Department of Economics, Delhi School of Economics, University of Delhi

On Black Money
Author(s): K. SUNDARAM and V. PANDIT
Source: Indian Economic Review, New Series, Vol. 11, No. 2 (OCTOBER 1976), pp. 121-132
Published by: Department of Economics, Delhi School of Economics, University of Delhi
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g. 1. In some discussions black income is defined in a more restricted way as the quantum revenue evaded. 23 Nov 2016 13:43:29 UTC All use subject to . One could also define black wealth symmetrically with the definition ol black income as that part of wealth which is not revealed for the corresponding set of taxes (e.On Black Money* K. wealth tax.. Pattanaik for extremely useful discussions.157 on Wed. wealth. B.e. in which is earned in the process of evading indirect taxes and/or the part of inco however earned. K. S.208. arises from the cumulation of the savings out of black inco ♦The authors are grateful to Prasanta K. PANDIT Delhi School of Economics. Inevitably. A basic source of confusion in many analyses of the problem is the failure to tinguish between stocks and flows. a stock. 2. The purpose of this paper is to provide an analysis. This content downloaded from 117. by virtue of the fact that such wealth would be concealed for the corresponding set of taxes as well. Das and an an ous referee are gratefully acknowledged. giving rise to the problems of w India has come to be known as black money. With this more general definition.). K. estate duty. Krishna. L. the use of our definition would not lead to any serious understatement of the extent of black wealth. While our judgements are largely conditioned b Indian èxperience.jstor. However. has been a common feature of fiscal scene of many of the developing countries outside the communist blo [9]. This is not very surprising in a situation where the average and the ma tax rates have had to be raised sharply over a short span of time to through plans for accelerated development. The usual disclaimers apply. we are hopeful that this analysis would be of relevance experience of other developing countries also. stamp duty etc. SUNDARAM and V. it may be easier to estimate the extent of black wealth by following our definition. University of Delhi. Gupta. There is the flow of black income. which is not declared for direct taxes. savings. R. Delhi Evasion of direct as well as indirect taxes. a number of empirical judgements have to be made i course of such an analysis. It also considers the major policy consequences that follow from analysis. investment and the price have been analysed systematically. i. insofar as difficulties of tax accountability do limit the magni- tudes of white savings going into black wealth. but also parts of wealth the full value of which is not declared for tax purpose but acquired out of regular or 'white' savings would also be covered. Com on an earlier draft by Elizabeth Krishna. operationally. Despite the attention that 'black money' has received in recent discussion India. Also.205.1 On the other hand. not only would the wealth accumulated from black savings be covered. neither the concepts relating to it nor its linkages with other mac economic variables such as consumption.

can only be reduced over time through changes in the structure of the economy.208. SUNDARAM AND V.122 K.157 on Wed. the tax function. 4.4 3.205. by itself. Generation of Black Income Typically. for simplicity. P' (X) > 0. 23 Nov 2016 13:43:29 UTC All use subject to http://about. as such. such as the high marginal tax rates. cannot. the penalty function applicable in the event of detection of tax evasion. such as the tax structure. on the basis of Srinivasan's analysis [8]. and that tt is independent of Y. T" (Y)> 0. Using his notation. (1 . Now X* is obtained by setting d Ajfk = 0 ===> 7t[P(x*) + x*P'(x»)] = y + (i . It should be clear that we are talking of 'infeasibility' in the sense of extra efforts at tax collection at given levels of administrative efficiency not being cost effective.X») r} =o Now. X the proportion of income not declared and P (X) the penalty rate.7t) rr'{(i . And several elements. assume that r' ( Y) = ß Y. a shift in the 'efficiency' parameter would alter the extent of such 'structural' black income. The amount of black income in this category should be recognised as being struc- turally determined and. PANDIT As we shall see. Therefore. ß > 0. taking as given the characteristics of income flows in the economy. also fall in this category. at least in part. be held responsible for the extent of tax evasion in an . Srinivasan shows that a unique X* exists in the interior of (0. this distinction plays a crucial role in money. However. the tight- ness of tax administration governing the probability of detection. Assuming that P (0) = 0. => it [P (X*) + X*P' (X*)] = (1 . the optimal extent of the tax evasion (from the tax payer's point of view) increases with an increase in the marginal tax rates and vice versa. T (Y). we find that in most UDCs which have a sizeable private sector a not insignificant part of black income arises from the infeasibility of enforcing direct and indirect taxes in a significant part of the economy comprising of a large number of household enterprises. it can be shown that. any one of these elements. the maximand is: ^(y)=«[y-r(y)-xp(x) y] + (i-7t)[r-:r{(i-x) y}] where Y is income. V (0) = 0.jstor. 1) such as to maximise A(Y). Of course. assume that the individual is choosing the proportion oí income not disclosed for tax so as to maximise the expected 'after-tax after penalty' income. 1). the characteristics of the fiscal environment and of the income flows govern the extent of tax evasion. together deter- mine the fiscal environment.X») Y This content downloaded from 117. P • (X) > 0 for all Xs (0. Following Snnivasan.3 Incomes from specialised services such as those of doctors and lawyers. n the probability of detection. Clearly. Tf {Y)> 0.

