A study conducted by the Federal Board of Revenue (FBR) on black economy has shown that frequent amnesty schemes, including 'Tax Investment Scheme', have protected the tax evaders, increasing the size of Pakistan's informal economy manifold. A research, conducted by FBR Directorate of Training and Research, headed by Abdul Wadood Khan, on 'Black Economy' is an eye opener for the government to tackle the informal economy through a national documentation strategy.
The report/study has recommended that the persons responsible for colossal revenue loss to national exchequer, tax evaders and their friends in tax machinery should be punished and debarred from holding any public office. The 'research' disclosed that amnesty schemes have facilitated the black economy and must be avoided in future to encourage documentation. The latest tax amnesty scheme, announced by the FBR under the title of 'Tax Investment Scheme', protected tax evaders asking them to pay just 2 percent of fair market value of their untaxed incomes and assets and no question would be asked about their sources.
The research/study showed that tackling the twin menace of black money and tax evasion has always been a difficult task. Successive governments, instead of dealing with these issues with an iron hand, have been pardoning the corrupt and appeasing tax evaders through various laws and amnesty schemes. There is an ever-growing informal economy undermining national growth and promoting lack of transparency in all spheres of life. The political culture is fraught with favours to those having economy power and control over economic resources - both, antithesis of a true democratic setup.
The analysis said that all steps and schemes taken in the past to document informal economy miserably failed and black economy has relentlessly been growing, rather than there being any sign of decline. The present size of underground economy, at $85 billion, almost half of formal economy, is symptomatic of a deep illness of the system where the corrupt rule, and the honest suffer; the rich thrive, and the poor strive, yet starve.
The latest tax amnesty scheme, announced by the FBR under the name of 'Tax Investment Scheme', is yet another attempt to protect tax evaders asking them to pay just 2 percent of fair market value of their untaxed incomes and assets and no question would be asked about their sources. The recurrent appearance of amnesty schemes and money whitening instruments/modes shows that the State conceded the failure of its tax machinery in performing its main function of tax collection. This nation has become addicted to easy money, and such schemes/instruments have become a routine matter for them.
People, hooked on illgotten wealth/income for the last many years, know for certain that, every now and then, there will be an amnesty scheme giving them a chance to get their income/assets whitened by paying far less the amount than what they are required to pay under the normal tax regime.
It is a tragic situation where the entire State apparatus is subservient to those who blatantly manage to hide their income and wealth. It is an ugly joke with those who have been paying their taxes honestly at much higher rates than those offered to tax evaders (2 percent) under the ongoing scheme.
"One of the worst consequences of black money and tax evasion is its pernicious effect on the general moral fabric of society. It puts integrity at a discount and places a premium on vulgar and ostentatious display of wealth. This shatters the faith of the common man in the concept of dignity of honest labour and virtuous living. It is, therefore, no exaggeration to say that ill-gotten wealth is like a cancerous growth in the country's economy, which, if not checked in time, is certain to culminate in its doom", the study paper of the directorate commented.
Since 1979, underground economy has been developing at a surprising rate. Its large size, ranging from 22 percent to 35 percent of GDP, is a cause of great concern for both official and independent economists. Its manifestations are very wide. It is not only large and all-pervasive but also exists in daily life of every Pakistani.
It includes production of fake and substandard goods, smuggling, 'black society' economy, human trafficking, contraband drugs, massive infringement of copyrights, interloping, tax evasion with the active collaboration of tax officials, financial corruption and rent-seeking [exchange of power for money] activities of government officials and plundering of bank loans, the report said.
The study further said that the active participation of government officials is the most disturbing feature of Pakistan's underground economy. The rent-seeking activities of government functionaries emerge in an endless stream. They are the single most important catalyst for accelerating the growth and sustainability of underground economy. It has certainty created distortions in the statistical data vital for economic planning and macroeconomic decision-making, but its one most devastating and direct effect is considerable loss of tax revenues of the State. Theoretically, losses of tax revenue not only refer to a static result, ie the tax revenue lost by the fact that the taxes payable failed to be levied or collected for all kinds of reasons, but also mean a dynamic loss process.
