Wednesday, December 14, 2011

Black Money and Tax evasion has always been a failure in Pakistan

Black Money and Tax Evasion has always been a Failure in Pakistan
BY. Shoaib Habib Memon
Tackling twin menace of black money and tax evasion has always been a failure in Pakistan. 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. The result is obvious.

There is an ever-growing informal economy undermining national growth and promoting lack of transparency in all spheres of life. Political culture is fraught with favours to those having money power and control over economic resources - both, anti-thesis of a true democratic set up.

All steps and schemes taken in the past to document informal economy have miserably failed and black economy has relentlessly been growing rather than there being any sign of decline. The present size of underground economy at US $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 corrupt, occupying top positions in State institutions, are giving blanket protection to offenders and plunderers of national wealth. In other civilised societies such anti-State elements are treated with iron hand, their ill-gotten money and assets are seized through proper legislation and exemplary punishments awarded to them.

The latest tax amnesty scheme, announced by the Federal Board of Revenue (FBR) under the name of 'Tax Investment Scheme', is yet another attempt to protect tax evaders asking them to pay just 2% of fair market value of their untaxed incomes and assets and no question would be asked about their sources.

Like all previous schemes, it will also prove a fiasco, being a move in the wrong direction: "persuading with helplessness" the corrupt to pay tax without realising that it is they who now control the State and are least pushed to whiten their colossal money and wealth lying outside Pakistan.

This scheme will further shatter the confidence of law-abiding citizens in the system of governance, besides adding to the prevailing illusions that even the so-called elected representatives in parliament are capable of passing such erratic laws.

The recurrent appearance of amnesty schemes and money whitening instruments/modes shows that the State has conceded the failure of its tax machinery in performing its main function of collection of tax from wherever it is due. This nation has become addicted to easy money and such schemes/instruments have become a routine matter for them.

Those people, hooked on ill-gotten 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%) 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.

Apart from direct monetary costs of corruption, other significant costs, such as loss of government credibility, spread of injustice, distortions in resource allocations and loss of foreign and local investment, are destroying the very fibre of civil society in Pakistan. Judging from different studies and reports published in print media from time to time, Pakistan's underground economy has the following salient features:

Since 1979 (courtesy General Zia's legacy of speed money culture and its adoption by all the subsequent governments, notably that of Benazir Bhutto, Nawaz Sharif and Musharraf et al), our underground economy has developed at a surprising rate. Its large size ranging between 22% to 35% 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, plundering of bank loans, just to name a few and significant ones.

Massive migration towards big cities confirms that a huge population of Pakistan is directly engaged in underground economic activities. Large-scale mobility of people is also a contributing factor in generating underground economy eg high demand of local private houses to accommodate the mobile population.

Active participation of government officials is the most disturbing feature of Pakistan's underground economy. The rent-seeking activities of the government functionaries emerge in an endless stream. They are the single most important catalyst for accelerating the growth and sustainability of underground economy.

The State has miserably failed to check rampant corruption amongst their officials. They have emerged as the most powerful mafia whose control over the underground economy is now invincible. The government must constitute an expert committee to determine the negative effects of underground economy.

It has certainly 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.


1. tax revenue loss of a compliance nature;

2. tax revenue loss of an administrative nature; and

3. tax revenue loss of an institutional nature.

Among these three categories, revenue loss of compliance nature results from underground economic activities because of taxpayers' evasion and fraud by non-compliance with tax laws, and such a loss is characterised by erosion of the tax base. The latter two types of tax revenue losses exist in the public economic field, and are characterised by reduction in effective tax rates.

In Pakistan, tax revenue losses due to inefficient and corrupt tax machinery are equally significant. Tax officials do not only properly enforce the promulgated laws, are always hesitant to probe tax frauds but also take active part in providing their "expert services" for exchange of money to tax evaders and plunderers of national wealth. They are active and potential generators of untaxed black money in the country.


