Why Demonetisation didn't work?

The country witnessed the second anniversary of demonetization some four months back. As done in the past, the opposition labelled it a 'scam' calling it a 'disaster' while the government battled hard to justify it with the help of statistics. Though nothing substantial has come out to term it a scam but opposition is justified in calling it a disaster. After two years of its implementation, it may be inferred that it was a failure in a sense that it didn't meet its intended objective. Though, the exercise did see an increase in tax compliance and tax collection, it remains a short-term achievement. It doesn't lead us to conclude that these tax payers would continue to do the same in the future. So, what was expected from this exercise? How far was that achieved?

After demonetization was announced, the nation was in panic. Media didn't help initially and created chaos. Poor and illiterate people believed that their hard-earned money was lost. It took some time to realize that old currency notes were being replaced by the new ones. People didn't understand the entire exercise. They were oblivious of the procedure followed by the revenue authorities post their notes were deposited in their bank accounts; many still are. However, many thought that with that one decision the rich have become poor and many would be behind the bars for holding black money. This was their desired outcome. But any sane educated mind would have said that it was not practical for obvious reasons. It is pertinent to note that, howsoever clean the intention of the government may be, this decision didn't change the mindset of the people overnight. People developed means to legalise their black money. There were agents who exchanged the old notes against the new keeping thirty percent as their commission. So, the culprits bypassed the banking system. Moreover, the cash was converted into monetised forms like RTGS transfers and gold by officials of various banks and the Reserve Bank of India. The officials were arrested later. There were many Non-Banking Financial Companies which accepted cash in a deliberate attempt to help the offenders which drew the attention of RBI resulting in the cancellation of their licenses but some damage was already done.

Old Rs. 1000 notes were replaced by new Rs. 2000 notes

Source: Google Images

But what about those who have deposited cash in the bank accounts? How will they be penalised for tax evasion? The demonetisation period would be under income tax assessment in the next year. The income tax return for the year under consideration had a requirement in this regard. Every assessee was expected to disclose the amounts deposited in his/her respective bank accounts if the aggregate deposits exceeded Rs. 2,50,000/-. Later, the income tax department was expected to issue notices to such assessees seeking explanation for the deposits made (to initiate income tax assessment, the notices must have been issued way back). Any explanation which lacks substance and found to be ingenuine would be subjected to interest and penalty. The penalty could be anywhere between 100 to 300 percent of the undisclosed income. This implies that the offenders are expected to pay tax more than what the money they had deposited. But where does it end? An assessee may not oblige to the order of the revenue. An appeal would be made against the order to Commissioners of Income Tax (Appeals) followed by Income Tax Appellate Tribunals and then High Courts. This is a time-consuming exercise. Also, it is pertinent to note that Income Tax Act is a civil law with prosecution being a part of the Act but rarely used. Also, any prosecution proceeding can be initiated only with the prior permission of Principal Chief Commissioner/Principal Director General of Income Tax which would lead to a new series of litigation.

New notes of the denomination Rs. 500 and Rs. 2000

Source: Google Images

Demonetisation was more of a perception battle. The government received appreciation in the initial days of this exercise but with the passage of time, people started getting impatient. It was difficult to believe that no politician and no prominent businessman was jailed for holding black money. Also, many businesses got hit but the big fishes escaped. The small and medium sector remained affected for a long time. The small traders sold goods on credit keeping a track of the receivables. It was only after a year or so, when the cash was back in the system the business regained its position. The real estate market collapsed. The builders were left with no cash to pay for the labour. Many laborers were left unemployed for long. The rural India faced the major brunt as in the absence of banks in the vicinity, villagers travelled far to deposit cash. Also, the villagers relied entirely on cash and they were left with no business. The tall claims made by the Prime Minister about Demonetisation affecting terrorism and left-wing extremism can't be easily found out. Moreover, the sight of long queues and the inconvenience which people faced do not seem to fade so easily. People wanted concrete results. They were under the impression that offenders would be either jailed for the wrongdoings or go bankrupt. The intricacies of law would not be appreciated by them. The corruption in the Income Tax Department and other law enforcement agencies is not unknown. Managing such cases by bribing officials would make the task easy. It is practically impossible to strengthen the surveillance and keep a check on every revenue official. Also, those keeping observation may not be honest as well.  Such complex repercussions are my arguments against demonetisation.

What is for the government in the basket? After this big step, now the government has data with it. It should judiciously use it to catch the serial offenders. After the corporates and traders, professionals evade tax at a massive scale. Doctors, lawyers, chartered accountants make huge earnings in cash but don't disclose the same. Similarly, eateries and roadside vendors (who make massive sales) must be scrutinized for not complying the law. Many such vendors do not even file returns. Local contacts would be of great help. Tax Deducted at Source (TDS) but not credited to the government is another major revenue loss. However, this was not something that is known after demonetisation but now they could be easily traced. Also, now there is information about people filing tax for the first time disclosing heavy income and people who had stashed black money abroad, they should be scrutinized every year to keep them in check.

The demonetisation may have been well intentioned but it was bound to fail in a chaotic democracy like India. The move did offer some pudding and brought many people into the formal economy. It had power to remove the demons of corruption and black money. But it proved to be another source of corruption. Any sagacious government should have done away with this.  It is a lesson to avoid self-goals.