Taxpayers do not register with the tax departments. One reason for this might be the activities they undertake which are illegal or even criminal and another reason might be that the tax payers attempt to escape registration and interlope for the purpose of tax evasion, despite the legal nature of their business.
Although a taxpayer registers with the authorities but he resorts to non-reporting. Taxpayers indulge in under-reporting so that a wide gap exists between the tax liability reported and the tax which would have been payable if tax returns were correct. On the basis of different studies conducted to determine the size of underground economy in Pakistan, in terms of different taxes, the following table shows the ratio of the lost commercial and industrial taxes to that of actually collected in the last 20 years:
The underground economy has caused substantial loss of revenue during the last 20 years, and brought about plenty of negative economic effects forcing the national growth to deviate from the objectives of efficiency and equity. A direct consequence of tax revenue loss is a reduction in the government's fiscal targets. The fiscal deficit could have been substantially low, or even zero, had the State effectively tackled growth of underground economy.
The research paper further said that it is an irrefutable fact that tax revenue losses due to underground economy, in turn, aggravate income distribution, and wealthy classes becomes more powerful thus making the entire society subservient to their interests and control. These colossal revenue losses reduce the efficacy of allocation of social resources, thus seriously retarding equitable distribution of societal benefits to cross-sections of society.
It is an incontrovertible fact that the income gap among the Pakistanis has been gradually widening and trend of rich becoming richer and the poor poorer is gaining strength. Generally, the analysts have attributed it to economic policy, but they have neglected the impact on income distribution of tax revenue losses generated by the underground economy. Virtually, all types of hidden incomes arising from vast and widespread underground economic activities escape tax regulations and this should be considered as an important cause of widening of the Pakistanis' income gap over the last 20 years.
In order to effectively reduce tax revenue losses, multi-sectoral participation and comprehensive co-ordination by and among different departments of the federal and provincial governments is much needed to curb underground economic activities, the paper recommended.
The introduction of feasible and effective counter-measures requires the removal of causes that generate black money and taxpayers' non-compliance. According to the recommendations of the report, removing the selfish non-compliant taxpayer should be tackled from economic perspective.
Reducing the total burden of taxpayers in the public economy is both desirable and urgent. At present, the Pakistani tax burden level is not very high vis-à-vis tax evaders (instead they get tax amnesty schemes frequently to get their untaxed money whitened at a nominal rate) and the critical issue is to reform the entire tax collection system preventing tax dodgers from going underground.
The first important issue is to strengthen tax administration raising the potential of discovering non-compliant taxpayers. The present situation in Pakistan is very weak, as far as effectiveness of tax administration is concerned. Besides raising evasion costs of taxpayers it is imperative to enhance the penalties of underground economic activities.
The most disturbing aspect of Pakistan's tax system is weak enforcement. Whereas FBR's perspective is that fault lies with tax legislation, it is a proven fact that the promulgated laws are not enforced effectively and whenever any shortcoming is pointed out, FBR stalwarts blame tax legislation.
In Pakistan, one never hears of sending tax evaders to the prison for their illegal acts. This confirms extreme slackness on the part of tax administrators or their connivance with tax dodgers. Instead, punishment of tax evaders is restricted to nominal fines or penalties, encouraging them to remain in the fold of the underground economy, which is constantly expanding every day.
Unwillingness of tax collectors to crack down on players in the underground economy needs thorough probe so that ways are suggested to ensure that in future this unwillingness/collaboration ceases to exist. The predominant cause of non-compliance in Pakistan remains ignorance of law and social non-acceptance of tax obligations.
