Bewilderment over rational tax policy

Huzaima Bukhari & Dr. Ikramul Haq

There is a national consensus that the existing tax system needs to be completed restructured to provide an equitable, pragmatic, investment-oriented and growth-inductive policy and nationally integrated automated tax administration with simplified laws that are easily understood and hassle-free from the implementation perspective, especially after heavy economic toll of Covid-19 endemic/lockdowns to help the businesses to revive, survive and grow. Since coming into power in August 2018, Prime Minister, Imran Khan has taken personal interest to reform the tax system through special task forces, advisory committees, consultation with a number of experts and relying on the reports of so-called foreign experts, but all his efforts have so far yielded no positive results or acceptability from the taxpayers.

According to a recent Press report, the Prime Minister on September 14, 2020 formed a ministerial committee to review proposals for “equitable taxation by increasing the burden on upper class….” According to the report, tax proposals, presented to the Premier and his economic team by former Finance Minister Dr. Hafiz Pasha who earlier served Nawaz Sharif, included reduction in corporate rate and salaried class and levy of tax on assets “to compensate for the revenue loss”. Now, the Prime Minister has instructed Minister for Industries, Hammad Azhar, Advisers Dr. Abdul Hafeez Shaikh and Abdul Razak Dawood “to review the proposals in detail so that the recommendations could be implemented”. The key proposal is “to immediately slash the corporate income tax rate from 29% to 20%”, as per report. This we proposed in number of articles since last 15 years, the recent ones were Taxation hindering investment, Business Recorder, August 21, 2020, Finance Act 2020: lacking initiatives and innovations, Business Recorder, July 3 & 10, 2020 and Review of PTI govt’s fiscal measures, Business Recorder, December 31, 2019 and January 2, 2020. It needs to be remembered that out of total registered companies of 125,000, only 43,191 filed returns for Tax Year 2019 and 91% of these declared tax of less than Rs. 5 million. Thus, we need strong enforcement capacity before reducing the rate.

The previous government announced a five-year plan [Tax year 2019 to 2023] to reduce the corporate tax rate from 29% to 20%. The Finance 2019 withdrew it making 29% for tax year 2019 and onwards. The report says that “to compensate for the revenue loss due to a drastic reduction in the corporate income tax rate, Dr. Hafiz Pasha proposed to impose the Capital Value Tax (CVT) at the rate of 1.5% on all assets, except for property”. The meeting was informed that the country’s constitution permitted the federal government to impose CVT, except on property. “However, the PTI government, as a policy, abandoned CVT and has also withdrawn it from stock market transactions in the FY21 budget”, it added. CVT was levied in 2012 on transfer of assets and not on net worth of assets. The collection was also negligible.  

According to the proposal, it is recommended that tax on assets was more progressive as compared to income. This is not supported by any evidence. Taxation of assets retards investment and savings that is much needed for generating employment due to economic losses during lockdowns. According to Dr. Hafiz Pasha, “the richest 20% of people earn five times more than the lowest 20%, but this gulf is far wider in case of assets”. The richest 20% have 12 times more assets than the poorest 20%, as higher income levels allow them to save money and create assets. Speaking at a function held by the Pakistan Business Council on December 13, 2018, Prime Minister stressed the need for wealth creation for poverty alleviation, thus, taxing the same would be counterproductive for growth and job creations. As regards Capital Gain Tax (CGT) on immovable property, it is pertinent to mention that it does not fall in the domain of Federal Legislative List, detail discussion is made in Taxing capital gains, Business Recorder, June 30, 2017 and Tax on gain of immovable property: Who is violating Constitution? Business Recorder, March 14, 2014. Perhaps this escaped the attention of Dr. Hafiz Pasha as he suggested to remove time limit for non-levy of CGT on immovable property and tax it at lower rate vis-a-vis period of retention.

We already have exorbitant income tax rates and now want to levy wealth tax on moveable assets as well. This double taxation will discourage savings and investments, hurting growth and creation of new employments. It will be a highly anti-growth tax measure! The remedy lies in lowering taxes but applying on the broadest possible base as suggested in 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 [PRIME Institute,2016].

The PTI government incurred tax expenditure cost of Rs. 2.12 trillion during its first two years in power [Analysing ‘tax expenditure’, Business Recorder, June 26, 2020]. It must be reduced to 50% in respect of exemptions, concessions and benefits to the privileged classes. At the same time, huge tax gap should be plugged and wasteful expenditures are drastically cut. In fiscal year 2018-19, fiscal deficit was 8.9% of GDP (Rs. 3.45 trillion) and for fiscal year 2019-20, it was 8.1% of GDP (Rs. 3.37 trillion). Had tax expenditure been curtailed by 50% (Rs 500 billion) and wasteful expenses by 40% (Rs. 400 billion), the fiscal deficit of GDP for both the years would have been around 5.7% of GDP. It was 6.5% in fiscal year 2017-18.

