Thoughts on economics and liberty

The IAC chases after shadows while the causes of corruption are left TOTALLY untouched

I'm reproducing below an important article published last week by the Liberty Institute. Please read this carefully if you are SERIOUS about elimination of corruption.

Of course, if you are only interested in drama then enjoy the show being put up by Anna Hazare talkies. I must say that this man is turning out to be quite a savvy politician, having smashed the UPA's resolve into a rubber ball that bounces from one end to the other each day. Clearly this government is SUPER-INCOMPETENT, with no capacity to think straight or to act straight.

Note that if Hazare was contesting elections, I'd understand his strategies. But he claims to be interested in removing corruption. That doesn't add up – for he is chasing after shadows.

On the other hand, while Hazare so successfully chases after shadows (!), I'm offering a DEAD SERIOUS REMEDY for corruption and a way to dramatically increasing India's prosperity. But the solution I offer is much harder. And few, it seems, are capable of understanding it, or rising to the occasion.

Well, do read Barun's and Mohit's views below. Very well researched piece:

Chasing Black Money: In search of red herrings

Barun Mitra and Mohit Satyanand

Tuesday, August 16, 2011
In the past few months, the debate over black money and corruption has been raging across the country. Some social activists and the government have been at loggerheads over the scope and structure of a new anti-corruption authority being proposed. There have been claims ranging from tens of billions of dollars to over a trillion dollar, money that may have been illegally acquired or wealth that evaded taxation. But the issue of corruption is not just about policing, but should be about about policies that help generate black money in the first place. The current focus on the Lok Pal, as a super cop, is only diverting attention from the real roots of corruption, write Barun Mitra and Mohit Satyanand.
This is a discussion paper from the Liberty Institute, New Delhi. Comments are welcome.
In the past few months, the black money debate has also been stoked by some citizens’ groups, and even by a popular yoga teacher. The activists and the government have been at loggerheads over the scope and structure of a new anti-corruption authority being proposed. There have been claims ranging from tens of billions of dollars to over a trillion dollar, money that may have been illegally acquired or wealth that evaded taxation, and deposited in banks invarious tax heavens.
One side is accusing the government of being insensitive to the popular concerns over widespread corruption. The politicians are accusing the activists of seeking to denigrate parliamentary democratic procedures. The 24-hour news media, as usual, is stoking the fire in search of TRPs. What is getting lost is the fact that corruption is the consequence of the distortions in the normal economic functioning caused by legal  and regulatory interventions. The resultant mismatch between supply and demand for goods and services are then attempted to be mitigated through the discretionary powers in the hands of various government agencies and ministers. This opens the door for patronage for a considerations, that is corruption.
A study by the Global Financial Integrity estimated black money stashed abroad at $462 billion. On the other hand, the Swiss National Bank (SNB) has estimated that the total deposits of Indian individuals and companies with allthe Swiss banks put together stood at about $2.5 billion (Rs 11,100 crore) at the end of 2010. And all of that can’t be illegal.
The government has been reiterating its intent to bring the black moneyhome, even as easily excited people's groups say such money should be declared a national asset. The Supreme Court, taking note of the matter, has asked forthe appointment of a Special Investigating Team (SIT), to bring black money back.
The government has offered to strengthen the money laundering law. Dual Tax Avoidance Treaties are being negotiated with over 80countries, including Switzerland, in an attempt to share information about financial transactions and taxation. At home, the government has also proposed amendments to the Benami Transactions(Prohibition) Act 1988 to make it easier to seize benami property, auction them and pass on the proceeds to States, where the property is located, for development activities.
In the past two years, the Indian income tax department had collected some 7,700 pieces of information from treaty countries on payments received by Indian citizens in various countries and on bank accounts. “We have made more than 175 requests to our treaty partners in cases of specific taxpayers in the last financial year,” claimed Mr Pranab Mukherjee, India’s Finance Minister recently.
A slew of initiatives are also being proposed to tackle corruption. The Lok Pal Bill, pending for over two decades, has been introduced to inquire and investigate corruption among political leaders and senior bureaucracy, at the national level. Another new law, the Judicial Accountability bill is on the anvil to check corruption in the higher echelons of the judiciary. And to encourage people to expose instances of corruption, a law to protect whistleblower is under discussion. A more structured public grievance redressal mechanism is also being proposed.
