Underground Economy, Dimensions of

views updated


UNDERGROUND ECONOMY, DIMENSIONS OF India's underground economy, or the "black" economy, as it is commonly referred to in India, has serious implications for India's social, political, and economic development. The underground economy is synonymous with illegality; incomes generated in the illegal sectors, on which direct taxes are evaded, constitute India's black economy. The underlying motives for generation of black income and its disposal in terms of consumption and investment usually differ from those of white incomes, but in some activities and in their convertibility, there are links between the two. The black economy, therefore, is not a parallel economy but one that is deeply intertwined with the white economy.

The level of tax compliance in India declined during the 1970s and 1980s, reflecting perhaps the growth of the black economy. Scams have become larger in magnitude and have increased in numbers. Despite being estimated at 40 percent of India's gross domestic product (GDP), the black economy has remained immune to precise mainstream analysis.

Black incomes are also identified as property incomes, profits, interest, rent, and dividends, rather than wage incomes as black incomes are generated through artificial escalation of costs or underreporting of production or sales or some combination of these; in other words, black incomes are generally generated by the propertied class. Illegal transfer payments such as bribes and tax-evaded incomes from capital gains are not to be included in the definition of black incomes, since that would lead to double counting.

The true economy of any country consists of a white and a black component. The importance of the black economy for a country can be gauged from its size relative to the size of the reported GDP. By its very nature, assessing the size of the black economy is a difficult task. Noteworthy studies giving estimates of the size of the black economy in India are not strictly comparable, owing to the differences in the underlying methodologies and the corresponding differences in its coverage. However, the size of the black economy relative to the size of the white economy has been growing since the 1950s.


The impact of the black economy on India's economy, society, and polity is too significant to be ignored. It vitiates data, thereby making it difficult to get a true picture of the economy. It has resulted in higher levels of unemployment, lower levels of human development, more skewed distribution of income, poorer quality of infrastructure, subversion of the political system, weakening of the institutions of democracy, and increasing problems of law and order, which result in poor governance.

Macroeconomic linkages

The black economy has strong macroeconomic linkages affecting all the major macrovariables. The black economy has rendered the information base of India's economy unreliable, which is crucial for policy making, as the data collected for national income accounting from the producing units are fudged in the presence of tax evasion. Incomes are often shown to be originating in agriculture to avoid taxation; therefore the GDP is underestimated.

The propensity for black income generation is greater in the tertiary sector than in the secondary sector, and virtually negligible in the agricultural sector. Thus sectoral composition of income as revealed by the official statistics is distorted. Income distribution and employment figures are substantially biased by the black economy. Furthermore, the growth of black incomes, property incomes, and the size of India's service sector tend to boost each other and constitute a growing trinity.

At the macroeconomic level, the efficacy of fiscal policy has been severely dented. Government expenditure gets inflated due to leakages while the actual delivery of services suffers. The poor quality of education and health services provided by the government in the majority of cases is forcing people to move toward privately provided services. Revenues turn out to be lower so that the deficit becomes higher, resulting in inadequate allocations of infrastructure, both social and physical. Several studies indicate that revenues from tax and nontax sources are far below their potential at all tiers of the government, which results in rising borrowing and interest payments, fostering budgetary crises.

The rate of growth

In sharp contrast to the channels of white investment, many black channels of investment are generally unproductive and are in the nature of transfers. Speculation, hoarding of cash, smuggling, and capital flight abroad through fake invoicing of exports and imports are some such channels. These channels of black investments opened up the Indian economy even before the liberalization process began during the early 1990s, and the economy traversed along a lower trajectory of growth. The black economy can be shown to result in deficiency of demand, thereby slowing down the rate of growth. The high costs of conducting business because of poor infrastructure, bribery and kickbacks, and uncertainty have contributed to India becoming a high cost economy. The black economy has led to criminalization of India's society due to a nexus among politicians, bureaucrats, and businesspeople. It is often argued that funding of elections by big businesses helps entrench such an unholy relationship. Societal unrest mounts as disparities between groups widen, while growth and employment remain below that which should be achievable, and thus sound policies fail.


There is no consensus concerning diagnosis or remedies for the menace of the black economy. The black economy continues to thrive, despite policy initiatives, because it is systemic, and there exists a nexus among the three groups: the corrupt politicians, the corrupt public functionaries, and the corrupt businesspeople.

The last of the Tax Reform Committees (Government of India, 2002) has suggested that the economics of tax evasion must be changed by reducing costs of complying with tax obligations, moderating tax rates, phasing out concessions, and increasing the use of technology in compiling information related to taxpayers, reducing the scope for interface between taxpayers and tax administrators. The general perception has been to reduce government intervention in the economy and to rely more on market forces so as to reduce the incentives behind tax evasion.

In the wake of India's integration with the global economy, there is an urgent need for restoration of fiscal balance and improvement in the efficacy of economic policies to accelerate growth and reduce poverty. The government stands discredited regarding its ability to rein in corruption. The black economy is a serious issue that must be remedied, as it darkens India's image abroad and undermines the quality of public life at home.

Saumen Chattopadhyay

See alsoEconomic Development, Importance of Institutions in and Social Aspects of ; Economic Reforms of 1991


Acharya, Shankar N., et al. Aspects of Black Economy in India. New Delhi: National Institute of Public Finance and Policy, 1985.

Bhattacharyya, Dilip K., and Susmita Ghosh. "Corruption in India and the Hidden Economy." Economic and Political Weekly 33 (31 October 1998): 2795–2799.

Chattopadhyay, Saumen. "Macroeconomic Dis-equilibrium and the Black Economy in the Context of Stabilization Policy in India." Ph.D. diss., Jawaharlal Nehru University, 2002.

Das-Gupta, Arindam. Reports on Informal Credit Markets inIndia. New Delhi: National Institute of Public Finance and Policy, 1989.

Das-Gupta, Arindam, and D. Mookherjee. "Design and Enforcement of Personal Income Taxes in India." In Public Finance: Policy Issues for India, edited by Sudipto Mundle. Delhi: Oxford University Press, 1997.

Government of India. Report of the Comptroller and AuditorGeneral for the Year Ended March 2000: Union Government (Direct Taxes), Number 12 of 2001. New Delhi: Comptroller and Auditor General of India, 2001.

——. Report of the Task Force on Direct Taxes. New Delhi: Ministry of Finance and Company Affairs, 2002.

Gupta, Poonam, and Sanjeev Gupta. "Estimates of the Unreported Economy in India." Economic and Political Weekly 17 (16 January 1982): 69–75.

Gupta, Suraj B. Black Economy in India. New Delhi: Sage Publications, 1992.

Kaldor, N. Indian Tax Reform: Report of a Survey. New Delhi: Government of India, Ministry of Finance, 1956.

Kumar, Arun. The Black Economy in India. New Delhi: Penguin Books, 1999.

Shukla, Arvind. Behaviour of the Velocity of Circulation ofMoney in India from 19801981 to 19931994: A Study of the Impact of the Structural Change in the Economy. M.Phil. diss., Centre for Economic Studies and Planning, Jawaharlal Nehru University, 1992.