Firstly, there is the traditional economy that is a system where the allocation is based on the basis of inheritance. It is an economy, which uses prehistoric instruments and techniques. In a traditional economy, everything is mostly based on what is popular, production responds to what is in demand from the people. An example of this would be in the prehistoric times where farmers grazed animals and produced food. Enough food would be produced for the people living in the area. A farmer would produce the food for the people and the farmer would get something in return. Although this economic system is rather old fashioned it is still available in some locations such as South America including the nations of Papa New Guinea and Brazil. It is also available in a number of African and Asian countries.
The exchange and trading of goods and services is what takes place in a market economy. This is a form of a free market hence also being known as “free market economy”. In a market economy, what to produce is determined by what the people demand. For example, in a city with no roads, cars would not need to be produced or traded due to the fact that there is no demand for them. In terms of how to produce, a market economy is the complete opposite of a planned economy where the government decides what to produce and in what quantities to produce, a market economy allows for much more freedom. Everything in a market economy is produced for people in exchange in goods or services. An example would be an individual purchasing an automobile due to their need of transportation; money would need to be exchanged for the product. In a market economy, there is something known as the “invisible hand” which represents the supply and demand market forces. This defines what is produced, in what quantity and at what price. One example of a country, which embraces such an economy, would be the United States of America, which actually includes more market economy traits than Western Europe countries.
As mentioned earlier, a planned economy is the complete opposite of a market economy. While a market economy is towards production being based on the supply and demand, or the “invisible hand”, a planned economy is mostly government controlled with the government deciding everything. In a planned economy, the government decides what gets produced, at what quantity and what price. Planned and market economies blend together in mixed economies. In this case, the government would have some input in such economic problems; however, the rest of the activities will be driven by the decisions of the buyers and sellers. No country has a completely free economy in a strict sense, meaning that there will always be some government involved, however we label the market economies with the fact that the government intervening is very minimal. Two countries, which are known as one of the best examples of, planned, or command economy would be China as well as former USSR. Despite the fact that there are many countries today switching from such an economy to mixed or free economies, other nations including North Korea and Cuba still embrace this economy in its full form. The state-owned as well as the private enterprises in such economies receive guidance and directives from the government regarding economic problems including what to produce, how to produce and for whom to produce.
In a mixed economy, both capitalism and socialist economies are found. This economy is basically a mix of a rather free economy such as a market combined with a planned economy as well as avoiding the issues with capitalism and socialist economies. Most countries have a mixed economy including the United States of America as well as Cuba. It was mentioned earlier that the United States embraces a market economy and Cuba goes by the planned economy, however, it must be taken into consideration that no country strictly uses one economy. For example, if a country had a strict market economy there would be no taxes, environmental laws, government owned businesses and other aspects of that nature.
In conclusion, the different economies used by countries include traditional, market, planned and mixed. Countries such as the United States of America associate with market as well as mixed. Traditional economy is used in Papa New Guinea, Brazil as well as many other Asian and African countries. Planned economy is found in countries such as Cuba and finally mixed is used by countries such as the United States as well as Cuba. Stating again that there is no country, which associates with an economy strictly, meaning that the United States doesn’t go by a market economy thoroughly or else the taxes found in the nation would not exist. All four of the different economies have basic economic problems. Questions such as what to produce, how to produce and for whom to produce require answers.
The Extent and Causes of Tax Evasion in Pakistan
Molar and woodland (2004) investigated the efficiency of tax through tax optimality index. In their paper they measured the difference between the current tax structure and an optimal tax structure. They used the methodology was based on a small open economy and they constructed an equation on economy’s equilibrium to construct their tax optimality index including public goods. The model used to calculate the total optimality index had four variables – three private and one public good.
The tax optimality index came out to be 0.7972 which showed that the taxes where 79.7% efficient compared to the optimal tax index. The advantages of the tax were that it immediately told how efficient where the current taxes of a country with reference to an optimal model.
Kemal (2007) discussed the extent of underground economy and tax evasion in Pakistan. He analyzed the main causes of increase in underground economy citing reasons such as intensity of regulations burden of tax and social transfers etc. The methodology he used was that he collected many micro and macro variables such as total number of bank deposits, interest rates, GDP, GNP, inflation etc in order to construct his equations to measure the extent of increase in underground economy. Years were ranging from 1973 to 2003. The equation developed was a regression equation, first legal money is calculated, and after that velocity of money is calculated by dividing the national income with legal money, lastly multiplying the velocity of money with illegal money gives the underground economy. Multiplying underground economy with total tax to GDP ratio gives tax evasion.
Empirical results showed that both the size of underground economy and tax evasion increased significantly during these years. The increase was most predominant in 1990’s. He also concluded that raise in underground economy poses many problems for policy makers. He also concluded that had there been no tax evasion budget balance could have been positive.
