#40: Economic Action, Criminal Sanction
How do we decide whether an “economic” action should be punished with criminal sanction?
As a policymaker, how do you decide whether some action should be punished with a criminal sanction? As the Jailed for Doing Business report points out, criminal penalties are written in too liberally in our business laws. A criminal sanction, whether prosecution with an imprisonment term or just a fine, is a very high bar for securing compliance.
How did India end up with over-criminalisation in economic laws?
The origin of the phenomenon of criminalisation of any violation in business laws can be traced to three underlying causes:
1. A vastly expanded state mandate
In the 1950s and ‘60s, the Indian state vastly expanded its mandate through economic laws as it went down the path of planned socialism. These laws were anti-people and led to constant resistance. An example of this is the Essential Commodities Act, which penalised traders for possessing items in short supply. Traders started violating the law. Sadly, the government identified hoarding as the cause of price rises, as against the fact that socialism was leading to shortages. Consequently, the Parliament started raising the imprisonment under the Essential Commodities Act.
Since then, many laws in India have tried to make economic actors make irrational decisions. Naturally, rational economic players try to avoid such laws. The state's response is then to jack up the deterrence, hoping it will lead to compliance. However, citizens instead developed novel ways to avoid the laws. An example is when people artificially break up factories to employ less than 20 workers so that the factory owner does not have to make economically unviable labour law decisions.
2. Low state capacity
There is a lack of state capacity to enforce laws, leading to the hope that stricter penalties will induce compliance and compensate for low enforcement. Even while implementing socialism, the Indian state did not build a large state capacity. This low state capacity, coupled with a wide mandate for the state, leads to the dilemma of how to deter citizens from taking actions that the state has determined to be illegal. The Indian state attempts to solve this problem by increasing the penalty.
This approach follows from a mistaken understanding of legal deterrence. Gary Becker’s famous theory of legal deterrence posits that: Deterrence = Magnitude of the penalty X The probability of getting caught. The strategy of increasing punishment fails because India’s state capacity has fallen below critical levels in many areas. When the probability of getting caught tends to zero, increasing the penalty does not increase deterrence. Violators see the penalty just as a random event (and rare) and do not abstain from engaging in the illegal activity.
This failure to create state capacity for prosecution also contributes to criminalisation in other ways. Because the state is aware that it is rarely able to establish fraudulent activity due to the lack of prosecutorial and investigative staff, it responds by criminalising defaults that are easy to establish. This leads to criminalising minor administrative failures where there is no intention to commit a crime.
3. Poor legislative drafting
There is a tendency to use omnibus criminal penalties across business laws. This is most evident in the case of current labour laws where they account for over half of all instances cited in the report.
India’s lack of state capacity even extends to drafting legislation. There are not enough legislative drafters, and the Indian state gives too little time to the legislative drafters to adequately research the topic being legislated. The drafter has no time (or resources) to identify the specific behaviour that should be criminalised by law. This results in legislative drafters taking shortcuts. One popular shortcut to take is to write an omnibus criminal penalty clause. This clause states that any violation of any provision of the law (and even subordinate legislation) may be punished with imprisonment. As expected, this leads to a plethora of criminal cases.
An example of this omnibus criminal clause can be found in India’s securities law. Section 24 of the SEBI Act reads:
“...if any person contravenes or attempts to contravene or abets the contravention of the provisions of this Act or of any rules or regulations made thereunder, he shall be punishable with imprisonment for a term which may extend to ten years...”
This provision leads to a funny and unintended consequence because the same law states that SEBI must:
“within ninety days after the end of each financial year, submit to the Central Government a report in such form, as may be prescribed, giving a true and full account of its activities, policy and programmes during the previous financial year.”
For many years, SEBI has missed this deadline. As a result, SEBI board members should be sent to jail for ten years. This does not happen because the government does not prosecute SEBI board members who enjoy immunity. However, the drafting of the omnibus clause shows the unintended consequences of omnibus clauses.
How do we correct this problem?
We have a stock challenge and a flow challenge. The instances of criminal sanctions in laws already on the books need some form of systematic correction. Jan Vishwas 1.0 was an attempt in this direction. For Jan Vishwas 2.0 to succeed similarly, we need to establish the principles by which criminal sanctions in existing business laws will be evaluated. That apart, we also need to correct for the future, so this phenomenon of over-criminalisation does not continue.
To evaluate whether sanctions in laws must invite criminal prosecution, we propose a 2-part approach: a conceptual approach and a practical approach. The conceptual approach shows a drafter “what to do” and the practical approach shows a drafter “what to not do”.
Conceptual approach: Only where the drafter can establish a certain mental state and predict a certain outcome, should they propose a criminal sanction.
Mental state: Is the act intentional, or, reckless? In legal Latin, this is called mens rea. Actions arising from mistakes, like forgetting to paint the factory canteen, should not invite criminal penalties.
Outcome: Will the act significantly harm societal cohesion, i.e. the action/inaction is perceived to be so harmful by ordinary citizens that they stop trusting their fellow citizens in normal day-to-day activities, or, can cause high levels of damage that cannot be compensated by the accused? Over time, humans have intuitively learned that certain actions harm social trust and interactions. As a result, all societies have criminalised murder and theft. The legislative drafter should carefully consider the outcome of the action sought to be prohibited. Civil damages and fines are more appropriate if the action is harmful but does not reduce trust in general social interactions.
For something to be considered a crime, the action/inaction must satisfy at least one sub-condition from each of these conditions. This frame of reference can be used to separate actions that should involve civil compensation as against criminal sanctions.
Practical approach: Where the drafter cannot establish that the criminal prosecution sanction has been introduced without sufficient consideration, they should not propose a criminal sanction. Sufficient consideration will include administrative compliance through threat, state capacity for enforcement, and quality of legislative drafting.
Compliance through threat: Is the state trying to secure compliance on administrative actions through criminal sanctions?
State capacity: Does the state have current capacity to successfully prosecute the action/inaction in a reasonable time frame?
Legislative drafting: Is the action/inaction sanctioned with criminal prosecution under the general penalty clause of the law?
Any time a drafter proposes a criminal sanction that violates the practical tests, they must substantiate their proposal in writing using the conceptual tests.
How do we implement this approach?
Once there is agreement on the principles, we recommend 4 action steps:
Amendment/repeal of all omnibus penalties that attach criminal prosecution.
Jan Vishwas 2.0 committee that evaluates all business laws with criminal prosecution and independently recommends provisions that invite criminal prosecution.
A legislative drafting guideline that mandates a justification note for every new business law where criminal sanction is provided for.
An Administrative Procedures Act for imposing civil penalties so they are not arbitrary and contain safeguards.
The government understands the need for infrastructure in the country. However, the definition of infrastructure is too narrow. The government must see the body of rules as infrastructure. Just like India’s investments in engineering are paying off, it is time to invest in creating a strong foundation of sound economic laws.
References
Chikermane, G., & Agrawal, R. (2022). Jailed for doing business. Observer Research Foundation.
Essential Commodities Act (1955).
Securities and Exchange Board of India Act (1992).
Bhuvana Anand and Shubho Roy are researchers at Prosperiti. The authors thank Abhishek Singh, Anandhakrishnan S and Akhileshwari Reddy for their contribution.