Post on 30-May-2018
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PakistansInformal
EconomyM. Munir Qureshi
Pakistan has an abnormally large Informal sector also known as Black
Economy, Shadow Economy, Gray Economy, and Parallel Economy- .
Estimates for this sector Range between 35 100% of GDP.
Conservatively, today its size may safely be estimated at 70% of GDP ie
US $ 119 Bill (Fixed Factor Costs) and US $ 350 Bill (PPP).
An obvious consequence of this state of affairs is significant loss of tax
revenue. By definition, the Informal Sector of the Economy is an
undocumented sector and earnings of the Players in this segment of the
economy are not formally Reported and no Tax Returns are filed.
However it would not be fair to infer that the taxable capacity of this
sector is at par with that of the regular, Formal Sector. Such a contention
would clearly be simplistic. This is because the major activity in the
informal sector is small scale, cottage industry based manufacturing, with
limited value addition. Mostly family enterprises, subsistence level
earnings are usually the norm. To be sure there are some medium scale
enterprises too yielding reasonable but not significant income. However
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these would not be more than 10 15 % of the total manufacturing units
operating in the informal sector.
Significantly, out of Pakistans total labor force of about 47 million, the
bulk of the countrys non agricultural labor force, some 18 million [the
agricultural sector accounts for a labor force of 20 million, has noparallel or black economy as such] , is employed in the informal sector
with about 9 million employed in the formal sector.
Looking to its composition, the cottage industry based manufacturing
segment of the informal sector would have limited tax potential but
certainly not zero.
The fact that the informal sector provides gainful employment to a very
large proportion of the working ( non agricultural) labor force albeit
yielding largely subsistence level earnings- is a positive feature as it
enables a very large number of working people ( men, women and even
children) to earn enough to keep body and soul together. It also gives
them a modicum of dignity and improves their self image.
The loss of tax revenue to the exchequer is however undoubtedly a
negative feature.
The growth in income in the informal sector does not find its way into the
National Income Accounts as such Income is not formally Reported and no
Returns are filed. For this reason the published national income of acountry is actually understated to the extent of the income generated in
the informal sector. Thus when we say that Pakistans GDP is $ 180 Bill in
2008 we are not taking into account the Income attributable to the large
informal sector. If this income is, say, $ 126 Bill ( ie 70% of the regular,
formal economy), then the real GDP of Pakistan in 2008 would be $ 306
Bill (Fixed Factor Cost basis).
A large informal sector can be problematic in that it becomes difficult to
factor in when planning economic development as very little is known byway of its structure , composition and range of activities.
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As the informal sector has both positive and negative features, it is also
often referred to as an oxymoron.
Ominously, the informal sector also has certain features that may not be
immediately obvious but are nonetheless certainly there and these can be
highly de -stabilizing for the regular, formal economy.
These features include, hugely profitable, business activities of a
criminal nature, surreptitiously carried out by a relatively small segment
of the total population of the informal sector. These players make a
mockery of the rule of law and their business activities include but are
not restricted to- smuggling of all kinds of contraband in general demand
( narcotics, counterfeit goods including cosmetics, auto parts, medicines,
digital media including information technology software ,movie DVDs,soft drinks, arms and ammunition and other miscellaneous merchandise).
Besides smuggling of these items into the country from exporters
abroad, a number of these items are even manufactured within the
country in small to medium scale, clandestine manufacturing
establishments some quite sophisticated using modern technology. The
smuggling of currency into and out of the country by illegal forex
companies - the so called havala networks, under investigation and
facing crackdown after 9 / 11 but still functioning are also part of thiscriminal segment of the informal sector.
