PakistansBlackEconomy

8/14/2019 PakistansBlackEconomy

1/30

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


2/30

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.


3/30

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


4/30

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?


5/30

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


6/30

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


7/30

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


8/30

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


9/30

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


10/30

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.


11/30

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.


12/30

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


13/30

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.


14/30

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


15/30

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


16/30

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) ].


17/30

The Global BLACK MARKET.


18/30


19/30


20/30

Quantifying the Pakistan Informal Sector.


21/30

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.


22/30


23/30

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.


24/30


25/30


26/30

In general, the greater the size of the Informal sector,

the lower is the tax to gdp ratio.


27/30


28/30


29/30

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.


30/30

PakistansBlackEconomy

Documents

Transcript of PakistansBlackEconomy