Tax evasion usually involves taxpayers purposely falsifying the true state of their affairs to the tax authorities to reduce their tax liability. It includes false tax reporting, e.g., declaring less income, profits than the amounts actually earned, or overstating deductions and exemptions. In contrast, tax avoidance is the legal use of tax laws to reduce tax liability. Both tax evasion and avoidance are essentially of tax non-compliance, as they describe a range of activities that intend to undermine the tax system. In a legal sense, tax evasion and avoidance are very different but from an economic perspective; however, the difference between the two is much smaller. Both tax evasion and tax avoidance, whether via an offshore tax haven or an anonymous establishment, undermine a tax system's ability to meet its three most important goals: (i) revenue generation; (ii) fair distribution of tax services burden across tax payers though not equally; and (iii) promote growth and equity.
Tax havens are territories and countries that offer foreign individuals and businesses little or no tax liability in a politically and economically stable environment. Tax havens also provide little or no financial information to foreign tax authorities. Tax havens are not just offshore territories; they also exist in the underground segment of the domestic economy in developing countries, where tax evaders and avoiders directly invest.
Tax evasion raises significant issues from the viewpoint of economic efficiency. Lower tax revenues may ultimately lead to higher tax burdens on those who do pay. Lower revenue causes lower public investment on infrastructure and lower public expenditure on the provision of social services and for community development. Moreover, to the extent that opportunities to evade differ by occupation and/or sector of the economy, tax evasion also distorts labour supply decisions as well as allocation of resources. Consequently, tax evasion creates socially inefficient incentives for individuals and businesses to engage in those activities.
ax evasion has also profound implications for income distribution. In terms of vertical equity, if the poor had more opportunity of evading taxes than the rich then the egalitarian policy makers might be happy on evasion up to a certain level. However, tax evasion and avoidance concentrated among rich classes, which makes them super rich, is most likely to distort income inequality. If individuals with similar incomes differ in terms of tax payments because of tax evasion then as a result, tax evasion violates the principle of horizontal equity (which calls for same treatment to people in an identical situation) and results into income inequality.
Tax havens clearly have significant effect on inequality. Tax justice and the struggle against tax havens have to be at center stage of policy agenda focusing on inequalities. With some $21-32 trillion in world financial assets sitting offshore, including Pakistan's reportedly $200 billion plus, largely untaxed, this severely undermines countries' abilities to effectively raise tax revenue. It is pertinent to note that offshore wealth is held by the world's 10 million wealthiest people: and a large share of that is held by the wealthiest 100,000. Developing countries lose about $900 billion in illicit outflows every year.
Offshore secrecy is another massive source of all kinds of inequalities. When people in power hideaway wealth in offshore, the consequent tax evasion and infringement has the effect of concealing wealth concentrations, resulting in political power, creating vicious circles to further raise inequalities.
Globalization poses a challenge to national tax administration and redistribution programmes. The increase in factor mobility and improved communication systems make tax bases more mobile and make tax avoidance less costly. Consequently, limiting the ability of governments to implement ambitious redistribution programmes for the benefit of poor. There is a widespread perception in developing countries that their welfare programmes are threatened by globalization, and that governments have lost their degree of freedom to manoeuvre.
Pakistan has the lowest tax-to-GDP ratio in the world. Its taxation system is often characterized as unjust and discriminatory. Tax-to-GDP ratio during 2013/14 was 9.0%. Low ratio in no way represents Pakistan's tax revenue potential. This is mainly due to narrow tax bases, too generous tax concessions and exemptions, weak and fragmented revenue administrations, and structural features of the economy. It is worth noting that only 0.5 to 0.9% of Pakistanis pay taxes. NADRA has identified 5% of should be tax payers who must be brought to the tax net. The amount of tax evasion reportedly estimated by the NAB is equal to Rs.7 billion per day.
Historic trends in tax evasion and income inequalities can be noted from the following table. It may be pointed out that these estimates are based on published studies on Pakistan that provide information only up to 2005. The table reveals that the lowest tax evasion was in the 1960s, followed by the 1970s and 2000s (up to 2005). The highest tax evasion was observed in the 1990s, followed by the 1980s. It is evident that in the 1990s when tax evasion was the highest Pakistan experienced the highest income inequality as well.
The tax system in Pakistan offers easy escape to those who do not pay taxes. The affluent classes with the connivance of tax officials evade taxes and trickle up the effect of their accumulated wealth. Although, the state is suffering, shopping centres and roads are chocking. It explains the size of the informal/shadow economy, which is estimated to be over 50% of the Pakistan GDP. To this extent actual growth is concealed.
A Voluntary Tax Compliant (Amnesty) Scheme has been introduced to bring evaders into the tax net. This 'evader friendly' scheme has pathetically failed to broaden tax base - instead it is likely to further encourage tax evasion and non-compliances, because tax evaders and non-filers understand that such schemes again and again will be available to them in the future. It may be underlined that out of more than 3 million traders only 8000 of them availed this scheme till the end of March 2016. Introduction of such schemes create discrimination and honest taxpayers surely feel disgruntled. Tax department needs to establish its writ without any discrimination.
Many businesses remain unregistered with tax department, especially retailers, wholesalers and dealers. Of course, they are registered with other government departments. Non-registration causes evasion of both sales and income taxes. A large number of dummy firms get sales tax registration by misusing CNICs of unconcerned persons. Such firms are engaged in tax fraud. Firms also get wrong registrations, e.g., registered as manufacturer without having manufacturing facilities. They illegally avail certain concessions and incentives.
To control tax evasion, it may be suggested to:
(i) improve tax administration and introduce effective enforcement of laws to control movement of illicit capital abroad;
(ii) simplify tax laws and remove holes and loopholes in the tax system;
(iii) create transparent, friendlier and less discriminatory tax administration system;
(iv) educate people about the Tax law;
(v) create such an environment in which people pay their due taxes, do not evade taxes and feel proud to pay their taxes;
(vi) all NIC holders must file tax returns even if many of them have no income;
(vii) all tax administrations (income, sales and customs) must be integrated to make pilferage impossible;
(viii) introduce governance reforms to control rampant corruption, which undercut lawful activities in the country;
(ix) refuse bank loans to tax evaders and non-tax filers;
(x) charity organizations should accept only 'account payee'cheques;
(xi) allow funds held abroad to be brought home by paying tax, interest and penalty, otherwise impose stringent punishment on detection;
(xii) invest heavily in developing ability of tax officials to use data and new and advanced technologies to identify tax evaders locally and overseas; and
(xiii) join hands with other countries in identifying tax evaders as laws are fast changing in tax havens about account secrecy.
Last but not the least, all the above proposed measures would require a strong 'political will' and creation of confidence in potential tax payers that tax collection will be honestly and fairly spent for the benefit of all the citizens.