Corrupt practices of government functionaries working at all tiers also
generate a great amount of black money in third world countries and
Pakistan is no exception. So it is not only black economy businessmen
who make a great deal of money illegally in developing countries. While
we generally tend to gloss over this aspect the fact is that they not only
do much harm to the State exchequer by evading taxes on their ill gotten
earnings but in a more subtle way, also undermine the integrity of suchvital institutions causing considerable long term damage. It is not easy to
quantify the illegal earnings attributed to corruption but anyone who been
following media reports in recent years can see that the problem is
indeed on a much wider scale than we are inclined to believe and the
billions of dollars worth of assets stashed away in safe havens abroad by
high profile players are testimony to the scale of the problem. It is now
no secret that these assets have been contrived in their entirety by
corrupt practices and there is indeed direct as well as indirect evidence in
the public domain in this context. Authoritative studies detailing the role
of banks- including big name multi-nationals- in laundering black money
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are also available and anyone who is adept at using a search engine with
a web browser on the internet should have no problem in accessing and
examining them at his leisure.
Strangely, government too can unwittingly put untaxed money in peoples
pockets and thereby make a contribution to the informal sector. Oneexample of how this can happen is when the electricity tariff is not at par
with what the market says it ought to be. Thus when government pays a
subsidy on the electricity generated thereby offsetting cost of
generation to that extent as it has been doing in Pakistan for a long,
long, time now- it is in effect increasing the consumers disposable income
by equivalent amount and since the receipt of such income is never
declared by the recipient, hence no income tax is paid thereon. It thus
becomes an informal income of the recipient. The income tax statute
was not able to cope with this situation prior to the enactment of the
Income Tax Ordinance of 2001 and thus everyone got away scot free. The
new law is much better able to deal with the matter and it remains to be
seen how the tax department deals with the situation.
While ALL informal sector activity is by definition illegal because it
violates laid down law, it does not follow that it is also criminal in naturein the sense that when detected by the competent authorities is
necessarily liable to be prosecuted and on conviction those involved
required to be incarcerated in a penitentiary. However the segment of the
informal sector that includes smuggling and manufacture and sale of
counterfeit goods as well as moneys contrived through bribes, kickbacks
and commissions illegally ( asin the case of public functionaries) entails
serious criminality. This is also the segment that generates significant at
times, huge- extra legal earnings. The players in this segment thoughrelatively few in number compared to the total population of the
informal sector- often have outlandish lifestyles with conspicuous
consumption the norm and because they are rich, are also well
connected they also have serious clout that enables them to keep
operating in the informal sector with impunity.
Why should it be so difficult to track down the informal sector players in
Pakistan? The tax authorities in Pakistan have not been able to prosecuteand send to prison even a single tax evader in the last (62) years. This, in
a country where tax evasion is endemic! Why so?
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The main reason is that it is not at all easy to nab any tax evader in
Pakistan but the informal sector tax evader is a special breed. For one
thing it would be rare for him to have no declared source of earnings at
all. If he is a smuggler he would of course not declare his earnings from
smuggling. Technically he can as the tax law, on pain of strict
punishment, mandates that ALL INFORMATION declared by a taxpayer be
kept secret. In practice however no criminal in Pakistan will ever take the
chance of making a public declaration to that effect- especially not in a
Tax Return. So he does the next best thing and declares all income but
that realized from smuggling. He may have agricultural land and if the
holding is large enough then he should be able to attribute good income
from that source. He could also be running a perfectly legitimate business
enterprise and declare good income from it and pay due tax. This would
give him legal cover from prying eyes. He could be the legal owner of
immoveable property and be earning rental income. Similar would be the
position when the player is a government functionary in receipt of black
money for favors bestowed illegally.
Unlike Al Capone, the tax evader today is no ghost to the tax authorities.
He has a tax profile that he has contrived with great care- often with
expert legal help, readily available. Thus it cannot be said that has no
legal income to support his lifestyle.
In actual fact he is often able to camouflage his illegal income by setting
up a faade of legal earnings in which the black money income of course
finds no mention. It is up to the tax authorities to peel away this faade
and expose the illegal earnings but that requires great skill, motivation,
integrity and daring. Unfortunately, in Pakistan these are qualities sadly
lacking in tax functionaries.
