India’s controversial decision to ban Rs500 and Rs1,000 notes has backfired. The idea was to root out “black money”—the profits of political corruption, tax evasion and ordinary crime. But efforts to get around the ban have been so effective that those problems may now be harder to solve than before.
Prime Minister Narendra Modi deserves credit for confronting the issue so boldly—few of his predecessors even tried—but he needs to rethink his approach.
Since November, an estimated 97% of the banned notes have been deposited in banks or exchanged for other denominations. Either Indians were hoarding far less illicit cash than the government believed or they found new ways to launder much of the money. There’s plenty of evidence to support the second theory: The money launderers rose to the challenge.
In fact, the ban may have been a bigger nuisance for lawful businesses and their customers than it was for the intended targets. Car sales saw their biggest drop in 16 years last month as the ban took effect and buyers were forced to delay their purchases.
Also read: How India coped with demonetisation
A better strategy would begin by recognizing the link between black money and political finance. The rules on campaign spending set a limit of Rs70 lakh (a little over $100,000) per candidate for national races—so low that few take it seriously. Candidates routinely spend 10 times more; the 2014 elections cost as much as $5 billion (second only to what the US spends).
This system doesn’t just tolerate black money, it also relies on it. An estimated three-quarters of the money given to India’s six national parties comes from undisclosed donors. Desperate for cash to pay for everything from TV advertising to booze and mobile-phone top-ups for supporters on Election Day, few politicians are inclined to question the source or upset potential donors by getting serious about illicit cash.
Modi has argued for concurrent state and national elections to reduce expenses, and he has urged his own Bharatiya Janata Party (BJP) to be more open about its finances. But he could go further. The BJP holds a comfortable majority in the lower house of Parliament; a campaign to eliminate black money from politics—a sure vote-winner—could help it gain control of the upper house as well. And the well-funded BJP is better positioned than smaller parties to withstand real reform.
Parties should be required to disclose the sources of all donations, with money moved digitally rather than in cash. Their books should be checked by third-party auditors. Parties should lose their tax reliefs if they don’t open themselves up to scrutiny, and politicians caught filing false returns should face severe sanctions. The Election Commission should have the power to deregister parties—more than 1,500 of which remain on the rolls, and thus able to collect “donations,” without contesting elections.
Breaking the connection between black money and politics would be only the first step. Simpler taxes and less red tape are also crucial, to reduce the incentives for businesses to operate in the shadows. Modi’s campaign in 2014 called for “minimum government, maximum governance.” His currency ban went wrong—but that was a good theme nonetheless, and it’s worth taking up again.