Distorted tax base & oppressive exaction

Huzaima Bukhari & Dr Ikramul Haq

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 in 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 top tax administrators of Federal Board of Revenue (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 a narrowed tax base rather than imposing lower taxes on broader base.

The above point has been mentioned many times [‘Fixing the ailing tax system’, Business Recorder, March 1, 2019, ‘Of taxpayers & non-filers’, Business Recorder, October 27, 2016, ‘Fallacies about tax base’, Business Recorder, August 21, 2015 and ‘Improving tax compliance’, Business Recorder, July 24, 2015,] that there are over 90 million unique mobile users who pay advance, adjustable income tax in Pakistan but return filers are pathetically low (2,666,256 for tax year 2018).

Source: FBR Year Book 2018-19

After about relief of 10 months, at least 95 million unique mobile users [as per website of Pakistan Telecommunication Authority (PTA), total cellular subscribers as on March 31, 2019 were 159 million, but many have multiple and/or dormant SIMs] after vacation of stay by Supreme Court on April 24, 2019 in Human Rights Case (HRC No. 18877/2018) have started paying 19.5% sales tax on services to provinces, 17% federal excise duty along with 12.5% income tax to FBR, and 10% service/maintenance charge with effect from April 27, 2019. According to submission of PTA, during the period of stay [June 11, 2018 to April 23, 2019] by Supreme Court, Rs. 90 billion tax was not collected by mobile companies. Total number of mobile users as on November 30, 2019 was 167 million as per PTA.  

After vacation of stay, millions of Pakistanis, having no taxable income or income below taxable limit, are again subjected to extortion in the name of advance income tax. This is the real dilemma of Pakistan—those having enormous incomes and assets are being offered frequent and generous amnesties and the vast majority of population, even those living below poverty line, are forced to pay exorbitant taxes. Adding insult to injury, they do not get in return even basic amenities of life, what to speak of free education and health facilities. 

The prevailing tax system is unjust, outmoded and unproductive with high taxes, yielding low revenues made worse by complex, time-consuming and costly operational procedure. It is not taxing the people according to their ability to pay but relying mainly on indirect taxes that are regressive, as these take a much larger percentage of earnings from low-income families than from high-income earners.

Let us try to determine a rational income tax base. According to 2017 official census, our population [provisionally] was 207.7 million (by February 25, 2020, it is estimated at 208.14 million). Dependent population of children under the age of 15 years as on June 30, 2019 was 35.4% while 4.2% people were above 65 years. Out of total population, 40 million were below poverty line earning less than two dollars a day. Our labour force was around 70 million—majority of it based in rural areas [42.3%] that earned below taxable income or agricultural income falling outside the ambit of Income Tax Ordinance, 2001.

Analysing all the above figures (juxtaposed), individuals liable to income tax could not be more than 4 million to file tax returns in tax year 2019. The FBR after extending the date to February 28, 2020, hope to receive 2.8 million returns. FBR collected 12.5% advance, adjustable income tax of 17.187 billion from 95 million unique mobile users alone during the fiscal year 2018-19 and in 2017-18 this figure was Rs. 47.38 billion. For tax year 2018, out of these only 2,666,256 (2.8%) filed tax returns after availing many months of relaxation—the due date of September 30, 2018 was extended up to April 30, 2019! After a generous amnesty, FBR was hopeful that the figure of income tax return filers may go up to 3 million—this figure was not achieved, and a huge gap of around 1.5 million still exists even for tax year 2019. The exact position will be ascertained once deadline for filing return for tax year 2019 expires.  

An analysis of FBR Year Book 2018-19  reveals the following:

