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Cash may not be king for long: the coins jangling in pockets or paper neatly folded in wallets are under threat.

The advent of new technologies has made the digital transfer of funds much easier. New payments companies such as PayPal and Square have already made a mark abroad. Established digital economy firms such as Apple and Facebook are trying hard to get into the game. Even developing economies such as Kenya have made huge strides in mobile banking.

It is against this backdrop that a recent decision by the Indian government has to be seen. The finance ministry last week appointed a committee seeking recommendations on how to increase the use of plastic modes of payment such as debit and credit cards in commercial transactions. This follows remarks made by finance minister Arun Jaitley on encouraging the use of plastic currency to tackle the menace of black money. Jaitley also alluded to the decreasing usage of cash as a medium of transaction in developed countries.

India, with cash in circulation amounting to 13% of gross domestic product (GDP), remains a laggard when compared to developed countries. Sweden, where coins and bank notes constitute just 3% of GDP, is a global leader in moving towards a cashless economy. The US, Canada and Singapore are other notable examples where a majority of consumer spending already happens through electronic means.

Increasing tax revenues and reining in black money have been the key reasons for moving towards plastic currency. Given that today cash remains the mainstay of transactions in India, and offers a great degree of anonymity, the focus automatically turns to the nature of the transactions. By helping bring more transactions under record, plastic currency can indeed play a crucial role in monitoring the flow of funds and help prevent tax evasion.

While such increased capabilities in law enforcement may be justified, the fundamental cause behind tax evasion should not be ignored. As data from various sources show, India’s tax-to-GDP ratio is one of the lowest in the world, averaging at around 10%. For financial year 2014-15, for instance, it is estimated to be 10.6%, which is low even when compared to our emerging market peers. Meanwhile, most of the tax burden falls on the middle class even as evasion rampant in the unorganized sector remains unaddressed.

The solution to the problem could lie either in giving more powers to tax authorities or the alternative of reducing taxes in order to increase compliance in the unorganized sector.

Black money is often the result of a high tax burden that prevents voluntary compliance on the part of citizens. As American economist Arthur B. Laffer showed way back in 1974, marginal tax rates can affect government revenues significantly. International experience also makes it clear that the size of the shadow economy is smaller in places such as Singapore, Switzerland and Hong Kong with lower tax rates as compared to others.

India’s tax rates are high compared even to many Asian countries that compete to attract capital. The finance minister has done well in promising to make corporate tax rates globally competitive by reducing it to 25% in the next four years. But more important was his commitment to remove exemptions that adversely affect the actual amount of tax collected.

The thirst for revenue can lead to stringent action from tax authorities and make matters worse for both tax revenue collection and work incentives. This has been evident in the repeated controversies over tax evasion between the income tax department and top businesses, both foreign and domestic. Much of this can be avoided through a simpler tax code that reduces the scope for discrepancy and disputes. As an analysis in Mint shows, India ranks in the bottom 20 among 90 countries when it comes to tax collection. The gap between India’s marginal income tax rate and the effective tax collection rate stands at 7.82% as compared to the global average of 2.6%.

Encouraging plastic currency should be welcomed from the perspective of increasing the government’s capability to monitor illegal transactions. But moving towards lower tax rates and a simplified tax code should be the larger goal of policy if growth and increasing tax revenues are the ultimate aim.

Will plastic currency help rein in black money? Tell us at views@livemint.com

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