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Tax-evasion and Money-laundering in Pakistan: An Overview

"There is no business in Pakistan today which can be run without paying bribes to the ministers and secretaries." Yusuf Haroon, a businessman [Quoted in Shahid-ur-Rehman] The economy of Pakistan is heavily regulated and controlled by the government. The ever-increasing burden of taxes and regulations has given rise to a parallel economy (usually termed as black economy) of which tax-evasion and money-laundering are two significant phenomena.



by Khalil Ahmad

"In a society, deep neck in corruption, I more often than not, find myself a misfit. There is no place for a veteran businessman anymore in the society." G. M. Adamjee, a businessman [Quoted in Shahid-ur-Rehman, Who Owns Pakistan?]

"There is no business in Pakistan today which can be run without paying bribes to the ministers and secretaries." Yusuf Haroon, a businessman [Quoted in Shahid-ur-Rehman]

The economy of Pakistan is heavily regulated and controlled by the government. The ever-increasing burden of taxes and regulations has given rise to a parallel economy (usually termed as black economy) of which tax-evasion and money-laundering are two significant phenomena.

The part-I of this brief study will focus on the following:

  • The nature of taxation
  • The process of taxation and tax-collection
  • The governmental uses of tax-money
  • The magnitude of tax-evasion
  • Why do people resort to tax-evasion?
     

The part-II of this study will focus on the following:

  • The nature and process of money-laundering
  • The sources and magnitude of money-laundering
  • The state of legislation regarding money-laundering
  • Why do people resort to money-laundering?
     

The part-III of this study will focus on the following:

  • The legality or illegality of tax-evasion and money-laundering
  • Tax-evasion and money-laundering and from the perspective of a free society
  • Concluding remarks/Recommendations
     

Khalil Ahmad
Alternate Solutions Institute
Lahore, Pakistan

Part I

The Nature of Taxation in Pakistan

Currently, it is understood in Pakistan that a nation or a society cannot do without a government; and, to run the business of a government, taxes are levied. It is said that the business of a government comprises two things: i) to provide services to the people such as maintaining law and order, and accomplish development works such as build and maintain roads, etc; and ii) (in case of a redistributive state) to provide welfare services such as ‘food, clothing, shelter,’ and education, health care, etc. For most of the people, it is quite natural a political philosophy!

Obviously, the more duties and responsibilities we assign to a state, the more machinery (bureaucracy, etc.) will it require, and the more expenditures will it incur. Thus, in addition to maintaining law and order, if a state is required to provide everything to its citizens, then its government won’t remain limited. It will require more revenue, and will resort to high taxes. Conversely, if its duties are limited to the protection of life, liberty and property of its citizens, it will have no justification to have recourse to more and more taxes.

But all the governments tend to expand, and develop a big state-apparatus which it with the passage of time becomes difficult for them to sustain without imposing high taxes. As a result, they are caught in a net of clear disproportion: their non-development expenditures outweigh their development expenditures; and, in some cases, their development expenditures, too, can be termed as non-development expenditures as they are spent without producing any tangible results. Such a state because of its erratic policy of taxation turns into an unhappy burden on the shoulders of its citizens.

Pakistani state is such a high tax state. On the one hand, it is not providing the least of the essential services to its citizens; that is, maintaining law and order, and protecting life, liberty and property of its citizens. On the other, under the slogan of Welfarism, it is resorting to high taxes and control over the lives of the people, and thus it has to sustain an ever-increasing state-machinery. Moreover, it has instituted monopolies, and likes to take care of their interests. And, last but not least, it has gathered around a ring of rent-seekers in the shape of politicians, privileged groups, civil and military bureaucrats, etc. who cause to manipulate its policy of taxation to their own benefit or to the detriment of others.

Another important aspect of the nature of taxation in Pakistan is trade protectionism; or, in other words, another cornerstone of taxation is the protection of local industry. For this purpose, the interests of the consumers, the common citizens, are ignored and, rather sacrificed on the altar of that holy cow, local industry. High duties are imposed on all of the imports, except ones benefiting the privileged ones, to protect the local industry which is inefficient, uncompetitive, and dependent on the help from the government to sustain itself. As a result of this, consumers are forced to buy low quality and expensive goods.

The Process of Taxation and Tax-Collection in Pakistan

In Pakistan, taxes are levied at three levels: federal, provincial, and local. At federal level, Central Board of Revenue (CBR) takes care of the revenue-collection. At this level, there are four major taxes: Income, Customs, Excise and Sales Tax. At provincial level, various departments perform this task. Major taxes at this level are: Stamp Duty, Motor Vehicle, Entertainment, and Electricity taxes. And, at local level, entities of district government levy taxes.