and possibly cannot be. However. the first example raises the basic question whether it would not be better to subsidise the poor directly by a cash subsidy rather than by allotting them a quota of specific commodities at premium exclusive prices. say. the former may well be a welfare raising situation. Bhagwati and Padma Desai [1]. Since th stringent restrictions on their transfe them obviously cannot be disclosed fo II.__ w => V= K 1 _ X* where (1 . This content downloaded from 117. 7.6 and in the process of acquiring authorities allotting quotas. of a wide ranging regime of qu intermediate and final goods. contains a lucid discussion of price controls on intermediate products in a situation where the prices of the final products using them are . ration sugar by the poorer class of people is not the same as that involving. Wanchoo Comm for 1968-69.jstor. the diversion of quota steel by contractors.205. in the context of black income they are symmetrical. K. controlled [3]. The fact that the tax has been evaded on the black income implies erosion of the progressi- vity of the tax structure and consequently a greater degree of inequality. ON BLACK MONEY 123 One important source of black incom have opted for planning as a means to mies.A • (1 . X*) [2 P' (X*) + y. To the extent that the ta + t. Incidentally. N. 23 Nov 2016 13:43:29 UTC All use subject to http://about.7 In India. of which Prof. The Report of the Committee on Steel Control. especially in the sphere of foreign trade. Consumption.157 on Wed. In India goods ranging from foreign exchange bricks are subject to price controls and of whether and to what extent these c the objectives supposedly underlying th the control prices in force is the exist and the market clearing prices. Savings. 6. Raj was the Chair- man. say.*P => op/OA . and In One immediate consequence of black i Government. It is th black income arising in the process of mium exclusive prices to those users w prices. Also see Arun Shourie [6].X*)8 3 X*/0ß > 0 5. see J.208. For a penetrating and detailed analysis of the functioning of these controls in India. It is possible that the welfare significance of such a transaction involving the sale of.

bank depos bonds. is unlikely any significant part of black savings. At the lower levels. However. The r of assets in which savings from black income can be the higher levels of income. o ence: for the individual saver. the asset forms that black savin far more restricted than can savings out of 'white' . Even if paid out of savings.157 on Wed. such supplements to lo the character of a redistribution in favour of lower in the proportion of income consumed on average. by showing high savings out of regular ' the like . There is.. has an ad possibilities. where typ form bribery and corruption. The pattern of consumption (out of bla to be biased in favour of glamorous consumer goo effects on two counts: (z) via its demonstration effect on in the rest of the economy. Savings out of black income like those out of 'white' income h ed by a corresponding flow of investment. In p tent to which such savings can take 'visible' forms . It is possible that a part of the black savings is utilised for investm equipment. We recognise that to a certain extent black savings can take these visib accounts in the name of minors. at the higher levels. Partly for this reason. One possible way in which this can happen is throu ment of the value of equipment with the difference between the eq price and the declared value being paid out of black savings. tend to be higher. it lowers the savings rate. 'white' incomes.and as such it may not be a binding constraint in the case of pients at the lower levels. the p sumed will.jstor. PANDIT consumption. since it uses could have been used for capital formation. on the average. real ca 8. . 124 K. SUNDARAM AND V. there is a loss in aggregate savings with the rate of growth. our judgement traint on the asset forms is likely to be binding. an of production tends to divert scarce resources away f uses. the l the loss of direct control over the use of such savings In the presence of black incomes which can be view varying proportions) regular. irrespective of its pattern. make for a larger proportion ed rather than saved. The consumption. It a if the equipment in question is imported from abroad under l Government or is domestically produced by large undertaking public or in the private sector translation of black savings into through understatement of the value of equipment etc. This content downloaded from 117. and shares of public companies severely restric obvious forms of holding black savings would be cash. and inventories of goods. gold an metals and stones. 23 Nov 2016 13:43:29 UTC All use subject to http://about. however.

