Taxation hindering investment

Huzaima Bukhari & Dr. Ikramul Haq

This survey shows that international and national evidence points out that taxation and growth are negatively correlated. It is time Pakistan took this seriously and changed the adjustment and growth model. If Pakistan thinks it through and can develop a good policy, the country can negotiate better with its international partners. Our growth is our responsibility and we should not follow anyone else’s model—Taxation and Economic Growth: A Review of Evidence from the Taxation Research bySarah Nizamani, Research Associate, Pakistan Institute of Development Economics (PIDE)

Pakistan is amongst the nations with the lowest investment and saving rates in the world. This has obstructed progress towards a sustainable economic growth. According to data from the Economic Survey of Pakistan 2019-20, the investment-to-gross domestic product (GDP) ratio deteriorated to 15.4% in the outgoing fiscal year—Private sector investment by Shahid Sattar & Eman Ahmed, Business Recorder, August 13, 2020

In the light of above two quotes, it is time that the coalition government of Pakistan Tehreek-i-Insaf (PTI) removes all irritants in the tax system responsible for hindering growth in the country. It is time that the Ministry of Finance (MoF) and the Federal Board of Revenue (FBR) start a meaningful dialogue with experts and stakeholders on vital issues related to policy flaws and operational difficulties affecting investment leading to accelerated and sustainable economic growth and creation of much-needed employment. The myopic approach of meeting revenue target has been the main impediment to devise a rational tax policy for encouraging investment, saving and industralisation through corporatization of business leading to export-led growth and documentation of economy.

It is worthwhile to mention that a number of recommendations for achieving the above goals were presented in a seminar on ‘Tax Policy for Overseas Investors/Non-residents’, held in the Directorate General of Training & Research (Inland Revenue) in Lahore on December 4, 2018. The seminar highlighted that the sole stress on irrationally-fixed revenue targets—with principal incidence on the weaker sections of society—has been the main malady. All the governments, civil and military, since decades through this faulty approach has created a fiscal mess that has virtually crippled the economic sovereignty of Pakistan, see the detailed discussion in Decades of subjugation, TNS, [Political Economy] The News, August 9, 2020 and Malaise of mounting debt, Business Recorder, July 24, 2020.

.

The persistent failure of successive governments to lower taxes, broaden tax base, crack down on untaxed assets and ill-gotten wealth, spend public money prudently and remove socio-economic imbalances has pushed Pakistan into a ‘debt prison’. We cannot come out of it unless the political leadership shows an unshakeable determination to pursue a pragmatic reform agenda to transform Pakistan into a true social democracy with justice for all. Foreign investors will never come to Pakistan unless our own investors first repose confidence in the system and enter into joint ventures with foreign investors.

The disincentives, negative perceptions and irritants for dissuading the local and especially the foreign investors, pointed out by Secretary of Overseas Chamber of Commerce & Industry (OICCI), in the seminar held in 2018, remain unattended. Some of these are:  

1. Taxation Policy and its implementation are focused on organized sector only and resultantly unregistered businesses are flourishing at a rapid pace as compared to the registered ones.
2. Lack of predictable, transparent, and consistent policies e.g. super tax, regulatory. duty, group taxation etc.
3. Pendency of tax refunds for years. Apart from the imposition of higher duties, long delays in release of tax refunds is another major issue afflicting the local industry. Many businessmen prefer to sell their finished goods in Pakistan as the government is not clearing tax refunds of different exporters.
4. Substantially large, undocumented economy. 
5. Highly complex withholding tax regime. There are over 60 withholding taxes with very high tax rates.
6. High tax burden for compliant taxpayers and multiplicity of taxes, dealing with many tax agencies. Normal Tax Regime (NTR), Presumptive Tax Regime (PTR), Minimum Tax Regime (MTR), Alternate Minimum Tax (AMT), Super Tax (ST) etc.
7. Number of provincial and local taxes and no clarity about Workers Welfare Fund (WWF), Workers Profit Participation Fund (WPPF) in the case of companies having trans-provincial operations.
8. Lack of harmonization and confusion about jurisdiction between FBR and provincial tax agencies as well as among Punjab Revenue Authority (PRA), Sindh Revenue Board (SRB), Khyber Pakhtunkhwa Revenue Authority (KPRA) and Balochistan Revenue Authority (BRA).
9. No centralised authority to focus on Foreign Direct Investment (FDI).
10. High cost of doing business for manufacturing sector. For example, steel industry is contributing 82% in different types of taxes and duties on the import of raw material whereas the government has imposed only 5% duty on Chinese goods under the free trade agreement.
11. Poor rating on World Bank’s ‘Ease of Doing Business’ parameters.

Pakistan is one of those very fortunate countries of the world that has an abundance of resources and a climate that is fit for simply any activity throughout the year. But thanks to donors’ agenda of overemphasis on retrogressive taxation and incompetence of our economic wizards (sic), Pakistan’s dependence on imported products has increased manifold, whereas value-added exports have not been given any attention, let alone promoting high-tech industries capable of technological innovations—modern economies are knowledge-based and future is for those who can develop them as quickly as possible.

