The biggest news last week was the Modi government's decision to discontinue 500 and 1000 Rupee notes to address the issue of 'black money'- those economic activities and the income derived from them that circumvent or otherwise avoid government regulation, taxation or observation. The move is expected to take a lot of ill-gotten cash out of circulation although it will cause considerable pain to the population in the short term.
So how big is the shadow economy in India? Estimates widely vary. One government report commissioned by the Manmohan Singh government puts the figure at a scary 75% of GNP. That number however, seems awfully high. Consider the fact that only 2.5% of Indian citizens pay Income Tax and the 75% does not sound all that ridiculous anymore.
The World Bank commissioned a study to gauge the size of shadow economies around the world. The 2007 figure puts the size of India's shadow economy at 21.4%. It has very likely grown since. The actual answer may however, lie somewhere in between 21.4% and 75%. The size of the problem is undeniably large. But how does India compare with the world's major developing economies and advanced economies such as the US? This week's chart sheds some light. Among large economies, towards one end of the spectrum is Russia at 41% while the US has an astoundingly small shadow economy of 8.4% of GNP. Smaller number of cash transactions and an empowered Internal Revenue Service have been instrumental in reducing the size of the shadow economy in the US. Here is to hoping the sweeping measure in India put a lasting dent in tax dodging and other white collar criminal activities and provide a boost to the legitiate sector of the economy.