Under the circumstances, as Pakistani government has not been able to form and practice a just, uniform and consistent policy of taxation, the process of taxation in Pakistan is in shambles. Indeed, it has become a tool in the hands of the privileged and powerful elites and groups. They pressurize, bribe or influence the authorities to impose a new tax or increase the rate of an old one to reap the benefits or to harm their rivals. Taxes are imposed and/or reduced to suit this or that elite. "The 1973 constitution had clearly provided that "imposition, abolition, remission, alteration or regulation of any tax" would fall in the jurisdiction of the Finance Bill to be passed by the national assembly. But during the Zia-ul-Hq era when there was no national assembly, this power was usurped by CBR which imposed duties, withdrew duties, exempted industries from payment of taxes and duties, made refunds with retrospective effect when somebody had to be favored, simply by issuing SROs." [Shahid-ur-Rehman, Who Owns Pakistan?] Perhaps, it’s never thought of in Pakistan that imposing/abolishing or increasing/reducing taxes should be done in the interest of the broader sections of society.

"The Central Board of Revenue (CBR) can enrich individuals and groups beyond one’s expectation and imagination by issuing the right SRO (Statutory Regulations and Orders) or vice verse turn them into pauper by starting investigations of tax evasion and assessing tax liability with retrospective effect." [Shahid-ur-Rehman] In this regard, the ‘politics of tax holidays, rebates and subsidies’ is also too known.

From the point of view of the tax payers, the mechanism of tax-collection is very difficult, complicated and cumbersome besides being time-consuming. "Pakistan today has a mind-boggling taxation system that defies comprehension of the average citizens and experts alike." [Shahid-ur-Rehman] The tax-assessing and tax-collecting officials enjoy unlimited discretionary powers, and by using these powers, they harass and blackmail the tax payers, and extort money from them. In Pakistan, it is said that even an honest tax payer can not pay his taxes honestly; he will be forced to bribe the concerned authorities to pay his due tax.

The most corrupt departments in Pakistan are the tax departments. "CBR has the reputation of being corrupt, besides being one of the most politicized departments of the Government of Pakistan. From the office of the chairman to middle and lower ranks, appointments are made in CBR on political and financial considerations. One frequently comes across people in Islamabad with offers of money for appointments or postings in departments under the jurisdiction of CBR. The amount that these people offer, even for a clerical job in customs, income tax or other subordinate departments give a measure of corruption and graft in CBR. . . It is thus not mere coincidence that the chairman of CBR has invariably been the first to go with each change of government since 1988." [Shahid-ur-Rehman] That was why, to contain the excesses of tax officials, in the year 2000, the federal government had to establish a separate institution of Federal Tax Ombudsman. Though, its scope and jurisdiction is too limited, but it is playing an important role in redressing the grievances of the tax payers against the tax officials.

A cursory look at the following table which details the year-wise figures of complaints filed and disposed of by the office of the Federal Tax Ombudsman can convince us of the notoriety of the tax-machinery in Pakistan:

Year-Wise Complaints Filed and Disposal

Year No. of complaints Disposed Balance

2000 72 72 0
2001 1782 1782 0
2002 1549 1518 31
2003 till 15th 1469 885 584
October
___________________________________________________
Total 4872 4257 615

[Source: Dr. Ikramul Haq, Federal Tax Ombudsman: role and challenges]

As to the number and rate of taxes, there is no comprehensive study available. But it is generally believed that everything is taxed and is taxed at a far higher rate. "In 1990, Karachi Chamber of Commerce and Industry had established that the industry was subjected to 50 direct and indirect taxes but the statement of Senator Ilyas Bilour, President PFCCI (Pakistan Federation of Chambers of Commerce and Industry) at the Businessmen Conference in Islamabad on March 25, 1997, that 37 government departments and agencies were collecting taxes gives a measure of the proliferation of taxes that has taken place in Pakistan." [Shahid-ur-Rehman]

The author of the same book, "Who Owns Pakistan?" has identified 70 major taxes to which consumers and producers are subjected. "In addition there are host of specific taxes like a Research and Development Levy, Drug Manufacturing License and Drug Registration Fee. It can be said safely that there are at least 100 taxes in vogue in Pakistan." [Shahid-ur-Rehman]

A List of Taxes in Vogue in Pakistan

Federal Taxes

S. No. Name of the Tax

1. Income Tax
2. Super Tax
3. Wealth Tax (abolished. K. A.)
4. Gift Tax
5. Turnover Tax
6. Corporate Asset Tax
7. Corporate Income Tax
8. Import Duties
9. Import Surcharge
10. Export Duties
11. Iqra Surcharge
12. Income Tax on Imports
13. Import License Fee
14. Import Registration Fee
15. Export Registration Fee
16. Central Excise Duty
17. Sales Tax on Manufactured Goods
18. Capital Value Tax
19. Export Development Surcharge
20. Development Surcharge on Petroleum
21. Gas Development Surcharge
22. Federal Education Cess
23. Workers Participation Fund
24. Workers Welfare Fund
25. Estate Duty
26. Zakat
27. Ushr
28. Oilseeds Development Cess on Companies
29. Tobacco Cess
30. Cotton Cess
31. Development Surcharge on Electricity
32. Textile Technology Cess
33. Airport Tax
34. Cargo Charges, etc.
35. Capital Gain Tax

[Source: Shahid-ur-Rehman, Who Owns Pakistan?]

