By Dr. Ikramul Haq
Dr. Ikramul Haq, a leading international tax counsel, is a well-known author specialising in international tax, press, intellectual property, corporate and constitutional law. Dr. Ikram is Chief Partner of Lahore Law Associates (fax: +92 42 7226953, e-mail: firstname.lastname@example.org; website: http://www.paktax.com.pk). He is a member of the visiting faculty of the Institute of Direct Taxes in Lahore. He served for 12 years as Deputy Commissioner of Income Tax. He studied literature, journalism and law, for his Masters and Doctorate degrees. He has written many books on various aspects of Pakistani law and global narcotics trade, some of which are co-authored with his wife, Mrs. Huzaima Bukhari, Additional Commissioner of Income Tax. He has been awarded Doctorate of Law for his research: Tax Reform in Quasi-Constitutional Perspective.
The emerging role of sales tax [since 1990 it has been gradually shifted from General Sales Tax (GST) to Value Added Tax (VAT) type] in Pakistan economy is significant, though highly controversial as hostility between the Central Board of Revenue (CBR) and the taxpayers over different issues vis-à-vis modes of collection of this VAT-type tax continues unabated. These controversial issues should be debated openly, thoroughly and publically to reach a consensus through a National Tax Reconciliation Commission, headed by a judge of Supreme Court and having representatives of CBR, businessmen and professionals. The survival of Pakistan as a viable economic entity now lies with the revenue mobilisation, in which the sales tax alone has over one third share.
VAT is a specific turnover tax levied at each stage in the production and distribution process. In its purest form VAT is a tax on all final consumption expenditures for the supply of goods and services. Although VAT ultimately bears on the individual consumption of goods and services, liability for VAT is on the supplier of goods or services. VAT is a percentage tax levied on the price each taxpayer charges for the goods or services it supplies. VAT normally utilizes a system of tax credits to place the ultimate and real burden of the tax on the final consumer and to relieve the intermediaries of any final tax cost. VAT is calculated by applying the applicable rate at a taxable stage to the appropriate taxable base of goods or services; it is then reduced by the VAT (as indicated on the invoices delivered to the purchaser), which has directly affected the cost of the various elements constituting the price of goods or services. In Pakistan there are substantial deviations from this pure form of VAT (as in vogue in Europe and some other developed industrial societies), because of exercise of various tax rates, exemptions and concessions for certain goods and services and specific provisions governing importation and exportation. It is therefore not VAT but VAT-type tax in Pakistan.
The task of enforcing VAT in Pakistan is very difficult as more than 70 per cent of its economy is undocumented. Total untaxed part of the overall economy is 70 percent and, according to the current rate of tax collection, if it is taxed then current tax to GDP ratio could jump from 11 percent to 18.9 percent, with an addition of 7.7 percent. Dr. Aqdas Ali Kazmi, Joint Chief Economist, Planning Commission has stated this in his research paper Tax Policy and Resource Mobilisation in Pakistan. Dr. Kazmi has concluded that this 70 percent part of economy consists of 36 percent ‘pure’ black economy, 18 percent exempted economy, 9 percent illegal economy, 4.5 percent unrecorded economy and 2.5 percent informal economy (unreported economy). His study says that the problem in the low resource mobilisation is the rigid system of taxation, and the emphasis of the government to increase revenue, ignoring the details of the long-term policy measures.
VAT, in fact, ensures documentation in an economy that ultimately leads to better collection of personal taxes. This is why there is so much resistance against this VAT-type tax in Pakistan. The forces representing bazaar [different associations of traders] are not willing to come into proper personal tax net. The traders are not ready to pay personal taxes on their colossal but undeclared incomes. They know that they can pass on the burden of sales tax to consumers, but if they do so honestly and record each and every transaction, their personal incomes in the process will get documented on which they will have to pay tax from their own “pockets”. A perpetual policy of appeasement towards these forces by successive governments in Pakistan has resulted into many distortions in the economy.
While the traders have successfully avoided documentation of their transactions so far, the corporate sector has suffered irreparably due to heavy burden of taxes. This has not only resulted in the erosion of tax base but the State has always tried to compensate this loss by levying taxes on other entities from whom collection is relatively easier. All along the history of taxation in Pakistan, the corporate sector in Pakistan remained the target of highhandedness of the tax authorities and no serious effort was made to bring into the tax net the large population of traders, small businessmen who otherwise have larger profit margins due to less overhead expenses. This is in a nutshell the story of failure of the rulers and the tax managers that has crippled the economy of Pakistan and forced it to debt enslavement, a phenomenon that is now threatening the very survival of the country. The trio of corrupt rulers (comprising politicians and civil-military bureaucrats), profit-hungry traders and foreign donors is to be blamed for the present state of affairs.
