Sources Attributable to the Sales Tax Gap
In Pakistan, people prefer to make business transactions in cash rather than through banking channels. Only 13 percent Pakistani nationals have formal bank accounts as compared to 83 percent people in Sri Lanka, 53 percent in India, 31 percent in Bangladesh and 92 percent in Iran, according to the JCR-VIS sector update of October 2016. This is the informal or cash-based economy which usually has a high rate of uncollected sales tax revenue.
Informal economy predominantly consists of small- and medium-sized enterprises resulting in uneven market competition, and a loss of market share and profitability of registered businesses. Such entities constitute 80 percent of the total enterprises.
In view of the dominance of unregistered businesses in large, informal sectors, legitimate businesses have difficulties in purchasing inputs from registered suppliers because they are difficult to find. Purchases from legitimate suppliers do include sales tax, but that sales tax can be deducted by the customer, which means that it is not an actual burden on the purchaser, unless the purchaser is not registered. Non-registered suppliers commonly offer inputs of similar quality for lower tax-exclusive prices. This is one of the reasons why sales tax gap is significant in Pakistan.
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