Nor would smuggled-in p unorganised sector account for a signifi fore. This content downloaded from 117. black savings us inflationary. a major part of black savings woul or as addition to the stock of currency of black savings held as currency. shares etc.157 on Wed. 9.jstor. Go quences finance additional real invest Equally. gold and other pre absolute liquidity). the black savings held in the real investments in the 'white' sector In an inflationary situation. by entirety constitute a leakage. a s mere transfers within the economy. silver etc. improvements in land or construc transfers.208.205. ON BLACK MONEY 125 out of black savings would tend to be using non-standardised equipment pr themselves may be in the unorganise black savings give rise to a further f Apart from cash. It should be clear that it is the net additio savings and as such only this part can legiti of the term rather than the entire volume mulation. It is possible that the capital gains arising for tax purposes and thus adding to the fl 10. taken together.9 In our view. arisin significant.). the additions to the stock Government bonds. . 23 Nov 2016 13:43:29 UTC All use subject to http://about. ar the asset portfolio of persons with bl the price of gold. there wou stocks of inventories over and above t asset choice available to holders of bla tunity cost of holding inventories is black savings is likely to be held in th savings held as cash. and gives r stones there will be a leakage from bla ponding to the value of gold and othe a part of the black savings is not avai It should be emphasised that when a black savings 'invested' in gold etc.

This content downloaded from 117.208.205. 23 Nov 2016 13:43:29 UTC All use subject to http://about. i tisation.157 on Wed. This measure is intended to part of black liquidity (on the presumption that holder would prefer to present only a small part of their curren sion).jstor. . It must be emphasised that pub context because holders of black liquidity cannot afford assets and as such it ought to be distinguished from a fa not to build up inventories) arising from a wrong choice put it differently. In any event. Nor can the ho persuaded to switch out of inventories into visible financ ing the cost of credit or by raising the returns on asset and Government bonds. thereby reducing the speculative demand for scar feasible to demonetise currencies of all denominations.126 K.11 gold and silver ed as black liquidity. attempts at restrai through credit rationing cannot succeed. one of th is currency demonetisation. this po down the price rise. black liquidity poses an institutional prob IV. The fact that black wealth gets indefinitely accumulated as cash ment's permissive policy with respect to money supply in that put a limit on the total stock of black wealth that can be held as c any addition to holdings of cash will have to be matched by a red of inventories or in the stock of other assets. The majo from the vast quantity of liquidity which comes into being over time of black savings held as cash. Thus. to the extent t the form of gold and other precious metals and stones. The crux of the problem is that thi any monetary/fiscal policy and that it can move around unpredictable excess demand in several vulnerable sectors to the existence of this vast liquidity. it is not so much the flow of black savings in which is the most serious threat to price stability. PANDIT m. SUNDARAM AND V. t turns on the extent to which black liquidity is in the sh denominations to be demonetised. insofar as the measure is anticipated conversion of currency in the relevant denominations tak 11. The Problem of Black Liquidity However. Some Policy Issues (a) Demonetisation Turning now to the policy aspects of the problem.

208. (b) Tax Reforms As regards reforms in the tax structure and tax administration.12 Since a m will be into gold and other precious m apart from currency of smaller denom be preceded by a complete ban on all Demonetisation. insofar as demonetisatio in liquidation of inventory holdings o inventories from the holders of black w a slackening in the rate of inflation. the tax rates should be reduced or not. if demonetisation is anticipated by everybody. In our view. the currency of the relevant deno- minations will be convertible only at a discount and to that extent the measure could be successful. 12. efforts to enforce them must be pushed to the point where additional expenses on enforcement are just matched by the additional tax revenue plus penalty. Before turning to proposals for reduction in marginal tax rates aimed at reducing tax evasion. Singh [7] has shown how the change in the penalty function relating it to the tax evaded rather than the income concealed suggested by the Wanchoo Committee [3] is likely to be less effective than a penalty function. T the Government's anti-inflationary p are expected to cause a reversal in the regard to future prices and thereby sl such . related to concealed income. which is primarily also have an impact on the flow of bla of black wealth come within the purv presenting demonetised currency for holders of black wealth are unlikely to part of their currency holdings for conv sure to which demonetisation succeeds it would fail in curbing the flow of bl Nevertheless. element in the inflationary process. 23 Nov 2016 13:43:29 UTC All use subject to http://about. given efficient enforcement. brought about by demon in favour of the measure.157 on Wed. This content downloaded from 117. The question therefore should not be one of better enforcement versus a reduction in marginal taxes but whether. ON BLACK MONEY 127 measure is further eroded. as is currently in operation in India.205. the exp held by the mass of consumers have. However. It expectations. it must be emphasised that whatever be the tax rates.