The present state of our economy is not only precarious but is also rapidly deteriorating. The toughest challenge faced by the economic managers is to reduce ever-growing fiscal deficit. In the frenzy of collecting more and more taxes, the impact on the already ailing economy of harsh tax measures has been completely ignored. We are caught in a dilemma; on the one hand there is a pressing need for revenue mobilisation to reduce fiscal deficit and on the other the ailing economy is becoming worse because of new taxes or due to enhancement of rates of existing taxes.
The role of sales tax in this scenario is becoming highly controversial as to whether it will help in documenting the economy (thus leading to more revenue) or will further destroy the already sick industrial units, which are overburdened with taxes at source that create a serious liquidity crunch for them. The high cost of taxes for the industry is the main issue in the present debate to determine the emerging role of sales tax in Pakistan economy. The following figures, facts and observations are very relevant:
- According to the CBR’s most recent claims, it has achieved remarkable improvement in collection of taxes. CBR claimed to have netted 13.9 per cent more revenue during the period July 2000 to January 2001 i.e. Rs. 213.054 billion against the last year’s collection of Rs. 186.976 billion. CBR sources claim that the ongoing tax survey and austerity measures for the revival of economy has given a positive impact on the revenue generation, as a result of which, there has been a growth of around 14 per cent. The increase in direct and indirect taxes during July-January 2001 is 15.7 per cent and 13.2 per cent respectively. The CBR collected a gross sum of Rs. 70.196 billion in direct taxes and Rs. 174.990 billion in indirect taxes in the seven months of the current fiscal year. The direct taxes include income tax and wealth tax while the indirect taxes comprise sales tax, central excise duty and customs duties.
- The CBR claimed to be successful in broadening the tax base of various goods falling in the category of sales tax. There has been an increase of 34.4 per cent in the revenue collection under sales tax while revenue collection in other two indirect taxes (central excise and customs) fell by 9.4 per cent and 4.6 per cent respectively.
- During the current fiscal year, CBR collected a gross sum of Rs. 100.581 billion in sales tax comprising Rs. 49.671 billion in import-related sales tax and Rs. 50.910 billion in domestic sales tax. After refunding Rs. 17.282 billion, the net collection was Rs. 83.299 billion. This included Rs. 49.642 billion in import-related goods and Rs. 33.657 billion in domestic sales tax. Last year, CBR mopped up a gross amount of Rs. 76.071 billion in sales tax, but after a refund of Rs. 13.836 billion the net collection in sales tax was just Rs. 62.235 billion.
- The figures presented by CBR may look impressive, but these do not reflect the role of sales tax in our economy in the proper perspective. The growth of 33.8 per cent in sales tax claimed by CBR will not help Pakistan either to reduce its fiscal deficit or make a big leap towards economic revival as the over all short fall in revenue collection in the first seven months in nearly Rs. 12 billion. Independent economists and experts believe that performance highlighted by CBR is a mere jugglery of figures and in reality growth rate in tax collection in real terms is in negative. The key economic issue that needs to be resolved now is: should higher taxes and larger revenue collection be given priority consideration over economic growth in Pakistan?
- As a result of the constant focus on higher revenues, the economic growth, which was 6.77 per cent in the 1960s and 6.45 per cent in the 1980s, slumped to 4.59 per cent in the 1990s, according to official figures. And that is partially explained by the fact that the average revenue collection, which was 13.1 per cent of the GDP in the 1960s and 5.1 per cent in the 1980s, reached 17.1 per cent in the 1990s. The effort now is to collect more and more revenue although the economy is stagnant and a large part of the industrial sector is sick. So the low growth syndrome continues, and the GDP growth that was 4.8 per cent last year may be around 4.5 per cent or even less this year.
- Large revenue is undoubtedly needed and possible. The efforts to raise larger revenue through stern measures, but without a corresponding increase in economic growth, may have initial success but cannot sustain over a long period. The CBR is blamed for the small revenue of the State. The way it (dys)functions and (ab)uses its authority results in low tax collection. Surveys done by independent consultants show that 40 per cent of the potential revenue does not reach the State treasury. If most of the payments made by taxpayers had reached the treasury, total revenue collection this year should have been close to Rs 600 billion instead of the budgeted Rs 436 billion (now revised downward at Rs.430 billion).
- In the 1990s, our total tax revenue got stuck around Rs 300 billion for a long time: Rs. 292 billion in 1998-99, Rs 286 billion and 268 billion during the preceding two years despite far higher targets. Last year collection rose to Rs. 351.6 billion following rigorous tax collection, though it fell below the target of Rs. 356 billion. Encouraged by that, the tax revenue target for the current year was raised to Rs. 436.7 billion – a steep increase of Rs. 85 billion. However, there is a mounting pressure now on the CBR to revise it downward (as already been revised downward to Rs. 430 billion and there are chances of further downward revision) as there is shortfall of nearly Rs. 12 billion in the first seven months of the current fiscal year.
- There is now a very heavy reliance on sales tax while other tax collections are falling far below the targets fixed. Sales tax collections are to jump by Rs. 100 billion within three years from 1998-99 or from Rs 72 billion to Rs 172 billion this year. It means a rise of Rs 52.6 billion this year from Rs 120 billion last year, making sales tax the single largest source of revenue.
