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On November 8, 2016, the government announced demonetization of two largest denomination notes, Rs 500 and Rs. 1000, ceasing to be legal tender except for a few specified purposes. At one stroke, 86 percent of the cash in circulation was thereby rendered invalid. These notes were to be deposited in the banks by December 30, 2016, while restrictions were placed on cash withdrawals. The aim of the action was fourfold, to curb corruption; counterfeiting; the use of high denomination notes for terrorist activities; and especially the accumulation of black money, generated by income that has not been declared to the tax authorities.

The Indian government had demonetized bank notes on two prior occasions—once in 1946 and then in 1978—and in both cases, the goal was to combat tax evasion by black money held outside the formal economic system.

Demonetization followed a series of earlier efforts to curb such illicit activities, including the creation of the Special Investigative Team (SIT) in the 2014 budget; the Black Money and Imposition of Tax Act 2015; Benami Transactions Act 2016; the information exchange agreement with Switzerland; changes in the tax treaties with Mauritius, Cyprus and Singapore; and the Income Disclosure Scheme. Demonetisation was aimed at signalling a regime change, emphasizing the government’s determination to penalize illicit activities and the associated wealth. In effect, the tax on all illicit activities, as well as legal activities that were not disclosed to the tax authorities, was sought to be permanently and punitively increased.

India’s economy is relatively cash-dependent. India’s level is somewhat higher than other countries in its income group and as measured by transparency international higher the amount of cash in circulation, the greater the amount of corruption. Amount of black money calculated using ‘soiled notes’ (notes returned to Central Bank because they are too damaged) has been found to be substantial, as it represents about 2 percent of GDP. The Watal Committee has recently estimated that cash accounts for about 78 percent of all consumer payments.

The amount of unreturned high denomination notes is not the proper measure of the amount of black money that has been “taxed” away from holders of illicit wealth. In addition, one needs to add the taxes collected on money declared under disclosure scheme (Pradhan Mantri Garib Kalyan Yojana, PMGKY), as well as the “taxes” paid to intermediaries who laundered money.

Pradhan Mantri Garib Kalyan Yojana, 2016 (PMGKY) is an amnesty scheme launched by the PM Narendra Modi led Government in December 2016 in the lines of the Income declaration scheme, 2016 (IDS). The scheme provides an opportunity to declare unaccounted wealth and black money in a confidential manner and avoid prosecution after paying a fine of 50% on the undisclosed income. An additional 25% of the undisclosed income is invested in the scheme which can be refunded after four years, without any interest. Valid from December 16, 2016 to March 31, 2017, the scheme can only be availed to declare income in the form of cash or bank deposits in Indian bank accounts and not in the form of jewellery, stock, immovable property, or deposits in overseas accounts. Not declaring undisclosed income under the PMGKY will attract a fine of 77.25% if the income is shown in tax returns. In case the income is not shown in tax returns, it will attract a further 10% penalty followed by prosecution.

Steps to facilitate and incentivize the move to a digital economy:
• Launch of the BHIM (Bharat Interface For Money) app for smartphones and BHIM USSD 2.0 for phone users.
• Launch of Aadhaar Merchant Pay, aimed at the 350 million who do not have phones.
• Reductions in fees (Merchant Discount Rate) paid on digital transactions and transactions that use the UPI.
• Encouraging the adoption of point of sale (POS) devices though tariff reductions.