On his blog, JP Koning offers two explanations for the surprisingly high rupee notes redemption rate—nearly 99%—after last year’s demonetization experiment: Money laundering, and a partial amnesty.
Indians who had large quantities of illicit cash were able to contract with those who had room below their ceiling to convert illicit rupees on their behalf …
Two weeks after the initial … announcement, the government introduced a formal amnesty for demonetized banknote holders. Any deposit of cash above the ceiling would only be taxed at 50%, assuming it was declared. If not declared, the funds might still get through the note blockade undetected, although if apprehended an 85% penalty was to be levied. These new options were better than throwing away one’s stash altogether and suffering a sure 100% loss …
As a consequence, the windfall for the government likely was smaller than expected. But poorer Indians may still have benefited, by selling their services in the money laundering scheme.
On Moneyness, JP Koning argues that India’s demonetization experiment could have proceeded more smoothly if bank notes had been overstamped rather than immediately withdrawn.
In a 2011 paper, Kaushik Basu argued that “harassment bribes”—bribes that people give to officials in order to get what they are legally entitled to—should be treated as legal. The reasoning is as follows:
Under the current law [treated as illegal], … once a bribe is given, the bribe giver and the bribe taker become partners in crime. …
Under the new law [treated as illegal], when a person gives a bribe, she will try to keep evidence of the act of bribery so that immediately after the bribery she can turn informer and get the bribe taker caught. The upshot of this is not that the bribe taker will get caught but he will not take the bribe in the first place.
Thanks to JP Koning.
On Alt-M, Larry White discusses three aspects of the Indian “demonetization” experiment.
The transition from old notes blocks “honest” currency transactions, reduces income, and harms the poor who don’t have access to alternative means of payment. Because not all old notes will be redeemed, the transition into new notes will generate seignorage revenue for the government on the order of USD 40 billion, according to White’s estimates. Not all groups or industries get access to the new notes at the same time; this changes the terms of trade (Cantillon effects).
India follows suggestions to fight tax evasion by taking high denomination notes out of circulation … and introducing new ones. Until the end of the year, Indians may exchange the old banknotes against new ones, at banks or post offices, by identifying themselves. On his blog, J P Koning discusses earlier demonetization episodes in Iraq and Sweden.
India’s move does not exactly follow the well publicized suggestions currently debated. But it might work.
In the FT, Amy Kuzmin reports that after debating for nearly a decade,
India’s parliament has approved a long-awaited overhaul of the country’s fragmented tax system … The bill … will amend the constitution to permit replacing the current patchwork of national, state and local levies with a single, unified value added tax system.
He expects the reform “to create a genuine single market” and hails it as “one of the most significant reforms to the Indian economy since liberalisation began 25 years ago.”