Because of the clout that the informal sector players wield, highly
motivated and skilled revenue personnel are required to be deployed totackle this segment of the informal sector effectively and they need to be
supported effectively by specialized intelligence gathering, surveillance,
exchange of information and the setting up and effective utilization of
data bases containing information pertaining to all kinds of assets and
property and financial transactions that have a bearing on income. Above
all, their integrity must be above board.
One is reminded of the great, indeed, heroic, effort made by the United
States Treasury Deptt / Internal Revenue in the 1920s in successfully
bringing the notorious U.S Black Economy player, Al Capone, to book in a
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daring and well planned operation. Indeed interest in the informal sector
of the economy starts with this landmark incident in US history. The great
risks that revenue personnel must take are still there today as there are
many such wannabe Al Capones operating in Pakistan who are just as
ruthless, devious and ingenious as the real scarface of yesteryears.
A large number of Pakistans existing taxpayers, especially those in the
wholesale and retail sale of merchandise, have forged close links with the
informal sector. Thus many of the top Departmental stores in posh
commercial areas in Pakistan openly display high value goods like
crockery and electrical gadgets that have been smuggled into the
country. They also sell a great deal of counterfeit merchandise either
smuggled into the country or manufactured in the many clandestine units
operating in different parts of the country. Many exporters also purchase
their goods from the informal sector including garments, sports goods and
leather goods. A plethora of Bara markets euphemism for smuggled
goods market- do a roaring business in every major city of the country.
The original Bara Market was, not too long ago, restricted ONLY to a
suburb of Peshawar city.
Unwittingly perhaps, the large, private, banking sector in Pakistanincluding the, so called, exchange companies and Hawala networks,
routinely launders a great deal of the black money generated in the
country. Corrupt businessmen, politicians, bureaucrats, Defense
personnel- all are involved.
In Pakistan many of the Hawala networks have been hijacked
and compromised by drug traffickers, corrupt officials, money
launderers, organized crime and terrorists. Pakistani Hawalanetworks alone move anywhere between 5 10 billion dollars
annually. In 1999 Institutional Investor Magazine identified 1100
money brokers in Pakistan and transactions that ran as high as
10 million US dollars apiece. Most Hawala networks are
controlled by Pakistani and Indian expatriates and immigrants in
the gulf.
Indeed one explanation for the plethora of private banks in Pakistan,
including some big name multi-nationals, is that Pakistan is perceived as
fertile territory with plenty of black money there for the taking by private
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banks that are well resourced and daring. True, under the know your
customer policy the State Bank of Pakistan mandates that due diligence
be shown by all Banks when dealing with customers and especially when
new customers are allowed to open accounts to ensure that moneys of
dubious origin do not find their way into the Bank. This requirement has
been in force for the last few years now and apparently it has had a
salutary effect insofar as black money cannot now be brought in as
brazenly as before. But there is reason to believe that human ingenuity
being what it is and the pressure to being in additional funds being there
it is too much to expect that the KYC policy has put an absolute end to
bring in ALL tainted money. KYC oversight too is perhaps not as
rigorous as it ought to be so all said and done loopholes are there and will
be found and are being found all the time to find a way around the KYC
requirement. Effective oversight is especially difficult in the case of the so
called exchange companies even those authorized to transact
business in the movement of foreign exchange.
Contrary to popular opinion, informal sector players do not stash their
illegal earnings at home at least not ALL of their earnings. Most players,
except may be those placed at the bottom rung of the subsistence level
earnings ladder, open a bank account and deposit a good part of their
takings there. The account(s) may or may not be in their actual name. In
any case tax authorities are barred by law from routine access to anybank account. And the banks are bound by confidentiality provisions in
banking laws from disclosing any information regarding their clients. Tax
authorities may requisition information in specific cases only. They have
to furnish the exact name and precise account number of a banks client.
More often than not there are gaps in the information that may be
available to tax authorities. Either the name may not match and / or the
account number may not tally. This mismatch may be further complicated
if the bank account holder in question involves a fictitious identity. Manyclients have more than one account and it is certainly not impossible to
set up an account in a fictitious name especially if the client is a moneyed
person and is in a position to give the bank a hefty deposit. He would be
then perceived as a good customer and various services gladly provided.
