Underground Economy and Tax Evasion in Pakistan A Critical Evaluation

This paper is an attempt to get fresh estimates of the underground economy and tax evasion in Pakistan. Various methodologies have been used to measure the size of the underground economy, i.e., the monetary, fiscal, and labour market approaches in particular. The monetary approach has strong assumptions but this is the best, easiest, and the most appropriate approach for estimation. The year 1973 has been chosen as the benchmark period, because the pre-1973 data on money supply is not reliable. The results obtained in the study show that the underground economy and tax evasion as a percentage of GDP have increased by 1.83 times in the last 29 years. These were the maximum in 1998 but after that, due to low level of economic activity, there was a decline. This shows that there is a strong relationship with the formal economy. The underground economy and tax evasion increased sharply from 1991 to 1998, and then declined till 2002. Between 1991 and 1998, the rate of increase in the underground economy is greater than the rate of increase in the formal economy, which is a major concern to the Government. It is recommended not to use estimates of the underground economy (estimated by any indirect methodology) for policy-making purposes, but rather to use the results to observe the overall trend of growth of the underground economy.