Provincial Taxes

S. No Name of the Tax

1. Professional Tax
2. Property Tax
3. Stamp Duty
4. Vehicle Tax
5. Entertainment Tax
6. Betterment Tax
7. Social Security Contribution
8. Explosive License Fee
9. Provincial Education Cess
10. Capital Gain Tax
11. Punjab Airport Tax
12. Provincial Excise Duty
13. Karachi Dock Labour Board Cess
14. Cess on Hotels
15. Cotton Fees
16. Paddy Development Cess
17. Land Revenue Tax
18. Employee Old Age Benefit Contribution
19. Trade Tax on Jewelers, Garment Shops

[Source: Shahid-ur-Rehman, Who Owns Pakistan?]

Note: These lists are not complete and up-to-date; from time to time, new taxes and duties are imposed, some of the old ones abolished. Now with the introduction of District Government System, an array of newer taxes at the local level has come to play its role. Also, some of the old things are still in existence such as Television License Fee.

The governmental uses of tax-money

The non-development expenditure of Pakistani Establishment has always been on the increase putting undue pressure on the tax payers. For example, "the level of current Government expenditure . . . (increased) at fast pace particularly during the period 1982-83 to 1984-85. As percentage of GDP at market prices, current Government expenditure fluctuated between 14 and 15 per cent during the period 1977-78 to 1981-82. In the subsequent 3 years the increase in current expenditure accelerated a great deal and as percentage of GDP at market prices it rose from 14.4 per cent in 1981-82 to 17.9 per cent in 1984-85." [Tax System in Pakistan]

According to a report of the World Bank, Pakistan consumed 10.3 percent of GDP in 2001. [Quoted in 2004 Index of Economic Freedom]

Internationally, Pakistan is considered a ‘soft state.’ But it’s too soft an acronym. Pakistan is one of the most corrupt states of the world. According to the Transparency International’s ranking of the most corrupt countries of the world, in 1996, Pakistan stood 2nd.

"Pakistan is one of the countries of the world that has achieved notoriety in terms of its association with twin evils (‘corruption and money-laundering’) and particularly with corruption. The gravity of the situation can be gauged from the fact that the then prime minister of Pakistan, Nawaz Sharif, himself admitted sometime back that the country was losing Rs.2 billion a day or Rs.720 billion a year to corruption. (This is significant because the total revenue collection in Pakistan is a little over Rs.300 billion.)" [Ijaz Hussain]

After the martial law of 1977, when a civilian government was installed, a new political tradition got started that strengthened the institution of corruption in Pakistan. Members of the parliament were to be given funds to use for the development of their constituencies; these funds were never to be audited.

A letter to the Editor of one of the top national English dailies relates the story as follows:

LEGISLATORS’ DEVELOPMENT FUNDS
[S. M. F. Hasan, Lahore]

It goes to the eternal infamy of the first dictator of Pakistan that to appease his supporters and to tame his opponents, he introduced the vicious system of transfer of huge state funds to his MNAs and basic democrats in the name of public development but actually for their own development. Stark corruption received a stamp of approval creating a new political culture. Money and manipulation became the dominant part of politics.

The abiding tragedy is that every succeeding regime, while condemning corruption and maladministration of the dictator, have retained his system of allocation of large amounts of state money to control MNAs and MPAs.

In no other country of the world, members of the legislature are encumbered with the responsibility of executing or supervising development projects. Their sole function is to frame laws for good governance. Being free of monetary temptations, they jealously guard their independence against the executive authority.

In Pakistan, every MNA, MPA or another public-spirited person should be authorised to submit his scheme of development to the Planning Division for central subjects and to Provincial Planning Boards for provincial subjects to be thoroughly scrutinized. If found suitable, it should be implemented by the normal executing agencies of the government without the intervention of the proposing body or person.

Unless this is done, development funds will continue to be wasted, politicians will continue to be corrupt and the legislators will continue to be subservient to the executive, whether the head of government is a dictator or not or provinces are autonomous or controlled. [The News International Lahore Edition September 3, 2004]

In addition to that most of the elected governments in Pakistan were dismissed by the sovereigns on the charges of corruption, and many a prime ministers and ministers have been and are being tried in the national courts and other country’s courts as well.

"It is noteworthy that corruption was the common ground in the dismissal orders of the three governments since 1990. For example, on 18 April, 1993, when the Nawaz Sharif government was dismissed, the dissolution order read that: "Maladministration, corruption and nepotism have reached such proportions in the federal government, its various bodies, authorities and other corporations including banks supervised and controlled by the federal government, the lack of transparency in the process of privatisation, in the disposal of public/government properties, that they violate the requirements of the oath(s) of the public representatives together with the prime minister, the ministers, and ministers of state prescribed in the constitution and prevent the government from functioning in accordance with the provisions of the constitutions."" [Ijaz Hussain]

Also, "the presidential order of 5 November, 1996, also embodied the similar charges against the Benazir Bhutto who was sacked for the second time. The order read: "Corruption, nepotism and violation of rules in the administration of the affairs of the government and its various bodies, authorities and corporations has become so extensive and widespread that the orderly functioning of the government in accordance with the provisions of the constitution and the law has become impossible and in some cases national security has been endangered. Public faith in the integrity and honesty of the government has disappeared."" [Ijaz Hussain]

The magnitude of tax-evasion

Though, investment is directly related with taxation, but it is the rate of tax that determines the volume of investment. It’s a fact that besides political instability and deteriorating law and order situation, high tax rates have played an important role in retarding the growth of domestic as well as foreign investment. Despite utmost efforts of various governments, the volume of investment has been static.

