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Analysing “tax expenditure”   

Huzaima Bukhari & Dr. Ikramul Haq

“We don’t do charity in Germany. We pay taxes. Charity is a failure of governments’ responsibilities”Henning When, a German stand-up comedian

The announcement of budget 2020-21 on June 12, 2020 amid devastating continuing impact of Covid-19 endemic, fixing irrational target of Federal Board of Revenue (FBR) attracted widespread criticism from all quarters, experts and laymen alike. Interestingly, even Dr Abdul Hafeez Shaikh, Adviser to the Prime Minister on Finance and Revenue, in a statement on June 13, 2020, “advised the provinces not to make their budgets on the basis of proposed Rs. 4.963 trillion tax collection target fixed for FBR for fiscal year 2020-21”, adding, “The provinces should make their budgets while keeping in mind the Federal Board of Revenue’s past performance and difference between performance, projections and reality”. It was, in fact, an admission that fixation of budget was not based on universally established norms of fiscal management.

It was explained by Dr. Ashfaque H. Khan in Setting FRB target for 2020-21[Business Recorder, June 11, 2020] noted: Projecting budgetary targets, in general, and tax revenue, in particular, with a fair degree of accuracy is an essential element of sound fiscal management and, therefore, of maintaining fiscal discipline in the country…If they persist on setting an unrealistic revenue target like that of last year, it will have multiple implications for fiscal discipline in the country…… FBR Revenue for 2020-21 equal to Base Year Revenue multiplied by the product of nominal GDP growth rate and tax elasticity (9.5 x 0.85 = 8.1%)….Rs 3,850 x (1.081 = Rs 4,162 billion. Assuming some additional efforts, which will be made by the FBR administration, the tax target should not be more than Rs 4,250 billion.

Before announcement of budget many sane voices advised the government to refrain from fixing an unachievable target for FBR as they then resort to all kinds of negative tactics to achieve it causing harassment and harming growth in economy, but all these as expected, were ignored with impunity.   

Somebody has rightly raised another vital issue: “Why debate on tax target and collection alone in media and elsewhere, and not mention tax forgone of the rich and mighty enjoying facilities of resorts, golf clubs, rest houses, palatial bungalows and other unprecedented perks and benefits etc.?”

In Annex-II appended to Economic Survey 2019-20, ‘tax expenditure’ for fiscal year (FY) 2020 is shown at Rs 1,149.95 billion. Many experts believe that this is grossly understated “as impact of Foreign Assets (Declaration and Repatriation) Act, 2018 and 2019 falling in FY 2020 is not shown at all among many other items”.

‘Tax expenditure” defined by Atshuler and Dietz in a study [‘Tax Expenditure Estimation and Reporting: A Critical Review’, Rutgers University, New Brunswick/Piscataway, Department of Economics]  as “revenue losses attributed to tax laws which provide for a special exclusion, exemption, deduction, tax credit, preferential rate of tax or a deferral of tax liability.” According to a study [The Future Path of Tax Reforms in Pakistan, Hafiz A. Pasha and Aisha Ghaus Pasha] way back in 2013, total tax expenditure was estimated at about Rs.560 billion. This, they concluded, “is a substantial amount, contributing to around 30-40% of fiscal deficit each year”. This trend continued, rather with more impunity as one commentator on Economic Survey 2019-20 noted: “In an alarming development, the Pakistan Tehreek-e-Insaf (PTI) government doled out a record Rs1.15 trillion in tax exemptions to the affluent people and under international commitments in the outgoing fiscal year, breaking its own one-year-old record”. It is revealed that “cumulatively, the PTI government has given Rs. 2.12 trillion in tax exemptions during its first two years in power—an amount that is sufficient to build two Mainline One (ML-I) projects of the China-Pakistan Economic Corridor (CPEC). The estimated cost of the ML-1 project is Rs1.1 trillion or $7.2 billion and the government has given Rs2.2 trillion in tax concessions”.

