Demonetization by itself can't tackle black money, it's one-time tax: Noted economist Bhagwati, a Modi supporter

By Our Representative
Perhaps the world's most powerful voice in favour of Prime Minister Narendra Modi's controversial decision to ban Rs 1000 and 500 notes on November 8, noted economist Prof Jagdish Bhagwati, has said that the move “cannot by itself tackle future of black money”, insisting, the move is no more than “a one-time tax on black money.”
In an opinion piece in a prominent business daily, Bhagwati, who is known internationally for his contribution on free trade, though missed a Nobel prize, simultaneously sharply criticizes those who say that “the return into the formal monetary and banking system of a large percentage, perhaps 80% or more, of the old notes represents a failure of the policy.”
Calling it “a fallacy”, Bhagwati, who is with the Columbia University and is known to be mentor of his Columbia colleague, Prof Arvind Panagariya, vice-chairman, Niti Aayog, says, that it is a “misunderstanding” to state that “unaccounted money that is deposited into bank accounts has been converted successfully without penalty from black into white.”
Pointing to the fact that “the current rules dictate that deposits of unaccounted money will be taxed at 50% – with a further 25% taken by the government (into the Pradhan Mantri Garib Kalyan Yojana) as an interest-free loan for a period of four years”, Bhagwati argues, “The return of money to the formal banking system, when taxed, will generate a fiscal gain to the system.”
Titled “Demonetisation fallacies and demonetisation math”, the article states, however, states,
it is also a “fallacy” to expectation demonetisation “will put an end to black money generation”, insisting, “Demonetisation, by invalidating existing high denomination notes, deals with the stock of black money – but, in and of itself, does nothing to address future flows of black money (which may accrue in the new currency notes).”
Argues Bhagwati, tackling “future flows of black money” would require “further reforms” such as “lowering stamp taxes on property transactions” to incentivize “lower levels of evasion associated with such transactions”, and “electronic registration of real estate transactions (and re-registration of existing ownership claims) to match individual identification numbers.”
Bhagwati believes, the money that “proverbially hoarded under the mattress”, on entering into the “formal financial system via bank deposits”, may now “grow via the classical money multiplier, assuming a portion of it is loaned out by banks. This could, at the margin, have an expansionary impact...”
Further, says Bhagwati, the critics' argument that “the current exercise will not tackle the underlying roots of corruption, which lie in areas such as election finance, burdensome regulation, high taxes, and so forth” is “perfectly true”, though adding, “This criticism misses the centrality of … the idea that, typically, each policy objective requires a specific, targeted policy instrument.”
As to whether demonetisation drive would “penalize those who have introduced counterfeit currency into the system”, Bhagwati argues, “To address this question, one needs to clarify the distinction between stocks and flows”, adding, “At best, to the extent that the security features introduced into new notes limit immediate counterfeiting, the policy may minimize the future flows of counterfeit notes for some time.”
This is the second article Bhagwati has written in favour of demonetization. Like the first one, which appeared as an editorial page commentary in another prominent daily, this article too has been written in collaboration with a group of two other US-based Indian origin scholars.
The first article, more forthright in supporting Modi, said that "demonetisation is a courageous reform that will bring substantive benefits”. It went so far as to say that “the Indian economy will move towards digitisation of economic transactions, with cash currency playing a relatively minor role”, an argument which he does repeal seek to just a week later.