Moreover, high tax rates have discouraged the personal initiative of the individuals. They feel deprived of their hard-earned money. That is why, in Pakistan, doing business legally is said to be a very difficult enterprise.

As has been pointed out earlier, heavily controlled economy has given rise to a parallel economy in Pakistan. The volume of this parallel economy exceeds to that of the formal economy which implies a greater volume of tax-evasion.

According to one study, "since 1973, a remarkable size and an upward trend in the underground economy and tax evasion are noticeable . . . the underground economy grew rapidly from about Rs.15 billion in 1973 to Rs.1115 billion in 1996 . . . the underground economy as a proportion of GDP was about 20 percent in 1973, which increased to 51 percent in 1996.

". . . the level of tax evasion was about Rs.1.5 billion in 1973, which tremendously increased to Rs.152 billion in 1996." [Zafar Iqbal, The Underground Economy and Tax Evasion in Pakistan: A Fresh Assessment]

It is also noteworthy that "the underground economy grew faster than the formal economy. . . . the underground economy grew annually at the rates of about 27 percent, 14 percent, and 26 percent in 1970s, 1980s, and 1990s correspondingly while growth rates in the formal economy for the same sub-periods were about 18 percent, 14 percent, and 17 percent." [Zafar Iqbal]

Another study states that "in the base year (1973), underground economy was 20.27 percent of GDP, and it increased to 25.51 percent in 1991. Between 1991 and 1998 the underground economy increased rapidly; it was 54.52 percent in 1998. However, by 2002 it had declined to 37.25 percent of GDP." [M. Ali Kemal, Underground Economy and Tax Evasion in Pakistan: A Critical Evaluation]

As to the tax-evasion, according to this study, "it increased from 2.15 percent in 1073 to 3.42 in 1990, peaked at 7.22 percent in 1998 and then 4.17 percent in 2002.

"There could be various reasons of this sharp increase in the underground economy and tax evasion between 1991 and 1998. For instance, rise in private investment level which increases the overall economic activity (formal and informal), increase in smuggling, etc. Similarly, decline in underground economy from 1998 to 2002 may have various reasons, for instance, decline in smuggling, but probably low level of economic activity is the most important. . . . documentation of the economy is one of the reasons which helped in preventing black economy not to grow faster." [M. Ali Kemal]

Estimates of Underground Economy and Tax Evasion

Year Underground Tax (As Percentage of GDP)
Economy Evasion Underground Tax
Economy Evasion
1974 18020 1814 20.27 2.15
1975 21756 2219 19.42 1.98
1976 27781 2944 21.15 2.24
1977 31412 3351 20.80 2.22
1978 41832 4644 23.51 2.61
1979 51774 6186 26.35 3.15
1980 66414 8670 28.24 3.69
1981 74784 9814 26.88 3.53
1982 98406 14076 30.36 4.34
1983 104759 13361 28.75 3.67
1984 130796 17215 31.16 4.10
1985 129443 15878 27.42 3.36
1986 155677 20390 30.26 3.96
1987 184308 26698 32.19 4.66
1988 192752 26672 28.54 3.95
1989 210487 30209 27.38 3.93
1990 227245 30473 25.51 3.42
1991 268951 34163 26.35 3.35
1992 390366 53219 32.39 4.42
1993 470124 62913 35.27 4.72
1994 591899 77655 37.92 4.97
1995 758163 104787 40.63 5.62
1996 1004289 144748 47.37 6.83
1997 1233620 164923 50.80 6.79
1998 1449891 193397 54.52 7.22
1999 1146839 152499 39.03 5.19
2000 1094052 141077 34.76 4.48
2001 1298233 169025 38.00 4.95 2002 1388064 175472 37.25 4.71

[Source: M. Ali Kemal, Underground Economy and Tax Evasion in Pakistan: A Critical Evaluation]

Why do people resort to tax-evasion?

The first answer to this question that comes to mind is that people do not want to lose what is their own. The English actor, Charles Kemble (1775-1854), after paying his tax to the tax-collector, said: "Sir, I now pay you this exorbitant charge, but I must ask you to explain to Her Majesty (Queen Victoria) that she must not in future look upon me as a source of income." [Quoted in Kaleem Omar, The ins and outs of taxes]

But that is quite a radical position. Sometimes people are willing to pay taxes provided the rate of tax is not too high and is not an unbearable burden on their personal income (one of the findings of a Canadian study tells that a ‘reduction in the marginal tax rates will increase taxable revenues.’ Taxpayers’ Response to Tax Rate Changes: A Canadian Panel Study), the taxation system is simple and intelligible, and they know that their tax money instead of being wasted will be properly utilized. But, in Pakistan the rate of tax is too high. The top income tax rate is 35 %, rated by 2004 Index of Economic Freedom as a ‘high tax rate; whereas the corporate tax rate is 43 %, and is rated by the same Index as a ‘very high tax rate.’

