Black Money: Institutional lacunae boosts the menace - Economic Times Black Money: Institutional lacunae boosts the menace - Economic Times

Saturday, May 26, 2012

Black Money: Institutional lacunae boosts the menace - Economic Times

Black Money: Institutional lacunae boosts the menace - Economic Times

The paper underlines the centrality of institutions in arresting black money. The paper does mention that estimating the shadow economy 'is a challenge'. One method is the currency demand approach. The reasoning is that since most transactions in the shadow economy are conducted in cash - so as to evade taxes, not disclose income, etc - the excess demand for notes can well reveal the extent of black money sloshing around. Another method cited is the electricity demand pattern, where the difference between growth rate of electricity consumption and the official economic growth rate can offer scope for estimating the extent of the underground sector.

And then there is the multiple indicators multiple causes, or MIMIC, model, with such observed variables as direct tax rates, the regulatory burden, per-capita income levels, etc. The MIMIC model is now used widely for estimating black money. The paper adds that the mavens gauge the size of the shadow economy in most advanced economies in the range of 14-16 per cent of total economic output - about 10 per cent in the US and Japan, 32-35 per cent of output in the emerging markets and far higher - often greater than 40 per cent of official output levels - in other developing countries.

The study cites earlier studies to show that there is considerable debate on the role of the burden of taxation in egging on black-money generation. It mentions of one piece of research that found that when the tax burden of corporates becomes more daunting, going up by one point on a scale of 1 to 7, the size of the shadow economy tends to rise by 11.7 percentage points. But other studies find that higher tax rates can well reduce the size of the underground economy. The explanation is that higher taxation implies stronger revenue streams, which can mean better provision of public goods including a more robust legal and judicial setting, thus discouraging black money. But convoluted labour market rules and restrictions can well boost informal employment and so rev up the underground economy.

What's underscored is that black money has a way of being inversely related to the regulatory burden, the extent of lax governance and the general absence of the rule of law. The paper uses cross-country regression analysis to show that controlling for taxes, inflation and per-capita incomes, institutional issues are the most important determinant of the size of the unofficial sector the world over. To combat black money, what's required is discernable improvement in governance, concludes the paper.

By (Inclusive Growth, Institutions and the Underground Economy, by Anoop Singh et al, IMF working paper, February 2012)

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