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 taxpayers 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:

Year % (losses)
1988-89 58.65
1989-90 60.75
1990-91 62.22
1991-92 58.44
1992-93 61.25
1993-94 64.55
1994-95 57.15
1995-96 70.20
1996-97 83.06
1997-98 89.04
1998-99 84.69
1999-2000 85.45
2000-2001 87.83
2001-2002 88.25
2002-2003 87.95
2003-2004 86.35
2004-2005 85.80
2005-2006 87.25
2006-2007 88.42
2007-2008 87.80
As evident from above, our 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 losses is a reduction in the government's fiscal targets. Our fiscal deficit could have been substantially low or even zero had the State effectively tackled growth of underground economy.

It is an irrefutable fact that tax revenue losses due to underground economy, in turn, aggravates income distribution and wealthy classes became 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.

It is true that as long as taxation exists, tax revenue losses will not completely disappear, but such losses can be reduced considerably by employing countermeasures effectively. It is high time that the government should start attacking underground economic activities to reduce tax revenue losses. This work cannot be done solely by reforming tax administration.

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 introduction of feasible and effective countermeasures, requires the removal of causes that generate black money and taxpayers' non-compliance. The theory of economics of taxation tells us that critical factors determining the taxpayer's compliance level include benefit incentives, social pressures and a self-regulating mentality.


-- selfish non-compliance, ie taxpayer makes a cost benefit analysis with regards to tax non-compliance and then decides that this course of action can generate greater net gains for him;

-- non-compliance through ignorance, ie taxpayers do not intend to violate tax laws, but do so inadvertently because of unawareness of their tax obligations; and social non-compliance, ie taxpayers' behaviour is influenced by the attitude of the whole society towards approving tax avoidance and evasion.


1. Removing the selfish non-compliant taxpayer should be tackled from economic perspective. The taxpayer must be considered as an economic person and the following formula should be applied:

-- Expected returns of tax evasion = expected gains of tax evasion minus the expected cost of tax evasion

Applying the above formula it is necessary to reduce taxpayers' economic earning arising from the underground economic activities and tax evasion. Even more important step would be to devise measures to enhance the taxpayers' cost of evasion.

2. 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.

As regards the latter, 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.

3. The most disturbing aspect of Pakistani 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.

Evidence of this attitude is clearly reflected in promulgation of a new Income Tax Ordinance which is quite a useless venture having nothing new to ensure proper collection of taxes. Mere promulgation of law cannot ensure enhancement of tax revenues, the greater need is to reform tax structures and improve attitude of tax collectors.

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. 4. The predominant cause of non-compliance in Pakistan remains ignorance of law and social non-acceptance of tax obligations.

The State has never bothered to promote tax culture through education of the masses who have never been informed of their duties towards the State, nor are they 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.

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 civil/military 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.

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 we want to survive as a self-reliant nation. 5. For the task of attacking underground economy and forestall losses of tax revenue, the most important and radical channel is deepening of reforms.

Conventional formulae and half-hearted attempts will not work. The State 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.

Our State is presently controlled by the corrupt politico-administrative structures where people having huge money power are the key players. How can the agenda of tax reform succeed in isolation? The need is to purge the society, make all financial transactions transparent, eliminate money power and corrupt administrative structures and only then colossal losses of tax revenue can be restrained.

6. 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.

7. The State has to give up its policies of appeasement towards plunderers of national wealth and tax evaders. The foundations of corruption and rent-seeking activities of the State functionaries have to be destroyed with full force otherwise the tax reform financed by huge loans will be another national waste. 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 State 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.

In the past, the National Accountability Bureau (NAB) was used for only victimising political opponents rather than cracking down on those who are engaged in massive tax frauds and evasions with the connivance of their friends in tax machinery. In the changed scenario, NAB should be asked to nab tax evaders and money launderers.

How many holding key positions in State institutions are engaged in rent-seeking and corrupt activities is not a secret, but their declarations before tax authorities have never been made public. Those responsible for colossal revenue losses to national exchequer, tax evaders and their friends in tax machinery, should be punished and debarred from holding any public office.

Unless this vital step is taken through a Tribunal headed by a Judge of Supreme Court after proper legislation to this effect, the dream of establishing a democratic polity will never become a reality in Pakistan, no matter how many elections are held.

Shahzad Afzal

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