Black money is a big problem in India. One factor that facilitates the use of black money is undervaluation of property on paper. Many people earn, evade taxes and invest in real estate. Effectively, real estate acts as a store of “black” value. So, to tackle the problem of black money, it is important to reform the real estate sector. One regulation is the use of circle rates.
In the property market in India, there are two prices—the market price and the price “shown” on papers. Taxes are based on the “shown” price. The lower the “shown” price, the lower is the tax paid. The difference between the two prices is the black money. Now, suppose there is a regulation in the form of circle rates. This requires that the taxes will be calculated on the basis of the circle rate. This reduces the incentive to show a very low price on paper.
For the regulation to be meaningful, the circle rate needs to be close to the market price. However, in practice, the circle rate regulation is either absent or, where it does exist, it is very low compared with the market price. The circle rate regulation was introduced in Delhi only last month. In other places such as Gurgaon, it has been in place for some time. However, the circle rate is in many places barely one-fourth to one half of the market price. This is the sad part. The good part is that there is some floor. In the absence of the circle rate regulation, in many places, it is an open secret that the “shown” price can be as low as 5-10%.
Circle rates have been in the news recently in the context of the National Capital Region. But the regulation has wider application.
Circle rates have several benefits. Obviously, the tax collection will go up for the government. At present, we have a low tax-GDP ratio.
Real estate markets and financial asset markets are somewhat segmented in India. If you sell real estate, then you may not be able to buy financial assets. This is because the sale proceeds from selling real estate are partly in the form of black money, which is very difficult to use in financial markets. With greater use of circle rates, the situation may improve.
Property prices in many metropolitan areas in India are effectively high compared with those in developed countries. However, real estate prices in India consist of the black part and the white part, whereas prices in developed countries typically consist of only the white part. In the absence of black money, the property prices would be lower than what they are at present. So, we need to adjust our prices downwards to make these comparable with the prices in developed countries. Once the circle rates have been adequately revised, there will be no black money component, and prices in India will be directly comparable with those in developed countries.
There are other implications, too. Retail trade in India was not carried out very efficiently so far. One reason was the absence of the corporate sector in this business, but there was another reason. In retail trade, real estate plays an important role. But real estate involves black money. Not everybody has access to black money. For example, those who rely on the formal sector for finance for their business have little access to black money. Therefore, this profession was open to some people only.
In the absence of black money, retail trade will be open to more people. Similarly, another area, viz. the business of intermediation in the real estate, is open only to those who are not averse to black money. This has, so far, restricted competition. With increased use of meaningful circle rates, will be cleaner business and services will improve.
The government seems to be interested in having real estate investment trusts (REITs). This is good. However, before these can be launched, we need to ensure transparency. Circle rates play an important role in this context. With greater professional participation, we may get a better sense of values of real estate—both absolute and relative. At present, we seem to be lacking in an efficient real estate market. Increased circle rates will bring greater transparency, and hence give a boost to real estate development in the organized sector.
With greater use of meaningful circle rates, not only will real estate prices go up on paper but many other transactions will come to the surface. So, previously unrecorded income will now get recorded. The implication is clear. We may witness an even higher growth rate, though we need to be careful in interpreting this. There will be an improvement as far as data is concerned. The actual growth rate need not have changed much.
To sum up, the use of circle rates is a good policy. However, it needs to have more bite. The way forward is to reduce the stamp duty, which is one reason why properties are undervalued on paper, to begin with. Let us end with a new policy suggestion. Increase circle rates by 1% per month. This seems small, but it can make a substantial difference in the next five years or so.
(Gurbachan Singh is an associate professor at the School of International Studies, JNU, New Delhi. Comments are welcome at email@example.com)