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Taxation, black money and informal economy

Huzaima Bukhari & Dr Ikramul Haq

That there is a considerable informal economy, revenue leakage and black money in Pakistan is undoubted but few in-depth studies have been undertaken to quantify its magnitude and extent. A sound development strategy seeks to reduce the size of the informal economy and bring into the open resources that lie in the form of black money. Apart from such mechanisms as foreign exchange and tax amnesties; and exercises such as demonetizations, taxation has been used as a tool to tap the resources inherent in these areas.

Our politicians, policymakers and tax managers during the last many years have miserably failed to tap such untaxed resources despite borrowing US$ 100 million for Tax Administration Reforms Programme (TARP), which many terms as “TRAP” laid down by foreign donors to cripple our fiscal system ensuring we never become a self-reliant economy. The fact is that policies framed under TARP have proved counter productive as billion of rupees are transferred by the people from Pakistan to Dubai and elsewhere. And now revenue collection in real terms is showing negative trends as admitted by the Finance Minister in his pre-budget statements at various forums. Those at Federal Board of Revenue (FBR) who made tall claims of achieving “extraordinary results” and got cash rewards should be held accountable and must be punished for fudging the figures and making exaggerated projections. The persistent failure of our financial managers and tax collectors to overcome fiscal deficit and remove fiscal imbalances has created a situation where the very economic survival of the country is at stake.

The FBR, according to all available data and indicators, is the most inefficient, incompetent and corrupt arm of the Government. It is in fact ruled by a band of mediocre and sycophants. In many meetings and private parties, the leader of the band tried to entertain the self-imposed head of state by dancing and cracking cheap jokes.e. The FBR, responsible for the collection of federal taxes, has miserably failed to introduce any tax intelligent computerized system, despite the fact that it has a market-wage oriented company, PRAL, at its disposal, to monitor the economic activities of corporate/business sectors. This failure coupled with corrupt practices (according to some estimates at least Rs. 200 billion go annually to the pockets of tax officials) has contributed to generation of enormous black money in Pakistan.

Large-scale tax evasion and the existence of a large black economy while resulting in loss of revenue to the state, tends to reduce the built-in elasticity of a fiscal system to the extent that the tax evaded income is spent on goods and services that help to generate inflationary pressures and raise the prices of real property.

A survey carried out by a reputed Lahore based academic institution few years back, as a part of tax reformation drive, concluded that mainly because of rampant corruption, in combination with a host of other factors, “the country suffers a loss of 64 per cent in income tax, 48 per cent in customs and 45 per cent in sales tax”. Translated into hard cash, it means that for each hundred rupees of genuine income tax payments of a typical Pakistani business, the government collects only Rs 36. “The rest of the money is shared among the three parties – assessor (taxman), the assessee (taxpayer) and the middleman (tax practitioner).

According to this study, out of every Rs100 taxable amount, the highest amount of Rs38, of course goes to the taxpayer, a typical Pakistani businessman. The taxman, an officer in income tax department, gets Rs16 for his services to the taxpayer in helping him to conceal his real income. The middleman who is a tax practitioner, advisor or a lawyer gets Rs 10.

If these estimates are taken as true, then the annual national revenue loss can go over Rs 200-300 billion. These estimates are summary judgments of a complex phenomenon. The survey concedes that these estimates may not capture part of revenue loss due to presence of a large unregistered business segment, on the one hand, and smuggling on the other.

It is not possible to predict the precise amount of revenue loss and size of black money or informal economy in Pakistan. The report prepared by the LUMS nonetheless claims that the data collected during the survey “is pointing to a very heavy leakage”. Revenue loss estimated by World Bank because of smuggling amounted to 15.08 billion dollars in 2006-2007. Another report estimates revenue loss, because of distortionary tax regulations and administrations, at Rs 40 to Rs 45 billion in 2005-06 and Rs74 billion in 2006-07. Apart from direct monetary costs of corruption, both Pakistani and international literature pin point many other costs, such as loss of government credibility, spread of injustice, distortions in resource allocations and loss of foreign and local investment.

Dr. Aqdas Ali Kazmi, ex-Joint Chief Economist, Planning Commission  stated in his research paper Tax Policy and Resource Mobilisation in Pakistan that 70 percent part of economy consists of 36 percent ‘pure’ black economy, 18 percent exempted economy, 9 percent illegal economy, 4.5 percent unrecorded economy and 2.5 percent informal economy (unreported economy). His study says that the problem in the low resource mobilisation is the rigid system of taxation, and the emphasis of the government to increase revenue, ignoring the details of the long-term policy measures.

In the context of the prevailing grave financial crises in the country and the problem of ever-growing black money, (which according to official and independent experts is around Rs. 1.8 trillion, about 70 % of the total economy), there is an urgent need to launch a well-thought for law to unearth this huge money to make it a part of the mainstream economy. However, it is important before launching such a law to identify the sources of generation of black money. If such sources are not eliminated, the black money will keep on growing. The Government must critically examine the features of such a law to unearth black money.

There is a need for a wider plan to document the entire economy once and for all. The present regime must remember that half-hearted measures, typical of tax bureaucracy, will not yield the desired results. The firmness, consistence and steadfastness must be shown to revitalize Pakistan’s economy. Our survival now lies in our economic salvation.

According to our estimates, the parallel economy is growing at an alarming rate of 20% per annum. Every fifth rupee transacted in Pakistan is black.   The volume of black money generated in the year 2006-07 was not less than Rs. 600 billion. This means that everyday tax fraud exceeds Rs. 1.64 million. It is not the final count. We have yet not accounted for kickbacks in foreign trade, smuggling and foreign exchange racketeering, apart from narcotic trade and other criminal traffic.  Add to this, the underground money generated through smuggling in goods and narcotics trade that is between Rs.100 billion and Rs. 150 billion and narcotics trade of Rs. 300 billion. This makes a whooping Rs. 1000 billion.

When the presence of black money is so apparent, why its criminal accumulation and generation are not revealed and the offenders punished, is a question which has been baffling honest citizens. They ask, whether it is on account of lack of political will, or rampant corruption, or collusion of tax dodgers and the tax administrators at defrauding the revenue, or the political system or the ineffectiveness and defectiveness of laws, or the pervasive stubborn indifference of the citizens towards their duties? Those who plundered the wealth of the nation were set free to have a good time in “exile” and those who abused powers are being invited to come again for ruling and looting whatever is left.

The ugliest face of black money emerges in the corridors of power, political as well as administrative. Our country is passing through the worst financial crisis of its history, i.e., the crisis of resources manifesting it in the huge budgetary deficits. Revenue has to be collected and all measures both stringent and persuasive have to be taken in that direction. The Government has, therefore, to plan in terms of a well-thought-of asset seizure legislation to draw upon the huge reservoir of the untaxed black money. In case swift action is not taken to seize money and property arising out of corruption, tax evasion and narco-arm-trade, the day is not far when our present tolerance to black money leads to  a suicidal path of self-annihilation.


The writers,tax consultants and authors of many books on Pakistani tax laws, are visiting Professors at Lahore University of Management Sciences (LUMS).

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