Agenda for tax reforms
Huzaima Bukhari & Dr. Ikramul Haq
The biggest challenge faced by the State of Pakistan is on revenue mobilisation front in the aftermath of Covid-19 pandemic/lockout and global meltdown of economy. Budget 2020 is in the making amidst very difficult times when we are faced with economic meltdown due to Covid-19 outbreak and extreme hardships by weaker segments of society. It is expected to be presented on June 5, 2020. The traditional approach adopted for decades in Pakistan for balancing the books, levying more taxes, containing fiscal deficit and other number games will have to be given up in totality under the prevalent exceptional circumstances.
The central point of budget 2020 should be achieving the long-delayed and much-needed goal of welfare of the common people and providing universal entitlements to all through a comprehensive social security system. It is only possible by following a rational tax system proposed in 2016 [Towards Flat, Low-rate, Broad and Predictable Taxes, PRIME Institute, 2016].
Like other nations in the coming days we will have to strive hard to ensure survival and revival of businesses adversely affected by Covid-19 pandemic that employ millions having no other source of income. Overwhelming majority of businesses in the wake of lockdown necessitated due to Covid-19 epidemic is on the verge of closure. These were already suffering due to sluggish economic activities, high utility bills and markup rate. Big to small and medium enterprises (SMEs) are demanding a comprehensive bailout, including tax reliefs. They are complaining of facing difficulties in securing loan facility announced by State Bank of Pakistan to pay salaries/wages. Those on rent are demanding remission/deferment/loan to pay the same. Their demand is of interest-free loan and/or grant to employees to avoid lay-offs as after opening of businesses, they argue it will require many months to recoup losses and achieve break-even position. Amid this bleak scenario, they claim, markup would be an additional burden. There is demand of massive tax reduction, deferment of old and forthcoming liabilities, tax amnesty, and zero taxation for employees earning up to Rs. 100,000 per month, waiver of advance income tax and over 70 withholding tax provisions contained in the Income Tax Ordinance, 2001, Sales Tax Act, 1990 and all provincial laws relating to sales tax on services.
In the present circumstances, in the forthcoming budget a fair and transparent tax system as elaborate in Towards Flat, Low-rate, Broad and Predictable Taxes [PRIME Institute, 2016] has assumed renewed importance and relevance. In this update to this study, we are presenting a plan that can help to overcome the prevailing challenge through Finance Bill 2020. It is a golden opportunity for the federal and provincial governments to take some right measures to not only help the needy but also ensure return to a vibrant economy with partial and ultimately full withdrawal of lockdown caused due to Covid-19 pandemic. The most essential step towards this is simplification of the tax system, guaranteeing ease of doing business, reducing cost of doing business, providing level-playing field, free and independent market operations. The governments should also focus on improving human capital, tapping resources and generating employment. For all these, dismantling and reconstructing the oppressive, inefficient and unproductive tax system is a prerequisite. The existing system imposes high taxes but yields low revenues. Only 2000 companies pay 75% of total taxes. The standard sales tax rate is 17% but effective collection rate is not more than 8%. Refunds of billions of rupees of sales tax and income tax were unlawfully withheld to show higher figures in the past many decades.
One of the many maladies in the tax system is cumbersome withholding tax system contained in the Income Tax Ordinance, 2001, Sales Tax Act, 1990 and all provincial laws relating to sales tax on services. It is operationally inefficient, anti-business, complex, time-consuming and costly and must be abolished except for payroll and payment of dividends, interest and payment to non-residents.
The agenda of simplification of tax codes and rationalisation of tax system can improve tax compliance, unless there is substantial improvement in public perception regarding the efficiency, technical competence, integrity and ability of the tax authorities to collect taxes fairly and justly, using modern technological tools. The present structures of the federal and provincial tax bodies have failed to achieve these objectives. Therefore, the fundamental challenge is providing a simple tax system that is manned by an efficient and competent administration, which is presently non-existent.
Tax administrations, both at federal and provincial levels, lack the requisite level of digitization, professionalism and human skills. Tax reforms certainly do not mean mere alteration of tax laws or making cosmetic changes here and there. Meaningful tax reforms are not possible without first establishing an efficient, workable structure. The best example of an efficient tax structure is that of Sweden’s tax agency, Skatteverket that maintains data of each and every person, natural or juridical. Skatteverket is accountable to the government, but operates as an autonomous public authority. We need to establish National Tax Authority (NTA) on the same lines as highlighted in Towards Flat, Low-rate, Broad and Predictable Taxes [PRIME Institute, 2016].
The issue of fragmentation of taxes and multiple collection agencies was discussed in detail in ‘Case for All-Pakistan Unified Tax Service: PTI & innovative tax reforms’ [Business Recorder, August 31, 2018] and viable solutions were offered. Strangely, the World Bank has not acknowledged in any of its papers/reports related to Pakistan Raise Revenue Project, the contribution of local writers and presented the same ideas as its own recommendations. For example, it may be noted that we gave the idea of National Tax Agency in 2014 in an article Revamping tax system. It was suggested that the FBR or any other tax collection agency need to be run by a competent board as a short-term reform measure before all of these finally merged into a single national tax authority [NTA]. The NTA should not only collect taxes at all tiers of government but should also disburse benefits like social security, food stamps, universal pension and income support etc. The linkage of database of various bodies with NTA (complete digitisation) can be a great step towards e-government model for the country that is presently non-existent. The models of Swedish revenue authority [Skatteverket] and Canadian Revenue Authority (CRA) suggested as worth studying/adopting after debate and suggesting modifications suiting our peculiar requirements. This was later elaborated by us many a times in various articles and in a paper, Towards Flat, Low-rate, Broad and Predictable Taxes, Islamabad: PRIME Institute, April 2016] qnd in Tax reforms strategy, The News, December 3, 2017and Comprehensive Tax reforms, The News, September 9, 2018]. It was also included by the Tax Reforms Commission in its final report submitted to the government in February 2016 [which was marked confidential and till today is not made public].
The issues faced on fiscal front and how to deal with them, especially in budget for 2019-20 were discussed in detail in a serious of articles, written under the title, ‘Avant-garde budget proposals’, published in four parts in Business Recorder on May 10, 17, 24 & 31, 2019. These and many other articles such as Essential reforms, Business Recorder, March 29, 2019, Challenges for budget-makers, Business Recorder, March 22, 2019, Optimising tax collection, Business Recorder, March 15, 2019, Fixing the ailing tax system, Business Recorder, March 1, 2019, Country needs massive reforms, Business Recorder, January 25, 2019, Time up for fiscal integration, Business Recorder, December 21 & 23, 2018, Tax policy for investment, Business Recorder, December 14, 2018, Productive tax reforms, Business Recorder, October 27, 2018, Overcoming fragmented tax system, Business Recorder, October 19, 2018, PTI & revival of economy, Business Recorder, October 12, 2018, Bridging the tax gap, Business Recorder, October 5 & 7, 2018, Case for All-Pakistan Unified Tax Service: PTI & innovative tax reforms, Business Recorder, August 31, 2018, Overcoming debt burden, Business Recorder, August 27, 2018, PTI and tax reforms, Business Recorder, August 17, 2018 and Wither tax reforms, Business Recorder, August 2, 2019.
The failure to tap real tax potential is the failure of both the federal and provincial governments. Poor performance of FBR [Annexure A] adversely affects the provinces as they are overwhelmingly dependent on the Divisible Pool. Provinces are not ready to collect taxes wherever due e.g. agricultural income tax from rich absentee landlords and property tax from owners of palatial houses/bungalows/farm houses etc and not giving fiscal powers to local governments as envisaged under Article 140A of the Constitution.
FBR Year Book 2018-19 concedes that withholding taxes constitute 67% of the total collection of income tax (it was 65% last year). Out of total collection of Rs. 1445.5 billion [it was Rs. 1536.6 billion in 2017-18], Rs. 39.2 billion [2.7%] received with returns and Rs. 344.2 billion [23.8%] as advance tax. FBR’s own efforts (collection of demand created) yielded only Rs. 84 billion (5.8%, it was 7% last year) and from arrears Rs. 18.6 billion (1.3%, it was 1.2% last year). It confirms negligible share [7.3%] on the part of FBR. The same trend continues in the first nine months of the current fiscal year and after Covid-19 crisis, the situation further worsened.
The Centre is unwilling to grant provinces their legitimate taxation right of sales tax on goods[i], while it collects too little to meet overall needs of the federation and federating units. The size of the cake is so small that it cannot help the country to come out of debt trap and spend adequately for the welfare of the masses, no matter which part of the country they belong to. The relief/stimulus package announced on March 24, 2020 by Prime Minister exposed our economic and fiscal vulnerabilities during testing times. Under the given scenario, Pakistan will remain in debt prison, and more and more people will be pushed below the poverty line, especially due to corona crisis. If we want to overcome it, the Parliament will have to reconsider the prevailing social contract between federation and the provinces.
The way forward is that provinces should have the exclusive right to levy sales tax not just on services but also on goods as was the situation in 1947. It is also imperative that further amendments 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 and it can tax the rich and mighty to improve infrastructure, retire debts and bridge fiscal deficit without sharing proceeds with provinces. This alone can eliminate/reduce fiscal deficit at the federal level and achieve fiscal stabilisation in Pakistan[ii].
The following measures/steps are necessary to recoup damage already inflicted to the economy by pre-Covid-19-lockdown policies, due to closing down of businesses [now partly opened from May 9, 2020] and other global factors resulting into demand contraction and absence of reliable national socio-economic registry as maintained by Skatteverket and many other tax agencies:
- All individuals, whatever the level of income may be, should be facilitated to file simple and easy tax returns made available both in English and Urdu—incentive for filing return should be Rs. 2,000 cash payback in the bank account of the filer. It would enable the process of creating National Registry about households and their earning levels at national level. Individuals earning below Rs. 400,000 should be paid income support (negative tax) till the time the State provides them employment and not keep them beggars for life.
