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Demonetization and Dwindling Tax Collections Records

The Indian economy has completed two years after Rs. 500 and Rs. 1000 notes were stripped of legal tender by the Government of India (GOI) on 8th November, 2016. The stripping of legal tender from the currencies is termed as  demonetization in a fiat money world. It was a historic and unparalleled given any such events historically in the entire world. Such act of removal of legal tender from Rs. 500 and Rs. 1000 notes left 86% of cash in India not worth to function as medium of exchange leading to massive chaos across cities and in the formal and informal sectors of the economy which are primarily dependent upon the cash transactions. The longer ques in front of banks branches and ATMs were routine observations causing not only harm and pain to the people’s health but also leading to the huge waste of productive man hours and therefore direct and indirect loss of potential GDP. Leading credit rating agencies and research agencies predicted the negative effect of demonitization on India’s GDP. The RBI’s 561st meeting held hurriedly on 8th November, 2016 to approve the act, though called it a bold step but warned in its minutes the short-term negative effect on the GDP and also recorded that such step will not be able to curb the black economy, as major black money is stored in the form of gold and real estate.

One of the arguments extended in favour of demonetization said that it will bring more tax revenues to the government as many wealthy but tax evading people will be caught in the process of conversions of stashed black cash in the form of erstwhile Rs. 500 and Rs. 1000 notes. Question arises whether such a hard-hitting approach really yielded the historical generation of tax revenues as it was claimed by the Government of India to build India’s developmental path parallel to the developed nations. Many media analysis have shown that tax base has increased by close to 10 million rise of tax filers after the demonetization and that has been considered one of the greatest achievement of the current government. But does that show the matching and historically unprecedented gains in the collection of tax revenues during the period of post-demonetization? The available data clearly deny that. There might be the highest growth rate of tax-filers but that does not guarantee the rise of tax revenues, which ultimately matters for economic progress. The growth rate of tax revenues (centre and state together) is a credible variable to reflect upon whether there was unprecedented buoyancy of tax collection.

For the period between 2014-15 and 2018-19, which is the NDA-2 period, the average growth rate total tax collection has been at 13.63 percent per annum. The financial year-2017-18, following the demonetization has witnessed only 14.92 percent growth rate of total tax collection. If it is compared to the average annual growth rate of total tax collection during the UPA-I and UPA-II, the performance of UPA-I and UPA-II overshadows the performance of the current government even though the later took the so called historic decision. The average annual growth rate of total tax collection was 18 percent between 2004-05 and 2008-09 with highest growth rate of 25.57 percent in 2006-07. Further during the period of 2009-10 to 20013-14 the average annual growth rate of total tax collection has been at 15.01 percent with highest in 2012-13 at 17 percent. This clearly shows that demonetization has failed to yield any unprecedented positive tax gain to the Government of India.

Even if we bifurcate the total tax collections into direct and indirect tax collections to assess that to what extent the rise of 10 million new tax payers has yielded to the tax revenue of the government of India, we will be still disappointed as far as achieving the objective of demonetization to raise tax collection is concerned. The average annual growth rate of direct tax collection during 2014-15 to 2018-19 has been 12.40 percent. While the period of UPA-I from 2004-05 to 2008-09 witnessed average annual growth rate of direct tax collection at 25.18 percent and the period of UPA-II from 2009-10 to 2013-14 witnessed 14 percent. This data bellies the claim that demonetization was the only way to improve the tax compliance and tax revenues to build the nation as the UPA-I and UPA-II achieve much better tax revenue performance without adopting any measure like demonetization.

Even with regard to the indirect tax collection the figures of average annual growth rate is not encouraging to place one’s voice in favour of the hard-hitting step of demonetization in India. The average annual growth rate of indirect tax collection in India has been at 14.49 percent between 2014-15 and 2018-19 with the highest annual growth rate at 20.15 percent in 2015-16, a year preceding to demonetization. The annual average growth rate of indirect tax collection for the period between 2004-05 and 2008-09 has been at 14.26 percent and between 2009-10 and 2013-14 it has been 15.81 percent.

This analysis clearly shows that the demonetization has failed to provide better tax collections which has been expected as a desirable outcome of the removal of legal tender from Rs. 500 and Rs. 1000 notes on 8th November, 2016. Even the Tax-GDP ratio during the period of current regime has not touched the point which was achieved at 11.89 percent during the financial year-2007-08. In the light of above analysis it brings an observation that one has to look at other measures which may improve the tax compliance and tax revenues in India rather than resorting to the policies which bring the normal functioning of the economy and individuals in complete disarray and uncertainties.

The demonetization has led to the lost opportunities to improve upon the GDP performance amidst better performing the world economy. Demonetization has led to the loss of employment opportunities and loss to many businesses which strive with cash-oriented transactions and it may take years to compensate that lost GDP and lost productive man days in search of cash and in search of jobs.

The Author: Shri Santosh Kumar, Assistant Professor, SRCC, University of Delhi, Delhi.  He can be contacted at sksultanpuri@gmail.com.

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