We all know that tax evasion is an offence punishable under the law and subject to payment of huge default surcharge and penalty including imprisonment where the offenders fail to discharge their assessed tax liabilities. We also know that there are people who become tax delinquents by mistake and would like to become honest taxpayers but are deterred by the huge tax cost as well as embarrassment.
People tend to evade and avoid tax and instead prefer to engage in undocumented transactions including cash dealings to prevent being visible to tax collectors and escape their detection when selected for audit. The level of tax evasion is very high in countries where tax rates are unreasonably high, where there are corrupt practices, and where the tax collected is not fully used for the benefit of the general public.
Peeking into the history of tax rates in Pakistan, we have seen the corporate tax rate of 66 percent for banking companies, 44 percent for public companies, and 55 percent for other companies; whereas non-corporate sectors have been taxed at varying rates from 0 percent to 35 percent. These rates gradually reduced to 30 percent for all taxable persons over a period of 72 years, but the government continues to introduce new concepts of taxes in the form of minimum tax, final tax, alternative corporate tax, surcharge or super tax, or enhance the tax rates on dividend and interest income. We do not need an expert to tell us that taxation at 0 percent of income of a person will not generate any tax revenue for the government. Similarly, no expert opinion is needed to tell us that taxation at 100 percent of income of a person will also not generate any tax revenue, as people would certainly not earn any income if all of that were to be taken by the State. Therefore, the rate of tax has to be reasonable giving due consideration to the income from all the sources available to the government, and, to meet the additional needs of the government for economic development, creating more opportunities for new businesses and employment.
Pakistan followed a policy of very aggressive rate of taxation in the past, both for corporate and non-corporate entities, which not only paved the way for tax evasion and avoidance, but it also slowed down the participation of private sector in the economic development of the country. Having failed to win the trust of the taxpayers and collect the right amount of tax from them, the government resorted to massive indirect taxation in the form of heavy excise duty and sales tax, thereby passing on the burden of taxes indirectly to the entire nation. These unreasonable methods employed by the government led to the promotion of informal economy and corrupt practices, which have sadly become the norm in Pakistan.
These are the situations that compel the governments to introduce tax amnesty schemes. The considerations are mainly financial, political, and technical:
• Financial - to collect immediate additional tax revenue to get out of fiscal stress as well as stress after deep institutional changes.
• Political - to provide an opportunity to the people engaged in tax evasion and corrupt practices to whiten their ill-gotten wealth and become honest taxpayers.
• Technical - to make institutional changes for the improvement of tax to GDP ratio by creating opportunities for transformation of informal economy to formal economy.
Understanding tax amnesty
Tax amnesty is commonly understood as government’s forgiveness of all or part of the tax, default surcharge and penalties due from tax defaulters, cheaters, or evaders provided they pay the tax demanded under the amnesty scheme announced by the government. It generally targets the undocumented sectors that have undeclared wealth and income on payment of an unreasonably low price on the condition that no question shall be asked of the source of income for creation of undeclared wealth and that the income and wealth so declared will be treated as whitened. Amnesty is a form of plea bargaining as it provides immunity to the application of tax law to both non-compliant and partly compliant taxpayers at a given price thereby offering an insurance to those who would avail tax amnesty. It could also be viewed as a trade-off between the opportunity of raising immediate extra revenue on the one hand and providing an incentive for future compliance on the other. Most governments introduce tax amnesty schemes on the assumption of heterogeneity among the taxpayers irrespective of whether the tax evaders are small or big, less visible or more visible.
Objective of tax amnesty
The objective of tax amnesty, no doubt, has always been to raise hundreds of billion rupees of taxes which revenue authorities would otherwise have found difficult or impossible to collect. A well-publicised amnesty coupled with stricter enforcement, institutional changes, and rationalisation of tax rates is expected to increase the level of future compliance with the tax laws.
Corrupt tax practices
Fraudulent tax practices have been rampant in Pakistan involving both the taxpayers and tax collectors with and without collusion. The connivance of the delinquent taxpayers and the tax collectors has been deep rooted in the country. To be honest, no serious attention has been given to curb tax evasion and false declarations by non-compliant as well as compliant taxpayers. Even no attention has been given to prevent the loss of tax revenue resulting from the collusion between taxpayers and tax collectors. Instead of introducing tax reforms and building trust between the taxpayers and tax collectors, every successive government, whether military or civilian, introduced tax amnesties for raising one-time revenue to meet the budgetary targets. Whilst complete data of the outcome of the tax amnesties is not officially published by the tax authorities, none of the amnesty schemes achieved the desired objectives. Even after 72 years of independence, Pakistan is still struggling to raise the right amount of tax or achieve a reasonable tax to GDP ratio, which, in a country like Pakistan, should not be less than 15 percent of the GDP.
Tax amnesties in Pakistan
The first tax amnesty scheme in Pakistan was launched by the military government of Ayub Khan in 1958, and the most recent was introduced by the civilian coalition government of Imran Khan in 2019. In between, more than seven tax amnesties were introduced by almost all the governments, but, barring tax amnesty scheme of the year 2000 and 2018 introduced by the military government of Pervez Musharraf and civilian government of Nawaz Sharif (PML-N) respectively, which were presumed to be a great success in comparison with others, none of the tax amnesty schemes achieved the desired results. Unfortunately, these amnesties did not bring any significant change in the tax compliance culture. As per World Bank’s report published in 2015, in terms of tax compliance status, Pakistan is ranked at 172 out of 186 countries. A table of outcome of the past tax amnesties in Pakistan is given below:
You will note that the tax amnesties in the past did not produce encouraging results. They also did not result in any significant improvement in the tax compliance culture. Accordingly, it is clear that the disease of tax evasion and level of informal economy remained a challenge for all governments. An analysis of the failures suggests the following:
a) There has been no political will of the government to ameliorate the situation, as every successive government engaged in corrupt practices, and the schemes it introduced were essentially meant to gain political advantages.