- For individuals, income tax rate exceeding income of PKR 0.6 million should be 10% with alternate minimum tax 1% of net wealth exceeding Rs. 20 million. Corporate income tax rate should be reduced to 20%.
- All citizens should be given a chance to pay any past unpaid liability due to non-reporting or under-reporting by just paying 10% tax latest by June 30, 2021. After the deadline, stringent action including confiscation and imprisonment should be provided.
- For the next three years due to challenges posed by Covid-19 economic toll, under a self-assessment scheme if any taxpayer pays more than 25% tax over the last year’s liability, no audit should be conducted. If definite information for underreporting or non-reporting of any income is received, the retrieval be made with penalty of 100%.
- Simplified and harmonised sales tax on goods and services at a low rate of 5% by making recourse to Article 144 of the Constitution. The collection will be through single national agency but provinces will get shares according to the provisions of the Constitution.
- Simplify Customs tariff with ‘One-Chapter One-rate’.
- Radiographic scanning of all inbound and outbound containers to plug revenue leakages.
- Effective mechanism to counter unfair practices on the part of tax administrators—subjected to punitive actions and pecuniary damages after the final fact-finding authority adjudges their actions arbitrary, excessive and beyond their assigned powers. The Federal Tax Ombudsman should be given the statutory power of awarding damages in such instances.
- Taxpayers’ rights must be safeguarded and strengthened by giving adequate rights under Taxpayers’ Bill of Rights ensuring quality of treatment, guaranteeing privacy and confidentiality of their declarations, providing right to assistance by the State in tax matters, ensuring unfettered right of appeal through an independent tax appellate system and providing facilities for independent review of disputes with tax authorities.
- In Pakistan under the repealed Income Tax Ordinance, 1979 (until assessment year 1995-1996), three specific characteristics were the hallmarks of advance tax, viz.
- Advance tax was paid by the taxpayer on the basis of last declared/assessed/estimated income for that assessment year;
- Credit for any advance tax collected for an assessment year was accounted for in that year and not the year of collection; and
- 6% mark-up on the amount retained as advance tax was paid to the taxpayer at the time of assessment thereby compensating his cost of funds or opportunity cost for the period his money remained with the government.
The above should be revived by suitably amending section 147 of the Income Tax Ordinance, 2001 which will help in ascertaining collection for the current tax year without accumulation of refunds after abolishing all regressive withholding provisions.
- Recovery of tax demand should be made only after decision of National Tax Court as suggested below.
- An efficient tax judiciary to help in removing impediments in the way of collection of genuine tax demands by the State and settling tax dispute within 12 months. For this we need to make the Tax Appellate Tribunals a truly independent forum. After merging Appellate Tribunal Inland Revenue and Customs Tribunal, the new entity should be renamed as National Tax Tribunal (NTT) andplaced directly under the Supreme Court as is the case with Federal Service Tribunal. After one intra-court appeal right with the NTT, only the substantial questions of law to go to the Supreme Court by way of leave to appeal as provided in Article 185(3) of the Constitution. Members for NTT should be recruited in the same manner as judges of High Court. The pay, perquisites and salary structure of NTT members and staff should be at par with that of High Courts.
Faced by Federal Board of Revenue (FBR) is bridging monstrous tax gap through automation and introduction of tax intelligence system and not levying more taxes or enhancing the rates of the existing ones. The World Bank in its report, Pakistan Revenue Mobilisation Project, has noted:
Pakistan’s tax revenue potential would reach 26 percent of GDP, if tax compliance were to be raised to 75 percent, which is a realistic level of compliance for lower middle income countries (LMICs). This means that the country’s tax authorities are currently capturing only half of this revenue potential, i.e. the gap between actual and potential receipts is 50 percent. The size of the tax gap varies by tax instrument and by sector. The tax gap in the services sector is larger than in the manufacturing sector (67 percent vs. 46 percent respectively) and it is larger for the GST/GSTS than for income tax (65 percent vs. 57 percent respectively).
The elite is unwilling, even in its own enlightened self-interest, to contribute on the basis of capacity to bear the resource burden required to build a fairer society. Instead, it has instituted a social order that imbibes the feudal value system and promotes a culture of paternalistic and personal relations (in contrast to impersonal market relationships and a culture of competitiveness in other economies), nepotism and patronage, violation of the rule of law, non-acceptance of the norms of fair play and justice, etc; wrecking institutions meant for checking such excesses. Even a slowly growing middle class from non-elite backgrounds has adapted to these value systems, creating a crisis of legitimacy for the state and its institutions—Shahid Kardar, Overhaul the system, Dawn, September 16, 2014.
For the last many decades, fiscal (mis)management in Pakistan has been a serious cause for concern for all, except for the government and donors. More and more taxes have been the slogan of the donors and governments alike. The sane voices have been advocating for structural reforms to end rent-seeking structures. The major issues like non-availability of impersonal market relationships, lack of competitiveness, violation of the rule of law, non-acceptance of the norms of fair play and coupled with reckless borrowing and ruthless wasteful spending have been side tracked or underplayed harpooning the mantra of achieving higher (sic) tax-to-GDP ratio as if it would have solved all the issues faced by the country. The real malady—an outdated, inefficient and non-productive tax system—remain untreated or even unnoticed by those who claim to know everything.
All efforts in the names of tax reforms (so-called) failed utterly as these were patchworks. Re-engineering and redesigning of tax system has not been given any serious thought till today. The Sisyphean task of improving and reforming incorrigible tax machinery, mainly through donors’ money, is still on the agenda of our policymakers.
Since Pakistan tax system is shrouded in masteries through myths and mystifications, in this series an effort is made to unveil all these and present what the reality is. Starting from reforms to misleading claims about narrowed (sic) tax base all myths are discussed and busted. In the end some viable and pragmatic solutions are suggested for public debate—it can be adopted as part of Election Manifesto by any party—to evolve a system that best suits our peculiar culture, socio-economic milieu, and business environment. If adopted this can accelerate the growth, provide jobs and ensure funds for rapid infrastructure development and public services.
The failure to tap the actual tax potential by the federal and provincial governments is the real issue and not the Constitution (Eighteenth Amendment) Act, 2010 [hereinafter “18th Amendment”] vis-à-vis the National Finance Commission (NFC) Award. Dismal performance [Annexure ‘A’ & ‘AA’, some differences in figures by FBR and State Bank of Pakistan (SBP) need to be reconciled by Ministry of Finance] of Federal Board of Revenue (FBR) of not collecting even Rs. 4 trillion adversely affects the provinces as they are overwhelmingly dependent on the Divisible Pool—presently as per formula decided in 7th NFC Award, prior to 18th Amendment. Provinces are also not ready to collect taxes wherever due e.g. agricultural income tax from the rich absentee landlords and property tax from owners of palatial houses/bungalows/farm houses etc. Since the passage of 18th Amendment on April 19, 2010, they have miserably failed to devolve political, administrative and most importantly, fiscal powers, to local governments as envisaged under Article 140A of the Constitution of Islamic Republic of Pakistan [“the Constitution”].
Existing tax structure & fiscal restraints
Presently, all broad-based and buoyant sources of revenue are with the federal government and contribution of provinces in total tax revenues is 8 percent—in overall national revenue base (tax and non-tax revenue) it is around ten percent. This has made them totally dependent on the federal government for transfers from divisible pool—the National Finance Commission Award as envisaged in Article 160 of the Constitution. 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 the independence, the provinces had the exclusive right to levy sales tax on goods and services within their respective physical boundaries. This was snatched from them in 1948 and was never restored. In the given circumstances when federations like Canada and India are moving towards harmonised sales tax on goods and services, there is a need to debate the issue in public and Parliament for reaching a consensus.
It is an established fact that federal government even after levying all kinds of irrational and expropriatory taxes has miserably failed to reduce the burgeoning fiscal deficit. It reached the figure of Rs. 1.8 trillion in fiscal year 2015-14 and since then every attempt to bring it down to 4 percent of GDP has not succeeded.
The Federal Board of Revenue (FBR), the apex revenue authority at the federal level, has been 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.
Tax gap of a country is measured by the amount of tax that remains uncollected due to non-compliance with tax laws. Pakistan Tax Gaps: Estimates by Tax Calculation and Methodology, a joint study of FBR, Andrew Young School of Policy Studies at Georgia State University and World Bank, provides in detail, tax gaps by type of tax and describes the methodologies and data used for such estimates. The report prepared in December 2008 by Rubina Ather Ahmad (FBR) and Mark Rider (Andrew School) says that views expressed “are of the authors and not of the Government of Pakistan”. For fiscal year 2004-2005, according to this report, Pakistan’s federal tax gap was Rs. 409.5 billion or approximately 69% of actual tax receipts of Rs. 590.4 billion. Terming this as “conservative estimate”, the report claims direct tax gap at Rs. 262.8 billion (around 143% of actual collection of Rs. 183.1 billion) and indirect tax gap at 146.7 billion (36% of actual tax collection of Rs. 407 billion). In 2008, the data selected was for fiscal year 2004-2005 and tax gap was estimated at 45%. Since then tax gap has increased and according to FBR’s own admission it is not less that 70% of actual tax potential.
Tackling twin menaces of underground economy and tax evasion has always been a failure in Pakistan. In fiscal year 2015-16, FBR collected Rs. 3.3 trillion against documented GDP of around US$ 300 billion. The underground economy is driven by many aspects of poor fiscal policy, and as highlighted by Dr. Arthur B. Laffer: “it isn’t just high tax rates that indicate whether illicit trade activity will be a problem, but rather high tax rates coupled with other factors such as affordability, level of corruption, effectiveness of enforcement, and cultural and societal reasons.”
