Huzaima Bukhari, Dr. Ikramul Haq & Abdul Rauf Shakoori
The continuously declining dismal share of income tax in overall tax collection during the last many years testifies to the lack of judicious balance between direct and indirect taxes, resulting in declining tax-to-GDP ratio, huge budgetary gap, unsustainable debt burden/debt servicing, and above all, pushing millions of Pakistanis below the poverty line. Non-collection of income tax from the rich and mighty is the root cause of many distortions in our tax system. In the overall collection of taxes by the Federal Board of Revenue (FBR), nearly 75% of indirect taxes prove beyond any doubt that the very purpose of redistribution of wealth as the main objective of income taxation is being defeated and nullified.
Figures provided in the Year Book 2021-22 [Revenue Division, Ministry of Finance] confirm, overwhelming reliance on indirect taxation [even under the garb of income tax through presumptive/minimum tax regimes on a number of transactions] without evaluating its impact on the economy and life of the poor masses. It should be a serious cause for concern for the incumbent Prime Minister, Shehbaz Sharif, who seriously discussed the Chinese model of alleviation of poverty during his recent two-day [November 1-2, 2022] visit to Beijing.
It is well-established that indirect taxation under different withholding tax provisions, imposed in the Income Tax Ordinance, 2001, is being overlooked. The actual share of direct taxes in total tax collection for the last 15 years is not more than 25%, contrary to the claim of FBR of 37.2% in fiscal year (FY) 2021-22, 36.5% in FY 2020-21 and 38% in FY 2019-20 and for the two immediately preceding years. In fiscal year (FY) 2013-14, it was 40%—the same was the case for FY 2015-16 and 2016-17.
The above figures show stagnation in direct-tax-to GDP ratio during the rule [August 18, 2018 to April 10, 2022] of coalition government of the Pakistan Tehreek-i-Insaf (PTI)—though it came to power on the promise of providing justice that in tax context means more direct tax collection from the rich and lower rate of indirect taxes to stabilise prices, especially eatables. Food inflation during the tenure of PTI remained high and prices of imported wheat and sugar were beyond the reach of majority of 60 million living below the poverty line. In the face of these realities, the Prime Minister and Finance Minister(s) of the PTI coalition government, ousted by virtue of a vote of no confidence on April 10, 2022, were jubilant over exceeding (sic) targets by FBR, without examining the composition of direct and indirect taxes!
With the extraordinary surge in imports, the contribution of POL products alone stood at more than 40%, resulting in higher tax collection. Adding insult to injury, taxes collected at source on import of goods, contracts, and supplies of goods, were made minimum (in fact final discharge) in utter violation of the Constitution of Islamic Republic of Pakistan [“the Constitution”] as this could be levied in lieu of but not in addition to income tax, as held by Supreme Court of Pakistan in Elahi Cotton Mills Ltd. and others v. Federation of Pakistan through Secretary Finance, Islamabad [(1997) 76 TAX 5 (S.C. Pak)].
In substance, the above are indirect levies and in respect of taxation of services on a gross receipt basis amounts to encroachment on the rights of provinces as decided in Pakistan International Freight Forwarding Association v Province of Sindh & Another [(2016) 114 TAX 413 (H.C. Kar.)].
Not only is there an acute imbalance in direct and indirect taxes having pro-rich and anti-poor bias, there is a huge gap in the collection of income tax. According to Pakistan Telecommunication Authority (PTA), the total number of cellular subscribers as on September 30, 2022, was 194 million (87.98% teledensity), out of which 121 million were 3G/4G subscribers (54.65% penetration), 2 million basic telephony users (1.19 teledensity) and 124 million broadband subscribers (56.03% penetration).
Not less than 110 million cell users (many have more than one number) paid an advance/adjustable income tax of 15% from July 1, 2022 (earlier 12.5%). The poorest of the poor, about 90 million were subjected to income taxation having none or below taxable income. The gap in income tax filers alone is over 15 million. The income tax filers appearing on Active Taxpayers List (ATL) were 3,886,448 (individuals around 3,473,969) as on November 12, 2022, at 11 am, and the majority filed nil or below taxable returns.
In FY 2021-22, the FBR collected only Rs. 2301 billion as income tax. This shows shrinking share of direct taxes in total collection of Rs. 6149 billion of FBR that is merely 3.4% of GDP. It could have been 6% of GDP had agricultural income tax from the rich and mighty absentee landlords, was also collected. Dr. Muhammad Ashfaq, the previous Chairman FBR, rightly asked provinces to plug evasion by the rich landlords but his efforts remained unsuccessful.