128 K.e. For simplicity. Whether the duced by the reduction in the marginal tax rates. Suppose.m + k (1+0)F m (1 + ®)Y m-k 13. accruing to nx and n2 individuals respectively. PANDIT In considering proposals for reduction in marginal t total tax revenue and on the distribution of after-ta inter-related issues to be kept in view. SUNDARAM AND V. i. while Dasgupta [2] may be right in his tion in the marginal tax rates from 95 % to 77 %. one can assert that the chances of an ov are higher with a reduction in the marginal tax rate groups than with a uniform reduction in marginal t slabs. 23 Nov 2016 13:43:29 UTC All use subject to http://about. Consider a simple situation in which there are two income levels. assume further that people make an 'all or nothing' choice about the extent of concealment. ev nal tax rates. the exemption limit is Y so that the marginal tax rates appliable to the income levels are 0 and t (say).t)]Y n2-m [1+0(1.208. e groups. we have three income distributions as follows : After-tax income with After-tax income with Pre-tax income marginal tax rate t marginal tax rate ť Income Frequency Income Frequency Income Frequency Y «i Y nx Y nx y(l +0) n2 [1 + 0 (1 . and the resultant increase in the tax reven in tax revenues from the previously honest tax payers o of empirical judgement. This content downloaded from 117.13 However if. it does not as proposed in the 1976-77 Budget will also not redu context. prop would not reduce the extent of tax evasion.205.157 on Wed. Suppose next that the marginal tax rate is reduced to ť and let the number of tax evaders in the new tax situation be m . Now. is suggestive.k. It is worth noting here that when the marginal tax extent of tax evasion may not be sensitive to small redu ble that the extent of tax evasion does respond to a mor tax rates. we present below a sim- plified model showing the relationship between the effect (of a reduction in the marginal tax rate) on tax revenues and thus on the extent of inequality in the dis- tribution of after-tax incomes. and possibly cannot. where m^k ^ 0. . as is likely to tion of the prospective assessees in the lower and m salaried persons who do not. the honest tax payer reveals his entire income whereas the evader conceals his entire income. Thus.jstor. the success of the recent Voluntary Disclos set at 66%. let m be the number of tax evaders ( m < n2 ) in this tax situation. Y and 7(1+0) where © > 0. Turning now to the distribution of after-tax incomes.V)'Y n2 .

see Sen [5]. This content downloaded from 117. G' = n .1 n + «20 . since it is the number of honest tax payers when the marginal tax rate is ť. H > 0 if [kť .nln2 . and A'= n + n2 © . the second term on the right hand side in the expres- sion for H is non-negative. 23 Nov 2016 13:43:29 UTC All use subject to http://about. For a lucid discussion of the welfare significance of the Gini-coefficient as a measure of inequality. So that.(m .(n2 -m) 0/ and G. A and A' are both .(«2 .1 A • A' where # = [kť .m + k) © ť. a necessary and sufficient condition for G> G' is that H is positive.m) © t.(t .(n2 .(n2 . Since A Y and AT are the total after-tax incomes in the two tax situations.ť) («2 . ON BLACK MONEY 129 Let us compare the inequality in th to the Gini-coefficient.14 If we denote with the two after-tax distribution a straightforward calculation shows Gr 0 nxn2 + (nm .k) .m (n + n2 ©)] +kť- A = n + n2 © .m)] [nnt .208.1 n + n2 & .m(n+n2&)' > 0.ť) {n2 . = © n1n2 + [n(m .m + k) Qť where n = n1 + n2..jstor.m)] 'nrii .m + k ^ 0.157 on Wed. since © is assumed to be a positive number. Now. Therefore.(t. n2. the sign of G .205.G' depends entirely on that of H.kf]ť n . Also.w2)' = n . From this it can be shown that G . Let T and T' denote the tax revenue corresponding to t and t' then it can be seen that 14. In other words.

a reversal. and m < . alternative sets of sufficient conditi (a) T' > T. It is. T'-T ^ 0 « Therefore. It has to be noted that in each case we have by construction of the problem n2^ k . Thus. m > m*9 is possible. expected that in India m <m Further.T and n2 .0. evasion is also high. the distribution of the after-tax income will improve if th 15. i. and k > 0. therefore. when the m t9 is less than the proportion of national income that accrues from income tax.208.205.T = [kť . SUNDARAM AND V.e.jstor. PANDIT T' . in a country where a large proportion of the population is liabl income share of the tax exempt (poorest) group might be very small.157 on . it will not be unreasonable to assume that n2 . n±y is the total income of the group exempted from ta is the total pre-tax income. This is likely to be true of all developing countries with a low covera ever. in the fr model..-L. So that. 23 Nov 2016 13:43:29 UTC All use subject to http://about.m > least one honest tax payer in the tax situation t.m > 0 or * (c) T' <T and m > m or (d) m = m*.< "1 = ni y n n+n2Ç> ( n + n2®)y Now. = m* (say «+«20 or (b) T' . To interpret these conditions note that m <m* ==> . This content downloaded from 117.m)] 0 Y. m > m*. 130 K. So that. m < m* amounts to the co proportion of tax evaders in the total population.(t-ť) (n2 . A special case of (c) would arise if k .