The collection of taxes at federal level is much below the actual potential and the way it is collected create doubts and suspicion. In 2014-15, as in the past, FBR failed to meet the third revised target. The original target of Rs. 2810 billion was first reduced to Rs. 2691 billion and then to Rs. 2605 billion. The claim by Finance Minister that FBR exceeded the target for fiscal year 2015-16 was also contested by many. In a report, it was alleged that Rs. 195 billion collection on account of non-tax revenue “is shown as ‘other taxes’ to claim higher tax collection”. It is further alleged that “Rs. 30 billion on account of Natural Gas Development Surcharge (GDS) is accounted for as ‘other taxes’ whereas it was placed under non-tax revenue till 2013-14”.
Tax collection figures for 2014-15 & 2017-18
For the fiscal year, 2017-18, revenue target was Rs. 4013 billion that was later revised downward to Rs. 3935 billion. FBR collected only Rs. 3842 billion. It collected income tax of Rs. 1441 billion against the target of Rs. 1562 (deficit of Rs. 121 billion). Sales tax collection at Rs. 1491 billion against target of Rs. 1541 billion witnessed shortage of Rs. 50 billion. Shortfall of Rs. 26 billion was under the head Federal Excise Duty, collection was of Rs. 206 billion against the target of Rs. 232 billion. Only collection under Customs exceeded the target by Rs. 8 billion against the assigned target of Rs. 600 billion as hundreds of items were subjected to regulatory duty. The overall shortfall of Rs. 93 billion vis-à-vis the revised target of Rs.3935 billion and that of Rs. 171 billion from original target pushed the fiscal deficit to a record Rs. 2.5 trillion as on June 30, 2018.
In 2015-16, FBR, despite imposing additional taxes of Rs. 360 billion, allegedly blocking over Rs. 220 billion refunds and taking Rs. 30 billion as advance failed to meet the third-time revised target showing shortfall of Rs. 222 billion vis-à-vis original target of Rs. 2810 billion, which was first reduced to Rs. 2691 billion and then to Rs. 2605 billion.
Income tax collection in fiscal year 2014-15 was Rs. 1033.7 billion and projection for 2015-16 was Rs. 1307 billion. The actual collection, reported by FBR, is Rs. 1220 billion—showing shortfall of Rs. 87 billion. Collection of sales tax in 2014-15 was Rs. 1088 billion and projection for 2015-16 was Rs. 1230.3 billion. By raising sales tax on POL products from 17% to 30-50%, the government managed to collect Rs.1329 billion in 2015-16. Customs collection in 2014-15 was Rs. 306 billion and projection for 2015-16 was Rs. 348.5 billion. After levying regulatory duty on over 300 items, it was increased to Rs. 404 billion in 2015-16. Federal Excise collection in 2014-15 was Rs. 162 billion. Against projection of Rs. 200.9 billion, actual collection for 2015-16 was Rs. 177 billion.
In another report, it is observed that “after withholding all the tax refunds during the last fiscal year and forcing companies to pay advance income tax, the Federal Board of Revenue (FBR) announced on Friday that it had achieved the tax revenue collection target of Rs 3.1 trillion set for Fiscal Year 2015-16.” It further says that “FBR was holding more than Rs 250 billion in tax refunds during the last fiscal year. The tax refunds were kept to maintain the tax revenue target agreed with the IMF.”
The meeting of target by FBR through “undesirable means” was also highlighted in yet another report as under:
“…that the overall collection of Rs3.1 trillion was a result of one of the largest clandestine operations, as the FBR took over Rs150 billion in advance taxes from oil and gas, telecommunications and banking companies. The government also blocked payment of over Rs250 billion genuine refunds of the taxpayers”.
It is obvious that on the one hand FBR is facing the challenge of bridging tax gap and on the other collection figures are not reliable. The way forward is suggested in a study published by Prime Institute. This study, available on http://primeinstitute.org, can be considered by policymakers and all the stakeholders. The study gives a detailed roadmap for low-rate, predictable taxes that can accelerate economic growth and yield substantial revenues for the government—much more than what is being presently collected.
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 to which part of the country they belong.
Track record of FBR shows remote possibility of collecting even Rs. 6 trillion in the next three years to give enough fiscal space both to 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 tax tangle will continue unchecked and further taxation through local governments, when elected, 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. If we want to come out of 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 overcome 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.
Distorted tax base & fiscal consolidation
Fiscal consolidation should be as growth-friendly as possible. In general, tax base-broadening reforms are identified as growth-oriented reforms. To the extent that they reduce distortions to economic decisions on work, saving, investment and consumption, they should increase output and improve social welfare—Choosing a Broad Base–Low Rate Approach to Taxation, OECD Tax Policy Studies No. 19
The policymakers (sic) sitting in the Ministry of Finance and FBR always make a totally fallacious assertion that “only 0.9 percent of the population of the country pays income tax”. It is shocking that even the top men of FBR do not know the difference between a “taxpayer” and “return filer”. Secondly, they are keen to retain higher rate of taxes (both under income tax and sales tax laws) on narrowed tax base rather than imposing lower taxes on broader base. It has been mentioned many times [‘Of taxpayers & non-filers’, Business Recorder, October 27, 2016, ‘The tax base’, Business Recorder, November 2, 2012, ‘Ailing tax system’, Business Recorder, August 21, 2015 and‘Improving tax compliance’, Business Recorder, November 16, 2012] that there are 90 million unique mobile users who pay advance income tax payers in Pakistan but returns filers are pathetically low (merely 1.3 million by end of May 2017).
In fiscal year 2015-16, exporters paid income tax at source of Rs.24.8 billion and salaried persons paid tax of Rs.92.3 billion. Importers paid at source Rs.179.7 billion and contractors Rs. 220. Out of gross collection of Rs.1270 billion under the head income tax (refunds issued were of Rs. 47.5 billion only), collection after raising demand was just Rs. 10.4 billion (0.8% of total collection). Collection through withholding taxes was Rs. 919.5 billion, advance tax was Rs. 302.3 billion and tax paid with returns was Rs. 38.4 billion.
The poor collection under income tax head testifies to the fact that it is not tax on total income base, but indirect tax on many items that include many others, consumption, expenditure, investment, and in many cases just transactions that are devoid of any income-yielding activity. For example, a person sells a house of his brother who lives abroad and on withdrawing cash on his instruction has to pay tax under section 236P of the Income Tax Ordinance, 2001. A salaried person, after paying tax under section 149, is compelled to pay tax on cash withdrawal (section 231A). In 2015-16, collection under section 231A (cash withdrawal) was Rs. 28.6 billion and under section 236P (non-filers) was Rs.21.6 billion. On commercial/industrial electricity bills advance tax collection was Rs. 25.5 billion and from mobile users it was Rs.47.6 billion.
It is an irrefutable fact that about 7.5 percent of the country’s workforce, approximately 4.5 million, earns taxable income of Rs 400,000 or above. However, tax returns received by FBR for tax year 2015 were only 1,064,108. Out of these, 90% filers paid income tax less than Rs 10,000! The issue is not only that of low return filers but also total gross under or non-reporting.
Tax base under indirect taxes (sales tax and excise) is also extremely narrow. About 82 percent of entire sales tax and federal excise duty comes from the top 100 companies. In fiscal year 2015-16, total collection of sales tax (import) was Rs. 683.6 billion out of which share of POL was Rs. 209 billion (30.5%). In sales tax (domestic) total collection was Rs. 668.9 billion out of which share of POL was Rs. 349 billion (52.17%).
Failure to harness the real tax potential (‘Oppressive taxes & unabated outflows’, Business Recorder, February 20, 2015) is the real dilemma of our policymakers. The existing tax structure is not only detrimental for economic growth but also not yielding required revenues for the State. The economic managers have failed to realise that excessive taxation on savings does not increase government revenues. Once income has been taxed then savings and transactions should not be taxed. Is there any country in the world where banking transactions and withdrawal of cash are being taxed like it is done in Pakistan?
The donors and lenders (IMF, ADB, World Bank and DFID etc) never mention the oppressive side of our tax system and non-availability of public services. They are fond of discussing “low-tax-to-GDP ratio” in isolation. Initiatives like Research and Advocacy for the Advancement of Allied Reforms (Raftaar), funded by Britain’s Department for International Development (DFID), keep on emphasising need for more revenues, without pointing out where the taxpayers’ money goes to.
Raftaar has pointed out that “more than 53% of federal government’s expenditure is incurred on interest payments, defence, and the wage bills”. But then why does it still want to support the incorrigible FBR, the dismal performance of which is brilliantly exposed by Mr. Shahbaz Rana in Despite host of measures, tax filers increase by just 10,745[The Express Tribune, September 18, 2016]. Paying proper taxes or filing returns, people say, is meaningless and unjustified when the State is indifferent towards public welfare and elites blatantly show apathy towards their fundamental needs.
Our rulers live lavishly while Pakistan ranks at 146 out of 187 countries in the latest Human Development Index (HDI). Not less than 25 million children out of school in Pakistan in gross violation of Article 25A of the Constitution—see detailed judgement of Supreme Court 2014 SCMR 396 re Petition regarding miserable conditions of schools. Raftaar and other initiatives like, Make Tax Fair, Pakistan Tax Justice Network, Tax Justice Coalition etc, must campaign for a just tax system.
Our successive governments have been taxing the poor and giving extraordinary benefits to the rich. Abuse of taxpayers’ money for personal comforts and luxuries of the ruling elite is the main malady. The government’s yearning for “more and more taxes” has become a source of irritation for the citizens who argue that they get nothing in return and their plight is worsening every day.
Irrational taxes have failed to solve any problem—debts, both internal and external, are rising and high inflation is crushing the poor. We need all-out reforms and complete overhauling of the system. Voicing this concern, Nadeem Ul Haque, ex-Deputy Chairman of Planning Commission, in Reform or face fundamental ascendency, emphasised:
“The State must first provide the social contract i.e. good law and order and security of life. It must dismantle the rent seeking that protects the rich. Rent seeking relies on three main components: state subsidies, licensing and regulation; special perks and privileges for ministers and army and civil service employees and land distribution system that allows the poor man’s land to be acquired for the elite especially the army and civil service.”