One of the main tools of tax policy is to increase the level of savings and capital formation in the private sector for enhancing investment resources for economic development. In Pakistan we have failed to achieve this goal. Recent years have experienced closure of large industries, stagnation in growth. According to a report, “for the second year in a row, Pakistan’s large-scale industrial sector shrank by 10.2% in the previous fiscal year, which was steeper than the post-Covid-19 estimate of the government, reported the Pakistan Bureau of Statistics…”

.

Inconsistent tax policies have forced the business community to search for safer havens abroad, depriving the country of invaluable capital. Similarly, foreign investors are reluctant to avail the tremendous Pakistani talent that goes to waste for lack of proper funding. For technological transfers, rapid industrial growth and employment generation, FDI is desirable. In Pakistan when local investment is dying, expecting FDI is like living in a Fool’s Paradise. Tax incentives play an important role in attracting FDI—which has nose-dived in Pakistan as highlighted in Private sector investment, Business Recorder, August 13, 2020.

Tax policy constitutes an important, if not a determinant factor, for favourable investment behaviour. Unfortunately, our budget makers have always been preoccupied with revenue targets and have never bothered to provide some long-term investment-oriented tax incentives for infrastructure development, investments and employment generation, without which sustainable growth is not possible. The corporate sector is the worst sufferer of arid policies—top management of FBR has myopic outlook as evident from over-emphasis on withholding taxes. With low corporate tax rate of 20% and abolishing withholding of taxes on transactions, we could have promoted corporate growth. In 2015, on the contrary, FBR imposed ‘Tax on undistributed reserves’ [section 5A of Income Tax Ordinance, 2001] ignoring the fact that reserves are created from already taxed income. It took three years to realize the mistake and it remained effective till tax year 2019! Minimum taxation on service sector companies was another wrong move.  In 2014, FBR imposed ‘Alternative Corporate Tax’ [section 113C of Income Tax Ordinance, 2001]. Such erratic, arbitrary and expropriatory taxation has retarded corporate sector, discouraged future investment, and encouraged informal sector.

Economic challenges faced by Pakistan are multiple and grim—we are ensnared in a deadly debt trap, but there is no plan or strategy on the part of the rulers to come out of it by exploiting untapped assets, revolutionizing agriculture to produce food security and exportable surplus, value-added agro-based industries, stop wasteful and unproductive expenses.

Pakistan faces the herculean task of providing jobs to nearly two million young people alone every year. For achieving this task we will have to ensure that economy grows at the rate of over 6% per annum over a long period of time and investment of 20% of GDP. This challenge is also our great opportunity for economic progress. Majority of job seekers are young people, who are our greatest asset—imparting education and skills to them and creating matching jobs is the real challenge. This can be met successfully by assignment of taxes for productive investment and employment generation—our real engine of growth. The prevalent pessimism is due to the attitude of financial managers, who cannot think beyond what they are “commanded” or “trained” to think at the behest of foreign lenders/donors. They keep on telling us about the symptoms of an ailing economy but never try to cure the real causes of illness. The work done by local experts is ignored by all the governments—civil and military alike—and PTI is no exception.

Pakistan has been facing an ever-worsening fiscal, debt and unemployment crisis and a perpetual challenge of rapid and sustainable inclusive growth but no government has ever thought of ‘earmarking of revenue’ for ‘employment zones’. Such employment zones can cater for:

• Creation of employment
• Technological renovations
• Export promotions
• Town renovations; and/or
• Experimentation with new economic management systems.

Pakistan is in dire need of establishing a number of “Employment Zones’, which should be low-tax or tax-free for corporate income and for companies creating new jobs. It will be an effective tool to reduce the mounting unemployment burden and to help boost industrial/business growth. The government should identify areas where structural employment is particularly high and then earmark revenue for establishing employment zones in those areas. Out of total collection of taxes at least 25% should be transferred directly to an independent fund for establishment of ‘employment zones’.

Devising an efficient tax model for encouraging investment, productivity, research, economic growth in Pakistan requires an analytical study of all the irritants prevailing in tax codes, procedures and implementation processes. The main irritants are inconsistent policies, inefficiency, lack of coordination, highhandedness, corruption and unprecedented high level of maladministration and inefficiencies in tax apparatuses—both at federal and provincial levels. We need public debate for suggesting solutions to remedy the situation and promote business growth attracting domestic and foreign investment aimed at promoting exports and ensuring much-needed employment generation.

For removing the irritants mentioned above through holistic reforms aimed at ensuring ease of doing business, incentivising growth, employment generation and voluntary tax compliance, the government must seriously consider latest study of PIDE, Taxation and Economic Growth: A Review of Evidence from the Taxation Research as well as two earlier recent studies,‘Doing Taxes Better: Simplify, Open & Grow Economy’ and ‘Growth inclusive tax policy: A reform proposal’, quoting  Towards Flat, Low-rate, Broad and Predictable Taxes,available at http://primeinstitute.org/wp-content/uploads/2016/08/Towards-Flat-Low-rate-Broad-and-Predictable-Taxes.pdf.

________________________________________________________________________

The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty Members at Lahore University of Management Sciences (LUMS)