Sunday, May 18, 2014

Black Money and Campaign Finance in India

It is estimated that political parties spent atleast Rs 300 bn ($5 bn) during the just concluded Indian elections, though only a very small fraction of this would be formally reported. The prohibitive cost of running an election campaign is a major entry barrier to electoral participation. It is a widely known fact, as evidenced by the several large-scale corruption scandals, that candidates view electoral expenditures as a capital investment with rewards to be reaped after assuming power. In the circumstances, it is imperative that any effort at addressing the pervasive corruption start with lowering electoral entry barriers by reforming the process of campaign financing.    

Unfortunately there are no easy solutions. A good summary of possible reforms, though all have compelling deficiencies, is here. For sure, there are some low hanging fruits. For example, it is imperative that all donations be disclosed. As proof of how the current law, which mandates only donations beyond Rs 20000 be disclosed, is being gamed, only 6.2% of Congress funding and 8.7% BJP funding comes from disclosed sources. Placing limits on general campaign spending by political parties is another issue which needs immediate action.

Another approach would be to encourage parties to solicit disclosed small donations and then let them leverage it up with larger corporate and even public funding. In the US, in the aftermath of recent Supreme Court decisions that have dented campaign finance reforms and the growth of back-door financing channels like Political Action Committees (PACs), there have been legislative efforts to introduce greater accountability and transparency into financing political parties. A common feature of all these proposals is the role of parties soliciting small public contributions, $100-150, with federal government matching it few-fold, and a $50 tax credit per voter donor per election cycle. Further, some proposals also link up large corporate donations to being a proportion of small contributions. All these efforts are aimed at both limiting large corporate influence in elections, whose detrimental effects have been well documented, as well as incentivizing candidates to solicit small contributions and thereby increase the likelihood of greater accountability and transparency into electoral campaigns.

A corporate financed election fund, created through tax-deductible contributions, matched with public contributions is another alternative, though its distribution among parties would pose difficulties.  

The difficulty of satisfactorily addressing campaign finance, itself a massive challenge given the problems faced even in countries like the US, may be compounded in India's case from the the fact that solutions lie beyond mere campaign finance reforms. In fact, the most important reforms have to come from addressing the incentives to make money from public office and by limiting the country's massive black economy. The former requires no introduction and its solutions are widely discussed. 

But in a country where black money makes up atleast a quarter of the total economy, any meaningful efforts at reforming campaign finance has to start with addressing the black money economy itself. Apart from criminal activities, a major share of black money is generated from legally permissible economic activities which are under-reported, mainly for evading taxes (eg. business profits) or avoid disclosing investment capital volume and source (eg. land registration), and from manipulation of financial records and accounting (eg. mis-represent and under-disclose income by under-invoicing production or trade - manipulation of sales receipts, expenses, capital employed, closing stock etc). 

Tightening of the norms of corporate accounting and reporting standards and the strict enforcement of existing regulations is critical to eliminating the creation of black money. Simplification of the tax code could help increase the ease of detecting accounting manipulations. Harmonization of reporting standards under different laws could also help tip the cost-benefit ratio in favor of compliance. There are larger regulatory issues of increasing standards of monitoring foreign capital flows, transfer pricing between entities of the same holding company, and so on, as well as enforcement of regulations thereon. 

Efforts at choking off the creation of black money itself has to be complemented with introducing greater transparency and vigilance into the largest channels of black money circulation. Real estate and gold are two of the biggest platforms for money laundering. In real estate, the steep difference, often a few multiples, between the official land/property registration price and the actual market transaction value is arguably the biggest channel for circulation of black money. The sales of gold, which is a major source of hoarding black money, upto Rs 2 lakh pass off without coming under the tax scanner. In both cases, the loopholes should be closed - land registration values should be the same as market value and all gold transactions should be tax accounted. Finally, cash transactions should be limited so that all transactions are incentivized to be inter-mediated through the financial system.

Update 1 (23/08/2014)

Here is an excellent collection of 40 graphs from Vox on campaign finance challenges in the US.   

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