• “The target for FY 2019-20 i.e. Rs.5503 billion [it is nor reduced to Rs. 5.2 trillion] requiring around 43% growth, is highly challenging, which would be possible only through extraordinary concerted efforts by the senior FBR management and field formations”.
• FBR collected Rs. 3,828.5 billion during FY 2018-19 against Rs. 3,843.8 billion during FY 2017-18 indicating a negative growth of 0.4%. The revised revenue target of Rs. 4,150 billion was achieved to the extent of 92.3%. Direct taxes, sales tax, FED and customs missed their respective targets by 12.9%, 2.1%, 10.5% and 6.7% respectively.
• During FY 2018-19, FBR missed the target by around Rs. 321.5 billion mainly for the following major reasons:
  • Petroleum (-) Rs. 96 billion
  • Telecom—Suspension of withholding tax by Honorable Supreme Court (-) Rs. 55 billion
  • Reduced Government Spending (-) Rs. 80 billion
  • Import compression (withholding at import stage) (-) Rs. 16 billion
  • Reduced rates on salary income announced in the Budget 2018-19 (-) Rs. 50 billion
  • Reduction in Customs Duty (-) Rs. 50 billion
• In the collection for FY 2018-19, sales tax was the top revenue generator with 38.1% share followed by direct taxes with 37.8%, customs 17.9% and FED 6.2%. During FY 2018-19 the share of customs duty and FED increased, whereas the share of direct taxes and sales tax decreased slightly. The overall growth in collection remained dismal during FY 2018-19 at (-) 0.4%, which is Rs. 15.3 billion lesser than the collection of FY 2017-18.
• During FY 2018-19 refunds of around Rs. 121.6 billion were paid, as compared to around Rs.154.7 billion in FY 2017-18. The refund amount paid during FY 2018-19 is 33.1 billion which is less compared to previous fiscal year (PFY).
• Direct taxes have contributed 37.8% to the total tax collected during FY 2018-19. Net collection stood at around Rs. 1,445.4 billion reflecting a growth of (-) 5.9 % over the PFY collection of Rs. 1,536.6 billion. An amount of Rs. 83.9 billion has been paid back as refund to the claimants in FY 2018-19 as against Rs. 69.5 billion during FY 2017-18. Collection of income tax comprises withholding taxes (WHT), Advance Tax/Payments with Returns and collection on demand (COD). Collection from arrear demand and current demand has been Rs. 18.7 billion and Rs.84.2 billion respectively during FY 2018-19. Collection from current demand showed negative growth of (-)1.1%.
• Advance Tax/Payments with Returns under the head income tax: Rs. 384 billion was collected during FY 2018-19 as compared to Rs 374 billion in the FY 2017-18. Major component of this mode of payment is Advance Tax where a sum of Rs 344.2 billion stood collected as against Rs. 335.8 billion in FY 2017-18 registering a growth of 2.5%. The second component is payment with returns, where a sum of Rs 39.3 billion has been collected during FY 2018-19 against Rs. 38.1 billion in FY 2017-18 registering a growth of 3.0%.
• WHT contributes a major chunk i.e. 67% of the total collection of income tax. The WHT collection during FY 2018-19 has been Rs. 960.7 billion against Rs. 1047 billion indicating a negative growth of 8.2%. The nine major components of withholding taxes that contributed around 80% to the total WHT collection are: contracts [Rs. 235.4 billion], imports [Rs. 221.8 billion], salary [Rs. 76.4 billion], telephone [Rs. 17.1 billion], dividends [Rs. 57.0 billion], bank interest [Rs. 58.1 billion], cash withdrawal [Rs. 32.0 billion], electricity [Rs. 35.5 billion] and exports [Rs. 34.4 billion]. As far as growth is concerned, collection from bank interest grew by around 27%, exports (22%), electricity bills (5%), imports (1%) while rest of the items recorded a negative growth in collection. The highest contributor in withholding taxes is contracts with 24.5% share, followed by imports (23.1%) and salary (8%). Further break-up reveals that the share of only two heads of WHT i.e. contract and imports is around 48% and further addition of withholding tax on salary raises the share of these three items to more than 55% of the total withholding taxes, showing high reliance on fewer heads.
• Higher reliance on withholding taxes and within withholding taxes a high concentration on a few items makes the income tax revenues vulnerable. Moreover, taxing the already taxed, is a regressive approach which creates burden on the compliant taxpayers hence, FBR is focusing on working out a plan to diversify the base of income tax in the country.
