Catching out of shadow economy

THE Ministry of Finance in 2010 estimated the size of our shadow or black economy up to 82% of the Gross Domestic Product (GDP). Black money is essentially currency that circulates parallel to regular economy and adds much of the unaccounted costs with illegal activities. An example is the illegal use of formalin in informal fruit business. This might raise investment for hospitals and contribution of health sector to the GDP, but such a mitigation-oriented growth does not justify development. In this regard, green taxation would be praiseworthy initiative by the government. On the other hand, unnatural expenditures with black money undermine the targets of monetary, fiscal and other policies. Meanwhile, all governments, either political or military, recognised the problems with shadow economy but their easy initiatives for money whitening though budgets were not effective in bringing black money into tax radar.
Economics of black money justifies people holding on to it in Bangladesh. Its financial return is higher than that of white money. Any non-taxpayer business with illegal money will obviously make more profit than taxpayers. The illegal money earners do not have social costs even from teasing due to degrading deontology. Under a changing state of political ethics towards political business, many leaders and even students do not care for making black money. Moreover, its legal cost is not high for a low probability of being caught and punished. Accordingly, the opportunity cost of holding black money gets higher for its lobbying capacity, too. When a budget offers any money whitening provision as per Section 19 of our Tax Ordinance, it shades them over a fiscal year. If such an offer continues for years, the costs get so low that a risk averter would not hesitate to make black money.
This money whitening offer is reversal of the strict clauses of our tax ordinance. Our tax policy emphasises on collecting more and more taxes almost from the same taxpayers. Moreover, the government keeps the income ceilings fixed for years or does not adjust with the consumer price index (CPI), which raises personal tax burden among existing taxpayers. Keeping the black money owners safe with a parallel policy is also a complete violation of equity principles in taxation. Our finance minister acknowledged this unethical offer as a political compromise. If it is due to invisible hands, our democratic government will be more compromising before election year at the end of a political business cycle. However, this flexibility in our strict tax regulations is responsible for enlarging our shadow economy but it will not be easy to come out of such a fallacy of hypothesis contrary to fact.
Will the strictness in tax regulations be capable of downsizing our giant shadow economy? It has a success story of whitening Tk. 98 billion during the regime of immediate past caretaker government. A current price estimate compared it with a total of Tk. 90 billion regularised between 1976 and 2006. However, the response has been very poor over the last few years. Why will people enter into tax-net when they believe on the compromises to repeat? On the other hand, it is not easy to disclose illegal criminal earning like unreported salaries or assets. Rather, it is somewhat true that many businesses, including our political system, will break down without black money. As the problem is not just with tax regulations, it cannot be overcome through capacity building of the National Board of Revenue (NBR).
Meanwhile, our shadow economy has proliferated into criminal, informal and household sectors. Its criminal part is the largesse coming from drug-trading, smuggling, bribery and other illegal activities. Isn't this economic dynamism linked to our power system? Our politicians need to make very high-risk investment during election, which that leads them to illegal earning to recover investment and also to prepare for the future. While a person gets a public job on bribe, he has scope of illegal earning to get the money back. Businessmen raise the product prices because of their additional transaction costs from corruption. Any contractor who gets work orders with additional transaction costs, would degrade works to recover costs. A report of the TIB added that contractors pay 10% bribe to get work orders from local governments. This is how the benefits move cyclically to all stakeholders of shadow economy, breaking of which can only scale it down.
Naturally, the earners of black money become risk-lovers because of their lower marginal utility of money. The adoption theory justifies their joining in new enterprises. However, the whitening scope is given to almost loss sectors, like the stock market after the crash. Would they regularise it if not economically viable? On the other hand, our investment situation is unsatisfactory and limited investment GDP ratio around 25% for the last few years. Moreover, the incremental capital output ratio has increased from 4.1 to 4.4 in a year not for capital intensification but for loss in capital productivity during political instability. Where a drive to single-digit interest rate was ineffective to lift investment, a compromising tax policy would not develop industries in our all-embracing market.
Whatever it is for, so-called political compromise depends on the willingness of our finance minister. He does not want to keep the unethical provision of money whitening for the next fiscal. However, such words are so flexible that our ex-finance minister even changed his words just before his budget speech. It is a cheap option to empower the minister but a costly option to weaken the NBR, and needs to be abolished from our Tax Ordinance. The government must not confer burden to payers who are neither a welfare agencies nor a commercial bodies. In this regard, a clause for automotive adjustment of income ceilings needs to be incorporated in the ordinance.
Moreover, a systemic strategy is needed along with necessary changes in regulations. A separate act with timeframe would be rational to regularise our shadow economy. It might impose an incremental tax rate like 10% for regularising in first year plus an extra 5% for second year and so on for all subsequent years. Subsequent attempt would be non-compromising, for which the NBR must be strengthened both with digital and human capitals. Our database for national ID would be a base to move forward. What is prime essence for all changes is the mindset of our political leaders. How can we expect the beneficiaries of shadow economy to initiate actions against it? It would be possible at least through reforms in capitalistic election system, accountability in parliamentary system and real independence in judicial system.

The writer is Associate Professor and Chairman, Department of Economics, Comilla University.     E-mail: [email protected]