The government has to promote tax culture through education of the masses who have never been informed of their duties towards the State. They should be convinced of proper utilisation of taxes by the government. There exists a relation of bad faith between the taxpayers and the State, which needs to be addressed through a process of reconciliation, the study paper observed.
A new social contract is needed to convince the citizens that taxes paid by them are to be utilised exclusively for the benefit of the country and not for providing a life of luxury to rulers and the bureaucracy.
The fundamental solution to promote tax culture is to popularise knowledge of the law through education, media and information services, enhancing the citizens' awareness of the need to tax payments raising the status to compliant taxpayers and thereby promoting the idea that paying taxes is an honour whereas evading taxes is a national disgrace, the report suggested.
This is indeed a difficult task, requiring a long period of time to change the people's perception but to do this work and do it as soon as possible is indispensable if for survival as a self-reliant nation. For the task of attacking underground economy and forestall losses of tax revenue, the most important and radical channel is deepening of reforms, the report said.
The government will have to flex its muscles to crack down heavily on the underground economy. All tax reforms, which are being initiated vigorously these days by obtaining loan from the foreign donors, will become useless unless black economy and its causes are eliminated once and for all.
The misplaced emphasis on tax reforms, without tackling the principal issue of underground economy, will bring more hardships for the common people of Pakistan as in the frenzy of collecting more taxes the incidence of taxation would be shifted to the poor and the vulnerable ordinary people, and those who have invincible money power (generator and protector of underground economy) will remain outside the ambit of tax obligations.
The government has to give up its policies of appeasement towards plunderers of national wealth and tax evaders. The tax-to-GDP ratio can only be improved significantly if the process of economic reform, especially elimination of underground economy, goes hand in hand with tax reform agenda.
Once the government shows positive attitude by cracking down on underground economy and reducing all wasteful expenditures, the citizens will certainly reciprocate by paying their taxes, diligently and honestly. This can be the only way to control and eliminate losses of tax revenue in Pakistan.
There should be a Tribunal, headed by a Judge of Supreme Court, after proper legislation to independently deal with the issue of tax frauds and big evaders in informal economy, the study recommended.
The report suggested that an increase in the size of the shadow economy is likely to result in reduced state revenues, which in turn reduces the quality and quantity of publicly provided goods and services. Ultimately, this can lead to an increase in tax rates for firms and individuals, quite often combined with a deterioration in the quality and administration of the public goods such as roads and hospitals provided by the government.
On the other hand, two-thirds of the income earned in the shadow economy is immediately spent in the official economy. This can be a boost for the official economy and may lead to additional overall economic growth. The growth of the shadow economy, therefore, affects everyone. But it is difficult to evaluate whether the shadow economy ultimately affects the official economy in a positive or a negative way.
The research shows that smaller shadow economies appear in countries with higher tax revenues that are achieved by lower tax rates (resulting in greater compliance), fewer laws and regulations combined with consistent enforcement and less bribery facing companies.
The major driving forces behind the size and growth of the shadow economy appear to be an increasing burden of taxation and social security payments, combined with more pervasive state regulatory activities. Weak and arbitrary enforcement of laws and regulations encourages shadow economic activity; the findings emphasise the importance of the rule of law in curbing both corruption and associated shadow economic activity.
It has been found that even major reductions in tax rates will not substantially shrink the shadow economy, but they may be able to stabilise it. The marginal tax rates are more relevant to people's shadow economy. Work decisions that are average tax rates replacing direct taxes with indirect taxes is unlikely to improve tax compliance. More frequent tax audits and heavier penalties for tax evasion may reduce the size of the shadow economy.
The research suggests that the governments should put more emphasis on legalising certain shadow economy activities, for example, by liberalising the labour market. The reforms that liberalise regulations and make the economy more competitive reduce the incentives for corruption, and encourage firms to move from the shadow economy into the official one. The governments should put emphasis on the rule of law and on the strict enforcement of a minimum necessary set of regulations, rather than on increasing the number of regulations, the study paper of the directorate added.
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