Tax amnesty: chasing shadows

The first-ever tax amnesty programme was announced in 300 BC in Egypt by Ptolemy V to please the priesthood and consolidate power. Since then, tax amnesties have been in vogue. Over the last three decades or so, around 30 countries – including Argentina, France, Brazil, Italy, Belgium, Chile, Columbia, Ireland, Indonesia, Switzerland, New Zealand, India, Pakistan, Philippines, Peru and the US – have had tax amnesty and voluntary domestic/foreign asset disclosure programmes.

An IMF study on such schemes presents some interesting observations. First, most programmes were unsuccessful, with very low achievements in comparison to their avowed objectives. Second, tax amnesties are neither a quick fix for tax compliance problems nor do they provide a sustained revenue increase. Third, if taxpayers perceive that an amnesty is due to a weakness in tax administration and is likely to be repeated, then they have a strong inventive to not come forward.

Fourth, the shifting of assets overseas is driven by political uncertainty; high tax rates; the ‘failing state’ syndrome; a coercive tax administration; and conflict within the country. As long as these ‘key drivers of capital flight’ are present, money will leave the country even if there were very intrusive administrative or regulatory blocking actions. Finally, only those schemes that are part of a fundamental overhaul of tax policies and administration reforms have had success.

Pakistan’s repeated tax amnesty programmes have failed because most of these lessons have not been taken into account. The scheme, which was announced last week, has several good features. These include the following: (i) only filers can open new foreign exchange accounts; (ii) NTNs have been replaced with CNICs; (iii) there is now an adjustable tax on immovable property and the government has a pre-emptive right to acquire such property; (iv) PEPs have been excluded from the scheme. While it is a good step, the third feature could be abused through the collusion of corrupt taxpayers and tax officials. In addition, it would require the FBR to have the capacity to acquire, manage and offload such properties.

Various features of the scheme lack clarity and are troublesome. First, why has the scheme been announced at this point? Second, why is there a need for a special scheme on foreign assets repatriation when any amount of money can be remitted without any penalty under existing laws? The third problems stems from the low rates of tax on declaration/repatriation that will reinforce the perception that the rich tax-evaders are once again being let off the hook. Fourth, there is a growing concern that the scheme may run afoul of the FATF policies. Fifth, the reduction of income tax rates and the increase of tax exemption threshold have been criticised. While this will lower taxes for some people, these measures should have been taken in the context of broader tax reforms. It is not clear how the revenue lost from this action would be recouped.

Another aspect of foreign asset declaration/repatriation requires careful analysis. With millions of overseas Pakistanis, a large number have acquired foreign assets through their foreign income. Many of these Pakistanis (and US, UK, EU citizens of Pakistani origin) are now tax residents in Pakistan. It would be unfair to penalise and club them with those Pakistanis who own foreign assets even though they have never worked overseas. In addition, the public and court discourse on foreign assets has been entirely misplaced. The government as well as opinion leaders must specify that the ownership of foreign assets acquired from after-tax domestic income is perfectly legitimate.

The key question is whether the proposed scheme will have the intended outcomes. One of the ways to estimate the outcome is to review the results of the recent Indonesian programme on the voluntary disclosure of foreign and domestic assets. In many ways, Indonesia and Pakistan have similarities in terms of their high levels of corruption, poor governance and coercive tax regimes.

The Indonesian programme ran for nine months – from July 2016 to March 2017. The results were mixed. The declaration of assets amounted to $370 billion or about 120 percent of the target. However, over 75 percent of declared assets were domestic. Of the $250 billion worth of overseas assets that are estimated to be owned by Indonesians, only 30 percent were declared under the amnesty scheme and only four percent were repatriated. Despite the credible threat of being caught in 2018 upon the initiation of the OECD Automatic Exchange of Information among tax authorities, the response to the voluntary disclosure/repatriation of overseas assets was disappointing. Indonesian tax experts predominantly believed that the citizens of Indonesia were reluctant to repatriate their wealth as the country continued to be unattractive in terms of high rates of taxes and the coercive and arbitrary nature of the tax machinery.

Taking Indonesia as the benchmark – and given that the Indonesian economy is four times larger than our economy and has vast oil reserves – the overseas assets of Pakistanis are unlikely to be more than between $50 billion and $60 billion. On that basis, the most we can expect in terms of the declaration and repatriation of overseas assets would be between $15 billion and $20 billion and between $2 billion and $3 billion, respectively. Even these numbers might be optimistic since there is uncertainty clouding the legitimacy of the scheme and it has also been rejected by opposition parties. There is also a lack of parliamentary debate and a negative image of the scheme among the people. In addition, Pakistan is still fighting the war on terror and the ‘key drivers of capital flight’ continue to be ever-present.

With regard to overseas assets, we must keep in mind that countries like Switzerland, the UAE and the UK – where much of the corrupt global wealth is parked – have absolutely no incentive to be too forthcoming in facilitating the return of assets of non-residents. They might do that for the odd foreign political leader who has fallen out of favour. But they cannot do this across the board as it would disrupt their financial and property markets.

The government is strongly advised to incorporate the good features of the scheme in the upcoming budget and put the features related to the declaration/repatriation of foreign and domestic assets on hold. For the latter to be successful, several prior actions are needed. First, the FBR’s highest priority and full focus during the next 18-24 months should be to go after non-filers within Pakistan, rather than chase shadows overseas. Improving tax compliance could double our tax revenues within two or three years.

Second, the FBR must first collect and analyse all data on foreign asset ownership that it will obtain this year from the OECD Automatic Exchange of Information. Once the FBR has this information, there will be a credible threat that it can proceed against those who do not voluntarily declare their foreign assets – especially Pakistanis who have never worked overseas. Third – and more urgently – the FBR needs to be fundamentally overhauled to transform it from a coercive and arbitrary institution to a taxpayer-friendly and rule-based organisation. The government must recognise that tax compliance and tax culture are strongly influenced by the perceived integrity of tax officials among taxpayers and the perceived waste of public expenditure.

The writer is a former adviser to the World Bank.