After all, commercial banks are commercial business enterprises and
clients with resources are vital to a banks profitability and growth. The
(80) million or so bank account holders in Pakistan - when the number of
registered taxpayers arehardly (3) million!)- are testimony to the greatinroads made by informal sector players in the banking sector. While it is
a fact that many account holders have more than one bank account , still
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the gap between the number of bank account holders and registered
taxpayers is too obvious to ignore.
A large proportion of the black money generated in Pakistan has been
sunk in real estate and property development. Huge profits by way of
capital gains have been made by speculators and they have not had to
worry about any effective system of capital gains taxation at the federallevel. The taxation of immoveable property is a provincial subject in
Pakistan and undervaluation of property is routine for registration
purposes. Largely as a result of the intense interest in this segment of the
economy, prices have been bid up to astronomical levels in the recent
past having come down only after the worldwide financial crisis of 2007.
There has also been significant flight of resources (contrived largely
through black money) to Dubai from Pakistan for investment in property
triggered by a housing bubble there. That bubble has now burst ( as allbubbles eventual must). Finally, billions of dollars of Pakistani black
money has been kept in safe haven banks abroad. It has been estimated
that the total hoard of Pakistani origin dollars in save haven banks in
foreign jurisdictions is probably enough to liquidate the countrys foreign
debt of $50 billion plus!
Strange though it might appear, prior to the enactment of the Income Taxordinance of 2001 when the Income Tax Ordinance of 1979 was in force
and before that, the Income Tax Act of 1922 (as adapted in 1947) in which
a similar position obtained - there was no provision in the tax statute
requiring a taxpayer to maintain accounts of any sort. When formally
called upon by the tax assessing authority to explain the declared version
as per the Return of Income filed by him In fact he was well within his
rights to say that he was not maintaining any sort of record pertaining to
the business transacted by him and the tax assessing authority was thenobliged to make an assessment of the taxpayers income on the basis of
whatever information was available at the time regarding the taxpayers
business affairs. More often than not such information was minimal if not
a complete blank. At best he would direct the circle inspector to conduct a
spot enquiry and submit a report which again was almost always
sketchy. Thus hampered the assessing officer was obliged to make an
educated guess and determine income accordingly. Naturally this more
often than not greatly facilitated the taxpayer. More seriously though, thislacuna in the statute encouraged undocumented transactions. And
undocumented transactions are the lifeblood of the informal sector.
Coupled with the fact that tax laws were enacted like the notorious
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Foreign Exchange Bearer Certificate Scheme of the 1990s (FEBCs) and
the repeated so called, Tax Amnesty Schemes- that actually encouraged
holding moneys contrived by less than legitimate means, the absence of
any statutory obligation to maintain records/accounts of any kind by a
taxpayer gave a huge impetus to tax evasion. Little wonder then that the
informal sector has grown by leaps and bounds in Pakistan.
The Income Tax Ordinance of 2001 (effective with effect from July 2002)
has for the first time made it mandatory for a taxpayer to maintain
accounts as prescribed under the statute/Rules. Non compliance attracts
stiff penalties under the statute. Deterrence to non compliance is thus
built into the statute. This is most certainly a big step in the right
direction- albeit a step late in coming. However it remains to be seen how
far it will facilitate revenue mobilization. .
While loss of tax revenue is an obvious negative feature of the informal
sector, a less obvious feature, but one that has enormous significance for
the future health of the economy, is the erosion in the overall
competitiveness of the economy.
A country, like Pakistan, with an abnormally large informal sector, will
have a very large number of manufacturing enterprises of all kinds that
cannot by their very nature properly exploit internal and external
economies of scale. Modern manufacturing technology is not put to use
and instead refurbished and improvised technology is employed. Very
often technology discarded as junk abroad is imported as scrap and
then re-engineered and put to use, often perforce. There is no access to
any kind of research and development and of course there is no conceptof modern management practices. The end product manufactured in
these improvised manufacturing enterprises is bound to have
deficiencies in quality and unit price will also usually be on the higher
side.
