Illegal trade: short-term profit, long-term economic decline

Illegal trade: short-term profit, long-term economic decline

When Pakistan’s government imposes restrictions on imports to reduce the country’s trade deficit in 2022, it doesn’t stop the inflow of goods – it encourages substitution and possibly smuggling, which is growing at 18% annually.

In particular, large-scale manufacturing firms and multinationals were negatively affected, while small-scale firms and commercial importers managed to find alternative routes, often without the government’s knowledge, and at times in collusion with some domestic elements.

Considering the impact, Prime Minister Shehbaz Sharif was recently forced to declare that “illegal trade and smuggling have caused huge losses to the country”.

I present an educated guess to quantify this loss here. First, I qualify that for this article, illegal trade consists of legal goods, produced, sold and used through illegal means including non-documentation and tax evasion.

Illegal trade can be classified into: counterfeiting, tax evasion, smuggling, and underinvoicing/misdeclaration.

According to several sources, smuggling through the Afghan Transit Trade (ATT) alone may be responsible for at least Rs1,000 billion in losses to the national exchequer in terms of forgone import-related tax revenue.

Looking at another dimension of illegal trade, the government loses about Rs300 billion every year in tobacco tax, which is increasing. If we add the estimated Rs270 billion lost due to smuggling of Iranian oil to Pakistan, the total loss is at least Rs1.5 trillion.

These are only approximate figures and as the nature of the illegal trade will dictate, it is impossible to find reliable numbers.

Using other sources, the Pakistan Business Council estimates the size of the gray and shadow economy at $68 billion. If the tax is assumed to be 10%, this would translate into a tax loss of nearly Rs1.9 trillion.

Therefore, it is safe to assume that the overall loss to the national exchequer due to illegal trade, smuggling and tax evasion could be between Rs1.5 trillion and Rs2 trillion, which is 21% of the current tax target.

This is more than 100% of the total target collection of federal excise duty and customs duty, as announced in the budget for 2023-24. This is coincidentally almost the same as the new loan negotiated with the IMF.

This estimate does not include under-invoicing or mis-declaration as well as losses due to counterfeit products. This also does not include the implications for the business environment, and in particular, the incentives for international investors, who are looking for a level playing field when it comes to tax policies and practices.

Clearly, in a country where the government seems focused on extracting taxes only from large-scale businesses and corporations, it sends the wrong signal to existing investors, which essentially sends a similar message to future investors.

One should not be surprised that the rate of foreign direct investment (FDI) in Pakistan has remained low in recent years.

According to the Transnational Alliance Against Illicit Trade (TRACIT), Pakistan ranks 72 out of 84 countries on the “Global Illicit Trade Environment Index”, published by the Economic Intelligence Unit. The parameters are government policy, supply and demand, transparency and trade, and the customs environment.

Illegal trade may provide short-term benefits to the economy in terms of cheaper alternatives, but in the long-term, it hinders productive investment, innovation and national competitiveness. In some cases, such as counterfeit drugs or pesticides, this also implies a direct threat to public health.

Prime Minister Shehbaz Sharif’s government is certainly concerned about the damage caused by illegal trade activities and tax evasion. The strategy is multi-dimensional: tax compliance, enforcement improvement, evaluation of trail and trail mechanisms and digitization of FBR.

It is not the first time that the government has launched such a drive. The tax compliance initiative, known as the “Tajir Dost Scheme” launched without proper homework, has failed.

It is able to bring only around 200 enterprises in the tax register, out of, more than three million enterprises. The prime minister has already expressed his disappointment with the track and trace system, which was implemented in four sectors in 2020.

Industry sources claim that fake stamps are being produced in the tobacco and sugar sectors. This system has met with similar failures in many other countries.

We have borrowed hundreds of millions of dollars for the digitization of the FBR in recent years, and have discovered, to the nation’s shame, that the FBR is using bogus software!

While I hope that the recent steps will bear fruit, one should remain cautious against over-reliance on technology where the underlying design is flawed.

As Pakistan remains one of the most protected economies in the world, unless we minimize barriers (as reflected in taxes, tariffs and regulations) to legitimate trade, the government has no chance of generating sufficient growth to raise the required and prescribed tax revenue. on a clear path to bankruptcy.

The prime minister has a clear choice: instead of asking the IMF to provide another $6 billion (or Rs1,674 billion) to be disbursed over three years, he can take a different route and aim to close the tax loss hole estimated at Rs1 .5-2 trillion in the same period of time.

The author is the founder and executive director of the Policy Research Institute for Market Economics (PRIME), an independent economic policy think tank based in Islamabad

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