Make black history, white the future!

Last week we wrote about how one can avoid getting lured into having black money ever again. We received strong feedback – most emails requesting further elaboration of the points discussed and still others downright rejecting our ideas on the topic. So this week, we shall discuss the same subject a little more in detail. Basically, the equation is simple. Income minus taxes equals legitimate (white) capital. And by corollary, income without paying taxes equals black money (black capital).

The genesis of generating the ‘black’ capital dates back to the high tax rates (upwards of 90 per cent) prevalent in the early 1970s. People started not declaring or under declaring their income in order to avoid paying the exorbitant taxes. But unfortunately, this went on to become a habit and as most habits are – well – habit forming – even when tax rates were moderated, people kept up with the practice (now a habit) of not declaring their income.

The problem became further exacerbated with the boom in real estate. Property attracted the ill-gotten wealth of corrupt politicians/industrialists who poured in their cash components in real estate investments. The builders on their part, saddled with cash started using the same for their day to day operations, thereby engendering a parallel cash market in real estate. Over time, this became a vicious cycle where all real estate transactions, by default required the mandatory cash element.

Anyhow, the fact remains that for one reason or another, Indians have traditionally hoarded a large amount of cash. Regardless of the actual tax rate, not paying the tax and keeping the entire amount to oneself is an appealing idea, notwithstanding the small overlooked fact that it is illegal! Be that as it may, now onwards, the threat of demonetization will hang like a Damocles sword on all those who still ‘hoard’ aspirations of stashing away cash.

Come to think of it, we don’t really need to take the risk. In last week’s article, we had taken an example where the tax rate is 20 per cent (on capital gains). Rs 80 invested at 10 per cent p.a. for 2.34 years would grow to Rs 100. Which means, that all it takes is around 2 years and 4 months to recover the tax paid.

One could argue that 20 per cent is too low a rate, most pay income tax of 30 per cent, not the capital gains tax of 20 per cent. Actually, though the maximum rate of income tax is indeed 30 per cent, on account of the various tax deductions (80C, mediclaim, HRA, LTA, etc. etc.), the net effective tax rate (percentage) could work out to around 25 per cent or lower.

But to be on the conservative side, let’s take 30 per cent. So basically it boils down to this – one has two options – option a. on every Rs. 100, pay tax of Rs. 30 (30 per cent) and invest the balance Rs. 70 effectively. Option b. not to pay the tax and illegally keep the entire Rs. 100 stashed away in a cupboard or locker etc.

That being said, have a look at the following figures. These are two well-performing diversified equity funds. As a disclaimer, we must add, that there are more such funds, these are just two examples of many. Now, in the above table, we have taken the current value (NAV) of these funds and compared it with the value five years ago. The rate of return on the Birla fund works out to 15 per cent p.a. and the Reliance fund works out to around 18 per cent p.a. (figures are rounded off).

If one was to invest Rs 70 in the Birla fund five years ago, by now the value of the Rs 70 would have grown to Rs 141! This is Rs 41 more than the original capital of Rs 100. Similarly, in the Reliance fund, the value of Rs 70 invested five years ago would have become around Rs 160! And please note that these funds aren’t some that are known only to a select few or available only to select audiences.

The date of inception of Birla Frontline Equity is August 2002! And that of Reliance Large Cap is August 2007! In other words, these investments have always been there, in the public domain waiting to be availed of. But apparently most black money hoarders don’t know about the same or don’t know how to pick this low hanging fruit. Instead they are willing to generate black money and undertake the effort, risk and peril associated with it.

Last but not the least
In economic parlance, there is a term called Discretionary Spending. It represents spending by consumers on luxury goods, vacations and non-essential goods and services i.e. spending on aspirational items rather than on essentials such as food, clothing, medicines etc. Obviously it follows that black money hoarders used to apply their ill-gotten stash for discretionary spending rather than use their white money on the same.

This was widely reported in the media but in different ways. Apparently after demonetisation, there was a discernible drop in foot falls in malls, shopping areas and other high end stores. It was almost as if the shoppers had stopped shopping overnight.

Basically what was happening was the following. A large part of the black money gets expended – it seems people prefer to get rid of the black element by exchanging it with some other purchase – such an activity has a dual benefit of not only offering a shopping experience but it also means one is able to get rid of the cash.

And that precisely dear readers is our point. Cash shouldn’t be earned only to have to get rid of it when you have the option of investing it and making it grow. Of course by all means, spend on those ‘luxuries’ that you need – but spending just to get rid of the cash just doesn’t make sense.

After all, everyone will agree that it makes more economic sense to earn Rs. 70 and see it grow to Rs 160 rather than earn Rs 100 and spend it all on things that one doesn’t really need. At the end of the day, it is up to you. Question is – are you up to it?
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