In addition to these factors, a great ‘incentive’ to tax-evasion is a complicated tax system. "Over the last fifty years, this country’s (Pakistan’s) tax regime has become so complex and baffling that a whole legion of accountants is now lucratively engaged in figuring out just which taxes taxpayers have to pay." [Kaleem Omar]

Dr. Ikramul Haq states that "one of the factors responsible for the present situation (‘perpetual crisis of resources for the developmental policies, crisis to meet trade deficit, crisis on account of fiscal deficit’) is the great speed with which black money is generated. The Central Board of Revenue is directly responsible for this as its Mafia-like operations has helped the people to avoid tax on incomes by paying hem "due share." Through the infamous system of SROs, the CBR’s stalwarts provided "legal" ways and means to the mighty sections of society to amass the very survival of state."

But, especially in the case of Pakistan, it may be pointed out that since a culture of corruption has taken root, the corruption has become a norm of daily life. The reason is very simple:

Corruption is just like snow
It falls on the cliffs of the hills
And melts down below.

As an American actor, Will Rogers referring to income tax said: "It has made more liars out of the American people than golf." Too much control, too much law and too much tax tend to make people ‘unethical.’ They start inventing ways to evade what is imposed unethically upon them.
"Too many taxes can be too much of a good thing, killing the proverbial goose that lays the golden egg." [Kaleem Omar]

As to this state of affairs, Mr. M. Ali Kemal is of the opinion that "We should improve our taxation policy. It is pragmatic that our tax rates are too high and, if possible, should be reduced to minimum level where every person in the tax net is willing to pay tax. Moreover, people have general dissatisfaction with the way government manages its budget and utilises tax income."

The overall situation is not much different from what was recorded in a report of a working group in (May/June) 1986. It stated that "Pakistan’s tax system, even after four decades of independence, continues to have essentially the same features as were inherited from the colonial period. The tax receipts continue to be pre-empted almost entirely by current expenditure on general administration, defence and debt servicing. For financing development expenditure, reliance has been placed almost exclusively on internal and external borrowings. The tax system continues to be regressive in character due to its over-dependence on indirect taxes and has failed to be conducive to the achievement of the objectives of growth, efficiency and equity." [Tax System in Pakistan]


 

Part II

The nature and process of money-laundering

The case of money-laundering, especially in Pakistan, is no different from the ‘crime’ of tax-evasion; here too the government itself is an accomplice. "The ugly face of black money emerges in the corridors of power, political as well as administrative." [Dr. Ikramul Haq, Money laundering facilitated by tax laws] In fact, "Pakistan has been the worst victim of money-launderers as during the last 30 years, the successive governments showed an extremely benign attitude toward corruption, drug trafficking and tax evasion." [Dr. Ikramul Haq]

The government, on the one hand, introduced laws to counter money-laundering, and, on the other, floated schemes to allow the whitening of black money. All the same, various governments successively introduced novel schemes to declare untaxed and illegal money. They used this ‘weapon’ to win political rivals, to please their allies and to strengthen their rule. ". . . why the government has floated schemes, which provide an easy way for whitening black money, is the fact that many individuals belonging to the party in power having amassed lot of money need to whiten it. In this backdrop such money laundering schemes come handy to the members of the ruling party and their associates." [Ijaz Hussain, Legal Control of Corruption and Money Laundering in Pakistan]

Also, "CBR (Central Board of Revenue; responsible for the collection of federal taxes) has never bothered to unearth laundered money, rather always joined hands with the tax evaders and money launderers by providing them unprecedented concessional schemes to whiten their ill-gotten wealth. These schemes were announced by the governments on the recommendations of CBR’s wizards in the name of improving tax collection!" [Dr. Ikramul Haq]

In its early years, Pakistan was not considered a favorable center for money-laundering. But "certain developments in the recent past have contributed to a climate conducive for money laundering. The first one was the presence in the 1970s of a large expatriate community exceeding one million, particularly in the Middle East, who relied on non-formal banking facilities to remit their foreign earnings to Pakistan." [Ijaz Hussain]

The other developments, according to Ijaz Hussain, are ‘the burgeoning drug addiction, an almost non-existent problem in the late 1970s, which emerged into a major one with alarming figures of 3.1 million drug addicts out of which 1.5 million were heroin abusers; the introduction of schemes, which provided opportunities and facilities to do so without much fuss; the promulgation of the Economic Reforms Ordinance 1992 which aimed at attracting foreign exchange into Pakistani banks; the introduction of yet another scheme under which any Pakistani citizen can buy government-owned real estate auctioned by a government agency and no questions as to the source of funds will be asked from the buyers of plots as per decision of the government.’

Thus, Pakistan turned into a heaven for money-launderers.

The process of money-laundering is the distancing of the money earned through illegal activities from its original source. At the first stage, ‘Placement,’ the launderer introduces his money into the financial system; at the second stage, ‘Layering,’ the launderer engages in a series of movements of the funds to distance them from their source; and, at the third stage, ‘Integration,’ the funds are merged in the legal economy. [Sam Vaknin, Money Laundering in A Changed World]

The other principal methods used for money-laundering in Pakistan are as follows: [Ijaz Hussain]

i) Hawala/Hundi. Mostly used by expatriates to remit money to Pakistan.
ii) Bearer Investment Schemes. In existence for the last two decades providing an attractive opportunity for money-laundering.