Economic Survey 2019-20 confirms that as against Rs. 141.6 billion worth of income tax exemptions given in FY 2019, the FBR estimated cost this year of Rs. 378 billion. The report reveals that there was an increase of 167% or Rs. 236.4 billion in the cost of income tax exemptions, primarily “because of tax breaks given to the powerful industrialists, government functionaries and certain entities”. The Rs. 378 billion exemptions were equal to nearly one-third of the total cost of exemptions given in the current fiscal year. The report further says: “Unlike the past, when the government had clearly named the beneficiary sectors, this time the government has vaguely explained these sectors. An amount of Rs. 36.4 billion income tax exemptions were given in allowances, Rs. 104.5 billion in tax credit exemptions and Rs. 212 billion in exemption from total income. An amount of Rs. 3 billion were lost due to reduction in tax rates, and another Rs. 3 billion on account of exemptions from “specific provisions”.  Meanwhile, Rs. 18.9 billion worth income tax exemptions from government income were given.

About 45% of the total tax exemptions were on account of sales tax. The cost of sales tax exemptions, which stood at Rs. 598 billion last year, reduced to Rs. 518 billion this time around. There was a 13.2% or Rs79 billion reduction in the cost of sales tax breaks within one year. Out of roughly Rs. 519 billion, Rs. 255.8 billion in exemptions were given to industries on imports. An amount of Rs. 54.8 billion was lost on local supplies. An amount of Rs. 13.6 billion was lost on account of exemptions on products which were protected under Fifth Schedule of the Sales Tax Act, 1990. The Fifth Schedule relates to the zero-rated tax system. Another Rs. 82.7 billion was lost due to the exemptions given under Eighth Schedule of the Sales Tax Act, which allows imposition of lower than standard 17% sales tax. The Rs. 53 billion worth of exemptions were given by reducing General Sales Tax (GST) rates under various schedules and Rs. 23.1 billion were lost due to low GST collection rates on mobile phones sales.

The cost of customs duty expenditure surged to Rs. 253.1 billion against Rs. 233 billion in the previous year. There was an increase of Rs. 20 billion or 18.5% over the previous year, according to Economic Survey 2019-20.  Maximum losses of Rs. 95.4 billion were booked on account of customs duties concessions to automobile sectors, oil and gas exploration sectors and China Pakistan Economic Corridor (CPEC). Rs. 88 billion concessions were booked under Fifth Schedule of the Customs Act, which deals with goods exempted from custom duties. The Rs. 45 billion custom duties exemptions were on account of low rates applicable to various bilateral free trade agreements. Similarly, Rs. 10.6 billion worth concessions were given under chapter 99 of the Customs Act, Rs. 4.8 billion exemptions were from additional custom duties and Rs9.4 billion were lost due to exemptions from regulatory duty.

It is pertinent to mention that FBR collected Rs. 3534 billion From July 2019 to May 2020 and in June 2020 for meeting the revised target needs to collect Rs. 374 billion, which appears an uphill task due to disastrous impact on economy in view of Covid-19 pandemic. Forgoing taxes of Rs. 1.5 trillion in these circumstances is simply shocking!

Had the above huge tax expenditure not incurred, the situation could have been quite different. It is an established fact that even prior to Covid-19 outbreak, FBR was far behind the revised target of Rs. 5238 billion after first review of International Monetary Fund [IMF] under $6 billion Extended Fund Facility (EFF) programme. It was later revised to Rs. 4803 billion on the eve of incomplete second IMF review, held prior to Covid-19 pandemic, and after virus outbreak, finally reduced to Rs. 3908 billion. 

The FBR on its website has posted Statement of Estimated Tax Expenditure of Federal Government claiming as under:

“Tax expenditure from federal taxes, in FY 2020, amounted to an estimated Rs. 1,150 billion. Tax expenditure in sales tax amounts highest at Rs. 518.8 billion (45% of the total), while in income tax it amounts to Rs. 378 billion (33%), and in Customs, at Rs. 253.1 billion (22%). In last fiscal year, FBR’s tax collection was Rs. 3,828 billion. Hence, tax expenditure to total collection ratio comes to about 30%, and tax expenditure to GDP ratio stands at around 3%. The following codes apply where tax expenditure estimates are not quantified:

“―”Cost of tax expenditure is zero or rounded to zero

“n.a.: Estimate is not available due to insufficient data

Note: The elimination of a tax expenditure would not necessarily yield the full tax revenues shown in the following tables”.

