Global Financial Integrity


Black Money, White Paper

Dev Kar
Sarah Freitas

Why Not Address the Practical Difficulties of Retrieving the Illicit Assets Held Abroad by Indian Citizens

This article was originally published by The Financial Express.

In his forward to the government’s white paper released on May 16, the finance minister acknowledged that black money has a “debilitating effect” on governance and the conduct of public policy in India. The paper’s review of the work done at Global Financial Integrity (GFI) on illicit financial flows from the country is clear and comprehensive and we commend the government’s efforts to develop policy measures to curtail the generation and cross-border transmission of these flows. Ongoing discussions among and between various stakeholders in the world’s largest democracy can in time coalesce public opinion on the required policy measures.

In the meantime, there are differing viewpoints on how to curtail the generation and cross-border transmission of black money. By their very nature, outflows of illicit capital are not directly observable. That is the reason why our study provides a range of possible values rather than a specific number. But even the higher end of the range of estimates cannot capture the myriad ways through which black money can be generated, let alone sent abroad in a clandestine manner. This general caveat applies to all countries, not just India. Data limitations exist not only on strictly illegal activities like drug or human trafficking, but also on legitimate economic activities such as international trade in services which can facilitate mispricing for the purposes of shifting profits. Anecdotal evidence on the volume of capital generated from these activities (for example, the rising volume of services trade in a globalised world) give credence to the view that the understatement of black money outflows due to data limitations is far more likely to outstrip illicit inflows, whether recorded or unrecorded.

GFI’s estimates of illicit outflows are based on well-established methodology, which economists have used for decades. The only point of departure is that we do not net out inflows of black money from outflows, the reason being that such inflows do not provide any benefit to the government. Because such inflows of capital are also unrecorded, the government cannot tax them or use them for any productive purposes. Rather, inflows of illicit capital are much more likely to drive the growth of the underground economy then they are to stimulate the country’s productive capacity.

In view of the harmful effects of illicit flows in both directions, our focus has been to curtail their generation and transmission rather than to estimate the current worth of illicit assets held abroad, let alone expend efforts to bring them back. In fact, efforts to date by various countries and international organizations to bring back illicit capital have been quite disappointing. For instance, the World Bank’s Stolen Asset Recovery (StAR) Initiative has been able to bring back only a minuscule fraction of the total volume of illicit assets that have been spirited away from poor developing countries over the past several decades.

There are many reasons why getting black money back is much easier said than done. For one, the “mapping” of illicit outflows from any country against the stock of private sector deposits in financial institutions held worldwide is extremely difficult given the lack of data on the transactions and operations of banks in tax havens, and the total lack of data on withdrawals. To complicate matters, illicit assets are held not only as cash deposits but also in financial instruments that are opaque, such as derivatives, stocks and bonds, private equity, and anonymous trust funds and companies. Moreover, survey-based data on the legitimate wealth of high net-worth individuals show that they typically hold about 10-14% of their portfolios as cash deposits. Assuming that the portfolio diversification on illicit assets is broadly similar, then the bulk of illicit assets are invested globally in non-financial assets such as real estate, precious metals, antiques, and art objects regarding which there is hardly any information. If basic information on the value and form of illicit investments is lacking, the question of getting them back is a far cry. Naturally, we would have liked to see the white paper present a fuller discussion of the practical difficulties of retrieving the illicit assets held abroad by Indian citizens.

On another note, while we agree that a low tax rate can encourage tax compliance, it does not follow that higher tax rates necessarily lead to tax evasion. Consider the developed and well-governed Nordic countries, France and Germany. The average income tax rates in these countries are relatively high compared to the US, but so is tax compliance, which is essentially driven by the age-old dictum—value for money. Because taxpayers are assured that they can count on the government to deliver goods and services effectively (such as good education and high-quality health care), they do not mind paying for them. So while the rationalisation of tax rates is important, we would also stress the importance of improving the effectiveness of government services and a widening of the tax base on an equitable basis in order to avoid tax fatigue and ensure better compliance.

Dev Kar, a former senior economist at the International Monetary Fund, is lead economist at Global Financial Integrity. Sarah Freitas is also an economist at Global Financial Integrity