What is black money and how does it work?

Created on 25 Mar 2022

Wraps up in 5 Min

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Updated on 13 Dec 2023

What do we talk about when we talk about black money and money laundering? Well, in India, it has to start with Vijay Mallya, Kingfisher and then gradually move on to Nirav Modi and his uncle, Mehul Choksi. “With all the kaala dhan they must have stashed in the Swiss Banks, at least 3 of their generations wouldn't have to do any labour!” - being the hackneyed dialogue. 

Why was it so unfair of Mallya to run away to the UK after he owed thousands of crores of money to the banks? How did Nirav Modi and Choksi manage to get so many fake Letters of Undertakings!

It is commonly believed that only millionaires and billionaires are the ones who own black money. Well, yes and no. It is very likely that they own black money but so could be owned by our next-door ration shop. 

When we talk about these things, do we really know what we are talking about? 

Let us learn today, what exactly is black money and why is it laundered. 

What is Black Money?

Black money is the revenue that is generated from activities that are either illegal or can include legal activities, tax on which has not been paid to the respective authorities. The transactions are mostly done through cash. The money is kept out of the banks to avoid record keeping. 

The money that the owner holds is thus, not legitimate, and is considered illegal to transact with it. The process through which this black money is converted to ‘white’ or legitimate money is called money laundering. The reason why it is not good for any economy is that the tax on that huge chunk of money has not been paid and the money gets back into the system and the huge inflow of money may lead to uncontrolled consumption and thus, inflation. 

On the evening of 2016, when the Prime Minister announced the demonetization of notes, the whole country was shaken. But for the ones with a huge stash of black wealth, it felt like they were electrocuted. The famous/infamous demonetization was done to stop people who found a leeway to recycle their black wealth.

How does Black Money work?

Black money is generated mainly in 3 ways- 

  • Through illegal activities:
    The highly scammy cases that we hear of drug trafficking, gunrunning, terrorism, smuggling, and corruption come under this. 

  • Tax evasion
    In this, an individual or an entity conceals its actual revenue earned and does not pay taxes to the authorities. 

  • Tax avoidance
    Although tax avoidance is not illegal but falls in a grey area. This is where an entity finds some flaws and gaps in the tax filing system and avoids paying taxes.

Suppose I run a grocery store. Of all the transactions that take place, people either pay by cash or online. I provide receipts for all payments done online, and for the ones done in cash, I don’t. The reason why I do this is so that I can show those online transactions in my tax filing and save taxes on the unrecorded cash sales. 

Sources of Black Money in India

These are the major sources and ways in which black money is earned:

  1. Bullion and Jewellery market
    The option of converting black money to gold ingots or jewellery is very widespread in practice. 

  2. Out of book transactions
    This one is the simplest and most used way of earning black money that even an unskilled or semi-skilled person could practise. By not providing bills and receipts for the sales, they are basically adding to their unaccounted sum of money on which they will not pay taxes. 

  3. Hawala
    This is an informal and inexpensive method of transferring money without the use of the bank. It works on codes and contacts and does not require disclosure of any kind of information. 

  4. Non-profit organizations and self-help groups
    Some privileges and incentives are provided to these organizations in taxing their income since they promote charity. These tax benefits are often misused and exploited for tax avoidance. Similarly, a lot of SHGs do not properly state the sources of the donations they have received which can lead to hera-pheri of money.

  5. Tax havens
    There are some small countries with liberal tax laws where foreigners don’t have to pay taxes. By setting up shell companies in these countries, people redirect their funds and reduce their tax liabilities.

  6. Real estate
    Since the prices of real estate are on the rise, many people undervalue their property to save on property taxes. 

Why is it difficult to quantify Black Money? 

How is the government supposed to quantify the one thing that people are intentionally and actively trying to hide from it? 

The whole concept that black money is the money that is unaccounted for makes it impossible for the government to identify the exact amount of black money that is in the economy and how much of it is converted into white. 

The sectors that have the highest contribution to adding black money in India are- real estate, mining, bullion and commodity market, and pharma. 

Effects of Black Money on the Economy

There are some severe consequences of increasing black money in India. Some of them include-

  • It directly affects a country's financial health as the policies that are made by the RBI to tackle inflation cannot be implemented correctly.

  • A major portion of the government’s revenue comes from collecting taxes and since people evade taxes, the funds that stay with the government are lesser than what should have been. 

  • People earning black money fall in a vicious cycle of using these funds for illegal activities and thereby increasing the amount of black money in an economy. These activities are bad for the economy as well for the people who get involved. 

  • Increased black money in a country leads to the formation of a negative image of the country and the credibility of the country is affected. 

  • Since black money is used to finance criminal activities in a country, the national security of the country is threatened. 

  • Black money can also cause real estate prices to go up, which may lead to an asset bubble.


The bad reputation that black money has got very properly justifies it. The severe consequences of it on the economy of a country and on the people living in it demands that black money be curbed. 

Although the government has tried bringing in various reforms and policies to curb it, people still find a leeway and that distances the goal even more.   

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