As stated earlier, many exporters in Pakistan purchase finished products
as well as semi finished items from the informal sector. This is especiallytrue in the case of garments, woolen carpets, sports goods, and leather
goods. In the past Pakistani exporters were uniquely placed to export
such items for a while when there was not much competition and made
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good profits but now with countries like China, India, Thailand and
Bangladesh offering stiff competition taking advantage of relatively more
elaborate manufacturing infra structure especially in the case of China
and India- Pakistani exporters are finding it difficult to compete and the
informal sector is becoming a clear liability.
In order to have an idea of the growth of the informal sector over time,
the increase in consumption of electricity vis a vis GDP growth is a
reliable ready reckoner. Interestingly, worldwide, the consumption of
electricity is seen to move in lockstep as it were, with growth in GDP and
to have unitary elasticity relative to GDP. Thus a 5% growth in GDP is
normally expected to lead to a (more or less) 5% increase in overall
electricity consumption. So consistent and direct is this observed
relationship that it has become a standard to estimate electricity
generation capacity requirements over time, given the projected growth
in GDP. An added spin off of this relationship is to use it to observe the
growth in the size of the informal sector particularly in developing
countries. Thus when electricity consumption is seen to outstrip growth in
GDP, the increase is attributed to increased informal sector activity. The
extra demand for electricity ( ie over and above the expected lock step
growth in electricity consumption relative to GDP) emanates from the
increase in electricity consumption from an enlarged informal sector
yielding higher income for the players.
Quantifying the growth in electricity consumption in different time frames
and relating the same to the growth in GDP will help appraise the size of
the informal sector by extrapolating base year size of the informal sector
by the rate of differential increase in electricity consumption over GDP.
According to published WORLD BANK DATA per capita electricity
consumption in Pakistan has increased from 6 Kwh in 1947 to 63 kwh in
1970 and 520 kwh in 2004. Thus between 1970 and 2004 ( the time
frame relevant for appraisal of the informal sector in Pakistan), there has
been a 725% increase in electricity consumption per capita. In the same
time frame,, per capita income has increased from US $ 170 to $ 640,
that is by 276%. The differential increase of 449% is attributable to theincreased demand for electricity emanating from the informal sector.
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The shortfall in electricity generation vis a vis demand in Pakistan since
2008 is creating serious problems for formal and informal sector industry.
In the case of the informal sector some 25000 power loom operators
employing more than 500,000 workers face the threat of under capacity
operation or even closure in some cases because of frequent and
prolonged interruption in the supply of electricity (load shedding). Most of
the power loom operators are placed in the informal sector and they
manufacture something like 50% of the total fabric manufactured in
Pakistan, a large proportion of which is consumed in the garment
manufacturing segment of the economy. This segment has a pronounced
export orientation and the interruptions in the supply of electricity will
surely lead to a fall in export earnings. Unlike composite textile mills that
have their own electricity generation capability, the informal sector power
loom operators rely almost entirely on electricity available on the national
grid. While some of these units might actually be stealing electricity
from the grid by using illegal hooks for instance (called kunda in the
vernacular)many more tamper with the electricity meters in connivance
with electricity meter inspectors who gladly supply their expert meter
tampering services for a fee (bribe).This has spawned a new class of rich
meter readers and has made meter reading a much sought after
profession for those placed in the under privileged segments of society
in Pakistan. The scale of this activity can be gauged from the fact that
some 25 30% of the electricity generated is lost in that no revenue is
generated as no Bills for electricity consumed- have been issued. This
is a huge loss indeed for WAPDA and PEPCO (Water and Power
Development Authority and Pakistan Electric Power Company,
respectively the two organizations responsible for generation,
transmission and distribution of hydel and thermal based electric power in
Pakistan).
Power loom operators are not the only ones guilty of stealing electricity.
