Black Economy in India: The Path to Growing Inequality

Arun Kumar

The single most important aspect of the Indian economy is its very large black economy. In fact, it impacts not just the economic aspect of society but also its social and political facets. All the macroeconomic variables like, growth rate of the economy, inflation and fiscal policies are affected by the black economy. The microeconomic variables like education, health, drinking water and other services received by the citizens are also adversely impacted by it. Elections, quality of leadership, governance, criminalization and governance are also adversely impacted by the black economy. Unfortunately, most policy makers and analysts ignore the black economy. As such, their analysis is partial and often incorrect.

India is characterized by large and growing inequality as various recent reports indicate. At a low level of per capita income India has one of the highest number of billionaires in the world. But these reports are based on the data from the white economy alone. If the black economy is included in the analysis, inequality would turn out to be much higher since black incomes are concentrated in the hands of the high income earners. Some of the key aspects of the black economy that lead to increase in inequality are presented below.

Definitionally it has been shown that in India, black incomes are property incomes, that is, profit, interest, rent and dividend. They are typically not wages since these are costs to businesses and they are usually inflated to show higher costs and lower incomes. Further, in India because the income taxation starts at about 400% of the per capita incomes and with deductions and concessions at an even higher multiple, most wage earners fall below the taxable limit. Thus, whether declared or not they are not black incomes. Thus, the black economy skews the distribution of income in favour of the profit earners and aggravates disparities.

It can also be shown that the black incomes are concentrated in the hands of 3% of the population, those with high incomes. The rest, 97% suffer adverse consequences of the black economy and have to bear higher costs. This author has shown that black incomes had become 62% of GDP in 2012-13. If this per cent remains unchanged, the implication is that the top 3% have this much of extra incomes over and above their white incomes while the bottom 97% do not  have any extra incomes from the black economy but only additional costs. This then aggravates the disparities in incomes.

Black economy leads to policy failure and unproductive investment which lowers the economy’s rate of growth. It may be characterized as `digging holes and filling holes’. This causes activity without productivity.The result is social waste. Investment does not yield the productivity that should follow. For instance, police is busy collecting hafta rather than maintaining law and order. In another instance, consider a road constructed with inadequate tar put in it. When the rains come it gets washed away so that it has to be repeatedly repaired. So, the investment in roads and police do not yield the productivity that the economy should benefit from. These examples may be multiplied. This leads to a shortage of investment in the economy.

When the rate of growth is less than the potential rate of growth of the economy, development slows down and employment generation is below the potential. Both these impact the poor more. Further, as delivery of public services, like, education and health, to the common people falters, the burden on the poorer sections increases and they can ill afford private services.

The shortage of investment in the country is further aggravated by black income generators resorting to flight of capital. To overcome the shortage of capital in the country, the nation has been offering a variety of concessions to foreign capital. For instance, labour rights in IT industry have been restricted. Further, the courts have truncated some of the rights that labour had been obtained till the 1980s. This has weakened labour and its capacity to bargain for higher incomes.

The black economy severely limits fiscal policies and the benefit that it can provide to the economy as a whole and to the poor specifically. If the black economy is 62% of GDP, it implies that this income is not in the tax net. Given that these are the incomes of high income earners, if this could be taxed, it would have paid about 40% as taxes. Thus, the economy could get an additional 24% tax GDP ratio while it is currently about 17%. The shortage of resources for development in the budget would be over. The fiscal deficit of about 6% would have become a surplus of 18% which could be plowed into development.

With these additional resources, the country could have spent 6% of GDP on public education while it has never exceeded 4%. Similarly, public health could get at least 3% while it has never exceeded 1.3%. Roads, ports, railways, power, etc., could be further developed.

An even bigger advantage would be that today, much of the expenditure does not yield the result it should since the money spent of development is wasted. So, `expenditures do not lead to outcomes’. As Rajiv Gandhi popularized in 1988, out of a rupee spent, only 15 paisa reaches the ground. Thus, the black economy leads to both a shortage of resources for development and reduces the effectiveness of what is spent. This hurts the poor the most who depend on government programmes to mitigate their poverty.

Black economy also leads to poor governance. As mentioned above, the police, the judiciary and the bureaucracy falter in delivery. Rules are systematically violated by the powerful. For instance, the environment protection rules are given a go by, whether it be deforestation, mining, coastal zone protection, river and air pollution, etc. In urban areas, the zoning and building bye-laws are systematically violated. The damage to the environment impacts the poor disproportionately more which damages their health and adds to their cost of living.

Due to the impact of the black economy, real estate has become highly speculative leading to expensive real estate which prices the majority out of housing in urban areas and they have to live in slum like conditions. They also encroach on public land which results in insecure living conditions and criminalization. They also fall prey to land mafia and political manipulation. This often results in families getting involved in illegal activities. All this adds to the growing inequality in society.

In conclusion, there are several paths to the black economy resulting in growing inequalities that are not measured in the white economy data. Thus, the inequalities are larger than indicated by the white economy data. Further, this suggests that the policy makers work with incorrect data since they ignore the substantial black economy. The implication is that their analysis is faulty and their policies faulty.

As government polices fail, the demand for the retreat of the state becomes stronger. Since 1991, with the New Economic Policies, society has turned to markets but they do not offer a solution for the problems of the poor. The state is further weakened as rising inequality undermines the sense of social justice in society. In turn that undermines democracy. The growing black economy undermines accountability all around – in the social and the political spheres also – and further weakens democracy. All this results in the disenfranchisement of the poor – money power rules and marginalizes the poor – and this opens the doors for further increase in inequality.