While the list measures may be impressive, and the intent of the political and civic leaders may be genuine, we believe these developments are naïve at best. However, far worse is the prospect that the plethora of initiatives just turn out to be red herrings to detract from the underlying problems.
The problem corruption and black money originate in bad public policy, rather than poor policing. Let us begin with trying to define black money, generally held to be income on which taxes are not paid. We believe there are 3 constituents of black money.
  • legally earned income on which taxes have not been paid
  • illegally earned funds, such as bribes, and contracts whose face value does not reflect the transactionvalue,
  • earnings from criminal activities
As far as the first category is concerned, this is primarily the tax collector's problem, and strengthening the mechanisms we already have in place is an on-going exercise. As more and more of our economy moves into the formal sector, and data collection systems are strengthened and cross-linked, this will be less and less of an issue. According to Dr Surjit S. Bhalla, a prominent economist, and who heads an investment company, the total amount of income tax evaded annually could be in the range of Rs 100,000 crore (i.e., Rs1,trillion or USD 22 billion), or about 1.5% of India’s GDP. A portion of itmay find its way to foreign tax heavens.
In the financial year 2010-11 (April to March), the official estimate of income tax collected is Rs 446,000 crore, which is around 46 per cent of the revenue for the Union Government treasury and 6.13 per cent of the GDP.
As far as the third category is concerned, this is primarily the remit of criminals and police agencies. The money being generated from such activity is not the most serious of the problems it creates and in any case fighting crime is the primary task of any government. But bad laws criminalise what should be legitimate economic activity. For instance, India restricted jewellery to 14 carat, with the infamous Gold Control Order of 1962, and then banned gold imports. Not surprisingly, for a people who consume the highest volume of gold in the world, the prohibition made gold smuggling a very lucrative proposition in India. In the 1980s, less than 4 tons of gold were being mined domestically, but it is estimated that about 150 tons were being smuggled in each year to meet the demand.
Inevitably, gold smuggling turned into a major source of income generation for gangsters which subsequently diversified into becoming guns forhire, international terrorists, and drug runners, corrupting almost everyinstitution of the state. In addition, this opportunity acted as a catalyst for the money laundering phenomenon, knows as the Hawala. It was only in 1992, that the restrictions on imports of gold were lifted, and smuggling has mostly evaporated.
Let us focus, then, on the second category. Begin with contracts where there is a divergence between the real value of the transaction, and that stated on paper. Ask any Indian, and they will tell you that the largest category of such transactions is real estate. In the Delhi and the surrounding region, our estimate is that the average property deal reflects only 50% of the value on paper (in the case of 'farm-houses', less than 25% of the property value is typically declared; for condominiums in the suburbs, it may be as much as 80%. A 100% 'white' money deal in property transactional is a rarity.) Over the last 5 years, property and real estate have generated almost 25% of the GDP of this region, one of the nation's most prosperous. This means that, this single area of untruth leads to 12.5% of regional GDP going underground. Nationally, the most conservative estimate is that property transactions generate black money worth about 1 to 2% of India’s GDP, annually.
From a policy point of view, it becomes important to ask why real estate deals generate so much black money. We believe that the primary cause is extremely high government fees for registration of land sale, between 5 and 10% of the value of the transaction. The desire to evade this levy is the starting point of evasion. Over time, real estate has become the parking lot for blackmoney of all sorts: this includes such money generated from sale of property, a self-reinforcing cycle; as well as speed money and slush funds, garnered from all manner of favours granted by powerful administrators and politicians.
Judging by the World Bank's “Doing Business Report 2010”, India ranks 134th among 183 countries. India is one of the most trouble some places for dealing with public authorities. Such frictions inevitably leads to the payment of 'speed money', whether for the tiniest of transactions, such as a driving licence or hawker's permit; or for major resources over which politicians have control, such as awarding telecom spectrum, mining and exploration rights, or large infrastructure contracts.
The higher transaction cost of carrying out normal economic activity in India, not only adds to inefficiency, but also raises the cost of doing business. This also explains, at least partly, the fact that anything between 25 to 40% of Indian economic activity takes place in the informal sector, mostly under the official radar.