In fact this is almost something of a national pastime and virtually anyone
who can do so will not miss out on an opportunity to get some electricity
at least for free. The extremely high, electricity tariff has a lot to do with
this. On a Unit basis (Kwh), looking to per capita income, the electricity
rate structure is probably the highest in the world. In fact it is prohibitive.
It is 60% higher than in India and 40% higher than in Bangladesh. And
practically no one can get an electricity connection at the official price.
An informal payment has got to be made in almost every case over and
above the official cost to the consumer.
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So it is the prohibitively high electricity rate structure that is at the root of
the endemic stealth of electricity. The impact of the high tariff has been
cushioned for a long time by a significant subsidy given by government to
offset the burden on the consumer. That however would no longer be
feasible as international institutions giving economic assistance toPakistan insist that all subsidies be removed as they are a distortion in the
system and the consumer bear the actual burden of the facility at market
price. The government is doing what it can to delay complete removal of
the electricity subsidy as it knows only too well that a public backlash is
inevitable. But for how long can matters be held in abeyance?
The present mix of thermal and hydel generated electricity (65:35) makesit inevitable that the rate structure be pitched high as thermal electricity
is particularly expensive because of the rising price of oil. What
complicates matters is that in Pakistan the so called (multi -national)
Independent Power Producers (IPPs) have, since the nineteen nineties
when agreements with them were first formalized, been able to negotiate
tariffs for supplying electricity that are seen by many to be prohibitively
high. At full capacity these seventeen IPPs are able to put something like
3500 4000 MW of thermal origin electricity on the national grid whichgiven the total installed capacity (thermal and hydel) of 19000 MW is of
considerable significance. However most of these units are not
operational due to accumulation of huge arrears of payment from
government. As a result the IPPs are not able to pay the Pakistan State
Oil Co (PSO) for deliveries of furnace oil used in their generators. The
magnitude of the problem can well be gauged from the fact that one such
large IPP, HUBCO, is owed Rs 50 Bill from government as of 1st June 2009
and HUBCO in turn owes PSO Rs 39 Bill for past deliveries of furnace oil.This circular debt problem has defied solution to date but government
has made a commitment to clear the outstanding payment to HUBCO by
august 2009.
What is ironic however is that Pakistan is sitting on 180 billion tons of coal
of reasonably good quality in Thar, Sindh province and has made no
attempt to exploit this valuable resource in electricity generation. Thiscoalfield is probably among the largest in the world and its existence has
been known since 1958. Presently 65% of the total electricity generated
in Pakistan is from thermal units that mostly use furnace oil which of
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course is priced high given the escalation in oil prices. Had a bold
decision been taken at the right time to tap the Thar coalfield and to use
coal in the thermal units for electricity generation, we would not be
confronted with the severe crisis with which we are presently burdened.
Matters can still be remedied provided the decision is taken to exploit
Thar coal and to convert the existing thermal units to use coal instead of
furnace oil and natural gas. Unless this is done, there is no way that
Pakistan can deal effectively with the prohibitively high electricity tariff
which is the root cause of widespread electricity theft and is holding up
industrial development both in the formal as well as the informal
sectors.
In the past, Pakistans high tax rate structure was seen as an important
causal factor in the growth of the informal sector. Indeed, with the highest
marginal rate of tax for Individual Income pitched at a prohibitive 98% (in
the latest fifties) there was little incentive to declare true income and pay
a rate of tax that was rightly perceived to be confiscatory. Similarly, in
the case of corporate income, tax rates were not only high but pitched at
three different tiers for public limited, private limited and banking
companies, respectively. Banking companies were subject to the highest
tax tier and public limited companies to the lowest. However thankfully
all that has changed over time and, income tax collection has increased
sharply (surpassing a trillion Rupees in fiscal 2007-08) as tax rates have
fallen bearing out Professor Laffers ( nay, Ibn e Khalduns ! ) proposition
that (a) revenues are increased upto a point with each increase in tax rate
and once that point has been crossed [ roughly the midpoint on the Laffer
Curve) tax rate increase leads to a fall in revenue and (b) for each
quantum of tax collection there is a high rate of tax as well as a low rate
of tax and it makes eminent sense to opt for the lower rate of tax to
achieve that quantum of tax collection because the lower rate of tax is
associated with economic benefits that may not be immediately
perceived but that are very much there and these benefits encourage risk
taking and lead on to innovation and increased productivity and
ultimately to an escalation in income and hence a higher economic
threshold.
