Suppose A earns Rs. 1000 in some legal activity eg tuitions, declares that income in his income tax return and pays Rs 100 tax on it – he has Rs. 900 of white money for his legitimate expenses and the govt. has Rs. 100 for governance expenses like defence, development, education and all that.
Now suppose he spend Rs 100 on veggies in a small shop that gives no receipt. Selling veggies is a legal activity but the vendor, B, may have made a profit of Rs 10 on this income. He owes the government Re. 1 which he has not paid. The govt. loses Re 1 of revenue from his income. Now B buys a match box from C for Rs 10, and gets a receipt. C makes a Re 1 profit on which he pays the government paise 10 as tax.
B has an unaccounted income of Rs 10 on which he has not paid a tax of Re. 1…. that makes it black money. The govt. can ask B how he had the money to buy a matchbox… or how he has Rs 10 in his bank or home. Then the govt can actually ask him to pay Rs 2 as tax including a penalty.
Suppose D steals Re 1 each from A, B and C. It is an illegal activity and obviously he cannot declare and pay tax on it. A and C can file a police complaint but B cannot admit he had a rupee that was stolen.
Suppose D now buys a soap for Rs 3 from E and gets a receipt and E makes a paise 30 profit on which he pays paise 3 tax. E has accounted tax paid white money.
So money turns white and black and white again. A strict govt. might penalise B and prosecute D.
Govts would like all transactions between citizens to be tracked and taxed. Citizens don’t like this much but they like to see rockets launched, borders defended and roads laid.
If all the citizens are busy earning and spending money legally and ‘whitely’ the govt. has more money to spend on the people.
In corrupt economies, money changes hands without any accurate record of goods/services exchanged and without tax properly paid on those transactions. Then there may be rich individuals, but the country may be poor.
A thought expt.
Suppose P and Q help each other by driving each other to work on alternate days. Then the govt. gets no tax.
Suppose P and Q resolve to pay each other Rs 10 when the other drives. And suppose they pay the govt. Rs 1 each time they transact money. At the end of a month the govt. has Rs 30 and they have Rs. 15 less each. But the govt. now adds a bus on their route. Now they can get to work without driving and at a fraction of the earlier cost.