Demonetization in India: A Reflection on Anti-Tax Evasion Policies


This past Tuesday, November 8, as many Americans were fervently refreshing polling websites to gain some insight on the possible outcome of the Presidential election, on the other side of the world in India, many individuals were instead fervently searching their wallets for change. Prime Minister Narendra Modi had announced his plan, which would take effect immediately, to demonetize the current 500 and 1,000 rupee notes, which convert to about $7 and $15 American dollars, respectively. This has had a massive immediate effect on individual holdings as these bills amount for almost 86 percent of all the paper money in circulation. Banks were set to be closed on Wednesday, November 9, to allow time to restock with the new notes, with the transfer being planned to take place over the next several weeks and months.

This move was made in response to the country’s rising concerns of the proliferation of paper money raised on the black market and through other corrupt measures (dubbed “black money”) which is in turn not declared to tax services. While the exact figure of the amount of contraband notes in circulation is unavailable, India’s Central Bureau of Investigation estimated in 2012 that the country’s black money totaled approximately $500 billion U.S. dollars.

The issue of tax evasion in India has long held back the country’s efforts to overcome its status as a “developing nation.” Due to the gross amounts of undeclared funds, India has one of the world’s lowest tax-receiving GDP ratios, impeding its efforts to compete with global economic powerhouses such as the United States and Germany. The government has struggled to implement strong legal ramifications for tax fraud, with the most serious consequence currently in place being heavy fines. This plan to briefly and without warning delegitimize the currently circulating currency is a major step in the effort to curtail the issue of black money and tax evasion. By essentially forcing citizens to declare and exchange all the cash assets they have as they replace the old notes with new ones, the Indian government hopes to account for all the holdings that had previously been withheld and undeclared by private citizens.

However, for a country that relies very heavily on cash exchanges and is far less reliant on credit-based transactions, this sudden announcement has caused an immediate inconvenience for millions of Indian citizens. Across the nation, ATMs were flooded with people attempting to withdraw change to replace the now useless paper notes they needed for daily necessities. In addition, unlike in the United States, Indian air travel and real estate sectors are largely dependent on paper money and this sudden policy change has put these industries in an unfamiliar position. Real-estate prices and housing developments are expected to head into a steep decline with the sudden disappearance of the black money that has, up to this point, funded a large majority of operations.

While the issue of tax evasion is one that plagues almost all governments around the world, there lacks a clear solution for addressing it. Punitive policies that have long been a staple for American tax agencies and the harsh tactics being implemented in India both serve the same anti-evasion purpose, with questionable levels of effectiveness. A study by Dr. Keith Snavely at Southern Illinois University broke down the policy initiatives to address this problem into two categories: coercive policies and value-based policies. Taxation agencies have largely focused solely on the former, increasing the punishments to dispel individuals from breaking tax laws. The United States, for example, uses strict jail sentences in an attempt to make the cost of not paying taxes worse than the perceived personal gains, while India has yet to enact such measures.

Value-based policies, on the other hand, encourage compliance by offering public services that work to create a productive relationship between taxpayers and governmental organizations. This instils in citizens an appreciation for the ethical responsibility of paying taxes instead of demonizing the process. In support of this theory, Dr. Snavely’s research involving using empirical data concluded that citizens respond best to policies that combine both approaches, rather than tactics that depend primarily on fear of negative outcomes and severe punishment.

Modi’s populist campaign in 2014 was largely based on his promise to use swift, coercive means to end the corruption and corporate cronyism that he claimed to have been plaguing India since its independence. This demonetization of certain widely-used paper notes is the first major step that the Prime Minister has taken to curb this issue. If all goes according to plan, the government will be able to retrieve a portion of the money that is unaccounted for while impeding upon the further usage of cash that has been illegally stashed overseas. While these policy changes are meant to come to fruition in the long-term, the ramifications have already severely disrupted the everyday lives of millions of Indian citizens.

Regardless of the severity of the laws, there will almost certainly always exist tactics for individuals to game the system and avoid paying their fair share. Even the current American president-elect, Donald Trump, has been under considerable scrutiny for possibly using loopholes to evade paying income taxes. However, rather than only relying on “do-it-or-else” methods that create a fearful environment amongst citizens, governments around the world should consider addressing the disconnect between citizens and tax agencies that leads to dishonest behavior. Donald Trump, much like Prime Minister Modi, ran with the promise of addressing corruption with the unique perspective of an outsider to the political elite. This new administration has the opportunity to complement coercive tactics with policies that imbue in the American people a sense of understanding and appreciation for tax services. This legislation can be as simple as providing educational programs on the purpose and benefit of taxes, as well as providing assistive services to demystify the process as a whole.

All around the world, these harsh and punitive policy actions only go as far as attacking a symptom of a much larger problem. By only punishing tax evaders, governments simply breed more incentive to find increasingly foolproof loopholes. In addition, these penal policies can have severe ramifications for those not involved in the illegal practice, as seen in India. Through the combination of coercive policy and value-based policies, governments can create a public environment that is conducive to citizens appreciating the moral and civil significance of paying taxes.

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