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Huzaima Bukhari & Dr. Ikramul Haq
Presently, all broad-based and buoyant sources of revenue are with the federal government and contribution of provinces in total tax revenues [Rs. 4748 billion] for the fiscal year 2019-20 [11.4% of GDP] was merely 8 percent and in overall national revenue base (tax and non-tax revenue) of Rs. 6272 billion [15% GDP] it was 9 percent against the total national expenditure of Rs. 9648 billion. All provinces together generated taxes of Rs. 414 billion and non-tax revenues of only Rs. 102 billion.
The federal government spent Rs. 1213 billion on defence and Rs. 2619 billion on debt servicing and after transfers to provinces under the National Finance Commission Award (NFC), these two alone were Rs. 554 billion higher than net revenue collection of the federal government. This is our main fiscal dilemma today. While the federal government is accumulating debts, the provinces are heavily dependent on transfers from NFC Award. What makes the situation more disturbing is the fact that right of provinces to levy sales tax on services is encroached by federal government through levy of presumptive taxes on services under the Income Tax Ordinance, 2001, sales tax on gas, electricity and telephone services and excise duty on a number of services.
Before independence, the provinces had the exclusive right to levy sales tax on goods and services within their respective physical boundaries. The subject of sales tax was on the Provincial Legislative List at Serial No.48 in the Government of India Act, 1935 and was described as “Taxes on sales of goods and on advertising”. In the Constitution, 1956, “tax on sales and purchases” was mentioned at serial No.26 of the Federal Legislative List, and therefore, for the first time it became a Federal subject. The position was maintained in 1962 Constitution, which mentioned “tax on sales and purchases” in the Federal Legislative List as clause (j) at serial No.43 in the Third-Schedule. In 1973 Constitution as originally adopted ‘tax on sales and purchases’ was kept on Federal Legislative List at serial No.49 of Part I of the Federal Legislative List given in the Fourth Schedule. The item was, however, completely substituted by Constitution 5th Amendment Act, 1976 with effect from September 13, 1976 that read “Taxes on sales and purchases of goods imported, exported, produced, manufactured or consumed”. The second half of the amended entry appears to have been taken from the amendment made in Sales Tax Act, 1951 by Finance Ordinance, 1960. Through that amendment the words “consumption of goods” in the preamble were substituted by “importation, exportation, production, manufacture or consumption” [see details in WAPDA v. Collector of Central Excise and Sales Tax (2002 PTD 2077 and also in Pakistan through Chairman FBR and others v Hazrat Hussain and others (2018) 118 Tax 260 (S.C. Pak)].
The solution is to move towards harmonised sales tax on goods and services for which there is a need to debate in public and Parliament for reaching a consensus. The total collection by imposing unified sales tax on goods and services can reach Rs. 4000 billion as against collection of around Rs. 1596 billion by FBR in 2019-20 through sales tax on goods and provinces cumulatively of Rs. 232 billion through sales tax on services. The additional revenue collection of nearly Rs. 2000 billion will not only give fiscal space to the federal government to narrow down fiscal deficit but will also enhance distribution amount to the provinces. Distribution will be strictly as per Constitution.
It is an established fact that even after levying all kinds of irrational and expropriatory taxes, the federal government has miserably failed to reduce the burgeoning fiscal deficit that reached a figure of 8.1% in fiscal year 2019-20 against the target of 7.1%. For the last many decades, every attempt to bring it down to 4% of GDP has not been successful.
The Federal Board of Revenue (FBR has persistently failed to tap the actual tax potential and bridge the tax gap. For the last many years, it could not meet even the budgetary targets what to speak of realising the real revenue potential, which at federal level alone is not less than Rs. 8 trillion. Tackling twin menaces of underground economy and tax evasion has always met with failure in Pakistan. Even after giving generous amnesties in 2018 by the Government of Pakistan Muslim League (Nawaz) and in 2019 by the coalition Government of Pakistan Tehreek-i-Insaf (PTI), total collection was only Rs. 3997 billion in 2019-20, after blocking refunds of Rs. 578 billion, which if excluded, the net collection comes to only Rs. 3.4 trillion against the claimed figure of Rs. 3.9 trillion (just 8.2% of GDP). Resultantly, the fiscal deficit is around Rs. 4 trillion, if FBR’s correct net collection is taken into account.
The failure to tap real tax potential poses a tough challenge to both the federal and provincial governments. Poor performance of FBR adversely affects the provinces as they are overwhelmingly dependent on what the Centre collects and transfers to them from the divisible pool. Provinces are not ready to collect taxes wherever due and generate their own resources after establishment of local governments as envisaged under Article 140A of the Constitution. Centre is unwilling to grant the provinces their legitimate taxation rights while it collects too little to meet their overall financial demands. The size of the cake—divisible pool—is so small that nothing substantial can be done to come out of debt enslavement and to spend adequately for the welfare of the people, no matter which part of the country they belong to.
Track record of FBR shows remote possibility of collecting even Rs. 8 trillion in the next three years to give enough fiscal space to both the Centre and the provinces to come out of the present economic mess, thus providing some relief to the poor, as well as trade and industry. Under the given scenario, federation-provinces fiscal woes will continue unchecked and further taxation through local governments, even if materalised, would not serve any useful purpose—there will be no relief to the people, rather tax burden will increase manifold. Thus, Pakistan will remain in debt enslavement and more and more people will be pushed below the poverty line.
The PTI Government secured over $13 billion in foreign loans in the fiscal year 2019-20 alone! It was the second highest in history—we are now borrowing mainly to repay maturing external debt. During the previous fiscal year, Pakistan received gross loans of $13.2 billion from bilateral and multilateral lenders including, the IMF and commercial creditors, according to a report, quoting data compiled by the Ministry of Economic Affairs.
We received $29.2 billion in foreign loans in the past two years that include $26.2 billion by the PTI Government since coming to power in 2018. Out of this, $19.2 billion was taken just to repay the maturing external debt. If we want to overcome this crisis, the parliament will have to reconsider the prevailing social contract between federation and the provinces. Provincial autonomy and local self-governance without taxation rights and equitable distribution of income and wealth is meaningless. We cannot subdue perpetual economic crises unless the provinces are given true autonomy; ownership of all resources; generation of own revenue and exclusive right to utilise it for the welfare of their denizens.
The way forward is that provinces should go for harmonised sales tax on goods and services. It is also imperative that further amendment should be made in the Constitution after debate and consensus to assign right to levy tax on all kinds of income, including agricultural income, to the federal government. All incomes should be taxed at a uniform rate that should be low-rate but broad-based without any exemptions or waivers. This will help both FBR in collecting income tax as per actual potential and by levying sales tax on goods in addition to services, the provinces will generate sufficient funds for their needs. It will also reduce fiscal deficit at the federal level. This is the only way to achieve fiscal stabilisation and consolidation in Pakistan. However, this can only be successful if we also reform and merge all tax collection agencies at federal and provincial levels for which, comprehensive structural reforms are inevitable as elaborated in A new tax agency, The News, November 15, 2019.
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The writers, lawyers and authors, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)