Political economy of tax reforms
The debates and discourse concerning political economy of tax reforms in Pakistan lack objective analyses and rational approach as evident from the latest book, published by Oxford University Press, The Role of Taxation in Pakistan’s Revival, edited by Jorge Martinez-Vazquez & Musharraf Rasool Cyan. The book contains nine chapters, which are in fact, studies conducted for 7-year-long [December 7, 2004 to December 31, 2011] Pakistan Tax Administration Reform Programme (TARP), carried out with total cost of US$149 million, out of which US$ 102.90 million came as loan from World Bank. The book confirms why TARP was a great failure—on its conclusion not only did tax-to-GDP ratio fall substantially, there was a tremendous decrease in the number of return filers. After reading the book, an irresistible conclusion which can be drawn is that prescription of the World Bank (WB) and International Monetary Fund (IMF) suggesting “more taxes” without growth, equity and delivery of social services to the citizens is a lethal pill, based on a diagnosis by a quack rather than by a qualified physician.
Imposition of regressive, high rate taxes, especially sales tax on essential items, in an underdeveloped, informal and struggling economy has been the tax policy of Pakistan, on the dictates of IMF and WB and the disastrous results are before us—see detailed analysis in Illogical Taxes, Business Recorder, September 18, 2015.
None of the studies in the book has highlighted the most painful aspect of Pakistan’s oppressive and unjust tax system. On the one hand, the State is least pushed to provide free education and health facilities and on the other, individual income taxation is insensitive to family circumstances to determine ability to pay, in utter violation of Article 3 of the Constitution of Pakistan.
In civilized, democratic countries income tax laws recognise the cost of living alone or with family—expenses to nurture children are always taken into account. The laws, thus, allow deductions/allowances according to size of family. In Pakistan, FBR not only denies any such allowance or deduction, but extorts advance income tax even from the lower-income earners and their family members having no income on facilities like mobiles. Adding insult to injury, FBR expects them to file tax returns to get the money withheld as refund, whereas the cost to get it is much more than the amount due and chances of harassment after filing return are obnoxiously high.
The so-called “experts” on Pakistan’s taxation system, at home and abroad, do not try to comprehend the basic elements of a repressive system, let alone suggesting ways to reform it. Their popular slogan is more taxes to improve tax-to-GDP ratio, but no concern for utilisation of money collected as taxes and its ruthless abuse for providing extraordinary perks and perquisites to the ruling elites. They want what is prevalent in the West without studying and considering the mundane realities of Pakistan where the State is not providing even security of life and property, what to speak of taking care of fundamental needs of all citizens—the denial of fundamental right of free education to children under Article 25A is the most glaring example of State’s apathy.
The real issue of taxation in Pakistan is lack of a judicious balance between direct and indirect taxes. Appeasing the rich and mighty and lavish spending on comforts of elites is the main cause of the huge budgetary gap. Such wrong policies are continuously increasing miseries of the people, 12.7 percent of Pakistan’s population now lives below $1.25 per day, which is categorised as extreme poverty—World Development Indicators (WDI) 2015. Non-collection of taxes from the rich and generously extending exemptions/concessions is the root cause of our unjust tax system.
In the book, edited by Jorge Martinez-Vazquez & Musharraf Rasool Cyan, even the internationally-acclaimed writers have failed to dislodge the claim of FBR that share of direct taxes is about 40% in total tax collection. They have blindly adopted the figures of FBR without examining their authenticity. They could not discern that under Pakistan’s Income Tax Law, overwhelming collection is through indirect taxes that are camouflaged as direct taxes. These presumptive and transactional taxes have nothing to do with the income of a person—the incidence of these is passed on to the clients/customers.
In FBR Year Book 2013-14: concealing the truth, Business Recorder, November 7, 2014, it is established with facts and figures that share of direct taxes in GDP is continuously shrinking—during the last 20 years, it was never more than 4% of GDP. If the experts engaged by IMF/WB to suggest tax reforms could not analyse the data properly, what can one expect from the commentators talking about taxation system in different TV talk shows or writing columns/articles in the vernacular Press. No expert hired by WB or IMF as the book shows is aware of the reality, or has not intentionally highlighted it, that the main incidence of the taxes in Pakistan is on the middle-low-income groups, while the beneficiaries of taxpayers’ money are rich members of the militro-judicial-civil complex and public office holders who get enormous tax-free perquisites and benefits. The State, captive in the hands of a few, is facing enormous challenges on fiscal front as parasitic elites have failed to deliver.
In our fiscal woes, there is also criminal culpability of IMF “bosses”, who dictate our economic managers to follow their ill-prescriptions. They plead for more regressive taxes and do not care even if the federal government raises sales tax rate to the extent of 50% on high speed diesel oil, 30% on kerosene, 29.5% on light diesel oil, 26% on motor spirit excluding HOBC and 24% on HOBC through statutory regulatory orders (SROs)—see detailed comments in Constitutional violations in taxation, Business Recorder, October 9, 2015. They know that such actions not only burden the poor but also constitute open violation of Articles 77 and 162 of the Constitution of Pakistan. In their countries, they talk about “rule of law” and in Pakistan they ignore our rulers’ blatant violations of the supreme law of land with impunity.
The Supreme Court in Engineer Iqbal Zafar Jhagra and Senator Rukhsana Zuberi v. Federation of Pakistan and Others (2013) 108 TAX 1 (S.C.Pak.) held that:
“Parliament/Legislature alone and not the Government/Executive is empowered to levy tax. As far as delegation of such powers to the Government/Executive is concerned, the same is for the purpose of implementation of such laws, which is to be done by framing rules, or issuing notifications or guidelines, depending upon case to case, as we have come across some of the cases noted hereinabove. But in no case, authority to levy tax for the Federation is to be delegated to the Government/Executive. Therefore, arguments so raised by learned counsel have no force and the same are repelled hereby.”
The IMF in its parleys with the Pakistani team in Dubai had never raised the issue of violation of constitutional provisions and burdening the poor with unprecedented taxes on petroleum products. Why should they? They are mainly concerned with getting their own money back, no matter if it means sucking blood of the poor. The fault of course, mainly lies with our shameless ruling elites, who beg before them, thrive on borrowed funds and taxes paid by the masses.
We should set our house in order and stop blaming lenders. An undeniable reality is that the Pakistani nation is the most heavily taxed in the entire region and the citizens get neither education nor health facilities from the State, what to speak of social protections like pension for all, out of taxes paid over the period of time. There is overwhelming reliance on indirect taxation [even under the garb of direct income taxation through presumptive tax regime on a number of transactions] without evaluating its impact on the economy and life of the less privileged sections of society.
In the face of declining income tax contribution (after excluding indirect ones levied under Income Tax Ordinance, 2001) to GDP, our Finance Minister and FBR officials have been making tall claims about “impressive” (sic) increase in taxes. The reality of this “impressive” performance was exposed in various columns, but IMF and WB remained mum as they were party to portraying all-good “projection saga”—FBR reforms-II, Business Recorder, August 3, 2015.
The existing tax system is not taxing the rich 15 million and main collection is from indirect taxes. Resultantly, income and wealth distribution disparities are rapidly widening in the country leading to social and political unrests. Under the given scenario, efforts are needed both at federal and provincial levels to enlarge the size of the pie by shifting to growth-oriented taxation—see details in Chapter 16 of Return to Prosperity by Arthur B. Laffer & Stephen Moore.
Though many authors, including ourselves, have presented suggestions for reforming the existing tax system and raising taxes to the level of Rs. 8 trillion at federal and Rs. 4 trillion at the provincial levels has already been given—New Tax Model, Business Recorder, August 28, 2015, our more-loyal-than-the-king stalwarts sitting in Ministry of Finance & FBR want “advice” and “assistance” from IMF & World Bank that miserably failed in the past. Their predicament can well be explained in the following couplet of great Urdu poet Mir Taqi Mir:
Mir kya sada hein beemar howe jis key sabab
usi attar key londey sey dawa letey hein
(What a simple soul is Mir; he seeks medication from the healer’s boy who is the cause of his ailment).
The present tax system and policies are detrimental for economy, social justice, business and industry. Those who possess more economic power (income and wealth) should contribute more to the public exchequer and vice versa. The ability-to-pay principle is regarded as the most equitable and just method of taxation and emphasized upon primarily for its redistributive role. In Pakistan, our rulers have completely deviated from this principle which, is in fact, a constitutional obligation of the government. Political economy of tax reforms must be studied from this fundamental perspective, if some meaningful change in nation’s life is desired.
Tax reforms with borrowed funds
The World Bank extended to Pakistan $125.9 million grant, including IDA credit of $102.9 million, and a UK DFID grant of $23 million, for the tax administration reform project (TARP, many sarcastically called it TRAP). The objective of the project, according to official quarters, was to improve the integrity and fairness of tax administration by improving organizational efficiency and effectiveness of the revenue administration. TARP was aimed at promoting compliance through strengthened audit and enforcement capacity and transparent as well as high quality tax services. The project was also to focus on improving trade facilitation through modern and internationally acceptable customs procedure’, says an official handout.
It was a national shame that for improving the integrity and fairness of tax administration we needed such a heavy borrowing from the World Bank and other donors. Although a part of revenue collection by the FBR could have been earmarked on annual basis for this purpose, but the Government was bent upon borrowing funds. It is obvious that the actual aim behind this project was to make us subservient to the agenda of foreign donors. In the name of tax reforms project, certain forces wanted to have control over our revenues and tax machinery readily obliged them just for few tours and chances to meet the old colonial masters. This was like the re-emergence of East India Company’s operations during the British raj in the subcontinent. On the one hand, our imported Prime Minister [who also retained the portfolio of Ministry of Finance] was claiming to free this nation from the clutches of IMF, and on the other was negotiating fresh loans/grants even for projects like tax reforms.
