This is how India can reduce the size of its black economy

A deeper understanding of the economy is needed to figure put ways to deal with black economy

November 8, 2016 will be a memorable day for Indians in years to come. On this day, Prime Minister Narendra Modi eliminated more than 85% of Indian currency notes in circulation, wreaking havoc in common people’s lives. While the effects of this policy may take some time to unfold, will they include reduction in the size of black economy and corruption? To explore the answer to this question, it might be a good idea to look at what are the determinants of black economy and corruption.

Regulations and the Indian black economy

India has a substantial informal economy, or transactions and businesses that are not registered and cannot be taxed. This informal economy employs almost 75% of the total workforce in India but only contributes 20% to GDP. It is substantially less productive than the formal economy, though it provides a livelihood to a majority of Indians. Not all the transactions in this economy are illegal and most economic activities are undertaken by people and firms that belong to the unorganised sector. Acknowledging the meaningful differences between the terms ‘black economy’, ‘informal economy’ and ‘unorganised sector’, one common theme underlying these various categories is either blatant tax evasion (in the case of the black economy) or the government’s imperfect and sometimes harmful ability to tax transactions.

Almost all countries have some degree of black economy, prompting a significant amount of research on its causes and determinants. According to a survey of such literature by Friedrich Schneider and Dominik H. Enste (2000) and Friedrich Schneider (2016), the most important and often cited causes are:

Burden of taxes and social security contributions. Read more