In the last two years, as was the case, tax reforms (sic) remain a closed door, bureaucratic exercise with patchwork here and there, with no meaningful dialogue with all the stakeholders and experts who matter in the subject. In the absence of a well-designed tax policy, the agenda of reforms would always remain lopsided. The government of Pakistan Tehreek-i-Insaf (PTI) should not make any legislative and administrative changes until public debate is initiated to formulate a rational tax policy after securing the support of  all those who are affected by it.

Over the period of time our tax system has become rotten, oppressive, unjust and target-oriented. There is a dire need to discuss the philosophical framework and principles that should be the main concern of our tax policy that is far above mere achieving targets set out unreasonably by foreign donors. Our potential is much higher than these targets, which we can never attain with the present tax laws and incompetent, inefficient and corrupt tax machinery.

The following points are worth considering and debating for rationalising tax policy and remove administrative irritants:

1. Taxation Policy and its implementation are mainly focused on organized sector only and resultantly unregistered businesses are flourishing at a rapid pace as compared to the registered ones. Lack of predictable, transparent, and consistent policies e.g. super tax, regulatory duty etc are harming the formal sector.
2. Pendency of tax refunds for years. Apart from the imposition of higher duties, long delays in issuing tax refunds have become a major problem that has afflicted the local industry. Many businessmen prefer to sell their finished goods in Pakistan as the government is not clearing tax refunds of exporters.
3. No taxation of the substantially large and undocumented economy. 
4. Highly complex withholding tax regime. There are over 60 withholding taxes with very high tax rates.
5. High tax burden for compliant taxpayers and multiplicity of taxes, dealing with many tax agencies.
6. Many regimes within income tax, like Normal Tax Regime (NTR), Presumptive Tax Regime (PTR), Minimum Tax Regime (MTR) with NTR, Alternative Corporate Tax (ACT), 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. Poor rating on World Bank’s ‘Ease of Doing Business’ parameters, especially tax related.
11. Complicated, costly and time-consuming tax compliance.

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 and stagnation in growth. 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 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.

Pakistan has been facing an ever-worsening unemployment crisis and a perpetual challenge of rapid industrial growth. However, 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.

Devising an efficient tax model for attracting FDI and rapid 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, red-tape, lack of coordination, highhandedness, corruption and unprecedented high level of maladministration 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 import-substitution, promoting exports and ensuring much-needed employment generation.

The existing tax system is highly exploitative as the common man is paying an exorbitant sales tax of 17% (on many finished imported items, the impact is as high as 35% to 65% after adding all other duties, taxes etc), but the mighty sections of society get exemptions and concessions. The determination of a tax base capable of measuring an individual’s ability-to-pay is a major problem of our tax system. The withholding taxes within the income tax are passed on to clients/consumers. The mighty sections are now part of the landed aristocracy by getting State lands as awards and rewards. The unscrupulous businessmen are paying meagre personal taxes, and the poor people are compelled to pay exorbitant sales tax and subjected to extreme hardships due to high cost of public utilities, POL products and ever rising cost of eatable items and other commodities of daily use.   

An equitable tax system is one under which tax payments are based on the amount of benefits received from government services. In other words, the cost of government services should be apportioned among individuals according to the relative benefits they enjoy. Clearly, implementation of the benefit principle presupposes determination of the incidence of public expenditure before deciding distribution of tax burden. Thus it encompasses issues of both tax and expenditure policies. Our men at the helm of affairs want more taxes but not ready to provide all essential services to the masses at grass root level.

The successive governments, including the present one, have failed to convince the people that payment of taxes is their collective responsibility. All civil and military governments alike remained engaged in wasteful expenditure, never caring to live within their means and failing to even protect the life and property of the people, not to talk of providing them basic needs of health, education, decent living and transport, and civic amenities (not even clear drinking water).

Tax policy must be for welfare of public. The Government should launch programmes, financed mainly through taxes, to solve the twin problems of unemployment and poverty. These welfare-oriented schemes may also include subsidized/free medical and educational facilities, low-cost housing, and drinking water facilities in rural areas, land improvement schemes, and employment guarantee programmes. Once people see the tangible benefits of the taxes paid, there will be better response to tax compliance. Taxes cannot be collected through harsh measures and existing irrational tax policy. The policy makers must through public debate and input from all stakeholders design and implement a just and simple model so that the taxpayers can place their trust in them and pay taxes honestly and diligently.

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