Tax Non-compliance and Its Consequences

Tax Non-compliance

and Its Consequences

An important reason for mobilizing tax revenue less than potential is tax non-compliance, which has different forms and shapes. In the literature, tax non-compliance refers to non-adherence to tax laws and regulations by taxpayers. It means if tax law prescribes for certain persons to file tax returns and one or more such persons fail to do so, it will be tax non-compliance. And if tax law provides that tax return must be filed within a stipulated time period and one or more taxpayers don’t file tax returns within that, this non-filing of tax returns within statutory time period will be tax non-compliance. Moreover, if tax law provides that the due tax must be paid at the time of filing of tax return, non-payment of tax at the time of filing tax return will be tax non-compliance. And if tax law prescribes certain documents such as audited accounts to be filed along with filing of tax return, non-submission of such documents will be tax non-compliance.
In order to ensure tax compliance, tax statues provide penalties and default surcharges. For example, Income Tax Ordinance, 2001, prescribes penalties for non-filing of tax returns, non-furnishing of documents, non-payment of tax dues, etc. under the provisions of its section 182. Tax laws provide severe punishments such as criminal proceedings against taxpayers found to be involved in serious tax violations such as tax frauds.
From above, it is clear that tax compliance is very important and efforts are being made through tax legislation to ensure tax compliance uniformly and indiscriminately. Further, to ensure tax compliance, tax authorities have been established for implementation of tax legislation in letter and spirit. Tax laws confer on them the powers to ensure tax compliance through prescribed procedures to be consistent for all taxpayers.
Measuring tax compliance in a jurisdiction remains a problem. Different tax authorities adopt different parameters to determine level of tax compliance, e.g. number of tax return-filers out of persons who qualify for filing those in a country. Suppose, Federal Board of Revenue (FBR) has received 3 million tax returns in tax year 2021 but the number of persons who qualified for filing tax returns was 5 million. It means 2 million people failed to file tax returns in tax year 2021. In other words, level of tax non-compliance was 40% in terms of non-filing of tax returns.
In a similar fashion, if tax due from all taxpayers was Rs 8 trillion but the FBR received Rs 5 trillion, it means tax gap is Rs 3 trillion. In other words, revenue loss due to tax non-compliance in terms of non-payment of due tax is 37.5%.
Level of tax compliance in Pakistan is extremely low. Around 3 million people are tax return-filers out of total population of 220 million. Majority of filers are non-active, that is, they have not paid tax with the return they filed. Similarly, a huge tax gap is considered to exist in the country due to tax non-compliance. Tax gap means difference between the tax amount actually collected and the tax amount collectable in case of full tax compliance. The World Bank and the Internationally Monetary Fund considered that Pakistan’s ‘tax collection is only 50% of its potential’. So, if currently Pakistan’s tax collection is 4 trillion rupees, Pakistan has the tax potential of Rs 8 trillion.
The direct impact of tax non-compliance is less than required tax collection, which causes budget deficits. To finance budget deficits, the government has to obtain loans. Too high public debts have adverse bearing on the economy and society. Pakistan’s debt-GDP ratio has already exceeded 70%.
Furthermore, in view of the widespread tax non-compliance, the government introduces withholding taxes so as to collect tax revenue for the sake of achieving tax targets. In case of acute tax non-compliance, the withholding taxes are declared final and full discharge of tax liability or minimum taxes. The Income Tax Ordinance, 2001, provides for a massive withholding tax regime. Many of its provisions are presumptive in nature and others are minimum in nature. As a result of such a tax policy, indirect tax is being collected under the garb of direct taxation. Consequently, the whole tax system turns out to be based on indirect taxation, which causes hike in prices of commodities. Taxation with inflationary impact tends to reduce consumption expenditure of low-income households and as such causes unrest in the society as more and more people are being pushed into poverty.
Why people don’t make tax compliance is an area of major concern for tax authorities. Tax non-compliance has been discussed in literature from moral, political, economic and religious points of view. In certain jurisdictions, if people feel that taxation is against their religion or defeats religious beliefs, they prefer not to pay tax until and unless forced to do so. Similarly, if persons considered that tax money is being wasted by the government on non-productive purposes, people don’t like following tax laws. If people feel insecure due to law and order and are deprived of basic services such as education and health, level of tax non-compliance increases in such jurisdictions.
Tax compliance is higher in countries where accountability regarding spending of public finances is higher and where people feel secure and are being rewarded by the governments in terms of provision of quality public services.
In order to improve tax compliance, which is essential to increase domestic revenues for financing entire budgets, the government has to increase accountability of persons entrusted with collection and spending of tax revenues, to ensure transparent use of public finances, to provide quality services and to restore public trust.

The author is serving as Additional Commissioner Inland Revenue at Federal Board of Revenue, Pakistan. He can be contacted at

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