Shame the evaders
Improving tax compliance is undeniably a Herculean task. It requires a big change in the methods and techniques of tax collection and, above all, in the norms of society. Many argue that norms are set in stones and are not easy to change. However, what is encouraging is that demand
Improving tax compliance is undeniably a Herculean task. It requires a big change in the methods and techniques of tax collection and, above all, in the norms of society.
Many argue that norms are set in stones and are not easy to change. However, what is encouraging is that demand for tax compliance is increasing and tax profiles of public officeholders have come under scrutiny by the press. But this is not sufficient. Established methods for controlling tax evasion like audits, third party reporting, paper trails, public disclosure of tax records, and satellite detections of unregistered businesses have not yet been optimally tried in our case – mainly due to political expediencies of successive governments.
The results are rampant tax evasion and a weak tax culture. According to the latest tax directory, 40 percent of the companies registered with the SECP have filed their tax returns, what to say of individuals.
There are many reasons for low tax compliance in Pakistan, and tax evaders come up with every type of justification for not paying their due taxes. My neighbour is not paying taxes, why should I? I keep a private security guard since the police are unable to give me security, so why should I pay for the police deputed for protocol duties with the politicians? Taxes other than religious levies are not in line with the injunctions of Islam, so why should I pay taxes to a state that is not Islamic?
Such arguments are very common and you hear them time and again in. We cannot brush aside these arguments altogether. Taxes are essentially a result of the contract between the state and its people.
Broadly speaking, the reasons for weak tax culture in Pakistan can be divided into four categories. First, the state is weak and public service delivery is poor. Private security guards are more reliable than policemen. Standards of education are better in private schools compared to their counterparts in the public sector. Visiting a private hospital is better than undergoing the humiliation of being treated at a public hospital. Second, there exists no clear social contract for revenue generation between the state and its elite.
Third, the perception that tax money will not be returned with value is high due to deep-rooted corruption. Fourth, there are perceptions of unfairness about the taxation system due to horizontal inequities in the taxation structure arising out of exemptions and a large informal economy. Tax evasion has become a norm for society and it is argued that norms are set in stone and are, therefore, difficult to change.
Defying payment of tax at toll plazas is not considered a bad act; rather it is taken as a source of pride and power. Vehicles of certain government departments are exempt from toll tax; such exemption is reflective of the power and authority of these departments in the hierarchy of public sector departments. A vehicle of the education or social work department may not enjoy the sort of amnesty that may be available to departments that wield hard power. All this simply points towards a nexus between power and tax evasion. Those in power treat tax evasion as a matter of pride.
The moral of the story is very simple. We need to make tax evasion a shameful activity. Shaming penalties have worked even in advanced countries. For example, Perez-Truglia et al in their paper ‘Tax debt enforcement: theory and evidence from a field experiment in the United States’ have compared financial and shaming penalties in the recovery of outstanding tax arrears.
The researchers conducted a field experiment with 34,344 individuals who were publicly listed as tax defaulters in three different states of the US. These people owed almost half a billion dollars as recoverable arrears and had been defaulters for two years despite numerous efforts and high financial costs attached to such defaults. The researchers devised a mechanism to make these defaulters realise that their neighbours could know that they were tax defaulters. The conclusion of this field experiment was that shaming penalties were more useful compared to financial penalties.
In our context, this field experiment has important lessons to offer. The topmost problem of our taxation is a low tax base. People who own palatial houses and large tracts of land are out of the tax net. Professionals like doctors and lawyers who earn in millions do not pay even a single penny as direct taxes. Retailers and wholesalers whose turnover far exceeds the taxable limit do not maintain accounts and remain out of the reach of the long arms of the law. Merely sending them tax notices will not work. We need to take some steps to impose shaming penalties upon such tax evaders. One possible course of action is to publish tax details of all the people of a profession (say doctors) and to widely circulate it for shaming the tax evaders.
Increasing tax net and checking tax evasion also requires that new technology should come to the aid of tax administration. Big manufacturing units like sugar mills where scope of suppression of production are high can be subjected to monitoring through use of modern technology. Audits need to be made more frequent and meaningful. Empirics in case of Greece show that one percent increase in the number of tax inspections per day of audit lowers the number of tax offenders per day of audits by 0.3-0.4%. Tax audits have their indirect impact as well. In case of Greece, 10% increase in tax audits increases tax revenue by 0.13 % of GDP. Improving tax compliance has become more significant in view of tax reforms Pakistan has undertaken with regard to rationalization of customs tariff. We are moving from “easy to collect taxes” (Customs duties, excise) to ‘hard to collect taxes’ (income tax, sales tax). In case of ‘hard to collect taxes’, we do not have physical controls and audit is the only effective tool to check the accuracies of declarations.
Besides audit, shaming penalties should be frequently used for tackling tax evasion. We need to publicly shame tax evaders. It is now well recognised that outcomes of economic decisions largely depend on the prevailing social norms. The number of tax evaders is high in societies where tax evasion is socially acceptable – as in our case. High rates of tax evasion not only point towards the fact that tax evaders view their behaviour as normal, but also to the lack of whistle-blowers; this behaviour seems to have become socially acceptable. We need to change such social norms. For tax compliance to be initiated tax evasion should no longer be a socially acceptable phenomenon.
The writer is a graduate of Columbia University.
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