Tax Policy Imperatives
Dr Ikramul Haq[*]
“Although successive governments have made attempts to narrow the revenue-expenditure gap by taking new fiscal measures in the federal budgets, little improvement has taken place in the overall fiscal deficit. Why is it so? Pakistan tax system is still characterized by a narrow and punctured tax base, over reliance on distortionary import-related taxes, high taxes on the one hand and tax concessions and exemptions on the other, and weak tax administration. The combined effect of these structural weaknesses resulted in low and stagnant tax-to-GDP ratio on the one hand, and tax elasticity and buoyancy on the other. Such a tax system has severely hampered resource mobilization efforts in the past despite a series of discretionary measures taken in almost every federal budget to reduce the widening gap between revenue and expenditure” (Economic Survey 1999-2000, Page58).
This is the most apt comment about our rotten, unjust and oppressive tax system and an open official admission that efforts to bridge the ever-increasing revenue deficit during the last 53 years have miserably failed. In every federal budget, the tax bureaucrats made mindless amendments in tax laws with the singular aim of achieving TARGETS set out by their bosses in the Ministry of Finance, under the dictates of the International Monetary Fund (IMF) and other donors. These targets were not impossible to achieve (as usually projected by the CBR stalwarts to conceal their own incompetence), but these could not be realised due to corrupt, inefficient and incompetent tax machinery.
The tax bureaucrats fully conversant with the working of their machinery, which itself is the main cause of huge revenue leakage, left with no choice but to adopt shortcuts to show higher collection figures by resorting to presumptive taxes (with yearly increase in their rates) and criminally withholding refunds that were created but delayed or blocked for a long time. They also fudged their books by inflating tax collections resulting into payment of fine by the government to the IMF. The taxpayers have also lost faith in the system. Once a system loses its credibility even the right measures cannot be enforced. This is exactly what has happened to our tax system. The promises made by the State were never kept. Inconsistency was the key word for the policymakers while devising tax policy. It is therefore not surprising that the taxpayers and the investors have become highly disillusioned.
Today there are no two opinions in the country that our economic survival now lies in better and efficient tax collection. The people of Pakistan will never be able to break debt shackles and economic subjugation will continue if we fail to bridge the gap between revenue and expenditure. The efforts to “reform” the tax system are now in the final stages as reports of Task Force, headed by Mr. Shahid Hussain, are now lying at the table of the Finance Minister for onward submission to the Chief Executive. It is interesting as well as painful to note that basic tax policy issues have not been addressed in these reports prepared by the highly-paid tax consultants, hired by the Task Force. This fact has already been highlighted/documented extensively by the national Press. I do not intend to add further to criticism already made against the Task Force. Let the time be the judge to see whether their efforts yield any positive results or not.
In this article, some tax policy imperatives are presented so that a public debate about tax reforms can be initiated to reach a national consensus. These policy imperatives aimed at making our tax system equitable, practical, acceptable and people-friendly. At this critical juncture of our history we should all make concentrated efforts to ensure tax collections rather than indulging in futile and unhealthy criticism. The efforts for tax reform cannot be meaningful unless there is a paradigm shift in tax policy. We need a consensus tax policy first and then accordingly changes can be made in administrative and legislative framework to effectively implement that policy. It is worthless to make changes without first determining the direction of change. We want to change our tax system and culture but have yet not evolved a national tax policy. It shows the level of confusion that prevails in the thinking of present rulers, who want to be great reformers, without having any vision for reforms.
The policy imperatives discussed in this article are prerequisites for any meaningful change in our tax system. In case we fail to determine a rational tax policy any attempt to reform tax administration or make legislative changes in the existing tax laws will be either futile or even counterproductive. It is, however, necessary that tax policy should be debated on national level, consensus of all who are affected is sought and be adopted through a democratic process. Needless to emphasize that unless this procedure is adopted its implementation cannot be ensured, no matter how good such a policy may be.
The basic principle of a sound tax policy should be to tax the people on the basis of their ability to pay and not in a ruthless manner as is being done presently; e.g. a rich person earning Rs.2 million per annum as profit from bank deposits pays Rs. 200,000 as tax under presumptive regime, whereas his normal tax liability comes to Rs.616,000. He is getting a net annual tax benefit of Rs. 4,10,000 since 1991. In contrast, a widow, who is earning just Rs. 30,000 per annum from her deceased husband gratuity kept in bank to make both ends meet, has to pay Rs. 3000 as tax although her income otherwise is below taxable limits. Can this kind of tax system inspire people to pay their taxes honestly and diligently?
If a given amount of revenue is needed to finance public services, then each taxpayer should contribute in line with his ability-to-pay taxes. Those who possess more economic power (income and wealth) should contribute more to public exchequer and vice versa. The duty to pay taxes is seen as a collective responsibility rather than a personal one. The ability-to-pay principle views tax policy issues in isolation to incidence of public expenditure. This principle is the most equitable and just method of taxation. It is emphasized primarily for its redistributive role. In Pakistan we have completely ignored it. Our tax incidence (due to indirect taxation even under the Income Tax law) is more on the poor and less on the rich whereas it should have been the other way around.
It is painful to note that the present structure of presumptive taxation has complicated the poverty problem of Pakistan. According to a recent study of the Asian Development Bank, the tax system of Pakistan, which was progressive till 1990, was converted into a regressive regime in 1991 with the introduction of provisions like sections 80B, 80C, 80CC and 80D in the Income Tax Ordinance, 1979 and VAT-type tax in the Sales Tax Act, 1990. The result is that during the ten years’ period (1991-2000), the tax burden on the poorest households is estimated to have increased by 7.4 percent, while it declined by 15.9 percent for the richest households. This study of ADB is an eye-opener for the target-oriented CBR’s stalwarts (sic) who in their frenzy of showing higher figures to their foreign masters have put extra burden of taxes on the poor of Pakistan. History will never forgive them for this senselessness and shamelessness.