Aslam (1998) measured the size of underground economy and tax evasion in Pakistan. His paper used Tanzi’s methodology with few changes made to the model. The range of the years was from 1960 to 1998. The modified model was of log to log specification with demand of currency assumed to me the main determinant of tax rate. The paper reinforced the presence of a large underground economy and huge tax evasion in Pakistan. Results showed the variation in underground economy is very sensitive and has significant impact on GDP. Further it showed that the Dollarization of economy is major problem because of significant involvement of underground foreign exchange. The limitation of this paper was that this paper could not be concluded as completely accurate and it does not tell about a remedy plan.
Jayasinghe (2007) evaluated the components and sources of tax gap in Pakistan.
Presence of significant tax gap forces a country to impose higher marginal tax rates of tax payers in order to collect additional revenue required to overcome a potential budget deficit.
The model assumes that tax evasion in the economy is represented by a fully established hidden economy. Tax evasion is estimated through estimating the size of shadow economy through 1984-2004. A regression analysis is conducted in two specifications for comparisons. One specification is run by using total values of GDP while the other using per capita values for GDP.
The size of the shadow economy estimated through both specifications, GDP and per capita GDP show an increasing trend. Results showed that size of underground economy has increased from 23% to 84% till 2004.
Increasing trend in underground economy is followed by an increasing tax gap. Lastly, the paper argues that the source of declining government, revenue is growing tax gap.
Hibbs and Piculescu (2005) proposed a model of how taxation and government regulations affect the productivity of private institution.
The model proposed considers private firm with fixed capital (K) and variable labor requirements: Lo, labor in official while Lu labor employed in unofficial production. Wage is identical at (w) but wage cost varies: regarding the public sector, it is demand as potentially corruptible and markets for corruption would arise giving firms opportunity for evading taxes.
The model also assumes that incentive to evade taxation depend on statuary tax rates.
Regression equation is developed and regression tests are run to arrive at the conclusion. Empirical results in this paper are that markets for corruption arise due to perception of figures taxes as not “worth paying”.
Dependency on how many and to what extent firms within a country have incentive to produce underground economy and evade taxation policies regarding taxation and employment conditions of enforcement bureaucrats may create tradeoffs between containment of tax evasion and overall level of economic activity.
Goerke (2003) investigated the relationship between tax progressivity and the tax evasion. In this paper, the consequences of tax evasion upon employment opportunities are investigated. It relates that an increase in tax progressivity has no employment effect in the absence of evasion opportunities. The model has a fixed number of workers whose only source of income are wages (w) and who can evade income taxes a regression test is run and conclusion are drawn.
The results are that employment effects more of progressive taxes in an efficiency wage economy has no employment consequences in the absence of tax evasion. The analysis has presumed a constant level of statuary tax payments at the initial wage level.
Niepelt (2003) explored the dynamic of tax evasion. He analyzed the dynamics of tax evasion using a model in a continuous time. He developed an equation using the model and his assumptions based on the households in that model.
The conclusion drawn in his paper is that risk aversion and endogenous detection probability play a central role in static theories of tax evasion. It concludes that in the presence of tax evasion, the statuary tax rate is an important policy instrument but an unpredictable indicator of the effective stance of fiscal policy.
Ahmed and Ahmed (1995) estimated the extent and level of black economy in Pakistan through monetary approach. Researchers have termed the underground economy in various names such as (i) illegal economy (ii) unreported economy (iii) unrecorded economy (iv) informal economy. The method adopted for quantification of the black economy is that of Tanzi, with some modifications. The equation is of double Log specification. Tax – GDP ratio sign is positive. Relationship between interest rate on time deposits and currency ratio is said to be negative. After estimation of equations through least square method results are obtained.
It has been found that the black economy as a percentage of GDP has shown a fluctuating trend. Black economy and level of tax evasion have increased over the number of years, but black economy as a percentage of GDP has experienced a decline. The sizeable magnitude loss of revenue indicates that substantial revenue can be realized by reducing the extent of tax evasion in the economy.
Crane and Nourzad (1985) analyzed the effect of inflation on aggregate tax evasion in the US over the period of 1947- 81.
The methodology used is to construct an equation using major determination of evasion. The major determinants are derived with the following implicit evasion function Z= f(O, f, TR, V, P). Z is a measure of tax evasion, D is probability of detection, F is fine rate, TR is tax rate, Y is real true income and P is inflation rate.
The equation derived comes out to be a logarithmic equation in Z. the most difficult variables to quantify is dependent variable itself, Z, measuring tax evasion. Probability of detection an independent variable is measure using moving averages over the period of 2 years. Tax rate is calculated using weighted average marginal tax rate. Inflation is calculated using CPI.
Empirical results show that aggregate income tax evasion in both absolute and relative taxes is positively related to inflation rate. Aggregate evasion is risen in absolute terms but has fallen in relative terms when real true income has risen.