The government has changed the demonetization narrative from one of fighting black money to being about pushing for a cashless economy. Critics say that is because demonetisation failed to fight black money. Most black money hoarders seem to have figured out how to launder even their old currency. As a result, most of the currency in circulation is already back in the banks.
But there's an alternate scenario, one where demonetization is only the first and the painful part. And what comes after will more than make up for a few months of queuing before ATMs. This is a theory about the larger political game plan for 2019.
The government's primary intention behind demonetization perhaps always was the push it is giving to cashless transactions.
The government's primary intention behind demonetization perhaps always was the push it is giving to cashless transactions. And that could be because the government plans to abolish or drastically reduce income tax and replace it with a flat banking transaction tax (BTT). The government hasn't specifically said this yet, but a little reading between the lines could yield clues about the path ahead.
On 24 November, finance minister Arun Jaitley told chiefs of private and public sector banks the "principal objective of the government's reform programme was to curtail the use of physical currency," according to The Hindu. "To this end, the Minister set banks a target of converting cash transactions worth Rs 2 lakh crore into digital transactions by December 30."
What is the tearing hurry to make Indians use the formal banking system over cash for every small little transaction? Why set a target?
The more cashless transactions there are, the more revenues the government could mop-up through a flat BTT.
The more cashless transactions there are, the more revenues the government could mop-up through a flat BTT. That could more than adequately compensate for the loss of revenue should the government decide to abolish/reduce income tax. Those with an annual income greater than Rs5 lakh are paying 20% in income tax and those with income greater than Rs10 lakh are paying 30% in tax (not counting all the indirect taxes all of us pay). There are some 35 million income tax payers in India. Abolishing or drastically reducing it (or raising the slab) will prove to be a massively popular move.
The idea of altogether abolishing income tax was hotly debated within the BJP in the run up to the 2014 general elections. The BJP never promised it officially, but some party leaders hinted they might do it. Right wing thinkers such as the minister Nitin Gadkari, MP Subramanian Swamy and S. Gurumurthy of the Swadeshi Jagran Manch, have all been long-standing supporters of the abolition of income tax. Needless to say, it is also very popular with the BJP's middle-class constituencies.
The idea of altogether abolishing income tax was hotly debated within the BJP in the run up to the 2014 general elections.
The Pune-based thinktank Arthkranti Pratishtan, which has been explaining its economic ideas to Mr Modi since 2013, and to former President Pratibha Patil and others long before that, has a larger plan in which demonetization is only the first step. In 2014, too, Arthkranti had made a presentation to top BJP leaders. Anil Bokil of Arthkranti has met prime minister Mr Modi, other leaders in the BJP and even finance ministry bureaucrats, repeatedly since 2013.
Here's how the Arthkranti-inspired plan makes political sense for the Modi government. A significant cut in income tax rates or easing of slabs (if not altogether abolition) would immensely spur consumption and thus economic growth. This may also ease the economic contraction that demonetization appears to have triggered. The loss of income tax revenue would be made up for through a small bank transaction tax. The goods and services tax will also, similarly, help the government earn more tax on consumption than it currently does.
For any of this to be possible, the government first needs to minimize cash transactions. Since the government wants to implement these ideas before 2019, the painful push of demonetisation seems to have been necessary to dramatically scale up cashless transactions. One criticism of the banking transaction tax idea has been that it would, like income tax, still leave a lot of people out of the tax net because India is a cash economy. Through demonetisation, the government is trying to change that overnight.
This is why the government wants, overnight, the number of Points of Sales machines to go up from 1.5 million to 2.5 million.
This is why the government wants, overnight, the number of Points of Sales machines to go up from 1.5 million to 2.5 million, and is ready to face some service tax loss by giving discounts of fuel and other purchases if they are made through cards.
A cut in income tax will endear the middle class to the BJP. Despite higher consumption taxes, the middle class will have more disposable income, and thus feel more financially empowered.
But that's just for the rich. For the poor, there may be a separate strategy.
This one is not inspired by Arthkranti. There has been, over the past few months, a lot of buzz about a "universal basic income" which may not be universal at all. It may look more like a cash dole to the poor through Jan Dhan accounts, along with the direct benefits transfer of subsidies (and an overdraft facility of up to Rs 2,500 for all active accounts). The government's chief economic advisor Arvind Subramanian has publicly backed the idea. The amount may be as little as Rs 1,500 a year -- but that's a lot of free money in the bottom rungs of the income pyramid.
These aren't necessarily great ideas. The banking transaction tax, like all flat taxes (those agnostic to income), is regarded as regressive taxation, where the burden on the poor is disproportionately higher. Besides, it will require enormous patchwork regulation to prevent people finding workarounds. It would also require the government to place caps on cash withdrawals and transactions.
Nonetheless, this plan could enable Narendra Modi to stand up in 2019 and say he has alleviated poverty and removed income tax burden from the middle class — a seductive political pitch.