The World Bank successfully convinced the Government of Pakistan that it needed substantial loan for its tax reform agenda. This reform agenda was prepared by the IMF and World Bank, and they wanted to give money to their “experts” (sic) by lending us money. The main chunk of loan went to their hand-picked consultants! This modus operandi was not new; all the subjugated nations underwent this kind of exploitation at the hands of international donors. Responsibility for this kind of maltreatment and exploitation of a nation lies with its inept, incompetent and anti-people leadership that succumb before donors.
Our history of economic subjugation commenced in the 1960s when our rulers set themselves on large intakes of foreign loans. With every loan comes a host of conditions. These conditions ostensibly aim at reforms, in fact meant to subjugate a nation in complete terms, i.e. economically, politically and mentally. In recent years our economic managers have started claiming that they are severing all ties with IMF and other foreign donors, whereas the reality is that new loans for reforming (sic) tax, baking and justice systems—just to mention a few—are still being negotiated with unprecedented vigour to please the foreign masters.
The process of so-called tax reforms was initiated in 2000. Way back in 2001 promising “a big change of culture” in the FBR in the next 12 months, our then Prime Minister as a Finance Minister, toeing the IMF conditionalities, announced that massive tax reforms were on the cards. He specified the following outline for intended tax reform agenda:
- Heavy investment in Information Technology (IT) to facilitate collectors.
- Massive surgery in tax system through human resource development and use of computers, which would increase efficiency and image of the department.
- Good officers would get compensation on the achievements of targets.
In 2000 while commenting on the tax reform drive (sic) launched by the Finance Minister, we made the following remarks, which are relevant even today:
The tall claims made by the government about six months back that by 1st January 2001, it would introduce major tax reforms and even a new Income Tax law proved to be yet another promise not kept. The deadline has now been extended to the budget time when the Finance Ordinance will be announced. This was not something that came as a surprise to many, including myself, as most of the claims by our government are wo wada hi kya jo wafa ho gaya (promises are made not to be fulfilled). We would have been much happier if the hasty attempts to further destroy the existing enactments and tax structures were abandoned, but it seems that some vested interests are bent upon to do so in the hope that they will get enormous money (for this poor nation it will be a loan of $100m) from the World Bank for this vandalism. This is the most painful part of the whole exercise.
Since 2001, in the name of simplification of tax laws, the FBR is imposing more and more obligations on the citizens of Pakistan without corresponding tax rights in tax codes. The nation has been burdened with a number of more cumbersome tax terms and new enhanced obligations of withholding taxes without any compensation. This is the sordid story of tax reform in Pakistan so far. With every new round of reform comes foreign loan. More money to handpicked consultants, who hardly know anything about a pragmatic tax policy and its administration. More workshops to mercilessly squander public money. At the end of every reform programme, the nation faced more well-equipped tax dacoits who play havoc with its peace and tranquility.
The great failure of all reforms programmes is now well-documented in The Role of Taxation in Pakistan’s Revival, edited by Jorge Martinez-Vazquez & Musharraf Rasool Cyan, and published by Oxford University Press.
Real dilemma of tax system
The real dilemma of our tax system is that it is not equitable. The burden of taxes is less on the rich and more on the poor. In the face of this stark reality, the government since 1991 has been resorting to regressive taxation like presumptive taxes in income tax and turnover taxes in the shape of multi-point sales tax. Over the period of time our tax system has become rotten, oppressive, unjust and target-oriented. There is a dire need to discuss philosophical framework, principles of equity and justice that should be the main concern of our tax policy; not mere achieving of targets set out by the foreign donors. Our worthy tax managers are more concerned with meeting budget targets through presumptive tax regime which is a distortion under the direct tax legislation shifting tax incidence on consumers rather than the actual income earners.
The great divide between the poor and the rich will further expand if the present tax policies continue. We may manage to collect higher taxes but it will not serve the real purpose of redistribution of wealth which is at the core of any direct tax philosophy. On the one hand we are not collecting taxes according to capacity to pay and on the other, annual targets are fixed to further squeeze the already dried tax base. During the colonial era when salt tax was imposed, the visionary leaders of that time staged a revolt against such high-handedness. But now in the so-called post-independence age the IMF/World Bank imposed rulers are playing havoc with the life of the common man by levying exorbitant tax on salt and many other every-day items. It is tragic that neither the politicians nor any public-spirited NGO have agitated against this injustice.
We can collect much higher taxes if the present tax laws are rationalised and incompetent, inefficient and corrupt tax machinery is overhauled. We should liberate ourselves from the reform game of the World Bank and other foreign donors. The tax policies implemented by us on the dictates of foreign donors have lead to abject poverty for vast majority of people. These policies are not making us self-reliant but on the contrary are destroying our industry and business. If we manage to formulate a rational tax policy through public debate and parliamentary process and implement it through consensus and not coercive measures, there is every possibility to get rid of World Bank and IMF in a short span of time. However, if we continue following their prescription, we will neither realise real tax potential, nor achieve the cherished goal of self-reliance through rapid industrial growth.
Our tax revenue potential is not less than Rs. 8 trillion provided that the existing tax base is made wider and equitable, tax machinery is completely overhauled and exemptions and concessions available to the privileged sections of society are withdrawn. To achieve these goals we do not need any loan from anyone. If we take money from World Bank or any other lender them then we are bound to follow their conditions because beggars cannot be choosers. Many local experts can do the reform work either voluntarily or at much less cost than what may be wasted on foreign consultants at the commands of World Bank and others.
Fiscal decentralisation and municipal self-rule
Taxation should essentially be linked with a social policy based on the principle of universal entitlements for all residents in terms of access to social benefits and social services. Taxation without representation also means denial of spending for the essential entitlements guaranteed in the Constitution. The principle of universal entitlements seeks to prevent the formation of inequalities and the foundation of the poor as a separate social group, whereas residualism/marginalism takes the form assisting the poor and the needy, and thus implicitly defining them as certain types of social groups.
The provincial parliaments in Pakistan should enact laws for establishment of local governments as ordained under Article 140A of the Constitution on the basis of social policy—they have so far just copied the previous outdated ones with patchwork here and there. The bureaucrats do not want to empower people through self-governance. They want to enjoy total control over resources. The local governments will not be meaningful unless entitled, within national economic policy, to have adequate financial resources of their own, of which they may dispose freely within the framework of their powers and for public welfare.
Taxes and self-reliance
For achieving the goal of fiscal decentralisation, local governments’ financial resources must commensurate with the responsibilities provided for by the constitution and the law to ensure welfare of the people and ensure sustainable growth at grass root level. Part of the financial resources of local authorities should derive from local taxes and spent for providing universal entitlements and development. Pakistan must follow the model of welfare states where resources available to local governments are based on a sufficiently diversified and buoyant nature to enable them to keep pace with the real evolution of the cost of carrying out their tasks.
There is no political will to implementing any rational fiscal reform agenda, though general consensus on it exists in society. Addiction to borrowed money and lust for wasteful spending are the main stumbling blocks for achieving the cherished goal of self-reliance that can pave way for rapid growth, employment generation and substantial spending for social sectors.
The ever-widening fiscal deficit amongst many other reasons has its roots in wasteful funding of a monstrous government machinery, especially corruption-ridden-inefficient public sector enterprises (PSEs), and extending of tax-free perks and perquisites to elites. These profusely bleed the already scarce resources—both tax and non-tax.
The story of persistent failure of implementing a prudent fiscal policy in Pakistan and poor management of economic affairs is thus, not unknown or untold—it is even candidly admitted in all official documents, released from time to time, relating to taxation, public expenditures and public borrowing.
Pakistanis are one of the most heavily taxed nations in the world—The News [Political Economy],October 10, 2010.
The yearning for “more and more taxes” by successive governments—civilian and military alike—has become a source of irritation for the citizens. They argue as why to pay taxes when in return they do not even get basic amenities of life. In a true social democracy people pay taxes as their collective responsibility while the State looks after their needs. Pakistanis are subjected to exorbitant taxes as the country is caught in debt enslavement. The major reason for tax defiant behaviour is lack of trust in the government—abuse of taxpayers’ money for personal comforts and luxuries by the rulers. The State has failed to protect the life and property of the people, what to talk of providing them basic needs e.g. health, education and civic amenities. The populist argument against paying taxes is ‘why we should pay when the government cannot even ensure safety of our lives.’ This scenario and narrative is paving the way for radicalisation of society. Our so-called experts have never thought of analysing this as a significant internal security threat.
Over-taxation to the extent of expropriation is Pakistan’s real dilemma. Collection of unjust taxes is no answer to resolving existing maladies. Rather they add to them. Rise in internal and external debts is a security threat as economic destabilisation can lead to dismemberment of the State—as was proved in the case of erstwhile USSR. We cannot overcome challenges on political fronts, including the menaces of terrorism and militancy, unless we restructure our economy for social democracy. For this we need an all-out reforms in all institutions as elaborated by Dr. Nadeem Ul Haque, former Vice-Chancellor of Pakistan Institute of Development Economics (PIDE) and ex-Deputy Chairman of Planning Commission, in Change the Sherriff [The News, February 16, 2015] as under:
“…… people in Pakistan are asking what their taxes are used for. ‘I get no public service, yet I pay high taxes. Why?’ This is a frequent lament. People are intuitively in line with enlightenment thinking. Surprisingly donor philosophy remains anti-enlightenment, forcing all Pakistanis to pay more regardless of the quality and quantity of public service. Remember there is no applause when the Sheriff of Nottingham raises his tax collection because everyone knows he is collecting for his own welfare. Our poor governance and failed public service delivery mechanisms are well-known. Should we give such a system more revenues? Surprisingly that has become the mantra. What did the system do well when they had more money in their hands? They engaged in poor quality projects that did not deliver social returns. They also engaged in self-dealing—maximising their own perks plots and welfare schemes. They created unnecessary and unprofitable public sector enterprises.”
