Legalising black money- theory and practice

Mabroor Mahmood | Published: April 12, 2016 17:31:20 | Updated: October 25, 2017 05:08:52

When anybody hides his/her income from the government and does not report the actual income to evade taxes, the hidden income then becomes "black money". There are many other softer terms to denote the same thing, such as undisclosed income, unreported income, covered income, etc. 
There are many ways how black money is created. The most common is through illegal professions, such as drug trafficking, prostitution and activities that are deemed as criminal offences in the eyes of law. 
Black money can also be created by corrupt individuals who have enormous power and who earn a substantial part of their income by abusing their power. Black money is also created through evading taxes by businessmen, corporates, professionals and celebrities, etc. 
TAX AVOIDANCE AND TAX EVASION: It is very important to understand the basic difference between 'tax avoidance' and 'tax evasion'. Take a look at the following table:
TAX HAVENS: It is widely believed that tax havens are located only in island states where there are small number of inhabitants and a few banks dealing with such dirty money. But Tax Justice Network (TJN), a UK-based non-profit charitable entity that conducts periodic research on tax havens, thinks otherwise. They have recently devised Financial Secrecy Index (FSI) that reveals most popular tax havens are not the island states or relatively less known countries in Latin America or in the Caribbean. According to the index, the most popular tax havens are in countries which are OECD (Organisation for Economic Cooperation and Development) members! 
(The full FSI Index 2015 can be accessed at
In the following table, we compare the top 20 countries listed in FSI 2015 with their corresponding ranks in the Transparency International's Corruption Perceptions Index (CPI) 2015. The countries having the most stringent secrecy laws are ranked higher in FSI 2015 and the countries perceived to be least corrupt are ranked higher in CPI 2015: 
FSI 2015 ranks a total of 92 countries in the world in terms of the degree of secrecy in their laws, while the CPI 2015 ranks a total of 167 countries in terms of the perception of corruptibility. 
As evident from the above table, out of 20 countries having the highest secrecy in their financial laws, eight countries rank very high in the CPI 2015 as well. This indicates that these eight countries, although discouraging corruption within their boundaries, are actually encouraging corruption beyond their boundaries by providing incentives through financial secrecy laws that induce people abroad to evade taxes and store money within their territories. 
OVERARCHING PRINCIPLES: We developed a theory on black money in 2005, but made it public in 2009 when we published a paper titled "Indefinite Corruption". The paper was targeted to Bangladeshi audience and was written in Bangla (the paper is available at assets/ Paper1.pdf)
Our theory on black money is guided by a number of overarching principles as follows: 
It should be treated as an unjust behaviour on an individual if s/he is punished severely through long jail terms because of evading taxes and generating black money when such behaviour is rampant in his/her society; 
If this happens, then the government punishes a few individuals through selecting them arbitrarily, while turning a blind eye to similar crimes of others. It is because it is not possible to impose the same jail terms for a large number of people at the same time; 
If the government does not allow citizens to legalise their black money through appropriate provisions, the only punishment left for the tax dodgers will be the jail terms. Legalising black money through paying taxes acts as a financial penalty, which is also a form of punishment, although to a lesser degree in terms of severity; 
From international perspective, it would be unjust to impose sanctions or other forms of severe punishment to select countries or individuals when many developed countries encourage corruptibility outside their territories; 
Encouraging corruption and generating black money through creating tax havens have been going on almost openly. Switzerland, the country that ranks the top in the Financial Secrecy Index 2015, also houses almost all the head offices of large global institutions where global leaders frequently meet to discuss on governance, transparency, etc. 
Our theory on black money goes as follows: 
"Legalising black money through various tax measures has economic significance when people would tend to use this particular provision for legalising their illegal income. If they do not use the provision despite its presence, it means that such provision does not have any economic significance. Therefore, there is also no need to spend time on such provisions. 
This provision will have economic significance only when it is supported by a concurrent effective anti-corruption drive. An anti-corruption drive has many elements, such as anti-corruption publicity, developing the required institutions to check corruptibility, effective monitoring in the banking transactions, strengthening regulatory regime, etc. 
If such a concurrent anti-corruption drive continues successfully, people will have fear of their illegal income and they would tend to legalise their illegal income. So the economic significance of this particular provision will also increase. 
If all countries follow this for a considerable period of time, then a time will arrive when there will be no black money available within and outside a country's boundary. Only then such provisions for legalising black money may be abolished for good." 
THE APPLICABLE TAX RATES: In order to encourage people to legalise their income quickly, the following measures can be adopted: 
a. For legalising the cash black money, the tax rate to be applied should be higher than normal tax rates of income; 
b. If any individual or a corporate wishes to legalise illegal income through investment, the applicable tax rate should be lower than above. This would encourage people to invest the sums in productive opportunities, which will benefit the people in the long run. Since there are risks in investments, proper incentives should be provided to encourage people to legalise their illegal wealth through direct investments. The government may select priority sectors where such investments should be channelled; 
c. For countries where people have a general tendency of paying taxes regularly, this provision should fix higher rates of taxes for legalising illegal income compared to those countries where tax evasion is rampant; 
d. The individual or corporates should legalise their illegal wealth in the jurisdictions from where illegal wealth was generated; 
e. The governments may encourage people to quickly legalise their illegal wealth by adjusting tax rates upward gradually in the long run. 
Allowing citizens to legalise their illegal hoarding is nothing new. According to a report titled "Update on Voluntary Disclosure Programmes: A Pathway to Tax Compliance" published by the OECD in August 2015 shows that out of 47 countries surveyed, 38 countries have "Voluntary Disclosure Programmes" under which tax payers are encouraged to disclose their hidden wealth through paying proper taxes. 
 In the United States, the Voluntary Disclosure Programmes that started in 2009 helped more than 45,000 tax payers to report their undisclosed wealth, generating an excess tax revenue of USD 6.5 billion. Many academic papers have termed such collection of revenue as "success". However, it needs to be determined what percentage of undisclosed wealth of US citizens has actually been disclosed through these programmes since 2009. 
In Bangladesh, between fiscal years 1971-72 to 2012-13, a total of Tk 138,080 million of illegal wealth has been legalised under various provisions offered by the National Board of Revenue (NBR). Of this amount, almost Tk 96,830 million or 70 per cent was legalised in 2007-08 fiscal year. 
During 2007-08, the government launched a massive crackdown on the politicians and businessmen who were perceived to be involved in big cases of corruption during various regimes. At the same time, the provisions for legalising illegal wealth were also kept open. Thus, an exit route was there for the illegal money-holders and they felt encouraged to legalise their illegal income in order to avoid any criminal proceedings against them. [The article has been abridged.]
Mabroor Mahmood is the founder  of Ideas for Development (IFD). The views expressed are  the author's own.

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