Corruption is not rocket science, and India is not an exception. Globally, countries that rigidly regulate their economies, and restrict the economic freedom enjoyed by their people, also tend to be also among the more corrupt ones, and generally poorer. While India has improved its standing in the Economic Freedom of the World Index, over the past two decades, its has not changed fast enough, and the low rank on the Doing Business Report indicate that the changes have not been deep enough to make substantive impact on corruption.
Graph 1: Difficult business environment breeds corruption (click for bigger image)
Graph 2: Greater economic freedom lowers levels of corruption (click for bigger image)
Whether in real estate, or in administrative corruption, it is worth noting that the illicit money is generated in India, not overseas (large defence deals would be the only major exception). Some of the funds generated in India are definitely 'exported' to keep them out of view, but much of this is brought back, through a variety of routes, including the stock markets. The money held abroad at any point in time is only funds in transit – a flow, rather than a stock. Looking to put a tag on such funds is like trying to catch the wind in a basket!
If the intent was to actually cut down the amount of black money being generated, the answer would lie in a slew of reforms in India. To name a few, these would include:
  • real estate registration fees that are reasonable – less than 1%; or flat fees per unit area
  • policy framework that reduces the discretionary authority of administrators and politicians
Transparency and economic freedom, however, may not suit a political class that has grown used to enjoying the spoils of the discretionary power. Focusing on money held abroad is 'exporting' the problem, passing the blame to an 'immoral' banking system in Switzerland or Liechtenstein, rather than having a public debate on the origins of black money.
Even if the funds held in Switzerland were a substantial percentage ofthe black money in circulation – which we doubt – the long-standing discussion of the issue, and government's repeated assertion that it will tackle this would have given any half-intelligent account-holder ample time to relocate his funds to discreet banks in any one of half a dozen locations in the world, not to mention laundering them through the convenient tax arrangements with Mauritius.
There are already quite a few existing organisations and institutions that are supposed to be investigating black money, tax evasion, money laundering and other crimes. There are a number of organisations involved in exposing financial misdemeanours and wastages, and fighting crime andcorruption, among them the Comptroller and Auditor General of India, the Enforcement Directorate, the Directorate of Revenue Intelligence, the Central Vigilance Commission, and the Central Bureau of Investigation. Also there are many existing laws, such as the provisions of the Indian Penal Code, the Prevention of Corruption Act, the Foreign Exchange Management Act, Benami Transactions Act, among others, all aimed at curbing black money and corruption. Finally, there are the Supreme Court and High Courts, which often decide to monitor the progress of investigation in important corruption cases.
Yet, there are very few successful prosecutions and convictions. Given such a poor track record, why do we expect a new anti-corruption institution or a more draconian law to have any dramatic success?
One wonders if the Indian political leadership is really serious about tackling corruption and tax evasion at its roots. Or is the posturing only an attempt to defuse the political tension currently caused by the likes of yoga guru Ramdev or civic activist Anna Hazare. The tragedy, however, is that many concerned citizens while sincerely campaigning against corruption, have only further legitimised the search for red herrings, by failing to focus on the root of the problem – the policy framework that breeds corruption and generates black money. One can only hope that even if the focus is misguided at the moment, the greater public churning will finally turn the spotlight on the real reasons for generation of black money in India.
Please send your comments and criticism to 
Liberty Institute
C-4/8 Sahyadri,Plot5, 
Sector 12, Dwarka, New Delhi 110078. India
This article was published in the Liberty Institute on Tuesday, August 16, 2011.
Authors : 
Mr Barun Mitra is the director of Liberty Institute, an independent public policy think tank in New Delhi.
Mr Mohit Satyanand is a management consultant, investor, columnist, and is the Chairman of the board of Liberty Institute. 
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2 thoughts on “The IAC chases after shadows while the causes of corruption are left TOTALLY untouched
  1. RC

    This is a great article in Liberty Institute. India's work force is 93% in informal sector. In other words except a tiny minority all working adults work in informal sector. This is mainly due to stupid labor laws that make laying off workers impossible/hard. 
    The reason I bring up this point is that it shows that how hard it is to do business in India and as the liberty institute's paper and data shows that the more difficult to do business the more corruption in general.
    Labor reform is the unfinished agenda of reforms in India but no one is talking about it. Simple minded people think that if there was no corruption in India tomorrow people will start becoming rich!!! 

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