In Reform or face fundamental ascendency, Dr. Nadeem rightly suggested that “the state must first provide the social contract i.e. good law and order and security of life. It must dismantle the rent seeking that protects the rich….. Rent seeking relies on three main components: state subsidies, licensing and regulation; special perks and privileges for ministers and army and civil service employees and land distribution system that allows the poor man’s land to be acquired for the elite especially the army and civil service”.
Dr. Nadeem has made a very valid point that “about 60 million uneducated children will enter our labour force over the next decade. All of us should focus our attention to jobs and growth if we are to have any peace here. Yet our policymakers are tailing donors into thinking that all economics revolves around increasing tax/GDP. As if tax alone will solve all our problems.”
Level of taxation in a country is traditionally judged in terms of the ratio, which taxes bear to some measure of national income. The study of tax-GDP ratio is considered important because trends in taxation in a country or group of countries are analysed mainly in terms of this ratio, and the composition of tax revenues. Are inter country comparisons of taxation levels meaningful? Some fiscal experts have sharply criticized these attempts. According to critics, the economic, political, and institutional characteristics of individual countries are so different that neither theoretical nor empirical studies provide useful information of policy relevance. Tax-GDP ratios do not consider the fact that some countries are more favourably placed to levy and collect taxes than others. For example, Lotz and Morssan analysed a sample of 72 developed and developing countries to examine the relationship between tax ratio variations and differences in per capita income and degree of openness. The sample included a wide spectrum of dissimilar economies ranging from Nepal to Singapore. It is prima facie erroneous to compare Nepal’s high rural and agricultural economy with a high commercial and industrial city-state of Singapore. Generally the tax revenue to GDP ratio in developed counties has been high and in the less develops countries low.
In Change the Sherriff, Dr. Nadeem rightly argued that “donors point to selected countries with a higher tax-to-GDP ratio without establishing a basis for a comparison. Are they implying all countries should have the same ratio? Examine the advanced countries: the US with 27 percent, the UK with 39 percent, Sweden with 46 percent, and Germany with 41 percent. Does this mean the US should increase taxes to 46 percent? Yet the US wants to lower taxes. Let us face it: there is no theory that tells us that all tax-to-GDP ratios should be the same. Those who use this argument on the media should be reminded of this simple truth.”
The root cause of our economic woes is the outlandish living style of the elites off taxpayers’ money. Look at the residences of judges, generals and high-ranking civil officials with an army of servants and fleets of cars. Wasteful spending on elites and disinclination to tax the rich is playing havoc with the economy. Behind the present chaotic socio-economic and political situation in Pakistan, amongst other factors, is fiscal indiscipline.
A democratic tax system is one under which tax payments are based on the amount of benefits received from government services—the Scandinavian social democracy model is a good example to quote. In social democracies, the cost of government services are apportioned amongst individuals according to the relative benefits they enjoy. In economic terms, this is called “benefit principle” that presupposes determination of the incidence of public expenditure before deciding distribution of tax burden.
The existing tax system is a worst expression of manipulation and exploitation. A highly unjust and distorted tax base benefits the rich and mighty (exploitative elements having monopoly over economic resources) and fleeces the economically-deprived classes. There is no political will to tax the privileged classes in Pakistan. The common man is subjected to exorbitant sales tax (though standard rate is 17% but actual incidence is over 40% in many cases after applicable customs duty, regulatory duty, mandatory value addition and advance income tax). In return, a common citizen even does not get what is guaranteed by Constitution e.g. free education and health cover—what to speak of affordable shelter and transport. On the other hand, the mighty sections of society—monopolistic industrialists, absentee landowners, generals, judges and bureaucrats—get exemptions and concessions. The cost of tax free perks and perquisites to members of militro-judicial-civil and political elite alone is in billions—it is borne by taxpayers!
Determination of a tax base capable of measuring an individual’s ability-to-pay is a major problem of our tax system. In all democracies, this rule is followed by adopting progressive rate schedule for personal income tax and property tax. In Pakistan, we have moved from this policy to unequal sacrificial rule where the mighty militro-judicial-civil complex (now an integral part of our landed aristocracy by earning State lands as awards and rewards) and political elite are paying meagre taxes and actual incidence is shifted to the less-privileged. The businessmen are offered presumptive tax regime, even under income tax law, to pass on burden on the customers. The masses are overburdened with oppressive indirect taxes, ever rising costs of public utilities and petroleum products.
It was Louis XIV’s finance minister, Jean-Baptiste Colbert, who claimed that the art of taxation was “to pluck the maximum amount of feathers from the goose with the least amount of hissing”. Colbert’s view was close to the truth, even in today’s world, but taxation in his day was not used as an instrument to achieve a broad range of economic and social objectives. Rather, it was a tangle of practices and customs designed to finance wars, private and public works, as well as the pet schemes of the royal family—and their aristocratic hangers-on. In fact, until the 20th century, the notion of a progressive tax on income did not strike them as being virtuous. Our rulers are, however, still living in that state of mind.
In the second half of the 20th century, a number of governments in the West realised that taxation was indeed a multifaceted instrument which, if used sensibly, could help each society attain its economic and social goals. This required a delicate balance between rewarding entrepreneurship, innovation and risk-taking on the one hand, and the need to finance important public expenditures on the other, including education and social programmes, as well as the traditional public works which attracted Colbert. Not easy to do, and few countries, if any, can be fully satisfied with the balances they have struck. Pakistan, of course, is not among such countries.
There are only three main sources of tax revenue upon which government treasuries depend: income, capital and consumption. Too heavy a tax burden on any one of those will cause it to become unreliable as a source of revenue, as well as generating distortions and inequities. In some cases, it might spur tax evasion or drive part of the economy underground or in age of globalization flight of capital to tax havens. Any well-intentioned politician sees no limits to levels of taxation and redistribution. If an elected politician has the courage to tax and spend in a transparent way on his or her perceived worthy social objectives, then it must happen in the democratic way. The politician must be sanctioned or approved by the electorate to go for great revolution.
However, a government can be tempted to exercise a philosophy of social responsibility by penalising the productive sectors instead of introducing reforms which require greater political courage. Yet, in doing so, it runs the risk of undermining the economy’s growth potential. Many do not believe that tax systems should be over-burdened with the social convictions of politicians. Have individuals and corporations pay their fair share of taxes, yes! Have social charges disrupt the good functioning of economies, no! Excessive and unbalanced taxation can prevent many individuals and businesses from taking full advantage of the opportunities of the new knowledge-based economies.
Taxpayers (including businesses) should share the burden of protecting those who are vulnerable as a result of change, either through well-designed social protection measures or retraining, not through excessively rigid job protection measures and inflexible labour regimes that penalise productivity. That is why a fair and transparent tax system is so essential for maximising economic growth. In this regards, a detailed study [Towards Flat, Low-rate, Broad and Predictable Taxes, Islamabad: PRIME Institute, April 2016] is available that can be debated publically to find a workable tax model for Pakistan. Politicians must have the courage to achieve a sensible balance between income, capital and consumption taxes. And they must also have the courage to spend, not on ill-designed social programmes introduced more to collect votes than social returns, but on important investments in creating human capital (e.g. education, training and health), and necessary public infrastructure to increase the productivity of the economy.
It is by no means an easy task in Pakistan. But one expects the public is increasingly suspicious of political motivations and better informed about the impacts of undisciplined public finance. At least, one hopes so! We must all do better. Independent observers should monitor tax data and survey the costs and benefits of various approaches to taxation that have been adopted, changed, abandoned and reinvented over many years; experts should give frank advice on reform and best practice, and help the government reach consensus on tax matters. Politicians listen to them. They should explore new challenges, such as the taxation of e-commerce, the problems of harmful tax competition and transfer pricing within large corporations. Simply put, the government must unshackle the constituent elements of economic growth by letting market forces play their respective roles. And governments must transfer the benefits of economic growth to enhance social well-being and cohesion through transparent and well-designed taxation. If the paradigm could be made to work, then Colbert’s geese would barely hiss at all!!
Tax policy should be aimed at achieving the cherished goal 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 subsidised/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 government must demonstrate by its action to the taxpayers that money collected from them is being spent for collective welfare
Taxes for growth and prosperity
One of the main tools of tax policy is to increase the level of savings and capital formation in the private sector partly for borrowing by the government and partly for enhancing investment resources within the private sector for economic development. On the contrary, Pakistani economic managers have not only failed to achieve this goal, they are ruthlessly taxing capital gains arising out of immovable property and shares to destroy creation of capital and incentives for investment that can boost growth. Tax is a byproduct of growth. With more growth we would have more taxes. The prevalent anti-growth taxes are the real cause of retarded economic growth, burgeoning fiscal deficit and insurmountable debt burden.
Recent years have experienced closure of large industries and stagnation in growth. Besides inefficiency, corruption and incompetence of Federal Board of Revenue (FBR), inconsistent, illogical, burdensome, complicated and expropriatory 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.
Economic challenges faced by Pakistan are multiple and grim—we are trapped in a deadly debt trap, but there is no will on the part of the rulers to come out of it. They are least pushed to accelerate growth, induce investment, stop wastage of resources and tap the real tax potential. Continuous surge in wasteful and unproductive expenses is no cause for concern. Rather, the entire emphasis on daily basis is on “more” (sic) taxes. Our total debt at present is about 68% of GDP which is increasing due to sheer callousness of our rulers. The last government during its tenure added Rs. 6.3 trillion to our debt burden—an increase of 103% while the record of the present government is equally appalling. It has been borrowing heavily to pay earlier debts and bridging the fiscal gap—pushing debt servicing alone to Rs. 1.5 trillion in 2015-16—nearly 68% of total revenue collection. The reckless borrowing to bridge burgeoning fiscal deficit is estimated to cross Rs. 2 trillion this year. The position of balance of payment is also worsening. Current account deficit widened by 91% in the first five months (Jul-Nov) of 2016-17, increasing to $2.6 billion from $1.36 billion in the same period last year, according to data released by the State Bank of Pakistan (SBP). Inward remittances and Foreign Direct Investment are also showing negative trends.