b) The focus of the governments has always been to introduce tax reforms without curing the disease of corrupt practices of the tax collectors.
c) Instead of cementing the holes in the tax laws or strengthening the tax laws, the governments opted for legislations to create loopholes to promote tax avoidance and tax evasion and prevent probe into such corrupt practices. One example is the introduction of section 111 in the Income Tax Ordinance, 2001 to grant immunity from probe into remittances from abroad.
d) The state of Pakistan remained in the control of landlords, industrialists, and military, who have legislated only to enjoy tax exemptions for themselves. Examples: Total exemption from tax on the income from agriculture, and specific tax exemptions to the military, judges, and bureaucrats.
e) Lack of institutional reforms including reduction in tax rates and other taxes to win the trust of taxpayers in the taxation system and tax administration.
Virtues of tax amnesties
To judge the virtues of an amnesty, policymakers will have to weigh the revenues raised against its other consequences, both negative and positive, which may be substantive. For example, some elements of a tax amnesty will support and other elements will undermine the legitimacy of the tax system and the revenues that it collects. Considering the prominence of taxes in the transactions of the public with the government, a tax amnesty may also affect the perceived overall legitimacy of the government. Before introducing any tax amnesty, it is necessary to decide whether it is to be coupled with institutional reforms to bridge the trust gap between the tax administration and taxpayers, and strict enforcement program or status quo or stepped up enforcement program, for amnesty alone may provide increased collection of tax revenue, but it may remain temporary.
Reasons for failure
An analysis of the reasons for failure, or less positive impact, of tax amnesties suggests the following:
• There has been a huge trust gap between the delinquent taxpayers and tax collectors
• Corrupt practices are rampant in the tax collection machinery and it is less costly to stay out of the tax net
• Each successive government tends to introduce tax amnesty as a tool to boost the tax collection for meeting temporary tax targets and the people believe that there will be future amnesties
• lack of knowledge and capacity of tax collectors to combat tax evasion, under-declaration or false declaration of taxable income, and
• Long drawn appeal options available to taxpayers where tax assessed could be appealed and its judgment is either delayed or compromised.
Risks associated with tax amnesties
• It annoys the compliant taxpayers
• It is unfair to those who pay their taxes honestly and on time
• It may weaken the incentive for tax compliance, especially if people expect that amnesties may be coming again in the future
• It may cause a fall in revenue, thereby reducing the efficiency of the tax system
• It may increase cheating, which is detrimental to the efficacy of the tax system
• It may reduce the equity of the tax system if we let the dishonest people off the hook
• It undermines the strength of the social sanction against the amnestied behaviour reducing the guilt felt by delinquents when they misbehave
• It may make cheating seem less significant, reducing the guilt felt by those who consider widening their deductions of admissible expenditures or under reporting their taxable income.
Benefits of tax amnesties
• The taxpayers who evade or under-declare unintentionally or inadvertently feel guilt or psychological loss for evading or making wrong declaration, may take it as an opportunity for reprieve to rectify their tax status and use it as a remedy for the psychological costs associated with non-compliance.
• It reduces the guilt of tax evaders by making payment of tax arrears.
• It allows collection of unpaid past tax, which was otherwise not collectible.
• It encourages renewed compliances.
• It makes the society better equipped to control the future.
• It allows the society to forgive violators who are unlikely to become repeat offenders.
• It helps in reducing or eliminating burdens from a social split or from individual guilt.
• It permits the society to declare that it made a mistake and now wants to rectify it.
• It can make the transition to a new enforcement regime seem fairer.
Conclusion
High tax rates coupled with corrupt practices and the trust gap between the tax administration and taxpayers encourages the taxpayers to stay away from the tax net and opt for informal economy. Limited attention affects our ability to make good choices, but governments can improve decision-making by taking the following steps:
• Reform the tax administration by inducting tax professionals of integrity.
• Set up highly independent office of tax ombudsman with powers to examine cases of corrupt practices and take punitive actions against the tax collectors.
• Eliminate red tape by introducing automation with log maintained and monitored by a strong professional oversight team.
• Introduce rewards and incentives for honest tax compliances by the taxpayers.
• Streamline tax rates for all segments of the society to make them pay taxes voluntarily, honestly and without fear of abuse by the tax collectors, which in turn should broaden the tax base and high tax revenue for the government.
• Stop giving tax amnesties because nobody takes it seriously, as it is introduced from the point of weakness and at the cost of annoying and slapping the compliant taxpayers.
Year Government Tax Collection People opted Value of Assets
(PKR’000) (No.) declared (PKR’000)
1958 Ayub Khan - (Military) 1,120,000 71,289 *
1969 Yahya Khan - (Military) * 19,600 920,000
1976 Z. A. Bhutto - (Civilian) * * 270,000
1997 Nawaz Sharif- (Civilian) 142,000 * *
2000 Musharraf - (Military) 10,000,000 79,200 180,000,000
2001 Musharraf - (Military) 2,500,000 * *
2016 Nawaz Sharif- (Civilian) 850,000 10,000 *
2018 Nawaz Sharif- (Civilian) 125,000,000 84,000 2,500,000,000
2019 Imran Khan- (Civilian) 70,000,000 100,000 3,000,000,000
*Figures not available
Note: Since FBR did not publish the information of amnesty results, the information tabulated above is taken from various news reports and published data available in the social media. Accordingly, some of the information presented above may not be accurate.
The writer is a chartered accountant