Monday, November 28, 2016

Ten ways to save demonetisation and stop the economy from choking

After almost three weeks of demonetisation, there is visible pain in the lives of ordinary people, a noticeable slowdown in economic activity, and reports of job losses in many sectors. The economy may contract by as much as two percentage points over the next two quarters — a colossal loss in national wealth. However, there can be no rollback. The gains from a cleaner, whiter economy are far bigger in the long run. Here’s how Narendra Modi can save demonetisation.

1) Speed is of the essence. Don’t depend only on our own printing presses to replenish the cash; subcontract the currency presses of friendly governments whose security levels are unimpeachable. Fly in the new notes and flood the system. The priority is to restore liquidity in the market so people can get on with their lives.

2) Extend the income disclosure scheme. True, the last amnesty scheme was only a modest success, but after the stick recently wielded by Modi, a little carrot might work better now. Demonetisation has given rise to new currency brokers who are converting the old notes at 30 to 40% discount. Since government is threatening more action against black money such as scrutiny of benami land titles, people will be more inclined to convert their black to white via an amnesty scheme — say at a 50% tax rate rather than the 60% it is considering — rather than convert old black money to new black money via a broker.

Some may opt to disclose their black money as ‘current income’ and get away by legally paying around 35% tax; this too should be welcomed. Another alternative is to offer low-yielding, long-term bonds that would convert black to white; the government would gain by getting money cheaply. The purpose is to diminish the fear in the most productive groups in society that create most of the jobs. Don’t demonize them: this is not a dharmayuddha. The objective is to change old, ingrained habits for the betterment of society.

3) End harassment. Law-abiding citizens will happily pay tax if they believe they will be respectfully treated by income-tax officials. People need to be reassured that they can file returns online today; pay tax online; and get refund online. The computer decides, not the ITO, which returns are to be scrutinized. Modi needs to mount a major campaign to reassure people about this reduction in official discretion. He needs to also severely punish any tax official caught harassing a taxpayer.

4) Put black to use. Offer a significant fiscal stimulus to the economy from the notes not likely to be exchanged, black money that will disappear forever. Spending this non-inflationary money — an estimated Rs 3 lakh crore — on infrastructure and housing can create masses of jobs and mitigate some of the jobs lost in demonetisation.

5) Focus on real estate. Demonetisation will not stop the corruption that creates black money. For this you have to attack its underlying sources. In real estate, every step is mired in corruption — from buying land to getting approvals. Black money is also the result of excessive stamp duty. For this reason, Vijay Kelkar had recommended merging stamp duty into GST in his pioneering report on GST. That may be too late but we must keeping fighting for sensible taxes and clean titles in land.

6) Roll back the customs duty on gold. Smuggling of gold declined in India when import restrictions were lifted after 1991. A decent white business developed in gold and jewellery. In 2013, there was a setback when customs duty on gold was reintroduced. Cash payments became common again because smuggled gold was cheaper.

7) Reform the silly curbs on legitimate election donations to candidates. This has led to the use of black money in elections. I do not favour state funding, where my hard-earned taxes would finance candidates and family dynasties I despise. Instead we should follow the best practices in the US and Europe in funding elections.

8) Reform the bureaucracy. Black money is generated because of administrative discretion. A good place to begin reform is to implement Justice Srikrishna’s draft Indian Financial Code.

9) Do not attempt to end black money. People should not break the law but we should overlook small transgressions, just like we ignore pedestrians who cross on a red light. Cash lubricates the system and a cashless society is the road to dictatorship.
10) Don’t touch the aam aadmi’s tender. Finally, the next time you want to demonetise, flood the market first with 5,000 and 10,000-rupee notes; once the black money has moved up to these higher notes, demonetise only the Rs 5,000 and Rs 10,000 notes. Spare the aam aadmi.

Sunday, November 13, 2016

When netas see votes in clean air, they’ll cut through the smog

Two apparently unrelated events occured in Delhi in the past few days. In the first, Narendra Modi made a tough, risky move — one of the riskiest in his career — against the long-festering problem of black money. In the second, Arvind Kejriwal was seen floundering as he tried to cope with Delhi’s foul air. What connects the two events is the stark contrast between the decisive action in the case of black money and a sense of helplessness in response to pollution. The dissimilar behaviours of the two politicans are explained by the Theory of Public Choice, enunciated by the American economist, James Buchanan, which won him the Nobel Prize in 1986.

At some point in his political career, Modi realised that there are votes in fighting against black money. He made an election promise, and after a series of other steps, he acted last Tuesday to withdraw high-value notes from the market. It was a risky move. It would bring huge pain to the aam aadmi before it brought gains to the economy. It would disrupt trade, slow down business activity in real estate, the largest employer in the nation. It would alienate the political establishment, including his own party, diminishing their ability to fight the next election. But if Modi manages to contain these risks, he would deal a body blow to black money, tipping India towards a clean, white economy. And in the 2019 election he might even be rewarded for it.

Arvind Kejriwal has been unable to see the electoral possibilities in providing clean, healthy air. He lost an opportunity two years ago when World Health Organisation declared Delhi as the world’s most polluted city. There was panic at the time with an upsurge in respiratory complaints; tourists cancelled bookings and diplomats refused to accept postings to India. But Kejriwal frittered away that political moment. Perhaps, he thought that his core constituency of migrant poor was indifferent to pollution. Or he was daunted by the challenge. After all, there is no single pollutant in this case. Road dust, construction, waste burning, vehicle emission, diesel generators, power plants — all these factors play a role. Then there are nasty jurisdiction problems with multiple agencies to cope with. Even the Supreme Court had not succeeded. In the end, he probably concluded that it was wiser to focus his resources on priorities that had a better chance of accomplishment.

Buchanan’s concept of Public Choice throws light on Kejriwal’s dilemma. Many of us are familiar with market failures, but few know about his systematic theory of government failure. We tend to have a romantic view of public officials, believing that they act altruistically in the public interest. Public Choice teaches that politicians and civil servants are just as self-interested as you and I, and they look out primarily for themselves. While Modi and Kejriwal may feel passionately about the common good, their driving force is their own interest — their re-election to begin with.

The key is how do we channel the self-interest of politicians and officials to our desire for clean air? Generally, ministers in a vast democracy operate under the influence of vested interests that are generous in their contributions to the minister’s election campaign. A small lobbying group with a narrow focus always has this advantage over dispersed and disorganised individuals who want clean air but have no voice. How can these individuals come together and persuade their politicians that there are votes in clean air?

One doesn’t know if Modi will succeed in fighting black money. Demonetisation is only one step in a prolonged campaign. But the lesson for those who want clean air is to bring public pressure on politicians so that the subject gets on the national agenda. It is not Delhi’s problem alone, and it not fair to dump it all on Kejriwal. Many Indian cities face this problem. Narendra Modi will have to get involved. It will also not be easy to raise consciousness because of political apathy.

The air improved slightly last week and the subject quickly disappeared from the media and the public imagination. However, the winter is upon us and Delhi’s air will soon become foul, and people will again begin to scream. Success will depend on institutionalising individual screams into a collective scream in order to awaken the political class to the possibility of votes in cleaning up the air.