India Surprises with a Wealth Tax on the Black Market

TheEconomicTimes: In a move to curb the black money menace, PM Narendra Modi declared that from midnight currency notes of Rs 1000 and Rs 500 denomination will not be legal tender.

In his 40-minute address, first in Hindi and later in English, the Prime Minister said the notes of Rs 500 and Rs 1000 “will not be legal tender from midnight tonight” and these will be “just worthless piece of paper.”

This is a big deal as these notes account for at least 80% of all cash in circulation! Ken Rogoff has argued for eliminating cash but this doesn’t seem to be a move in that direction since the notes will be replaced with new Rs 500 and Rs 2000 notes. Rather it seems to be a wealth tax on the black market. Old notes can be turned into a bank for replacement so ordinary people won’t lose money. People in the black market, however, probably have a lot of cash that they are unwilling to turn into a bank because they don’t want to reveal their wealth. Imagine walking into a bank and depositing a million dollars in cash–that is going to create a record that the tax authorities can follow. The wealth tax on the black market interpretation is consistent with the surprise–if people knew that this was coming they could have laundered the money but that is going to be more difficult and costly now.

It’s impressive that a government could pull off this level of secrecy. Good for Modi’s image as competent, uncorrupt and technocratic. Indians are calling it a “surgical strike on black money” which is the imagery Modi wants. But what will happen tomorrow when people don’t have enough cash to buy goods and services?

And there is another issue. Why is the black market so large to begin with? The wealth tax will punish current holders of cash but if the policies that generate the black market aren’t addressed the black market will grow again perhaps using gold, USD or bitcoin (see my addendum). It would be better to reduce barriers to entry and encourage more economic activity to move out of the black market and into the formal sector.

Hat tip on twitter to Evan Soltas and Kevin Grier for some discussion.

Addendum: Bitcoin up today.