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Tax evasion in Pakistan: A critical analysis

The economic problems of Pakistan are multifarious. The country has the lowest tax-to-GDP ratio in the world and a taxation system that is characterized as unjust and discriminatory. The macroeconomic variables are dismal at best, yet the economy shows signs of resilience. The secret lies in the sizable shadow economy that makes growth a ‘private’ affair. The task before the new government will be huge and it will need to take the bull by its horns to help the country out of its current problematic state.

A complete paradox – the economy of Pakistan continues to confound observers. The sentiment is understandable. Logic suggests that a country that suffers from the woes of terrorism, increased sectarian conflict, frequent political turbulence and poor human development indicators should be fighting a war on all fronts for its survival. Hence, it is strange that the stock market in such a country should maintain a record-breaking spree soaring at levels higher than 18,000 points (reflective of good investor confidence) while macroeconomic indicators continue to paint a dismal picture of economic standing. There is growth – plenty of it, but at the expense of a government that continues to get poorer by the day.

The current state of affairs is not entirely unforeseen. The tax-to-GDP ratio decreasing from 9.8% (FY 2007-08) to 9.1% (FY 2011-12) during the tenure of the previous government was more than the nation’s failure on moral grounds. It was reflective of the incompetence and complacency of the rulers in ensuring compliance with tax laws. With 0.9% of the people of Pakistan paying taxes and the country having the lowest tax-to-GDP ratio, it comes as little surprise that it is unable to generate enough revenue to break free from the shackles of the IMF and other donors.

Such a blatant disregard for the country’s law (as depicted in the statistics) warrants severe repercussions for offenders. It is certainly a sad piece of news that not a single offender has been prosecuted for tax evasion in 25 years in the land of the pure. The system in Pakistan offers easy escape to those who do not pay taxes so the affluent classes continue to evade taxes while the economy suffers. Yet, there is hustle and bustle in the streets as restaurants and shopping areas are jam-packed with gourmands and enthusiastic shoppers. These are but the tell-tale signs of ‘private’ growth via a flourishing shadow economy estimated to be around 36% of GDP.

The amount of tax evasion estimated by the NAB is equal to Rs 7 billion per day. The culprit is corruption that comes at a heady cost of an estimated Rs 12 billion per day and is an evil that has been growing at an unchecked pace. Even institutions like the Federal Board of Revenue have fallen prey to corrupt practices. State-owned enterprises such as PIA, Pakistan Railways and Pakistan Steel Mills have bled the national exchequer of Rs 625 billion. The people are thus discouraged and demoralised as they feel that taxpayer money is being used for reasons other than social welfare and uplift. The taxation system is also viewed as unjust as it is regressive and indirect.

A significant amount of academic literature is devoted to examining the tax culture in Pakistan. A study titled ‘Fresh Assessment of the Underground Economy and Tax Evasion in Pakistan: Causes, Consequences, and Linkages with the Formal Economy’ by M. Ali Kemal (2007) claims that if there were no tax evasion, budget balances could have been zero and positive for some years, therefore, removing the need for borrowing altogether. This means that the goal was achievable to some extent- if completely eliminating tax evasion was not possible, its percentage could have been reduced through stricter enforcement of laws.

Under the previous government, however, public debt surged to an alarming figure of Rs 14,561 billion in 2012 as against Rs 6,691 billion (the pre-2008 figure) adding to the dismal situation of Pakistan’s economy. The government replaced 5 finance ministers, 4 governors of the SBP, 5 finance secretaries, and 6 heads of the FBR raising doubts about its commitment to the cause of improving Pakistan’s dwindling economy. Economic policies, framed by some of the best minds in the country failed to help pave way for betterment.

The Tax Amnesty Scheme for example, an effort to bring evaders into the tax net came under sharp criticism as an incentive to tax evaders. The Institute of Chartered Accountants Pakistan opines that “these initiatives have never helped broadening tax base in the country rather these have encouraged tax evaders and non-compliances”. In fact, if anything, such a measure endorses discrimination between the subjects of a state where honest taxpayers will surely feel disgruntled.

The very idea of tax collection is based on the theory that not many people wish to voluntarily pay taxes. It follows thus, that the system must be chalked out with a view to ensuring flow of taxes into the coffers of the State. Having said that, it is important to add that the system should go a step further and ideally provide funds for development expenditure.

As IMF loan repayments of $250.7 million have already been made and $143.7 million was due on May 10, 2013 and another $390 million is due on May 24, 2013, the situation is becoming increasingly difficult. Foreign exchange reserves of the country will suffice for only 2 months of the import bill payments (wherein reserves held by the State Bank amount to $6.697 billion and reserves held by commercial banks stood at $5.061 billion). The GDP growth rate is not encouraging either. It stood at 3.7% in 2011-12 as opposed to 5.4% for India, 7.8% for China, 6.1% for Bangladesh and 6.8% for Sri Lanka thus reducing Pakistan to an equivalent of the likes of Senegal and Guyana.

After the general election, there is hope that the democratic process and emancipated institutions will usher in a new era of tax reforms and compliance. The onus is on the next elected government to serve as the proverbial messiah and face the issue head-on. The ambitious manifestoes of the political parties contesting the elections surely provide a reason to be optimistic about the future and for the public to expect better. The task is monumental but luckily, the winner does not have very big shoes to fill.

Enum Naseer, "Tax evasion in Pakistan: A critical analysis," Business rcorder. 2013-05-15.
Keywords: Economic policy , Economic issues , Economic growth , Tax policy , Tax-GDP , Tax reforms , Economy-Pakistan , Terrorism , Tax laws , Pakistan , IMF , NAB