• Direct taxes are collected from manufacturing, services, construction, whole sale and retail trade, transport and mining and quarrying. Major contributor is manufacturing sector with around 34.5% share in direct tax collection. Second major contributor is the services sector with around 24.2% share in collection. The share of wholesale & retail trade and transport sector is 2.9% and 2.3%, which is in fact very low as against the existing potential in the country.
• Wholesale and Retail Trade sectors together paid Rs. 48.2 billion: Large Retail Trade (7.9 billion), Small Retail Trade (9.7 billion) and Wholesale Trade (25.1 billion).
• During FY 2018-19, sales tax remained top revenue generating sources of federal tax receipts after direct taxes. It constitutes around 38.1% of the total net revenue collection. Collection during FY 2018-19 has been around Rs. 1,459.2 billion against around Rs. 1,485.3 billion in the PFY. Overall sales tax collection registered negative growth of -1.8% and around Rs. 26.1 billion of lesser amount has been collected during FY 2018-19 as compared to the collection of previous year. The downward revised target of sales tax has been met to the extent of around 97.9%. Major reasons of shortfall in the collection of sales tax domestic and imports during FY 2018-19 are following:
  • A sharp reduction in the GST rate on Petroleum Products at both import and domestic stages            
  • Reduced GST on Natural Gas
  • Import compression
• Domestic sales tax collection recorded a negative growth of 1.9%, whereas collection of sales tax on imports recorded a negative growth of 1.7%.The overall net collection of Sales Tax Domestic (STD) was Rs. 648.9 billion against Rs. 661.1 billion in the PFY and the net collection grew by (-) 1.9%. In absolute terms Rs. 12.2 billion less amount of revenue has been collected in FY 2018-19 as compared to PFY. The POL products the top revenue generating source, with 38.3% share, its collection grew by 4.9% during FY 2018-19. The collection from sugar, cigarettes, withholding agents, food products and electrical energy recorded a growth of 31.8%, 12.6%, 9.9%, 9.6% and 7.5% respectively during the period under review. On the other hand negative growth was recorded in cement, aerated waters, iron & steel and motor cars.
• Sales tax on imports (STM) is a significant component of federal tax receipts. The share of STM in total sales tax net collection has reached to around 55.5%. The net collection of STM during FY 2018-19 stood at Rs. 810.4 billion against Rs. 824.2 billion in FY 2017-18, registering a negative growth of 1.7%.
• Top 10 commodities of sales tax import have contributed a major chunk i.e. 76.5% in STM collection. The detailed data indicates that more than 59.6% of STM is contributed by POL products (Ch:27), machinery (Ch:84 & 85), iron & steel (Ch:72) and vehicles(Ch:87).
• Like sales tax (domestic), petroleum is the leading source of sales tax collection at import stage as well. Its share in sales tax imports is around 27.3%. During FY 2018-19 collection from POL products was Rs.221 billion against Rs. 264 billion during FY 2018-19 reflecting a growth of (-) 16.2%.
• Customs duty constitutes around 28.7% and 17.9% of the indirect taxes and federal taxes respectively. The share of customs duties in FBR collection is gradually increasing. The net collection from customs duty during FY 2018-19 has been around Rs. 685.6 billion indicating growth of 12.7%. The healthy growth in customs collection has helped the overall FBR revenues positively. Out of total net collection under the head Customs of Rs. 685.575 billion, the share of vehicle (non-railways) is Rs. 81.459 billion. POL products are the second major contributor of customs duty [Rs. 79.3 billion], Machinery & Mechanical Appliances [Rs. 42.5 billion] and Electric Machinery [Rs. 42.4 billion].
• Collection from Federal Excise Duty (FED) was Rs. 238.2 billion. FED constitutes 10.0% of indirect taxes and 6.2% of total federal taxes. The major sectors which contribute in FED revenues are tobacco [Rs. 91 billion], cement [Rs. 56 billion], beverages [Rs. 23 billion], natural gas [Rs. 10 billion] and edible oil [Rs. 6 billion] and some of the services. The tobacco (cigarette) is the top source of FED collection with around 38% share in FED revenue. The collection from cigarettes grew by around 36% during FY 2018-19. The second major sector is the cement which contributes about 24% in FED revenue. Nearly 94.6% of FED collection is realized from five items.

