Tax on black money
The most important way to view demonetisation is as a tax administration measure, one designed to tax holdings of black money. Of course, demonetisation of large denomination notes is not exactly the same as demonetisation of black money. Some cash holdings were perfectly “white”, the fruit of income upon which taxes had either been paid or had not been applicable in the first place (agricultural income, for example).
Cash holdings arising from income that had been declared could readily be deposited at banks and ultimately exchanged for new notes. But those with black money faced three difficult choices. They could:
- Declare their unaccounted wealth and pay taxes at a penalty rate;
- Continue to hide it, not converting their old notes and thereby suffering a tax rate of 100 percent; or
- Launder their black money, paying a cost for converting the money into white.
Tax compliance
Demonetisation can also be interpreted as a regime shift on the part of the government. It is a demonstration of the state’s resolve to crack down on black money, showing that tax evasion will no longer be tolerated or accepted as an inevitable part of life. Since this action has commanded support amongst the population, demonetisation shows that black money will no longer be tolerated by the wider public, either. Demonetisation could also aid tax administration in another way, by shifting transactions out of the cash economy and into the formal payments system. With large denominations eliminated, households and firms have begun to shift from cash to electronic payment technologies.