jstor. n2-m ť k The analogy with a price elasticity is easily seen. This content downloaded from 117. the Government is enabled to pursue more vigorously its policies directed to growth and/or a better dis- tribution via outright transfers. . 23 Nov 2016 13:43:29 UTC All use subject to http://about. tax enforcement must be pushed to the point where the additions to revenue and penalty are just matched by the additional administrative costs.208. (iii) in the event of a reduction in the tax rates leaving the tax revenue unchanged or increasing the same. the all or nothing choice about evasion . We wish to emphasise that our model. in the framework of our model t . is the case which Dasgupta [2] has in view when he compares the two after-tax distributions among the set of honest tax payers. ON BLACK MONEY 131 increases or at the least remains unch noted above. which.157 on Wed. In case there are no tax evaders even in the initial situation so that m = 0 and therefore k = 0. possibly. To summarise.205. under certain conditions the effect of such a reduction on the distribution of after-tax incomes is also favourable. may prove restrictive from the point of view of generali- sability of our results. 16. leave it unchanged. it can be readily seen that G < G' and T ' < T. Since each set of the conditions above is onl G> G* even if any of the set of these conditio exceed G' even if T' < T and m <m*. (ii) the acceptability of proposals for a reduction in the marginal tax rates is critically dependent on whether it results in a sufficient reduction in the extent of tax evasion so as to increase the total tax revenue or. is a highly simpli- fied one in many ways. This.ť is also the proportionate change in the assessed income. See footnote 16.17 In this context. it should be noted that if the tax revenues increase. And ť portionate reduction in the tax rate. in the least.T >0 as k > ' ~ ť . from which these results follow. 17. And the specifications in respect of the structure of groups. becomes intuitively clear in T . the conclusions from our discussion of tax reforms are: (i) irrespective of the structure of tax rates. For l%2 Wî increase in the number of honest tax payers.

London. For instance. 1973. Baltim 1965. K. Delhi. Journal of Public Economics . Desai. Oxford University Press. K. this step would ensure an efficient all It should be emphasised that even if the price mar machinery tightened. J. so that t their market clearing prices. Milton. 1963. [2] Dasgupta. In such a situation. D 1971. In ad significantly. Delhi.. [8] Srinivasan. Planning for Industrialization : Industrialization and Tr Policies since 1951 . A. "Tax Concession as a Remedy for Evasion". An important case in point would be the price c mediate products like steel and cement. T. say. excise duties facilities. Econom and Political Weekly . Ministry of Steel and Heavy Industries. 1973. August. In of controls converts black incomes into 'white'. Direct Taxes Enquiry Committee.jstor. there would continue to be a accruing due to the infeasibility of enforcing tax law It is. 1973. in a situ price of the final products are infeasible.132 K. clearly the solu vast majority of detailed controls which are often de ale. Final Report . Special Number. [7] Singh. [4] India.. "Making Honesty the Best Policy". SUNDARAM AND V. and P. [3] India. This content downloaded from 117.157 on . London. The Johns Hopkins Press. Economic and Political Week June 1. Ministry of Finance. 1970.205. 19 [9] Taylor. On Economic Inequality . PANDIT (c) Rationalisation of Controls We have seen earlier how black incomes arise under titative controls. Journal of Public Economics . [5] Sen.. essential that efforts be made to keep th to the minimum. 23 Nov 2016 13:43:29 UTC All use subject to http://about. November. Report of the Committee on Steel C trol ... For. allowing the prices of i their equilibrium levels would merely divert the unearn intermediaries to the producers of the intermediate the producers of these goods are in the organised s to bring the additional profits within the tax net.208. A. References [1] Bhagwati. India.. 1974. Oxford University Press. [6] Shourie. C. B. N. if and to the extent that credit and/or physical inputs from the Government to coordinate the enforcement of. A. however. Fiscal Survey of Columbia. "Tax Evasion: A Model".. July. "Control and the Current Situation: Why Not Let the Hounds Run? . et al.