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Tuesday, November 15, 2016

India’s War on Cash

Here are the excuses given by the government.

This past Tuesday, India’s prime minister, Narendra Modi, made an announcement that the existing ₹500 and ₹1000 currency notes would cease to be legal tender. The result was widespread chaos. People rushed to ATMs to withdraw smaller denomination notes, or to banks to get the old notes exchanged. The lines were long (even resulting in scuffles and stampedes). The ATMs quickly ran out of cash, and banks failed to supply enough notes.

People were unable to shop for basic things such as groceries and food. An 8-year old girl died, because her father could not get her to the hospital, since the petrol pump attendant refused to accept a ₹1000 note (which is essentially paper now).

This is just a small fraction of the horror stories from across India. The government has reintroduced these notes with a different design and added a new ₹2000 note. But what was the wisdom behind this whole exercise and making people suffer so much? Here are the excuses given by the government.

1. To Combat Terrorism

The government of Pakistan is supposedly using fake notes to fund terrorism, particularly in the Kashmir valley. By removing high denomination notes, Modi is supposedly making it more difficult for them. What are the facts? The Pakistani government gets hundreds of millions of dollars in foreign aid from its American and Chinese counterparts. There is nothing to prevent them from using that money to legally buy Rupees in the foreign exchange market and funding terrorism.

Not too long ago, Douglas French wrote an insightful article on how the European Central Bank used this very same excuse to stop printing 500 Euro notes. The real reason was that it would render more transactions cashless, thus helping the Central Bank keep negative interest rates, which would not be possible if cash is used.

Moreover, the real problem is not Pakistan. As I explained in an earlier article, the Indian government is responsible for the violence in Kashmir due to its bad economic policies which keep Kashmir economically isolated from the rest of the country.

2. To Fight Corruption and Tax Evasion

This one makes sense on a superficial level. If people have a lot of black money stashed in their homes, it will be rendered worthless by this move. The problem is that a lot of black money is not in the form of cash. Does Modi honestly believe that people keep billions of Rupees under their mattress? Do politicians physically steal cash when they perform a scam? They do not.

Do politicians physically steal cash when they perform a scam? They do not.The fact is that large corporations evade taxes by hiring armies of accountants. Some of their methods are legal, and others illegal. But the common thing is that none of the CEOs or shareholders keep piles of cash at home. Far better to close the tax loopholes to fight corporate tax evasion. Or, better still, abolish the corporate tax.

Politicians do not use physical cash in scams. They use similar creative accounting so that the scam is not discovered until long after the theft is done. What about low-level corruption? Many people use cash to bribe their way into government colleges or secure government jobs or get around red tape.

The obvious and effective way to deal with that is not to get rid of cash, but to reduce the size of government. Privatize the colleges and cut down on the bureaucracy. If government officials have no power and authority, there will be no reason to bribe them.

3. Keeping Inflation Under Control

By far the most ridiculous excuse, a government official says that this move will reduce conspicuous consumption, which (according to him) results in inflation. That’s nonsense. Consumers do not cause inflation. Inflation is made in one place and one place only. It is at the Reserve Bank of India; where money is printed. If printed in excess, it causes inflation.

The Real Reason for the War on Cash

India’s Finance Minister, Arun Jaitley, says that this move will push India towards being a cashless economy. The banks are to exchange only ₹4000 a day. Therefore, those who had large amounts of cash will have to deposit it in the bank. Depositing more than ₹2.5 lakh of one’s own money will result in scrutiny and questions by the government. If the government decides that the holder has evaded taxes, the money will be confiscated, and a 200% penalty imposed. But why is the government doing this?

This government, like all others, is fiscally irresponsible.This government, like all others, is fiscally irresponsible. It spends every single Rupee that it collects in tax revenue, plus a bit more. Now that “bit more” has a limit. It comes from either printing money (which will cause inflation) or borrowing (which is limited by demand for government bonds). Therefore the deficit cannot be indefinite.

Where and why does government want to spend? It wants to spend on populist schemes like subsidies and freebies so it can be re-elected. That is a wasteful use of taxpayer’s money. A cashless economy would mean that every transaction would go through the banks, and be monitored by the government. This would help it increase tax revenue and, by extension, spending on wasteful populist schemes.

The Implications

Since the government would be spending an ever larger portion of our money, it would create a drag on the economy. It would slow down private investment, which would dampen production and job creation.

India was like that before 1991, and we don’t want to return to those circumstances. Russia, Venezuela, Cuba, North Korea; all countries that have poor economic performance have a large share of government spending.

This government control over India’s economy is already too much. The total government spending; central, state and local is around 27% of GDP. This is way higher than the ideal maximum limit of 10% which Milton Friedman recommended.

Moreover, it is a blatant attack on privacy. I for one do not want the government to know how, when and where I spend my hard earned money.

Preserving Freedom

It is interesting to see the ways in which Indians are preserving their freedom and safeguarding their privacy, along with avoiding taxes, in light of this event.

The first alternative that you would think of is Bitcoin. It helps conduct transactions anonymously, the government cannot monitor it. As a result of this announcement, the price of one Bitcoin jumped to ₹48665, up from ₹46963, within twelve hours. People are buying Bitcoin to deal with this situation. But these are a small minority who are sophisticated enough to do that.

If the war on cash continues, entrepreneurs will come up with even more ways to help people evade taxes. And that would not be a bad thing.What about lower income people who do not have smartphones and internet access? They have an interesting method that could merit its own article. They are using Sodexo vouchers. Many small companies pay their employees partly in these coupons, which can be used to buy meals, groceries, and some other things. The merchants can redeem these for money at the end of the year.

When people did not have enough cash, they used the vouchers to get food and groceries. Now the merchant pays his wholesale supplier with vouchers instead of fiat currency. The wholesaler, in turn, uses them elsewhere. This is because the vouchers are valid for a year. The merchants use them for everyday business because then those transactions would not have to be reported when filing for taxes! Sales tax, service tax, and a bunch of others are avoided in this way. It is a kind of parallel currency being used in Indian cities.

If the war on cash continues, entrepreneurs will come up with even more ways to help people avoid taxes. And that would not be a bad thing.

It is not a crime to arrange our business in a manner such that we pay as little tax as possible. Indeed, it is a sacred duty of each and every individual to ensure that government gets to spend as little as possible, that it stays as small as possible. That is the only way we can preserve our freedom and ensure a better life for ourselves, our families, and the future generations.

  • Jairaj Devadiga is an economist. His work mainly deals with public policy and economic history. Apart from FEE, his writings have been published by the Centre for Policy Studies, the Institute of Economic Affairs and Pragati among others. He is on twitter @JairajDevadiga. Readers can also email him at [email protected].