In addition, the money to be laundered is mostly invested in real estate. Various other methods in vogue are: over/under invoicing of imports and exports; bogus imports/exports; double invoicing; currency smuggling; money declared as proceeds of agriculture (since the agricultural income is exempted from tax)/poultry; and bank loan methods. [Ijaz Hussain]

The sources and magnitude of money-laundering

The underground economy is the main source of black money. It consists of illegal business and financial activities such as drug trafficking, smuggling, insider trading, illegal arms sale, organized crime, bribery, embezzlement, extortion by force, computer fraud schemes, etc. "In Pakistan, the banks, insurance companies, non-banking financial institutions, investment companies, money transmitters and real estate agents are all targets of money launderers. The financial institutions, inadvertently or otherwise, support money laundering by providing means to convert cash into different types of financial instruments, to convert the currency of one country into the currency of another and to transfer funds to other financial institutions. [Observations of the Chairman, Securities and Exchange Commission of Pakistan quoted by Dr. Ikramul Haq]

The latest turn in the process of money-laundering is the replacing of gemstones as a tool for laundering money. The "Western intelligence community has claimed that some very powerful terrorist groups are engaged in using gemstones, diamonds, tanzanite, and other commodities to store and launder money for terrorist activities across the globe." [The News International Lahore Edition June 26, 2004]

According to US Drug Enforcement Administration March 2002 Brief, "Pakistan is not considered a major center for international money laundering activity. However, Pakistan-based traffickers are extensively involved in the production and transportation of opiates and hashish. This suggests that drug proceeds are laundered within the country." [http://www.usdoj.gov/dea/index.htm]

And, a 1996 estimate of the International Monetary Fund reveals that ‘money laundered annually amounts to 2-5% of world GDP (between 800 billion and 2 trillion US dollars in today's terms). The lower figure is considerably larger than an average European economy, such as Spain's.’
[Sam Vaknin, Ph.D., Money Laundering in A Changed World]

Another study estimates that ‘approximately $ 2 billion are transferred each year through the Hundi system alone.’ According to the UNDCP report, the domestic heroin market in Pakistan is around Rs.35 billion (1994 figures) per year and turnover of the heroin industry is 5 % of the 1992-93 GDP and 20-25 % of the total estimated "parallel" economy. [Quoted in Ijaz Hussain]

The same report estimates that ‘most of the foreign exchange in the "parallel" currency market was utilised to import foreign goods and for flight of capital during the 1980s. Unofficially funded imports or smuggled goods (through the Afghan transit trade, baggage rules, and diplomatic bonded warehouses among others) constitute 10 % of the official imports. Revenues generated from the sale of illicit drugs were estimated at $ 1.5 billion in 1992. Drugs earnings averaged $ 1 billion per year during 1985-91.’ [Quoted in Ijaz Hussain]

According to a conservative estimate, ‘Rs.600 billion is generated every year by the parallel economy. Add to this, the black money generated through smuggling in goods and narcotics trade that is between Rs.300 billion and Rs.500 billion. This makes a whooping Rs.1000 billion.’ [Dr. Ikramul Haq] And, according to ‘official and independent experts, ever-growing black money is Rs.1.8 trillion, about 70 % of the total economy.’ [Quoted in Dr. Ikarmul Haq]

These rough estimates suggest the sheer volume of laundered money in Pakistan.

The state of legislation regarding money-laundering

Since its inception, the Pakistani state has been infected with corrupt practices. Hence, the laws were also enacted to deal with it. The question is: are these laws sufficient to counter money-laundering as a form of corruption? As to this, two views exist. The first one is that there is no need of further legislation; what we need is the political will to implement these and not to use them for political gains. The second view is that we need further legislation.

Ijaz Hussain is of the view that ‘the survey of legal control of corruption and money laundering . . . shows that Pakistan is not deficient in laws and regulations, which purport to combat and eradicate the twin menaces of corruption and money laundering. In fact they are quite numerous and comprehensive.’

He himself poses the question why then ‘Pakistan has failed to make real headway in effectively dealing with the twin menaces.’ He explains this failure in the following way:

"One problem with laws relating to corruption is that they apparently propose to create independent institutions to deal with the problem but in the ultimate analysis invest the real power with government bodies. . . Another bane of the accountability laws on corruption is the selectivity with which they are applied. The government in power uses these laws to ruthlessly pursue its opponents but when it is a question of accountability of the members of the party in power, these laws do not seem to exist." [Ijaz Hussain]

His conclusion is that "it signifies that there is nothing wrong with the laws but the manner and the method with which they are applied is defective. The only way is to apply the laws even-handedly and impartially."

This shows the need and importance of the rule of law in Pakistan.

