Almost immediately after taking over as Advisor to the Prime Minister on Finance, Dr. Miftah Ismail made a statement to the press emphasizing the government’s resolve to implement tax reforms, particularly cracking down on tax evasion. This was all very uplifting and made the headlines. And then came the fine print.
Among Dr. Ismail’s delineation of the government’s plans on tax reform were: slashing personal tax rates to encourage more people to file returns (a top rate of 15% was mentioned, as opposed to the 35% applicable now); and giving legal protection to the money Pakistanis are keeping abroad to encourage them to bring it back.
If there were ever any doubt about which constituencies Pakistan’s economic policymakers seek to service, Dr. Ismail’s assertions should put paid to it. Slashing personal income tax rates would, of course, be a highly popular measure in any country, but does it make any sense in a state where the tax-GDP ratio has only recently edged up to 12%, still far below the government’s own medium-term target of 15%?
Should one talk of slashing taxes at all in a country where the government’s provision of basic services is woefully inadequate and generally of poor quality? Should the government not be upholding the solidarity principle of provision of basic services—that yes, those who are paying the taxes may not be using public services, but that they should pay nevertheless because they are a part of a larger community, a society, a nation, and have an obligation towards those less fortunate than themselves? As citizens we can gripe about paying taxes and not availing services, but the government has to espouse a different agenda.
And then there is the second statement, that relates to encouraging Pakistanis to bring money back. There are no details of this, but it is not difficult to figure out where this is going. In a global environment where tax evasion through offshore accounts, trusts and front companies is becoming a scandal, Dr. Ismail wants to provide legal cover to the super rich who use such channels to keep their assets beyond scrutiny. The excuse of course is that the scheme would be a one-off. History does not suggest that that holds up.
Pakistan has quite a history of tax amnesty schemes, aimed at bringing non-filers into the tax net and keeping them there. One of the earliest examples were the whitener bonds that Dr. Mahbub Ul Haq, the then finance minister, wanted to float in the 1980s. The idea was for the Pakistan government to float bonds in foreign capital markets, targeting the overseas Pakistanis community to invest in the government paper. The key attraction for the purchase of the bonds, which carried a ten-year maturity period, was to be that no questions were to be asked on the sources of the funds. The bonds were floated in 1984, and by the time they matured in 1994, a third of current expenditure was going towards debt servicing (as per the 1994 Economic Survey), outstripping expenditure on defense for the first time. In effect, the Pakistan government managed to bring in some much-needed capital, but paid a huge price for it. Meanwhile, tax evasion continued unimpeded and there is little indication that the bonds made any dent in illegal money flows over a longer period.
Tax amnesty schemes continued into the 1990s, with the PML(N) introducing a scheme in 1997 that allowed traders to declare income, pay tax on a one-time higher tax rate and gain a reprieve wherein their income would, from then on, not be scrutinized. The scheme largely failed as traders correctly assessed that the government was not serious about introducing documentation of the economy and that they could continue to evade taxes. A similar attempt was made in 2008 by the PPP government.
But the year 2016 was when the government really got into its stride regarding tax amnesty, announcing not one but two schemes. The first one, announced on Jan 1, allowed traders who had never filed tax returns, to do so, paying just 1% tax. Those filing under the scheme would also be exempt from an audit for three years. This was followed up in December of the same year, with a tax amnesty scheme for those investing in real estate. According to this scheme, investors could pay 3% of the difference between the DC rate or government-notified value of a property and the value estimated by the Federal Board of Revenue, and still have the value of the property registered on the (often much lower) DC rate. Further, real estate investors taking this route would not be questioned about the source of funds. Although the scheme applied only to real estate, it’s a no-brainer to see how it could be exploited by a range of people wanting to practice tax evasion. Real estate is the best sector to invest in if you are trying to legitimize capital. This scheme just made the process easier.
All of the above is in addition to the money laundering opportunities under remittances, which cannot be taxed by law, and which are generally not questioned. Thus a permanent channel exists for whitening money: send funds abroad through any number of illegal means, and then bring it back to Pakistan through banking channels. Voila! Your money is squeaky clean. Why do you even need to bother with amnesty schemes?
Tax amnesty schemes work if they really are a one-off, and if the State’s market signaling on future regulation is taken seriously by the key stakeholders. When neither of the two conditions is met, tax amnesty schemes are simply a means to allow more people off the hook in a country where evasion is already rife. The history of the more than ten tax amnesty schemes that have been announced in Pakistan over the decades, bear ample testimony to the fact that they rarely result in substantial revenue generation, and they certainly don’t widen the tax net. Perhaps it’s time to go beyond such gimmicks.
