Insanity, it is often said, is doing the same thing repeatedly and expecting different results. If this statement is true, then we can conclude that Pakistan’s ruling elite, irrespective of political affiliation, needs to change its course of action.
Almost 10 months in power, the Pakistan Tehreek-i-Insaf (PTI) seems to have run out of ideas on the economic front. A party whose leadership had promised new ideas and a structural revolution of the country’s political economy has approved a tax amnesty scheme, which is the proverbial last nail in Naya Pakistan's coffin.
The larger question, however, is whether these amnesty schemes really work. The answer to that, according to most research conducted around the world, is mostly no.
Let’s start with the concept of moral hazard, which says that, in general, there will be a lack of incentive to guard against risk where one is protected from its consequences.
In simpler terms, it means that humans will take excessive risks when they know that someone will, at the end of the day, offer a way out without making them pay a significant price for the bail out.
This usually applies to industries that rely on state bailouts and was a topic of much discussion when the American government rescued big banks and the auto industry in the wake of the 2008 financial crisis.
Editorial: Documenting the economy
It also applies to Pakistan’s wealthy elites, who, after extracting wealth from the country and getting away with not paying their fair share of taxes, know that governments will sooner or later give them amnesty with minimal consequences.
The result is that citizens, particularly wealthier ones, are incentivised to evade taxes and take risks (in most societies, evading taxes is a criminal offence) and hide their wealth in precious metals, cash, real estate assets and offshore shell companies.
Evidence from abroad
This phenomenon is not unique to Pakistan and countries like India, Greece, Argentina, Russia and others have offered amnesty schemes to their citizens. Researchers and academics who have studied these schemes have concluded that this policy has, by and large, been ineffective.
Like Pakistan, India has offered several such schemes in the past, and while its government has a better track record at collecting taxes than us, its success with amnesty schemes is rather poor.
The Bharatiya Janata Party-led government announced an Income Declaration Scheme in 2016, which led to the disclosure of over INR650 billion (approximately $9-10 billion) of undisclosed assets.
The scheme resulted in over INR29 billion (approximately $400-450 million) in taxes for the government, representing 0.2pc of total tax receipts, which stood at $211 billion in the 2016-17 Indian budget.
This means that the taxes raised through this policy were paltry in the larger scheme of things, despite being a key goal of the Indian government
Russia has also tried its hand with amnesty schemes and a September 2009 paper written by academics from Georgia State University analysed its impacts following the collapse of the Soviet Union.
The researchers, after conducting a comprehensive analysis, concluded that “these amnesties had little demonstrable permanent impact on revenues” and that “the use of fiscal gimmicks such as amnesties imposes additional costs” and that “countries would be better off avoiding them”.
Argentina’s recent experience of it, however, is one of the rare success stories. The 2017 amnesty scheme brought the South American country over $116 billion of assets from offshore locations (far more than the $20 billion target), including Switzerland and the United States, and over $9 billion in revenues.
This made it the most successful such scheme in the world, allowing the Argentinian government, which was facing a financial crisis at the time, greater room to invest in the country’s economic development.
One reason for the scheme's success was that Argentinians not only had to pay a 10-15pc penalty and declare their assets, they also had to repatriate and invest them in government bonds for a period of three years at 0pc interest rate, or for a period of seven years at 1pc interest rate.
Secondly, Argentina engaged with international initiatives to transfer information and make it harder for citizens of the Organisation for Economic Cooperation and Development (OECD) countries to hide their wealth abroad.
A bilateral exchange of information agreement with the US was also signed, and these measures convinced Argentinians to repatriate their offshore assets back to the country.
Why Pakistan’s scheme might fail
This amnesty scheme is the fifth one offered to tax evaders since 2013, reinforcing the moral hazard problem.
Its broad contours are similar to the 2018 scheme announced by the outgoing Pakistan Muslim League-Nawaz government: the new scheme charges a 4pc penalty for cash that is declared and deposited in Pakistan’s banking system, while those who wish to keep their wealth abroad will be charged 6pc; the 2018 scheme allowed people to bring back foreign exchange by paying a 2pc penalty and declare foreign liquid assets like bonds by paying a 5pc penalty.
The 2018 scheme was able to raise almost Rs100 billion, which was about 2pc of the total tax revenue of Rs4.3 trillion expected in that year's budget. Over 55,000 individuals availed the opportunity to declare over Rs1,500 billion in assets, the highest amount declared under any amnesty scheme in Pakistan’s history.
However, there is no data available that suggests that tax compliance increased following this scheme, and one can safely say that incentives to evade taxes remained in place.
Explore: Why don’t we pay taxes?
Given that the PTI’s scheme has little new to offer, one can safely argue that its decision will not lead to any meaningful change in terms of taxpayers’ behaviour or the stated aim of increasing the size of Pakistan's documented economy.
This scheme also does not learn from international success stories, such as Argentina’s. There is no mandatory requirement to invest the newly-declared assets in government bonds. Pakistan did, however, sign the OECD Multilateral Convention last year to gain access to information about Pakistani residents' offshore accounts. But there needs to be more demonstrable evidence that the government is working with the OECD or countries like Switzerland and the United Kingdom on this matter.
In addition, the PTI government, like those in the past, has not fully explained the sticks it will use to go after individuals who refuse to declare their assets. Claims of using “data” and “automation” have been made in the past as well, and therefore should be treated as rhetoric.
What is also alarming is the lack of research that is conducted before such major decisions are made. After all, a country that has offered several amnesty schemes, should at least do studies and collect survey data to understand why people do not pay taxes, and assess best practices from around the world prior to devising policy.
The real tragedy here is that those in power in Pakistan do not seem to believe in evidence-based policymaking and learning from international case studies. The PTI, like its predecessors, is packaging gimmicks as real economic reforms.
Are you working on economic reform? Share your insights with us at firstname.lastname@example.org