Other writers highlight the need for new legislation. "Our country is passing through the worst crisis of resource mobilization manifesting it in the huge budgetary deficits. Revenue has to be collected and all measures both stringent and persuasive have to be taken in that direction. The government has, therefore, to plan in terms of a well-thought-of anti-money-laundering cum asset seizure legislation to draw upon the huge reservoir of the drug and untaxed money." [Dr. Ikramul Haq]

In another place, Dr. Ikramul Haq writes that "in the context of the prevailing grave challenge to combat terrorism, coupled with money-laundering crises, and the problem of ever-growing black money, there is an urgent need to launch a well-thought for anti-money laundering law to block this huge money becoming a lethal weapon in the hands of Mafias who now control the economy as well as governments."

Another writer addresses the problem in the following way:

"A great deal can be done to fight money laundering. This includes increasing awareness of the phenomena -- both within the government and the private sector -- and then to provide the necessary legal or regulatory tools to the authorities charged with combating the problem." [Kashif Mateen Ansari, Dealing with organised financial crime]

He suggests the following tools:

0 Making the act of money laundering a crime;
0 Giving investigative agencies the authority to trace, seize and ultimately confiscate criminally derived assets; and
0 Building the necessary framework for permitting the agencies involved to exchange information among themselves and counterparts in other countries.

He also suggests that ‘financial institutions must play their role in dealing with the problem. This involves establishing financial transaction reporting systems; customer identification; record keeping standards; and, a means for verifying compliance.’

It’s clear that all this requires more and more regulations and legislation endowing the government with more and more free hand to control the already heavily controlled economy.

After the gory events of September 11, 2001, the government of Pakistan too has given extraordinary importance to the task of countering money-laundering. The State Bank of Pakistan, Securities and Exchange Commission of Pakistan, and other financial institutions are paying more and more attention to the issuance and implementation of rules and regulations to stop the laundering of money.

But, the overall situation in this regard is not satisfactory. Dr. Ikramul Haq points out that "the SECP (Securities and Exchange Commission of Pakistan) and Governor State Bank of Pakistan, perhaps, are not aware of the fact that even today when the Pakistani government, under tremendous pressure from the US and other states, is introducing anti-money laundering law, the CBR is committed to giving a free hand to money launderers assuring them that no question would be asked if they remit their ill-gotten money from outside through banking channels and surrender the foreign currency to the state and get Pakistani rupees as encashment."

In this regard, the evidence quoted by Dr. Ikaramul Haq is conclusive: "The CBR in its letter no. F4(34)/ITP/2002 dated 29-02-2002 reaffirmed that "the Department would adhere to its policy of not probing the foreign remittance" brought into Pakistan by any "person."

He further points out that "in the Income Tax Ordinanace 2001, promulgated on the dictates of IMF on 13 September, 2001, a special provision [section 111(4)] has been inserted giving a free hand to money launderers, that no question will be asked to them if they remit (laundered is more appropriate term) their ill-gotten money from outside through banking channels and surrender the foreign currency to the State Bank of Pakistan and get Pakistani rupees as encashment."

Why do people resort to money-laundering?

On the face of it, people resort to money-laundering because they are forced to do so just like they are forced to evade tax. It is obvious that people indulge in drug trafficking, smuggling, insider trading, illegal arms sale, organized crime, bribery, embezzlement, extortion by force, computer fraud schemes, etc. Of course, some of them are crimes against property and person; their nature won’t change in any society be it a free or an unfree society.

But, when people are unjustly stopped from doing business with one another, and thereby an incentive for more profit is created in that particular area, as in production and trading of drugs, arms, and across the borders trade, they start taking risk to earn higher profits. In case, there is no illegality is involved, for example, in drug-trade, the rate of profit in that trade would remain at a normal level; this would discourage people treading that path anymore.

Thus, we may say that the lower the volume of ‘black economy’ under a government, the lesser the amount of money laundered. It means that the freer the people to pursue their businesses, the lower the volume of black economy, and consequently, the lesser the amount of money laundered.


 

Part-III

The legality or illegality of tax-evasion and money-laundering

The legality or illegality of tax-evasion or money-laundering is determined by the nature of relevant legislation means that a thing or an act that was legal or ‘alegal’ yesterday, after the legislation becomes illegal today. For example, years before when VCR (Video Cassette Recorder) came to Pakistan, owning it was neither legal nor illegal; then, it was made that without obtaining a license owning a VCR was illegal. Or, as it is today in Pakistan, to own a Television Set, one needs to pay an annual license fee.

The question is: is the determination of legality or illegality of a thing or an act in this manner itself legal or illegal? Asking this means: what is legality or illegality? As we who believe in the self-ownership of an individual assert that no legislation repugnant to the ‘inalienable rights’ of the individual citizens can be made; we do believe that this is how the legality or illegality of a piece of legislation regarding a thing or an act is determined.

Thus, the acts of evading tax and laundering money are illegal since the collectivist anti-individualist legislation makes them so. In the absence of such legislation, they were/are not legal or illegal. Thus, in a free society, where there is generally no restriction, for example, on producing and using drugs, the businesses related to it will not be illegal; and, consequently, there will be no incentive for the people to earn higher profits.