- It is an irrefutable fact that the incidence of sales tax finally falls on the consumers. If the people are forced to pay 15 per cent more for the things they buy, their purchasing power will be eroded substantially as there is no corresponding increase in their incomes. This will result in a sharp decline in demand. A fall in demand means a fall in production and a fall in production means a large fall in tax revenue. In Pakistan the industry is the largest tax-paying sector and any decrease in its income will have a negative impact on the tax collections in general and sales tax in particular. This phenomenon proved when large-scale industrial sector registered a negative growth of 0.7 per cent last year while the manufacturing sector overall grew by just 1.1 per cent.
- It should be remembered that the backbone of economy after agriculture is small and medium size manufacturing sector in which millions are employed. Poor industrial growth means large unemployment and no employment for new comers. VAT is destroying our medium scale manufacturing sector, as most of the units in this sector are dependent on informal sector for buying raw material. This sector is yet not compelled by the Government to issue tax invoices for input purposes. The result is complete distortion in VAT system that cannot be successful unless complete chain of transactions is ensured.
This is the emerging (disastrous) role of sales tax in Pakistan economy. It is causing deathblow to already sick industry. We have about 190 dead and sick industrial units and the number is on increase since 1990, when on the advice of IMF and the World Bank VAT at the exorbitant rate of 21 per cent was introduced. Since then, it is pushing more and more Pakistanis towards below poverty line. It has created and is bound to create more unemployment, as small and medium manufacturing units cannot survive in the VAT system. These units buy most of their inputs from informal sector, which is not at all ready to issue tax invoices.
The Government is forcing the manufacturing units to follow VAT but has adopted a policy of appeasement towards traders, wholesalers and retailers. They have been again allowed to remain outside the record-keeping regime and just pay turnover tax on self-determined sales! The recent amendment(s) in Sales Tax Act of 1990 that certain class of taxpayers cannot sell raw material to unregistered persons is a direct admission on the part of the Government that it has failed to widen the tax base of VAT by brining into its net the mighty traders. However, the Government again decided to penalize the manufacturing sector through this amendment, whereas the real culprits, persons not willing to come into registration and record keeping regime, have been left untouched. This is a strange strategy that one who is complying law is being punished and those who openly defy it are left unpunished.
According to a recent Gallop Survey, there are 2 million small business houses/outlets in Pakistan, which include small-size service providers. Out of 2 million, there are only 4,00,000 manufacturing concerns, rest are 6,00,000 commercial service providers like workshops, vocations like barbers, drycleaners, tailors, doctors, small schools etc, whereas one million are retail/whosale outlets/stores. This small business sector is not dependent on bank loans and truly represents our vernacular business sector, where ustad (teacher) and shagird (pupil) relationship still exists. This sector is facing three big problems to survive. The top most issue is growing highhandedness of tax officials, the other two are ever-increasing cost of utilities and lack of modern skills and technology. These units are worst hit by the system of VAT.
It is not possible to implement VAT in Pakistan at one go because of various reasons, especially due to the following:
- Lack of tax culture
- Poor tax administration
- Problem of widespread illiteracy,
- Lack of monetisation
- Poor accounting practices
It is interesting to note that CBR has created a situation of permanent disturbance through the vehicle of VAT, though the total number of registered taxpayers under this tax regime is just 91,000, out of which 25,000 has not paid any tax during the last six months. About 10,000 did not file any return at all! About 16,000 are those who were registered but did not have taxable turnover or have closed down their business since registration, courtesy highhandedness of Sales Tax staff. VAT cannot be enforced unless a proper audit system is ensured. At present CBR is conducting audit of only 1.2 per cent of registered persons, whereas the minimum international required standard is 25 per cent. This is the sordid story of our VAT system, about which we daily hear so much of hue and cry and which has created a situation of national crisis in business and industrial circles.
The problem of Pakistan is that its tax system is not equitable. The burden of taxes is already less on the rich and more on the poor. In the face of this reality, the government is resorting to regressive taxation like presumptive taxes in income tax and turnover taxes in the shape of multi-point sales tax. In the Pakistani perspective, the retail stage sales tax at a lower rate will be more beneficial from the point of view of generation of revenue, broadening of tax base and in the interest of the common people on whom the ultimate tax incidence lies. Taxation requires pragmatic thinking and is most effective when developed from the practical and possible agenda for building a sound tax administration. The widest possible taxpayer base has to be identified for any tax to be equitably spread across the whole taxpayer population. Even a small tax at a lower rate spread over a wide taxpayer base will invariably yield more revenue than a higher tax on a narrow base. The levy of VAT-type tax at 15% (16.5% where non-registered persons are involved) in Pakistan has failed to bring the desired results, as it is a higher tax on a narrow base. Had it been a 2 to 3% levy across the board, it could have been acceptable as well as successful in terms of yielding more revenue being a low rate tax spread on a wide taxpayer base.