undervaluation that also leads to property tax undervaluation. With an average tax rate on capital value of 2 percent, the aggregate amount of lost property taxes can be calculated. These losses are shown in Table 15<sup>34</sup> . These estimates are meant only as broadly suggestive of the aggregate revenue losses that might be present. They again indicate that undervaluation of transaction value has a major impact that cascades beyond its effect on stamp duty collections.

|**Table 15. Forego**|**ne Property Tax Collections, 200**|**0-2001 **(in Rs.Mill|ions)|
|---|---|---|---|
|**Percent**|**Percent of Base Subject to Pro**|**perty Tax**||
|**Undervaluation**|**25%**<br>**50%**|**75%**|**100%**|
|10%|373.3<br>746.5|1119.8|1493.1|
|25%|1119.8<br>2239.6|3359.4|4479.2|
|50%|3359.4<br>6718.8|10,078.2|13,437.6|

As with the capital gains tax, State government attempts to improve valuation for stamp duties generates benefits for a different level of government, in this case, urban governments that impose the property tax.

<u>State Sales and Central Excise Taxes.</u> A less direct link may be between stamp duties and State sales and central excise taxes. Suppose that the existence of high stamp duties lead companies operating in the real estate sector, especially builders, to undervalue properties. Such undervaluation saves the company tax payments, thereby increasing company revenues. However, these increased revenues are illegally generated, sometimes referred to as “black money”. In order to avoid revealing the existence of this black money, the company must utilize it in ways that maintain secrecy; that is, the company cannot use it to pay, say, sales taxes on inputs or excise taxes because these transactions must stay off official company records. As a result, there emerges a cascading effect through the entire production process, as activities must remain hidden. Put differently, the underreporting incentive in stamp duties feeds the “black economy” by driving money and resources into the sector.<sup>35</sup> In many scenarios, the revenue effects of this resource movement can be quite significant.

To illustrate, consider a stylized economy that is divided into two sectors: a taxed sector and a “black economy” sector that is legally subject to taxation but that escapes taxation because activities there are hard-to-tax. In response to a tax imposed on the taxed sector (e.g., stamp duties), resources move from the taxed sector to the black economy sector. Under various assumptions about demand for each output (e.g., elasticities of product demand), about production conditions for each output (e.g., factor proportions, elasticities of substitution), and about sectoral size, it is possible to simulate the impact of a change in taxation on tax collections. In this stylized model, it is easy to generate settings in which the movement of resources from the taxed sector to the black economy sector reach as much as 25 to 50 percent of the initial

> 34 Recall that the reported value of the transactions VR and the true value VT are related by VR = (1-s)VT or VT = VR/(1-s), where s is the fraction underreported.  Capital gains revenues equal the tax rate (20 percent) times the amount of this base subject to the tax.

> 35  The authors are grateful to Dr. Vijay Kelkar of the Ministry of Finance and Company Affairs for helpful discussions on this issue.

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