Tax-evasion and money-laundering from the perspective of a free society

In a free society, the nature of tax-evasion and money-laundering would be quite different from what exists now and here. There would be no exorbitant taxes and not many taxes also. And, of course, there wouldn’t be many things declared illegal also. But, we must remember that as there would be taxes though too lower and too less in number as compared to the present tax-scenario; the occurrence of tax-evasion in that society cannot be ruled out.

Same is the case with money-laundering. Though, we believe that so many things due to the nature of existing legislation presently considered ‘criminal’ wouldn’t be treated as criminal in a free society; for instance, the use of drugs, ‘illegal’ trade, owning arms for self-defense, etc. However, there may be something which would be treated as illegal in that society. In such cases, the act of laundering money may happen and require some legislation to countering it.

But, these are mere surmises. What we know for sure that in a free society there would be crimes such as organized crime, bribery, embezzlement, extortion by force, computer fraud schemes, etc. People who earn money in these ways would try to launder it; so, we do have to deal with them for which we would need legislation.

As we believe that in a free society people would be free to create and produce, to do business and to transact when and where and with whom they happen to choose; thus, there would be little scope of anything to be declared illegal but encroaching upon other people’s freedom, or in other words, the crimes against property and person.

Concluding remarks/Recommendations

A government that tries to control many things, resultantly, comes to have less and less control of many other things. Perhaps, that was why Ronald Reagan had to say: Government is not the solution to our problem; government is the problem.

And, probably, this is why a limited government (in the words of Thomas Jefferson) is considered best because it governs the least. It does not extort money in the name of this or that tax from the people; and, thus, forces them to evade tax. It does not declare this or that thing or act illegal in the name of propriety, morality, equality or welfare of the poor; and, thus, turns them to resort to impropriety, immorality, inequality and continuing willful poverty. It does not stop them from doing business with the people of their choice in the name of localism, nationalism, or patriotism; and, thus, converts them to regionalism, internationalism, and cosmopolitanism and declare these as crimes. Finally, it does not make them launder the money earned through the ‘illegal’ ways.

What such a government or Pakistani government needs to do is to keep the rates of taxes low, number of taxes reduced, and the tax net broad-based. As regards, income tax, a far better strategy is to have a flat tax system. And, of course, there should be no exemptions and tax holidays since this is what is used in the interest of the privileged and powerful groups of the society at the cost of other sections of society.

But, from the perspective of a free society, also, the issues of tax-evasion and money-laundering need serious deliberations. This acquires more significance when we see that the transition from an unfree society to a free society wouldn’t be instantaneous; rather it would be gradual and painful. There would be hurdles and reversals, progression and regression.

Moreover, this shows that though there are issues that are the creations of this particular government-controlled society, however, the issues of today, such as tax-evasion and money-laundering, do not belong exclusively to the complex of present unfree society. Actually, it is this society that possesses in its womb the seeds of a future free society. Instead of ignoring those seeds as being the negatives of a controlled society, we need to look after them, even during the transition period, to let them flourish into a free society.

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Bibliography

[In the preparation of this paper, following books, articles, etc. have been used.]

1. Ansari, Kashif Mateen., Dealing with organised financial crime, (The News International Lahore Edition August 29, 2004)
2. Gagné, Robert., Nadeau, Jean-François., Vaillancourt, François., Taxpayers’ Response to Tax Rate Changes: A Canadian Panel Study, CIRANO, Montreal, 2000 (http://www.cirano.umontreal.ca/publication/documents.html)
3. Haq, Dr. Imramul., Money laundering facilitated by tax laws, (The News International Lahore Edition February 8, 2004)
4. Haq, Dr. Imramul., Federal Tax Ombudsman: role and challenges, (The News International Lahore Edition November 24, 2003)
5. Hussain, Ijaz., Legal Control of Corruption and Money Laundering in Pakistan, in "Corruption in South Asia: India, Pakistan and Sri Lanka," Edited by K. M. de Silva, G. H. Peiris and S. W. R. de A. Samarasinghe, International Centre for Ethnic Studies, Colombo (http://payson.tulane.edu/ices/Default.htm)
6. Iqbal, Zafar., Qureshi, Sarfraz Khan., Mahmood, Riaz.,The Underground Economy and Tax Evasion in Pakistan: A Fresh Assessment (Research Report No. 158), Pakistan Institute of Development Economics, Islamabad, April 1999
7. Kemal, M. Ali., Underground Economy and Tax Evasion in Pakistan: A Critical Evaluation (Research Report No. 184), , Pakistan Institute of Development Economics, Islamabad, 2003
8. Miles, Marc A., Feulner,Edwin J. Jr., O’Grday, Mary Anastasia., 2004 Index of Economic Freedom, The Heritage Foundation and Dow Jones & Company, Inc. 2004
9. Omar, Kaleem., The ins and outs of taxes, (The News International Lahore Edition July 5, 2004)
10. Shahid-ur-Rehman, Who Owns Pakistan?, Mr. Books (Pvt.) Ltd., Islamabad, 4th Edition August 1998
11. Tax System in Pakistan: A Critical Evaluation and Recommendations for Change (Report of Working Group May/June 1986), Institute of Policy Studies, Islamabad, 1986
12. Vaknin, Sam., Money Laundering in A Changed World (http://samvak.tripod.com/cv.html)



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