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Presently, Pakistans corporate and Individual income tax rates are attheir lowest ever( 35% and 25% respectively) and the discriminatory rate structure fordifferent types of corporate earnings has also been done away with.
Pakistan government policies have also had a lot to do with the growth ofthe informal sector. Take for example the practice of allowing a so calledAmnesty on black moneys held by people allowing them to get itlaundered (whitened) by paying nominal income tax. A number of suchschemes have been announced by government over the years and peoplehave almost become conditioned as it were to wait for the next amnesty
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scheme and get their black money hoard whitened! Such expectationcreates a mindset that is highly detrimental to the development of taxconsciousness which is central to effective voluntary compliance withtax laws. Besides periodic tax amnesty schemes, special financialinstruments like the foreign exchange bearer certificates and theforeign currency bearer certificates have been floated with a no
questions asked policy that actually made it possible for people holdingblack money to earn good interest on their
Black money holdings giving Pakistan the dubious distinction of being the
only country in the world where there was a government sanctioned
premium on holding black money! While the plethora of money whitener
schemes are gradually being phased out, a great deal of damage has
been done already and governments stated resolve not to repeat such
costly mistakes in future needs to be tested before it can be said that
lessons have actually been learned.Weaknesses in tax administration are also an important reason why it has
been so safe for a very large proportion of the working (non agricultural)
population to operate in the informal sector with virtual impunity over a
protracted time frame. Perception is said to be 9/10ths of reality. If the
ordinary man in the street is of the opinion that State Institutions set up
for revenue mobilization and economic vigilance are inept, corrupt,
apathetic and lethargic in the discharge of their duties, he will most
certainly take advantage of the situation. This of course means that hewill evade taxes. But then institutional malfeasance is not confined to tax
matters only. Thus if the police force under performs, crime will rise as
criminals take advantage.
Tax personnel either lack the necessary expertise to understand the
informal sector phenomena and track down players especially those
engaged in the criminal segment of the informal sector where the bulk ofthe supernormal profits are generated or have been seen to be
susceptible to monetary inducement (bribes) to permit such activity and
let the players get away with non reporting of income and resultant tax
evasion. Some important first steps have indeed been taken to motivate
tax personnel to resist the temptation to accept bribes such as doubling
of the basic emoluments of officers and support staff. However much
more needs to be done.
Pakistan desperately needs to deal effectively with the worst features of
the informal sector. The miserably poor tax to GDP ratio currently
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pitched at an abysmal 9% or so- and the extremely narrow tax base
hardly 3 million taxpayers regularly filing Returns- are cause for grave
concern. Pakistan desperately needs to be able to generate revenues to
meet the pressing needs of economic development, Defense and debt
liquidation. A concerted effort will therefore be required to achieve this
objective and tackling the challenge of the informal sector is a key
element in this effort.
The only truly effective long term solution to the menace of the black
economy with a preponderant criminal segment to it is thoroughgoing
documentation of the economy and the setting up of data bases coupled
with the use of specialized computer based software to collate and
analyze the data on a real time basis. Mere collection of data is not
enough. It is only when there is a demonstrated capability to sift the data
and get to the tax evader that there will be a deterrent effect on the
public. In our time and age the technology that can make all this possible
is there in the global market place. It may not be cheap but the cost is not
prohibitive and given the enormous benefits to the economy an
investment in such technology is most definitely feasible. Required more
than anything else however, is a sternly committed executive will and an
unwavering determination to recognize and deal with the problem.
Important beginnings have been made in Pakistan but more, much, much
more, needs to be done. In India, during the Indira Gandhi emergency rule
imposed in 1975, the Hawala networks were specifically targeted and
ruthlessly dealt with and ultimately eradicated. Similarly in Bangladesh,
Philippines and Sri Lanka the governments have put an end to their
operations. There is absolutely no reason why the same cannot be
replicated in Pakistan.