The details of Tables mentioned above in the FBR report can be seen at: https://www.fbr.gov.pk/Budget2020-21/FinanceBill/Statement-of-Estimated-Tax-Expenditure.pdf

In a Press report, the following tax expenditure is estimated for fiscal year 2019-20:

  • Rs 270 million relief for Lahore University of Management Sciences (LUMS).
  • Rs. 680 million to Shaukat Khanum Memorial Trust Lahore.
  • Rs. 283 million on account of perquisites, benefits and allowances received by superior judiciary and house rent allowance (to superior judiciary judges) is Rs. 55 million.
  • Rs. one million for goods imported under the President/Prime Minister/Governors’ Salary, Allowances and Privileges Act, 1975.
  • Rs. 4 million for goods received as gift or donation from a foreign government or organisation by the federal or provincial government or any public sector organisation or goods received as gift by Pakistani organisations from Church World Services or the Catholic Relief Services.
  • Rs. 23.154 billion of sales tax on cellular mobile phones under Ninth Schedule of the Sales Tax Act 1990.

In another report, it is highlighted:

  • “The federal government has written off Rs. 90 billion worth of income tax in the current fiscal year in favour of charitable organisations, rich people who donated money in charity and institutions engaged in commercial activities in the name of philanthropy. 
  • The Rs. 90-billion income tax exemption in favour of a handful of organisations is more than the Rs. 70 billion that the PTI government has allocated in the federal development programme to fight the Covid-19 pandemic across the country.
  • The official data showed that Rs. 21.2 billion had been waived in favour of non-profit organisations. Another Rs. 4.6 billion was waived in favour of people who gave donations to various charitable organisations and Rs. 64.2 billion worth of income tax was exempted for just 37 enterprises including the State Bank of Pakistan (SBP).
  • A debate has begun after the government proposed to completely exempt the income of Lahore University of Management Sciences (LUMS)—a leading and credible educational institution in Pakistan—from taxes. Earlier, LUMS was getting conditional income tax credit under Section 100C of the Income Tax Ordinance, 2001.
  • The official record of the Federal Board of Revenue (FBR) showed that the income tax credit and exemption from total income tax payments was given under section 100C that deals with non-profit organisations, section 61 (tax exemption on charity) and section 66 (income tax exemption for certain institutions) but now the government has brought it under clause (66), Part I of the Second Schedule to Income Tax Ordinance where it has been given complete immunity.
  • Under clause (66), Part I of the Second Schedule of the Income Tax Ordinance, the income of about 67 entities has been exempted from income tax. Out of these, 37 availed cumulative income tax exemption of Rs. 64.2 billion in the outgoing fiscal year, showed the official documents. Some of these entities, like Abdul Sattar Edhi Foundation and Shaukat Khanum Memorial Hospital, are serving the humanity and deserve tax exemptions. However, there are many entities that are in the list because of their connections to the top offices and FBR headquarters.
  • The SBP got the maximum Rs. 50.2 billion in income tax exemption and the Water and Power Development Authority got Rs. 8.4 billion in tax exemption. The Abdul Sattar Edhi Foundation, Karachi availed Rs. 689 million in income tax exemption and Bilquis Edhi Foundation, Karachi got Rs. 395 million worth of exemption.
  • The Pakistan Engineering Council, a commercial entity, got Rs.184 million worth of income tax exemption. The Institution of Engineers Pakistan, Lahore also availed Rs. 11 million worth of exemption. The Liaquat National Hospital Association, Karachi got Rs. 224 million in income tax exemption. The Sindh Institute of Urology and Transplantation, SIUT Trust and Society for the Welfare of SIUT, which is serving the humanity, got Rs. 840 million in income tax exemption.
  • Pakistan Poverty Alleviation Fund got Rs. 312 million worth of income tax exemption, but it is a commercial entity.
  • The National Rural Support Programme, another commercial entity, got Rs. 510 million in income tax exemption. Saylani Welfare International Trust got Rs. 34 million exemption, Layton Rahmatullah Benevolent Trust secured Rs. 47-million income tax exemption, Kidney Centre Post Graduate Training Institute got Rs. 75 million exemption, Forman Christian College Rs. 30 million, Habib University Foundation Rs. 25 million, Begum Akhtar Rukhsana Memorial Trust Hospital Rs21 million, Al-Khidmat Foundation Rs. 18 million, Dawat-e-Islami Trust Rs. 512 million and Akhuwat Rs. 148 million.
  • Out of the 44 entities listed to receive tax-free donations, about half of these received donations and the government waived Rs. 4.6 billion in favour of their donors, according to FBR’s working.
  • The Supreme Court of Pakistan Diamer-Bhasha and Mohmand Dam donations cost Rs. 2.13 billion in income tax.
  • Donations to Al-Akhuwat cost Rs134 million worth of tax loss to the exchequer.
  • The cost of donations to Layton Rahmatullah Benevolent Trust (LRBT) was Rs227 million. Similarly, FBR waived Rs. 13 million on donations to Sindh Institute of Urology and Transplantation, Rs. 41 million on donations to Aziz Tabba Foundation and Rs. 23 million on donations to Al-Shifa Trust Eye Hospital. The Indus Hospital, Karachi donations’ cost was Rs. 186 million, donations to Shaukat Khanum Memorial Trust, Lahore caused Rs. 681 million loss and Fatimid Foundation, Karachi donations’ cost was Rs19.2 million.
  • Out of total tax losses in the outgoing fiscal year amounting to Rs1.15 trillion and 7.8% were on account of charitable work and institutions involved in commercial activities, according to the Economic Survey 2019-20.

