Black money in Swiss banks

Wildly exaggerated numbers have been floated on the amount of black money belonging to Pakistanis lying in Swiss banks.

The claims with regard to such sums of money stashed abroad are being made a) without supporting evidence; b) without making a distinction between Pakistanis resident abroad and earning incomes there and those resident here and earning the bulk of their incomes from economic activities within the country; or c) without distinguishing between what could be white (and already declared as such for tax purposes by the person holding a deposit in a Swiss bank) or black.

Read| $200bn of Pakistan in Swiss banks: Dar

Moreover, officialdom seems to be confident that it can demand of the Swiss to hand over its money.

Unfortunately, however, tax evasion is not a crime under Swiss laws!

Wealthy individuals seek professional assistance from investment bankers to manage their funds which they transfer to accounts in foreign locations.

In today’s world money maintained in Swiss banks can be shifted swiftly to other off-shore tax and other havens and invested in other financial and non-financial assets or brought back to Pakistan to conduct a fresh round of business operations.

Also read: Dar rules out easy access to billions in Swiss banks

It is not possible to trace such money in off-shore locations. It can only be tracked down in Pakistan where the incomes which are its source have been earned.

Black income can arise from both legal and illegal activities. Money is black if it is earned from illegal activities — trade in drugs, gambling operations, smuggling and corruption/bribes. Income from hoarding scarce commodities (as opposed to speculation, although making a distinction between the two would be easier said than done), formation of cartels, tax evasion (of all forms of income, sales and excise and customs duties). The last-mentioned category could be money earned from perfectly legal activities/actions, eg tax-evaded on income from legitimate services provided by professionals such as lawyers, doctors, architects, accountants, engineers, tax advisers, etc.

Tax can be evaded on incomes through non-reporting or underreporting of income or by reporting higher expenditure through fictitious invoices/bills or by claiming private spending to be business-related expenditure. When it comes to GST the evasion can take place by either not reporting sales (simpler in the case of sales against cash) or by collecting it from the buyer/customer but not depositing it in government coffers. In the latter instance the same approach is adopted in the case of withholding taxes (deducted from purchases but not deposited). In the case of duties/taxes on imports the value of the consignment is under-declared.

Moreover, there is a general confusion about the nature of black money in the sense that it is widely perceived that the informal/unsanctioned sector somehow operates in isolation. In reality, the black and white money sectors of the economy are interlocked, at the disadvantage of the formal sector because, in our case, government systems expect it to perform the tax collection functions and ensure documentation of economic transactions recognising the administrative inability of official institutions to fulfil their mandates and responsibilities effectively. The two sectors buy and sell goods and services from, and to, each other, with black money also getting legitimate by transacting with the white economy, simply through the issuance of a formal receipt for expenditure incurred by the black sector. At times — fairly common in the case of property related transactions — a part of an otherwise legal transaction is concealed voluntarily by the transacting parties.

Much of black money is concealed by spending on foreign travel, education of children in universities abroad, investment in gold and jewellery, maintaining a luxurious lifestyle, electronic gadgetry, functions and festivals, acquiring property in Dubai, Abu Dhabi (following greater scrutiny of transactions in western countries post 9/11), etc. It is interesting that the system, as well as the country’s Constitution, legally protects, if not actively facilitates, capital outflows from the country, whether the source of the funds is white or black.

The factors that generate black money include the high rates and complexity of the taxation regime, an environment of inflation and scarcities, the character of the politico-social system and the electoral process overseen by weak election laws — large volumes of black money finance elections. There is also the manner of policy formation and its implementation, and the nature of the economic system and the mechanisms and institutional structures through which it operates (eg defective overly stringent regulations and controls).

Other factors include corruption or poor administrative capabilities that fail to prevent or check such outcomes making it relatively easy, say, to manipulate import costs or export receipts, long-winded procedures and processes that delay transactions. Black money is also generated through incentivising bribes to accelerate approvals and inadequate penalties for such transgressions. The last two enable those undertaking such activities to get away with it.

All these factors influence the size and range of processes and transactions generating black money, thereby placing limitations on the scope and quality of government policies aimed at tackling such activities.

The efforts of successive governments to check black money, especially that earned by evading taxes, through whitener schemes have failed miserably. In fact, tax laws and the desperate need for foreign exchange have resulted in rather low transaction costs through an efficient and officially protected hundi market for foreign exchange. At less than a cost of 2pc, black money can be taken out of the country and brought back into the country (no questions asked) as ‘foreign investment’ (including as portfolio investment in the country’s stock exchange) or ‘inflows reported as remittance for family maintenance’, way below the official tax rate, and become white legally for use again in business operations.

Incidentally, the State Bank’s monetary policy is also rendered ineffective by more currency in circulation, ie money outside the banks than within the banking system for the central bank to exercise control over it.

Finally, societal values have also changed. Even when it is known that someone with wealth and a fancy lifestyle has acquired it through dubious sources, there is no social opprobrium or shaming. If anything their conspicuous consumption is a status symbol and a perfect advertisement for more of such activities, especially since there are no penalties, either economic or social. Their wealth is an effective passport to respect, power and influence.

The writer is a former governor of the State Bank of Pakistan.

Published in Dawn, February 17th, 2015