Among Dr. Ismail’s delineation of the government’s plans on tax reform were: slashing personal tax rates to encourage more people to file returns (a top rate of 15% was mentioned, as opposed to the 35% applicable now); and giving legal protection to the money Pakistanis are keeping abroad to encourage them to bring it back.
If there were ever any doubt about which constituencies Pakistan’s economic policymakers seek to service, Dr. Ismail’s assertions should put paid to it. Slashing personal income tax rates would, of course, be a highly popular measure in any country, but does it make any sense in a state where the tax-GDP ratio has only recently edged up to 12%, still far below the government’s own medium-term target of 15%?
Should one talk of slashing taxes at all in a country where the government’s provision of basic services is woefully inadequate and generally of poor quality? Should the government not be upholding the solidarity principle of provision of basic services—that yes, those who are paying the taxes may not be using public services, but that they should pay nevertheless because they are a part of a larger community, a society, a nation, and have an obligation towards those less fortunate than themselves? As citizens we can gripe about paying taxes and not availing services, but the government has to espouse a different agenda.
Should one talk of slashing taxes at all in a country where the government's provision of basic services is woefully inadequate and generally of poor quality?
And then there is the second statement, that relates to encouraging Pakistanis to bring money back. There are no details of this, but it is not difficult to figure out where this is going. In a global environment where tax evasion through offshore accounts, trusts and front companies is becoming a scandal, Dr. Ismail wants to provide legal cover to the super rich who use such channels to keep their assets beyond scrutiny. The excuse of course is that the scheme would be a one-off. History does not suggest that that holds up.
Pakistan has quite a history of tax amnesty schemes, aimed at bringing non-filers into the tax net and keeping them there. One of the earliest examples were the whitener bonds that Dr. Mahbub Ul Haq, the then finance minister, wanted to float in the 1980s. The idea was for the Pakistan government to float bonds in foreign capital markets, targeting the overseas Pakistanis community to invest in the government paper. The key attraction for the purchase of the bonds, which carried a ten-year maturity period, was to be that no questions were to be asked on the sources of the funds. The bonds were floated in 1984, and by the time they matured in 1994, a third of current expenditure was going towards debt servicing (as per the 1994 Economic Survey), outstripping expenditure on defense for the first time. In effect, the Pakistan government managed to bring in some much-needed capital, but paid a huge price for it. Meanwhile, tax evasion continued unimpeded and there is little indication that the bonds made any dent in illegal money flows over a longer period.
Tax amnesty schemes continued into the 1990s, with the PML(N) introducing a scheme in 1997 that allowed traders to declare income, pay tax on a one-time higher tax rate and gain a reprieve wherein their income would, from then on, not be scrutinized. The scheme largely failed as traders correctly assessed that the government was not serious about introducing documentation of the economy and that they could continue to evade taxes. A similar attempt was made in 2008 by the PPP government.
But the year 2016 was when the government really got into its stride regarding tax amnesty, announcing not one but two schemes. The first one, announced on Jan 1, allowed traders who had never filed tax returns, to do so, paying just 1% tax. Those filing under the scheme would also be exempt from an audit for three years. This was followed up in December of the same year, with a tax amnesty scheme for those investing in real estate. According to this scheme, investors could pay 3% of the difference between the DC rate or government-notified value of a property and the value estimated by the Federal Board of Revenue, and still have the value of the property registered on the (often much lower) DC rate. Further, real estate investors taking this route would not be questioned about the source of funds. Although the scheme applied only to real estate, it’s a no-brainer to see how it could be exploited by a range of people wanting to practice tax evasion. Real estate is the best sector to invest in if you are trying to legitimize capital. This scheme just made the process easier.
All of the above is in addition to the money laundering opportunities under remittances, which cannot be taxed by law, and which are generally not questioned. Thus a permanent channel exists for whitening money: send funds abroad through any number of illegal means, and then bring it back to Pakistan through banking channels. Voila! Your money is squeaky clean. Why do you even need to bother with amnesty schemes?
Tax amnesty schemes work if they really are a one-off, and if the State’s market signaling on future regulation is taken seriously by the key stakeholders. When neither of the two conditions is met, tax amnesty schemes are simply a means to allow more people off the hook in a country where evasion is already rife. The history of the more than ten tax amnesty schemes that have been announced in Pakistan over the decades, bear ample testimony to the fact that they rarely result in substantial revenue generation, and they certainly don’t widen the tax net. Perhaps it’s time to go beyond such gimmicks.