Ability-to-pay rule is based on the philosophy that tax burden on taxpayers should be so distributed so as to force them to make ‘equal sacrifice’, being defined as loss of utility or satisfaction by surrendering units of money as tax. The equal sacrifice rule, associated with such distinguished economists as J.S. Mill and A.C. Pigou, is based on the following assumptions:
- It is possible to relate units of income with units of utility.
- The utility curve for income has a downward slope, i.e. marginal utility of income varies inversely with income.
- The marginal utility of income curve is the same for all individuals.
Under these assumptions, the equal sacrifice rule is clear for taxpayers with equal incomes. They should surrender equal amounts as tax which in turn means sacrificing equal units of utility (horizontal equity). However, difficulties arise in interpreting equal sacrifice rule for people with different incomes. How is the term ‘equal’ to be understood? In the tax literature the following interpretations of the equal sacrifice rule are found.
- Equal Absolute Sacrifice. It means the number of units of utility taken away from each taxpayer should be exactly the same.
- Equal Marginal Sacrifice. The marginal sacrifice is the same, i.e. utility left with, rather than taken from, every taxpayer after tax should be the same. This will ensure minimum total sacrifice for society, and hence it is also called Least Aggregate Sacrifice Principle.
In short, determination of a tax base capable of measuring an individual’s ability-to-pay is a major problem of tax theory. This rule is incorporated in the form of progressive rate schedule for personal income tax, estate duty, and property tax worldwide. In Pakistan we have moved from this policy to unequal sacrifice rule where the mighty civil and military bureaucrats (now they are part of the landed aristocracy by getting State lands as awards and rewards), rich industrialists and greedy businessmen are paying meagre personal taxes and the poor people are compelled on the directions of the IMF to pay GST of 15%[16.5% in case of non-registered persons] and ever rising costs of public utilities and POL products.
Assignment of Tax
Assignment of a tax means transfer of taxation power form a higher level to a lower level government. Taxation power includes the following: right to levy the tax, collect the tax, and appropriate the proceeds from the tax. Thus, there can be three interpretations of assignment of a tax. Firstly, higher-level government may levy and collect a tax but handover the entire proceeds to lower level governments. Secondly, the higher-level government may levy a tax but allow the lower level governments to collect it and retain fully the proceeds therefrom. Finally, the higher-level government may transfer a tax to lower level governments, a situation which defines assignment of a tax in its strictest sense.
In the Pakistani scenario the opposite and worst has happened. The federal highhandedness in tax matters (by using both federal and concurrent lists) has destroyed the financial and economic rights of the provinces. The provinces have the exclusive right to levy taxes on goods and services within their respective physical boundaries, but the Federal Government blatantly encroached upon their undisputed right by levying tax on goods and services under sections 80C, 80CC and 80D of the Income Tax Ordinance. Such taxes are no more taxes on income (which the federal government is empowered to levy under item 47 of the Federal List) but tax on goods and services. It is a great tragedy that this argument was not addressed in the Supreme Court when the constitutionality of these provisions was challenged and the matter only revolved around academic discussions over the concept of income. If the Federal Government can treat even tax on goods and services as tax on income, as upheld by the apex court per incuriam, then what will be sanctity of division of fiscal powers provided in the Constitution of Pakistan.
Generally, the purpose of tax assignment is to augment the resources of lower level governments. The assignment of tax may be conditional. Thus, it may be obligatory on the part of a lower level government to levy the tax assigned to it. Not only this, the lower level government may not have powers to alter the basic structure of the assigned tax. It may enjoy flexibility in fixing the tax rates within a minimum and maximum rage prescribed by the higher-level government.
There is an urgent need in Pakistan to reconsider the equitable distribution of fiscal and taxing powers between federation and the provinces. The true provincial autonomy can only be guaranteed if assignment of tax principle is followed in letter and spirit. By just electing some people under the local body elections and asking them to dislodge the District Management, provincial autonomy cannot be extended. Let the provinces have exclusive right over their resources and finances. Let us transfer taxes to local governments so that grass root democracy and funds for public services can be guaranteed.
According to this principle, 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 successive governments have failed to convince the people that payment of taxes is their collective responsibility. All the civil and military governments alike were engaged in wasteful expenditure, never bothered to live within their means and failed to even protect the life and property of the people, not to talk of providing them basic needs of health, education and civic amenities. Are they justified to ask people to make sacrifices when the life style of the rulers is Shahana (Emperor like)?
Tax policy should be used as a tool of distributive justice. 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 irrational policies. The rulers and tax bureaucrats have to demonstrate by their actions a clear inspirational model for the taxpayers to believe them and to pay taxes honestly and diligently.
[*] Dr. Ikramul Haq, a leading international tax counsel, is a well-known author specialising in international tax, press, intellectual property, corporate and constitutional law. Dr. Ikram is Chief Partner of Lahore Law Associates (fax: +92 42 7226953, e-mail: firstname.lastname@example.org; website: http://www.paktax.com.pk). He is a member of the visiting faculty of the Lahore Institute of Tax Education [LITE]. He studied literature, journalism and law, for his Masters and Doctorate degrees. He has written many books on various aspects of Pakistani law and global narcotics trade, some of which are co-authored with his wife, Mrs. Huzaima Bukhari. He has been awarded Doctorate of Law for his research: Tax Reform in Quasi-Constitutional Perspective.