Withdrawing Currency Notes Of Higher Denomination Will Not Curb Black Money In Real Estate

It is a common belief that the government will be able to curb black money in real estate by withdrawing currency notes of higher denominations, like Rs 1000 and Rs 500 notes. This view has become more popular in the recent past, because the amount of currency which was in circulation at the end of April 2016 was 15.32 per cent higher than the corresponding amount in April 2015. Some believe that the amount of money in circulation is higher because assembly elections in Indian states are in progress.

A careful look at data suggests otherwise. The rise in the money in circulation has been gradual. There was no sudden rise in the currency in circulation when the elections neared. But even in the United States, the spending on elections is often modest. The annual donations intend to be under a billion dollars, while the annual spending of the federal government tend to be well over a trillion dollars. So, spending during elections is unlikely to bring more money into circulation.

The Indian government had pointed out nearly four years ago that withdrawing currency notes of higher denominations is not likely to curb black money because this money is often invested in benami real estate assets, bullions and jewellery. Some people are of the view that black money is parked in the Swiss Bank accounts, but economists doubt whether this is statistically significant.  

It is not strange that there is a perception that black money is largely invested in real estate assets. Even in the primary market, real estate developers accept black money. But withdrawing currency notes is a move similar to curing pimples by cutting them off. To curb black money, we should first understand why this happens. Real estate developers accept black money for sales in the primary market, perhaps because they might be expected to pay large amounts of money for necessary clearances from various government agencies. It is unlikely that something can be done about this without eliminating the root cause. So long as government officials are given life-and-death power over developers, this will happen.

But this is not the only reason. Market rates of real estate assets is often much higher than circle rates. This is because the circle rates of government are usually not periodically revised, corresponding with fluctuating real estate prices. It is, of course, possible to make circle rates closer to market rates. But, this would prove to be even more harmful. If circle rates are closer to the market rates, it is quite probable that in many neighbourhoods transactions it will come to a halt. This is because real estate prices fluctuate widely. If authorities set circle rates closer to market rates, if prices fall, landowners will have no incentive to sell. It is much better to allow transactions to happen in black money.

Black money is, in fact, a way to get around government regulation that do not make economic sense. The government can easily prevent transactions in black money by abolishing stamp duty, registration charges and capital gains tax, or at least by lowering them. Economists have been arguing for long that revenues would rise even if stamp duty and registration charges are abolished, if property taxes are raised. Even though property taxes are harmful too, they do less harm than stamp duty. In most developed countries, property taxes are much higher than in India, but stamp duty is lower.