______________________________________________________________________________________
[ The author is a former officer of the INCOME TAX GROUP, FEDERAL BOARD OF REVENUE (1969-2008) and has served
as MEMBER, CBR, (HRD)/RE-STRUCTURING/WEALTH TAX ( 1998-2000), MEMBER, INCOME TAX APPELLATE TRIBUNAL
OF PAKISTAN (2000-2006) and DIRECTOR GENERAL, TRAINING & RESEARCH (INCOME TAX- 2006-2008) ].
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The Global BLACK MARKET.
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Quantifying the Pakistan Informal Sector.
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The results of one
researchers efforts to
quantify the Informal Sectorin Pakistan are tabulated
above. The Informal Sector as a matter of economic significance is seen to have arisen in the
1970s and to have peaked in the closing years of the 20 th century. This is understandable
given the state of fiscal policy in that time frame. However there is no unanimity here and the
size of the informal sector has been appraised differently by different economists and
researchers. Because of data constraints analysis of the size of the informal sector is difficult.
However the fact that demand for electricity has registered a sharp surge in recent years is a
factor of considerable significance as, given the normal lock-step relationship between
electricity consumption and gdp growth over time, the present asymmetry is being related to
a considerable increase in the size of the underground economy. The high growth in thefinancial services sector as well as money supply vis a vis demand and time deposits in banks
(M2) also lends support to the view that the UGE has grown much faster than what the
researchers might cautiously calculate. In 2009, informed opinion on the matter is inclined to
hold that the informal economy is at least as large as the regular economy. Some even hold
that it could be larger than the regular economy.
1973 15 2.15 20
1978 41.832 4.644 23.51
1983 104.759 13.361 28.75
1988 192.752 26.672 28.541993 470.124 62.913 35.27
1998 1449.891 193.397 54.52
1999 1146.839 152.499 39.03
2000 1094.052 141.077 34.76
2001 1298.233 169.025 38
2002 1388.064 175.472 37.25
UnderGround Economy in Pakistan- vital statistics
Year UGE -
SIZE
UGE Tax EvasionUGE-% of GDP
Bill Rs Bill Rs %
Source : M. Ali Kemal, Underground Economy & Tax
Evasion in Pakistan -A Critical Evaluation.
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The Informal sector is present in ALL countries, no matter whattheir scale of development. However, in general, the moredeveloped an economy, the smaller the size of the informalsector and vice versa. Also again, in general- the greater thesize of the informal sector, the more inequitable is thedistribution of income ie the higher is the gini coefficient.
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In general, the greater the size of the Informal sector,
the lower is the tax to gdp ratio.
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Factors giving rise to the informal sector
1.Inequitable distribution of Income.
2. Inequitable Tax System.
3.Prohibitive taxation. High tax ratestructure.
4.Sociological factors. Colonial legacy.
5. Perceived disconnect between payment
of tax & matching benefit to the payer.
6.Institutional decay.
DISTRIBUTION OF FAMILY
INCOME- Gini Index
NAMIBIA 70.7 CHINA 44 AUSTRALIA 35.2
S.AFRICA 59.3 IRAN 43 EGYPT 34.4
BRAZIL 59.7 SINGAPORE 42.5 INDONESIA 34.3
MEXICO 54.6 TURKEY 42 INDIA 32.5
ARGENTINA 52.2 PAKISTAN 41 SPAIN 32.5
THAILAND 51.1 RUSSIA 40 EUROPEAN UNION 32
MALAYSIA 49.2 JAPAN 37.9 BANGLADESH 31.8
PHILIPPINES 46.6 UK 36.8 FINLAND 26.9
UNITED STATES 45 S.KOREA 35.8 NORWAY 25.8
SWEDEN 25
DENMARK 23.2
In general, significant inequalities in the distribution of
Income are associated with relatively large Informal
Sectors.
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