According to FBR’s Year Book 2017-18, total direct tax collection in 2017-18 was 1536.6 billion, out of which income tax was Rs.1528.5 billion—Rs. 1047 billion from WHT(68.5%), Rs.335.79 billion came as advance tax (21.9%), Rs. 41.64 billion with returns (2.7%) and Rs.1.31 billion under ‘Tax Arrears Settlement Incentive Scheme (TASIS) 2008’ (.08%). FBR’s own efforts (collection on demand) yielded only Rs. 102.82 billion (6.7%)—from arrears Rs. 17.69 billion (1.2%) and from current demand Rs. 85.13 billion (5.6%). It confirms negligible share on the part of FBR to tap the actual tax potential as it would have been hurtful to the rich, majority of which are non-filers, despite having substantial undeclared, untaxed wealth and the audacity of ruling this country as a matter of right. They are ready to pay additional tax at source as non-filers but are not inclined to file tax returns.

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 among others, consumption, expenditure, investment, and in many cases just transactions that are devoid of any income-yielding activity. 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. The World Bank in its Project Information Document (PID), updated on April 22, 2019, reported as under:

“Income tax receipts come from a small number of taxpayers due to generous thresholds for individuals and widespread tax evasion.The budget law adopted in 2018 reduced the maximum income tax rates from 35 to 25 percent and for firms and from 25 to 15 percent for individuals. It also raised the threshold for Personal Income Tax to PKR 400,000 (around US$2,860 – approximately double the per capita GDP), with a nominal tax up to PKR 2,000 applied to incomes up to PKR 1.2 million (around US$8,580 – more than 5.5 times the per capita GDP). ^[1] Only incomes above PKR 10 million (around US$71,500) are subject to the maximum rate of 15 percent. In addition, legal loopholes combined with weaknesses in compliance enforcement enable large-scale tax evasion, which also erodes the tax base. While people and firms unregistered as taxpayers pay GST and income tax withheld on their transactions (e.g., by banks, telecom, and utility companies), the number of taxpayers who file tax returns (for GST and/or income tax) remains very small at 1.52 million, while those who declared incomes above the taxable threshold amounted to only 1.12 million FY2017/18 (Table 1)”.

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 indicating 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 prominent journalist, 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 are 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, presently Vice-Chancellor of PIDE and 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.”

Elites and the rich are not sharing the burden of taxes due from them—the rich and mighty are not paying taxes according to their ability. From tax year 2013 to 2018, less than 40,000 paid income tax between Rs one million and Rs. 10 million, and less than 5,000 declared tax over Rs 10 million.

Sparing the ultra-rich and offering them unprecedented amnesties and asset-whitening schemes, who are deliberately avoiding tax obligations, and taxing the millions having incomes below taxable limit, is a gross violation of Article 3, 4 and 25 of the Constitution. Why should poor people paying 12.5% advance income tax as mobile users, having income much below the taxable limit, hire a tax adviser to file return and pay money to get refund? The cost will be much higher than what is refundable, and that too is hardly paid by FBR!! The extreme injustice in tax system demands a widow and a senior citizen to pay 10% income tax on gross yield earned from Bahbood [welfare] Certificate or Pension Account of National Saving Scheme. On the other hand, the rich and mighty landowner, absentee landlords are paying meagre or no tax.

FBR has failed to tax those who have amassed mammoth wealth, some of them availed generous amnesties—see details in Amnesties and tax losses,Surkhiyan , November 13, 2019. Had they been taxed at normal tax rates, collection could have reached Rs. 8 trillion. This target is still achievable provided collection is fully automated, tax machinery is overhauled, leakages are plugged and all exemptions/concessions to the privileged classes are withdrawn. Banks, WAPDA, PTCL and mobile companies that collect advance taxes on behalf of FBR are fully computerised. By using their database, FBR can easily determine fair tax base and tax due from the ultra-rich, which they are avoiding/evading. Provisional assessments and recoveries can be made in respect of persons who are not filing tax returns but earning substantially.

At present millions of mobile users having below taxable incomes are paying income tax at source, yet FBR is engaged in a vicious propaganda that people of Pakistan are tax cheats! This is highly deplorable especially when small traders using commercial electricity connections are paying advance income tax under section 235 and all millions of mobile users under section 236 of the Income Tax Ordinance, 2001. It is an undeniable fact that FBR has miserably failed to get due tax from the rich—its main emphasis is on withholding taxes that is borne even by millions having income below taxable limits. This is the worst one can expect from a government whose head keeps on making tall claims to rebuild Pakistan on the principles of Riyasat-i-Madina.  

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The writers, lawyers and authors, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)    

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[1] These exemptions apply to individuals who draw more than half of their total taxable income from salaries.