactions like burglary, robbery, drug dealing, etc.

Informal household economy consists of household enterprises that (1) are small in terms of persons engaged, and
(2) are not registered officially under various specific forms of national legislation.

2. Why is there a shadow economy?
The growth of the underground economy is associated with various factors, such as rise in taxes and social security burdens, intensity of regulations in the official economy, especially the labour markets including forced reduction of weekly working time, early retirement, prohibition of not working at more than one office for government officials etc. Apart from economic factors certain non-economic factors also lead to the expansion of the underground economy such as unwillingness to show the accurate income etc. According to Schneider and Enste (2000) micro- sociological and psychological approaches provide interesting insights in the decision-making process of individuals choosing to work underground. For example, the decline of civic virtue and loyalty towards public institutions and decline in tax morale of the people. Burden of Tax and Social Security Contributions

The most important determinant of the increase of the underground economy is the rise in tax and social security burdens [ Tanzi (1982, 1999)]. As a result of increase in tax rates people generally get involved in those activities where they can earn more and pay as less taxes as possible. Schneider and Enste (2000) state that bigger the difference between the total cost of labour in the official economy and after tax earnings (from work), greater the incentive to avoid this difference and work in the underground economy. Since this difference depends broadly on the social security system and the overall tax burden, therefore, these are the key features of the existence and rise of the underground economy. Loayza (1996) estimates the size of the informal sector in fourteen Latin American countries and finds that tax burden and labour market restrictions increase the underground economy activity, while the strength and efficiency of government institutions reduces the underground economy. Schneider and Neck (1993) emphasize the complexity of taxation system. A complex tax schedule allows more legal tax avoidance by providing various tax exemptions and reductions. Intensity of Regulations

Regulatory frameworks are generally designed to get control over certain things. Increasing the number of regulations for any market is not a good policy to adopt; more regulations mean more restrictions which lead to increased labour costs in the official economy. Since most of these costs can be shifted onto employees, it reduces individuals’ choices to work in the official economy. As a result, they would work in the informal/unofficial sector, which thus leads to more tax evasion and increase in the underground economy. Intensity of regulation is often measured by the number of laws and requirements such as licenses, and various other labour laws, e.g., labour restrictions for foreigners, price controls and trade barriers. Friedman (1999) showed that more regulations are correlated with larger underground...
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