Pakistan also faces the herculean task of providing jobs to millions—on an average we need to create 1.2 million jobs annually for young people alone. For achieving this task we will have to ensure that economy grows at the rate of 8% to 10% per annum over a long period of time—for this we need investment of 20% of GDP. This challenge is also our great opportunity for economic progress. Majority of job seekers are young people, which 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 rulers and financial managers, who cannot think beyond what they are “commanded” or “trained” to think. They keep on telling us about the symptoms of an ailing economy but never try to cure the real causes of illness. Unfortunately no serious effort has ever been made in Pakistan to devise a rational tax policy for encouraging industralisation through corporatization of business leading to economic growth and documentation of economy. The sole stress on irrationally-fixed revenue targets—with main incidence on the weaker sections of society—has created an ugly fiscal mess.
The persistent failure of successive governments—military and civil alike—to broaden the tax net, 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 can get out of it provided there is leadership having competence and unshakeable determination to pursue a pragmatic reform agenda to transform Pakistan into an egalitarian state—true social democracy with justice for all.
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 people who can develop them as quickly as possible.
For technological transfers, rapid industrial growth and employment generation, foreign direct investment (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 during the last decade. 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.
Foreign investors will not come to Pakistan as long as unsatisfactory law and order situation and energy shortages exist. Due to these and other negative factors even the existing industrial units are closing down or working at low capacity. Nobody is willing to invest in special economic zones, where tax incentives are available. The main reason is lack of proper infrastructure. The result is unprecedented decline in foreign direct investment during the last ten years. Pakistani industrialists—fearing loss of life and property, threats from extortionists, acute power shortages, rising costs of doing business and hostile tax policies—are shifting their capital abroad. Investors, both domestic and foreign, prefer a place that characterises stability, consistency and requisite infrastructure facilities—we lack all these.
Tax incentives do matter but not as first priority—any feasible growth-oriented project can be profitable after paying reasonable taxes. In Pakistan, corporate taxation in 2016 is still as high as 42% (company tax rate plus tax on dividends). The corporate sector is the worst sufferer of FBR’s designed policies and widespread corruption—top management of FBR has very myopic outlook as evident from over-emphasis on withholding taxes. With low tax rates we could have promoted corporate growth. On the contrary, in 2015 FBR imposed ‘Tax on undistributed reserves’ [section 5A of Income Tax Ordinance, 2001] ignoring the fact that reserves are created from already taxed income. 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 would further retard corporate sector and discourage future growth.
We need to incentivize corporatization of business. At present there are about 80,000 companies registered with SECP out of which 24,000 filed tax returns. There are numerous anti-corporate provisions in the tax codes. Companies are maltreated by FBR—after collecting billions as ‘withholding tax agents’ of the state without any compensation; they are penalised for small lapses that may neither be intentional nor willful. Taxation of notional benefits e.g. concessional loans in the hands of employees, high corporate tax rate and double taxation of dividends and reserves out of already taxed profits are some examples of anti-corporate provisions—the list is not exhaustive. In these circumstances, no one would like to conduct business through a company, especially when audited accounts by independent and credible auditors are rejected on mere whims and without bringing any material on record, by taxation officers. Litigation is imposed on the companies and they have to hire costly professionals to get justice. It is thus no surprise that in the World Bank’s ‘Doing Business 2016’ data for Pakistan, our ranking has gone down to 138 from 136!
Devising an efficient tax model for rapid economic growth in Pakistan requires an analytical study of all the irritants prevailing in tax codes, procedures and implementation processes. The main irritant is 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 to promote taxation and business growth attracting domestic and foreign investment and ensuring much-needed jobs.
On our part and for initiating such a debate, we are identifying some main maladies that need to be fixed through holistic tax reforms aimed at incentivising rapid growth and voluntary tax compliance.
Collection dilemma: flat-taxation is the answer
At present, both the centre and provinces are not collecting taxes according to their respective potential due to weak enforcement and inherent problems of an out-dated tax system. Total tax potential of Pakistan is around Rs. 12 trillion if agricultural income tax and other provincial and local taxes are also collected efficiently. As shown below, at federal level, income tax alone can be collected to the tune of Rs. 7 trillion provided the entire undocumented economy is brought into tax net. So far, all efforts to achieve this objective have miserably failed. The existing tax system itself is the root cause for encouraging parallel economy, the reform of which is a fallacy. Patchwork here and there is just an exercise in futility and no matter how many tax reform commissions or committees are constituted the consequence would be attempting to cure the incurable. Remedy lies in dismantling the existing oppressive tax system and shifting to a flat-rate that is pragmatic, growth-oriented, workable and acceptable to all stake-holders. Under this flat rate taxation, those not coming into tax net or avoiding true disclosures would opt to pay voluntarily as rate would be minimal and compliance cost almost nil. Tax system is meant to incentivize growth and not otherwise as the present one is doing.
After levying all kinds of oppressive taxes, the federal government has failed to bridge the ever-increasing fiscal deficit that is creating a greater debt burden—at present 65% of tax revenues are going towards debt servicing alone. On the other hand, provinces are critical of inefficiencies of FBR due to which their share in the overall divisible pool is insufficient to meet their annual budgetary requirements. Since the share of every province in federal taxes under the National Finance Commission (NFC) is dependent on how efficiently taxes are collected by FBR, it is important that the centre and federating units actively participate in tax collection apparatus/processes/efforts. No serious debate has ever been initiated on the issue as to how we should increase the size of the cake to ensure that both the centre and provinces flourish as sufficient funds are made available to run the governments and fulfill the needs of the people.
Tax System in Perspective
The ever-growing size of parallel, undocumented economy has much to do with the way taxes are being administered for the last many decades—from a tax compliant public to a tax rebellious one, from high tax-to-GDP ratio to an obnoxiously low one, from greater revenue from fewer taxpayers (2 million) to very low revenue from a broad-based population (approximately more than 20 million), from a relatively thriving economy where debts were at their lowest to an apparent prosperous one where share of debts is 68% of the GDP, from a comparatively greater reliance on direct taxes to a complete turn-around towards indirect ones (even in the garb of income tax law which is essentially a form of direct tax), from relative simplicity of compliance to complicated procedures both at the federal and provincial levels especially in the aftermath of the Eighteenth Constitutional Amendment for which the earlier government takes immense pride. Even the Inland Revenue Service has transferred a major portion of its responsibilities of collecting tax, on withholding tax agents leaving very little to justify its own existence.
In short, all that could have been done has been done to make the life of a compliant taxpayer as miserable as possible and snatching from him that little iota of motivation that was egging him on to be an obedient citizen of this country. The helplessness of seeing one’s hard-earned money going down the drain has compelled many to look for greener pastures around the world where their taxes would trickle down in the form of some benefit coming back to them. With this in mind, it becomes imperative at this stage to rethink and devise a scheme that would alleviate the sufferings of the common man and help generate substantial revenue for governments to function comfortably. Our country is rich in resources and its people are very generous. There is no doubt that a logical scheme of things capable of sucking in large revenues without disrupting the common man’s life would be a welcome respite from the constant lashing by tax collectors.
Another important factor that discourages compliance with tax laws is the extremely complicated and cumbersome nature of procedure involved in being registered with the revenue authorities. Even the corporate and educated class finds it difficult to comprehend, follow and observe the simultaneously applicable innumerable legal obligations, what to talk of the illiterate and ordinary man on the street. If a survey is conducted with respect to merely the advance tax provisions (almost 75 in number), it would reveal how a person is supposed to be aware of so many avenues where either tax is being withheld or he is himself paying income tax and the consequences of these taxes, the credit of which he may or may not be allowed to take while filing his return. In the first instance, a highly meticulous record of all such transactions that invoke taxes would have to be maintained and secondly, an even higher level of grasp over the law would be required to apply it.
Considering the present level of inflation and the high cost of living, the minimum threshold of income (Rs. 400,000) where no income tax is to be paid nor a return needs to be filed is within reach of an overwhelming population including people who are earning income from simple employment, trade and vocations. With the prevailing standards of literacy in the country how can it be expected that the common man has any cognizance about tax laws let alone complying and then tackling the authorities who are perpetually ready to whip anyone—innocent or guilty. Had it been restricted to simple arithmetic, things could have improved but the cruel methods adopted to teach the nation lessons in paying taxes have only proved detrimental rather than motivating.
People take pride in beating the authorities, no exemplary punishment has been meted out to confirmed evaders, no effort has been made at the grass root levels to educate the public about its obligations and instead of serving the nation, officials of the revenue department are poised to pounce upon the first stray taxpayer to squeeze him dry. Revenue officers are trained to look suspiciously at every registered taxpayer—their motto being “guilty until proven innocent.” Even though law requires that officers should counsel and guide the taxpayer with respect to his duties and rights, he is conveniently forced to engage a tax consultant who, if professionally unethical, is capable of causing much more financial damage to his client than the amount of tax in question.
Black economy and tax losses
Tackling the twin menaces of black money and tax evasion has always been a failure in Pakistan. The study, What is hidden, in the hidden economy of Pakistan? size, causes, issues and implications, by Ahmed Gulzar, Novaira Junaid and Adnan Haider, shows that corruption and tax evasion are not only causing an expansion in the size of the informal economy but also hampering the growth rate, thereby adding more to economic uncertainty, income inequality and poverty. Successive governments, instead of dealing with these issues have been pardoning and appeasing tax evaders through various laws and amnesty schemes.
