The anti money laundering laws have come into effect. The voluntary period of compliance is set at 30th September. Those desirous of escaping punishment and prosecution have to declare their income, pay 30% as tax and a further 30% as penalty in return for immunity.
Behavioral economists would dismiss it as an amateurish attempt. From the ‘incentive to act’ angle, this looks like the weakest attempt to mobilize black money amongst all the voluntary disclosure schemes announced so far, since independence. Government has to decide what is more important – punishment of the guilty or mobilizing money for growth (even if it does not give up on either).
If it is the punishment which is more important, our legal systems ensure enough loop holes for the guilty to escape and effectively prolong the period of justice delivery into oblivion. Even death penalties have ceased to be a deterrent in our country. Even if the government had all the information with it today and started prosecution immediately without any grace period, it would take 2-3 decades for it to reach any finality. The ‘mental’ present value effect of a punishment 20-30 years later with so many chances of escape can never be a deterrent.
The current scheme amounts to a 60% tax on ‘accumulated wealth’. Higher tax on current income is easier to recover than a similar tax on wealth. Supposing we shift from taxing current year’s income to recovering taxes after 4 years – will the compliance be better? Definitely not and is one reason why most governments have shifted to Pay as You Earn systems. Most of such stashed income are in the form of assets (or even if it is in the form of cash) the ‘owner’ tends to develop an attachment with it which only increases with time. This is part of what the Behavioral economists call the ‘endowment effect’.
Even in commercial establishments, an invoice or debt is best recovered by the seller within the credit period or reasonable extension therefrom. It would almost be impossible to recover it after 2-3 years. The buyer or borrower would find some excuse or the other to fend off payments. Some may even be paying the current dues even while keeping the older ones in dispute or keep raising issues to delay payments in the hope some favourable ‘settlement’ will be feasible. This is one reason most MNCs insist on writing off overdue debts beyond the current accounting period and black-listing the counter party.
Recovering a high tax of 60% is almost impossible. They will use every legal recourse to fend off the payments including migration, filing appeals after appeals, or just taking the risk to say ‘catch me if you can.’ And they can afford much better legal advice for much longer than the Government can ever afford.
A far better approach would have been to recover the same indirectly. Supposing the government taxes such income at say 10% of declared amount and asks them to invest the declared income in GOI bonds at 3% interest and repayable at par in 15 years. The ‘endowment effect’ will be far easier for the owner of ill-gotten wealth to swallow at 10% than at 60% and will more likely pay the tax and declare his income. If the ill-gotten assets are already in the form of cash and bank balances it is even more likely.
If the Bonds so created are made tradable, many of them may be willing to finish the declaration and sell off the Bonds (immediately or over time) at discounts and redeploy the proceeds in their business at better returns. In which case they don’t even have to keep dealing with their ‘regret’ over 15 years; they can dismiss it as a onetime nightmare.
For those who have hard assets abroad, GOI should have given the choice of 10% upfront payment and 4 % every year for next 15 years. Liquidating to pay taxes at 60% is almost a thing that will never be done.
For the government, the Net Present Value of such an arrangement is the same thing – Rs 60 net of taxes, if discounted at 8% which is GOI’s current rate of market borrowings for similar term. It is essentially the same thing but ‘framing’ the question or problem differently in a manner more palatable to the tax payer. Instead of recovering more, GOI is paying less (on its borrowing) whose present value is equivalent to what it desired to recover in the first place. This is the essence (or one of the elements) of Prospect Theory for which Daniel Kahneman, the Israeli Psychologist won the Nobel prize in economics in 2002.
The other penal provisions can remain same without any dilution whatsoever, so GOI is not seen as bending to their interest and accused by an aggressive opposition.
It would be interesting to see how the current scheme works. Let’s wait till 30th September, 2015. Meanwhile let the behavioral economists wait with bated breath.