Taxes are the backbone of a country’s economy as these help to meet day to day expenses for running the government’s machinery, for developmental projects, for maintaining the profitability equilibrium of commercial enterprises to discourage monopolies and create a level playing field for all types of entrepreneurs, to enable equitable distribution of wealth so that the rich do not get richer and the poor, poorer.

Democratic governments are not supposed to snatch or steal from the citizens nor are they supposed to intervene in their private/commercial affairs. Governments facilitate and regulate, of course with the help of their people to improve their lot and contribute towards national prosperity by paying taxes. The idea that charity can help alleviate suffering and relieve the poor is quite preposterous since it relies on the whims and discretion of the donor. Take the case of micro-financing. A little amount of money is given as loan to run a very small business that barely allows a person to make his ends meet. This implies that a few hundred thousands will always remain at a marginal low level of income with hardly any chance of reaching a bigger scale. Contrary to that, setting up an industrial unit and taking on board as shareholders those very borrowers can not only enrich their lives but even those who would be associated with that concern and this would also mean better growth as well as more revenue in the form of taxes for the country.

A quote from the biography of Britain’s one time prime minister (1945-1951) Clement Attlee is quite thought provoking. He says: “Charity is a cold, grey, loveless thing. If a man wants to help the poor, he should pay his taxes gladly, not dole out money at a whim.” In Pakistan, while the government pleads its people to pay their taxes honestly, there is no dearth of philanthropists. As a consequence, during this period of crisis brought upon by the Covid-19 pandemic, the Pakistani government has resorted to beseeching the super-rich to donate towards a special fund established for this purpose. This is the height of an irresponsible government that has persistently failed in performing its functions efficiently! Wryly, most of the proud donors who appeared publically promising heavy amounts of money are ones who engage expensive consultants to ‘legally’ arrange their financial matters in such a way that they are subjected to minimum possible taxes.

According to Owen Jones, a Guardian columnist, “Philanthropy is a dangerous substitution for progressive taxation.” Rather than adding billions to the funds of a few non-governmental organizations that could be addressing problems of a miniscule percentage of people, the government treasury needs to be filled up substantially to be used for the vast majority and more specifically during emergency situations. This would, however, mean that those who want to cultivate close relations with the men in power by making their presence conspicuous through donations would become lost in the multitude of taxpayers.

There is a need to understand that charity, despite being a noble act has limited value. We may have been indoctrinated to believe that by giving alms we will earn a high place in heaven but this must come after absolving ourselves of our national duty. The former cannot take precedence over the latter. A dishonest citizen who cheats the authorities but doles out large sums of money in charity cannot be forgiven in the same way as the government that fails to efficiently utilize taxes paid by the honest.

Time and again, people justify tax evasion as a means to avoid enriching a corrupt and incompetent government taking the plea that what authorities cannot do, they could do in the name of charity. This mindset has to change! Empower the government, to such a degree that it is able to reach every nook and cranny of the country and ably fulfill its obligations to the people. Make the government transparent and responsible through participatory democracy [known in political economy as ‘open government’]. Only this transformed attitude can turn around the destiny of any country, let alone Pakistan.       _______________________________________________________________________

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

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