Similarly, in sales tax, federal excise and custom duties, due to rampant corruption and inefficiencies, the total collection was far below actual potential. In fiscal year (FY) 2021-22, FBR collected Rs. 2532 billion under the head sales tax, Rs 320 billion under federal excise duty and Rs. 1009 billion under custom duties. Total indirect collection of Rs 3851 billion was pathetically low. It should have been at least Rs. 6000 billion.
If the existing tax gap is bridged, our tax collection at national level can reach Rs. 13 trillion (direct taxes Rs. 7 trillion and indirect Rs. 6 trillion) which would change the entire fiscal scene. We would have enough money for current expenditure, development and public welfare outlays—federal government would be able to retire debts in few years and we can easily become a self-reliant economy. However, this dream for Pakistan can never be realized unless the mighty sections of society are taxed according to their actual ability to pay and tax policy is used as a tool for rapid industrialization for the creation of job opportunities.
Determination of a tax base capable of measuring an individual’s ability-to-pay is a major problem of our tax system. This rule is incorporated in the form of progressive rate schedule for personal income tax, estate duty, and property tax in democratic countries. In Pakistan, we have gradually and deliberately moved from progressive to regressive taxation. The mighty civil and military bureaucrats (now an integral part of our landed aristocracy by earning State lands as meritorious awards and rewards), industrialist-turned-politicians and greedy businessmen are paying meagre personal taxes, whereas the poor people are subjected to pay sales tax of 17% and exorbitant rate of excise duty on many items of daily use. The incidence of regressive taxes on the poor is making their lives miserable beyond imagination.
The present tax policies are detrimental for economy, inclusive development, social justice, rapid sustainable growth, 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. The existing tax system protects the rich and exploitative elements that have complete monopoly over economic resources. There is no political will to tax the privileged classes.
Pakistan has been facing a variety of challenges on economic front, namely, resource mobilisation, reducing current/wasteful expenditures, curtailing fiscal, current and trade deficits and infrastructure development. One most ignored is improvement in tax-to-GDP ratio as the figures released by the Ministry of Finance for FY 2021-22 show it at dismal 10.1 percent whereas actual potential is 25%. The collection to this extent at national and provincial levels alone can address the unabated, continuous fiscal mess.
According to Year Book 2020-21 [Revenue Division], in total collection for fiscal year (FY) 2020-21, sales tax was the top revenue generator with 41.9% share, followed by direct taxes with 36.5%, customs 15.8% and FED 5.9%. During FY 2021-22, the share of FED (5.2%) marginally decreased, whereas customs duty (16.4%), direct taxes (37.2%) and sales tax (41.2%) increased slightly. Our policymakers need to study how the Indians increased their tax-to-GDP ratio from 9.9% to 18.3% in the last 10 years. Apart from many other successful initiatives, India utilised third party information that increased the capacity of Indian tax administration immensely and resulted in enormous revenue growth. On the contrary, we came down from 12.5% in FY 2017-18 to 10.3 in FY 2021-22 and official forecast for FY 2022-23 is just 9.9% as the will to collect taxes, especially income tax from the rich and mighty, has dwindled down to almost zero. There is an urgent need to reverse the imbalance between direct and indirect taxes.
Year Book 2021-22 [Revenue Division] admits that percentage of direct taxes was only 37.2% in total net collection and that of indirect taxes was 62.8%. If we exclude indirect taxes (presumptive and/or minimum), the ratio comes to 25%. It should have been the other way around. It is worth mentioning that in FY 2015-16 and 2016-17 under the government of Pakistan Muslim League (Nawaz) direct tax was 40% and indirect was 60%.
The incumbent government of Pakistan Democratic Alliance, representing 14 parties, must realize that lowering the burden of indirect taxes will reduce skyrocketed prices of common commodities substantially in use by the poor. Out of total tax of FBR, 80% should come from the ultra rich classes. It will not only increase tax collection, reduce disparities, enhance tax-to-GDP ratio, but also make tax collection judicious and equitable—shifting burden from the marganalised sections to the rich and mighty.
Huzaima Bukhari & Dr. Ikramul Haq, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE).
Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’. They have coauthored a book, Pakistan Tackling FATF: Challenges and Solutions