The result is obvious—there is an ever-growing informal economy, which is ironically declared as The Secret Strength of Pakistan’s Economy. Only 25 percent of the economy is taxed if the undocumented sector is taken into account. It means that tax gap in Pakistan is 75%. The tax-to-GDP ratio is much less than what is claimed by FBR. They do not take into account informal (untaxed) part of economy. Former Finance Minister Shaukat Tarin said in 2010 that “Pakistan loses 800 billion rupees a year in tax evasion”. The tax collection of each year, after blocking refunds and taking advances of billons of rupees is not enough to bridge the budget gap, which last year was over 5 percent of GDP. The present accumulated size of informal (untaxed) economy is estimated at Rs. 50 trillion. If tax at flat rate of 10% is offered to all who have failed to pay in the past, in just one year FBR will collect Rs. 5 trillion and then in future this figure would be much higher compared to what is collected at present—in fiscal year 2015-16 FBR collected merely Rs. 3.1 trillion against documented GDP of around Rs. 24.7 trillion.
The New Paradigm
Under the afore-stated situation of imbalances, a fresh approach and a renewed policy are urgently needed to replace the entire taxation system for fiscal stabilization. The equation is simple. Federal government needs at least Rs. 7 trillion of revenue (for meeting all development and non-development expenditure along with retirement of expensive loans), for which determination of a fair tax base is imperative. The current complex system, only favours a few thousand officers and their staff along with people having money power and who can blatantly flout the law. It is possible to suggest a simple flat rate tax that is neither burdensome nor difficult to implement but it would deprive the bureaucracy and some vested-interests who would be most likely to oppose it. Nonetheless there is no option but to dismantle the existing, out-dated and anti-growth tax system if we have to overcome the twin but inter-related malaises of fiscal deficit and debt burden.
Arthur B. Laffer and Stephen Moore in their book “Return to Prosperity,” have expanded upon a theory that meets our existing conditions. While elaborating upon the practicality of flat rate of tax, they write:
“Excessive taxation is detrimental to labor and capital, poor and rich, men and women, old and young. Excessive taxation is an equal opportunity tormentor. Businesses locate their plant facilities in order to make higher after tax returns for their owners. In the short run, higher taxes on labor or capital lower after tax earnings. During depressed times, businesses are often desperate to reduce costs because of a shortfall in revenues. Increased taxes in one location can be the final straw leading to businesses’ relocating to more tax friendly locations or making the ultimate decision to close down operations. In the longer run, immobile factors (such as low wage workers and commercial and residential real estate) are left to suffer the tax burden.”
Referring to the significance of mode of taxation, the writers draw justification from a noted nineteenth century American economist Henry George who wrote in his book, “Progress and Poverty” (1879):
“The mode of taxation is, in fact, quite as important as the amount. As a small burden badly placed may distress a horse that could carry with ease a much larger one properly adjusted, so a people may be impoverished and their power of producing wealth destroyed by taxation, which, if levied in any other way, could be borne with ease.”
There has to be a source of motivation for taxpayers to comply voluntarily and to some extent eagerly in contributing towards the national exchequer. Whenever the governments resort to high-handedness in collecting taxes, the people term it as broad daylight robbery, instrumental in encouraging tax evasion. As propounded by the eminent authors of “Return to Prosperity” on pg. 174:
“The theory of incentives provides the basis for the concept of a flat-rate tax, which is so called because a tax applies equally to all sources of income and does not change as a result of taxpayer’s volume of income. Any exemptions, deductions, differential rates, or progressivity would, as a matter of linguistics, preclude the name flat tax. They also represent a deviation from the principles of efficient taxation. Such exemptions to the even application of a single narrow tax base, lead to a higher tax rate, make for greater complexity, and increase tax avoidance.”
They further say that:
“In the realm of economics taxes are negative incentives and government spending entails positive incentives, subject to all the subtleties and intricacies of the general theory of incentives. People attempt to avoid taxed activities—the higher the tax, the greater their attempt to avoid.”
The tax system that will work smoothly for Pakistan, keeping in view our peculiar socio-economic circumstances and mind-set of masses, must be a flat rate with no compliance hassles. All taxes should be merged into one single tax with complete assurance to the masses that they would be free from any kind of harassment; and money collected would be spent towards their welfare. The agenda of fair taxation cannot succeed if wastage of public funds and its abuse by the rulers continue unabated. The quid pro quo for paying taxes is as important as the system to collect tax. Where the public is blamed for not paying their due share, public authorities are equally, if not more, responsible for indulging in corrupt means taking cover of complicated procedures that eventually lead to poor collection of revenue. As mentioned by the writers:
“A flat rate eliminates much of the inefficiency in a convoluted tax system by broadening the tax base and sharply reducing marginal tax rates. Many of the distortions that exist with the current tax system are minimized. A flat tax rate reduces the collection cost per dollar of tax revenue and eliminates much of the bureaucracy necessary to monitor and enforce numerous taxes. Its adoption leads to a surge in growth and creates a more competitive economy.”
The tax base with respect to direct tax vis-à-vis fair distribution of incidence can be achieved by imposing 10% flat rate tax on net income of individuals and reducing corporate tax rate to 20%. This kind of simple taxation would induce voluntary compliance provided all the citizens are aware of the fact that competent and effective tax machinery exists having a tax intelligence system that can easily detect tax avoidance. Without this deterrence even the new system which is a great deal simpler, will be unworkable. Nowhere in the world is proper collection of taxes possible without a strong enforcement apparatus. However, the apparatus should be friendly and firm—friendly, to the extent of educating and guiding the people for fulfillment of their tax obligations, and firm to the extent of punishing willful defaulters.
As far as sales tax is concerned, it has been emphasized time and again that Pakistan needs harmonized sales tax (HST) which should be single-stage and single-digit. This envisages collection through a National Tax Authority which should replace all existing authorities at both federal and provincial levels.
The further details of simplified, flat-rate taxation can be seen in our paper, 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 National Tax Authority (NTA)
National and provincial assemblies should pass a law agreeing on establishment of NTA responsible for collecting all taxes imposed by the federal and provincial governments. This would facilitate people to deal with a single revenue authority rather than multiple agencies at national, provincial and local levels. The mode and working of NTA can be discussed and finalised under Council of Common Interest [Article 153] and its control can be placed under National Economic Council [Article 156].
The provinces should also feel responsible for better and efficient tax collection. Presently they are isolated and rely on distribution from the divisible pool whereas the Federal Board of Revenue annually collects less than the assigned revenue target. The responsibility to collect revenues should be joint and several giving a participative sense to all federating units.
The NTA should consist of officers and staff representing the federation of Pakistan as in taxes, both the centre and provinces have equal stakes. If the size of the pie grows every federating unit will get more and the Centre will also have more money at its disposal. For NTA, an all Pakistan Tax Service should be established. Recruitment for All Pakistan Tax Service must be independent of the present Central Superior Services structure. Competent people having knowledge in accounting, law, IT and administration should be selected through a special Board, comprising members from the existing Federal and Provincial Public Service Commissions.
Determination of Direct Tax/Income-Based Method
According to available data, total number of persons having taxable income of more than Rs. 400,000 is between 10 to 12 million and tax base is around Rs. 50 trillion (after taking into account informal economy). Flat rate taxation of just 10% with strong enforcement system will yield Rs. 5 trillion under income tax alone.
Determination of the Indirect Tax Base
All existing indirect taxes should be replaced both at the federal and provincial levels with Harmonized Sales Tax (HST). There are multiple tax collection authorities now, rendering the life of the ordinary citizen miserable since he is unable to comprehend complex laws without having to pay heavily to professionals.
If the present indirect taxation is replaced with HST as in a comparable federation like Canada, it would not only improve revenue collection but would also help to alleviate the sufferings of taxpayers who have suddenly been bombarded by multiple tax authorities.
In the Pakistani milieu if a single-stage 5% HST is levied, it would yield at least Rs. 3 trillion both at federal and provincial levels. A comprehensive study, courtesy Tax Reform Commission (TRC), is already with FBR. In this study, prepared by a sub-committee of TRC, even the matter with respect to cascading of prices has been addressed and dealt with satisfactorily.
- If we want optimum collection of taxes fairly and without hampering growth, it is imperative to abolish the present tax laws and enact new ones.
- Collection of taxes through a single national authority as suggested above.
- Establishment of a Tax Intelligence System sending quarterly information to potential taxpayers about their economic activities so that they can be informed in advance as to how their incomes and expenditure should finally look like in their tax declarations.
- Prudent spending of public money through a transparent process enjoying the confidence of the people.
Annexure A: FBR’s Targets, Collection & Growth etc (1996-97 to 2018-19)
(Rs. in billions)
|Year||Targets||Collection||Growth in Collection (%)||Target Achieved (%)||Tax to GDP ratio||Ratio in total taxes (%)|
|Indirect taxes||Direct taxes|
Source: Economic Annual Surveys & FBR Year Books
Annexure AA: Tax-wise Performance of FBR (1996-97 to 2018-19)
|Fiscal Year||Direct Taxes||Sales||Excise||Customs||Total of Indirect Taxes||Total Tax Collection||Indirect tax ratio||Direct tax ratio|
The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)
[i] Sales tax on goods at time of independence was a provincial subject. 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” on 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 to 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 detail discussion 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)].
[ii] Article 160(3A) of the Constitution, inserted by 18th Constitutional Amendment, categorically says: “The share of the Provinces, in each Award of National Finance Commission shall not be less than the share given to the Provinces in the previous Award”. However, outside the ambit of Article 160 of the Constitution, the Centre can impose taxes to meet budgetary gap as it did in 2013 by enacting Income Support levy Act, 2013, but repealed it the very next year [A tax for the poor that the rich never paid, Daily Times, October 21, 2018].