Recently in the Budget Proposals for FY 2005-06 the Union Finance Minister of India, Mr. P. Chidambaram, made one of the proposals relating to putting a tax of 0.1 percent for any cash withdrawal over Rs. Ten Thousand from ones bank account on a single day (ie. tax of Rs. 10/- on withdrawing cash of Rs. 10,000/- on a single day from one bank account). The ostensible object of such proposal was to put in a tax trail and discourage the creation of black economy. This is particularly when the government is under pressure not to introduce a new amnesty scheme and at the same time do something about black economy. According to him large sums of money are withdrawn from banks everyday and they simply disappear into the black economy.

The biggest objection to this proposal is putting a tax on the money that is rightfully of the person withdrawing it. Infact it is the money on which the person has already paid taxes - so, in principle it amounts to double taxation. Such double taxation is something that is not really palatable with the people. It is not really known whether such tax paid would be deductible expense for the purpose of computation of Income tax.

Now it is being heard that the Finance Minister, faced with opposition on this count would prefer to raise the limit from ten thousand to fifty thousand. However, the question of double taxation remains.

Despite of this, there would be some really good outcomes if such a proposal is passed. Notwithstanding the limit of withdrawal, it can be expected that a part of the money would go from cash economy to the cheque economy. This is quite appreciable for various reasons.

Firstly, when cheque would be used, the money would in situ remain with the banks. This means that the banks would have greater lending capacity. This would contribute directly to the expansion of the economy.

Secondly, large transactions that still take place through cash and finally end up as being part of the black economy - at least a part of such transaction can be expected to be done by cheque. This means that many of the money on which the taxes were not being received, now the governement would be able to realise the taxes from such persons who would have otherwise not disclosed their income.

Thirdly, the tax net would widen to include part of black economy. An important consequence of this would be that till now much of the burden of the taxes that fell on honest taxpayers would get distributed, and would be shared by people not disclosing their actual income.

A way out that the Finance Minister can do is not put a tax on the cash withdrawal, but put a limit to the cash withdrawal for the day. However, this is again something that would not be acceptable in a democracy as people would be denied the very right to access to their money. Also such thing would smack of an economy in distress - which certainly does not seem to be the case.

However a better way would be making payment of this 0.1 percent tax a deductible expense from ones income tax. But, all these are going to require a lot of paperwork.

So, while the proposal seems to be good economics, politically its a balancing act.

It can definitely be said that with the income tax proposals that Mr. Chidambaram has pronounced, the slogan of new India would have a paradigm shift from Garibi Hatao (remove poverty) to Amiri Lao (bring prosperity). As, now the people would really be motivated to earn more, rather than worry about paying taxes when income increased. Now the income tax slabs and the calculation of tax should be understood by the common people who till now were simply befuddled by the complexities of calculating tax.

Further reading:

1. What’s so BAD about the cash withdrawal tax?

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