Huzaima Bukhari & Dr. Ikramul Haq
The outdated and oppressive tax structures at federal and provincial levels, wasteful expenses, mounting debt servicing and annual tax expenditure of over Rs. one trillion have created fiscal instability since 2008. The coalition Government of Pakistan Tehreek-i-Insaf (PTI) is facing tough challenges on the fiscal front as ‘Summary of Consolidated Federal and Provincial Fiscal Operations, 2020-21, released by the Ministry of Finance on February 3, 2021, for the first six months of the current fiscal year, shows that even part of defence spending is now from borrowing. It is more than a fiscal fiasco—a serious concern threatening economic viability and a visible threat for national security. The reckless wasteful spending, unwise, imprudent and costly borrowing, both external and internal, has resulted in 15% increase in debt servicing, with fiscal deficit reaching Rs 1.4 trillion from July to December 2020.
Total tax revenue collection by Federal Board of Revenue (FBR) from July to December 2020 was Rs. 2.2 trillion and after transferring the shares to provinces under 7th National Finance Commission (NFC) Award (Rs. 1280 billion), the remaining funds available to federal Government from tax and non tax revenue of Rs. 861.6 billion was Rs. 1.79 trillion that could not even meet the two major heads, debt servicing of Rs. 1475 billion (domesticRs. 1357 billionandforeign Rs. 118 billion) and defence of Rs. 486.5 billion.
Punjab is the most populous [110 million people] province of Pakistan with largest resources and budget size after the Federal Government and beneficiary of lion’s share from NFC Award. From July to December 2020, it received Rs. 621.7 billionfromthe Federal Government and collected only Rs. 117.8 billion of taxes at its own. The total expenditure for this period of Punjab was just Rs. 621 billion, almost the entire amount received from share under the NFC Award.
The detailed analysis of challenges on the fiscal front are highlighted in ‘Towards Flat, Low-rate, Broad and Predictable Taxes’ (PRIME Institute, Islamabad, 2016, its revised and enlarged version of December 2020 is available free at: https://primeinstitute.org/towards-flat-low-rate-broad-and-predictable-taxes/). This innovative tax model presents ways and means for growth and prosperity as sufficient funds will be available to the federal and provincial governments to fund all current expenditures, development outlays and quality social services on the basis of reciprocity of taxes.
It includes a model ‘Pilot Project’ of low and flat rate taxation of retail sector showing its potential of US$ 5 billion whereas FBR in fiscal year 2019-20 collected total tax of Rs. 3998 billion that included total sales tax collection of Rs. 1596 billion (after retaining accumulated refunds of over Rs. 710 billion as on June 30, 2020). Surprisingly, the data released by Ministry of Finance in respect of federal and provincial fiscal operations for fiscal year 2019-20, is still showing collection of FBR at Rs. 3998 billion. It means due to artificially inflated tax collection figures by FBR, the provinces got more than their due share under the 7th NFC Award.
According to a Press report, a closed-door meeting on February 11 at the FBR headquarters with the Finance Minister “did not go down well with the top tax brass, which struggled to satisfy the minister over a 10-month delay in clearing the legacy of income tax refund claims and increasing corruption in the FBR”. According to details given in the report, “out of the Rs.328 billion income tax refunds, an amount of Rs. 82 billion was outstanding against 114,436 claims of up to Rs50 million each”. The report added that the Finance Minister “issued the instructions on April 16 last year—10 months ago—to clear these refunds and the orders were repeated again in July, with which the FBR management did not comply”. The Minister, according to report, during his recent visit to Sindh “received complaints about growing corruption in the FBR, including the misuse of offshore tax-haven information”.
The report further reveals that FBR “has also adjusted Rs. 51 billion worth of refunds against the tax demand. It received fresh income tax refund claims of Rs. 155 billion in the past seven months, which kept the overall income tax refund stock at Rs. 328 billion despite rejecting and adjusting old claims. “The issue of taxpayer refunds has remained a headache for every government. Although the FBR claims that it has increased sales tax refund payments in the past one year, this is because of ending the zero-rated facility for textile exporters”, the report adds.
According to report, “the presentation showed that during the past seven months, the FBR paid Rs.117 billion worth of sales tax refunds, which was equal to the fresh claims submitted during the current fiscal year. But Rs110 billion in refunds were related to the exporters, which mean that the rest of the businessmen suffered”.
It is worthwhile to mention that FBR’s officials on September 2, 2020, before the National Assembly Standing Committee on Finance conceded that actual liability of income tax and sales tax refund as on June 30, 2020 was Rs. 710 billion (sales tax Rs. 142 billion and income tax Rs. 568 billion).
Federal and provincial governments in Pakistan have shown a lukewarm attitude in restructuring the country’s tax system to achieve efficiency, equity and to promote economic growth. Complex tax codes, complicated procedures, reliance on easily-collectable indirect taxes, weak enforcement, inefficiencies, incompetence and corruption are main factors for low tax collection.
Instead of broadening the tax base and simplifying laws, federal and provincial governments offer amnesties, immunities, tax-free perks and perquisites to powerful segments of society. As a result of this policy mindset, ordinary businesses and citizens suffer. The above mentioned model presents radical revamping and restructuring of the entire tax system, suggesting broad, low, flat and predictable taxes.
Tax reforms undertaken to date, have mainly been patchwork, and proven to be exercises in futility. Tax reform commissions and consultative committees, constituted for reforming the system, have proven to be unsuccessful as they have been suggesting remedies for curing the incurable or otherwise curing symptoms rather than addressing the causes.
The reforms, including World Bank-funded six-year-long Tax Administration Reforms Project (TARP), have failed to motivate people towards voluntary tax compliance. The number of tax filers has fallen since 2003 (excluding those filing income below taxable limit of paying negligible amount to become part of Active Taxpayers List to avoid higher incidence of withholding taxes). In 2020, the Federal Government obtained loan of US$400 million for Pakistan Raises Revenue (PRR) Project. It may be mentioned that the total cost of Pakistan Raises Revenue (PRR) Project is estimated at US $1.6 billion, of which counterpart contribution is $1.2 billion and IDA financing is US$400 million. Following in the footsteps of the Federal Government, the Punjab Government also decided to borrow US$304 million from the World Bank for tax reforms and it was approved by Planning Commission on September 16, 2020. Like earlier programmes, these are also bound to fail having no research studies and understanding of our peculiar milieu—culture, behaviour of citizens, their values, mores and traditions.
The only viable option for meaningful change is to replace the existing tax system with lower, flat and a predictable tax system that is simple, pragmatic, growth-oriented, and broad-based tax system that allows all sectors to grow and ensure social mobility of the have-nots and less-privileged classes. With such a system in place, those who are not in the tax net or who avoid true disclosures would be induced to pay their taxes voluntarily. This should be coupled with transparent and quality spending of taxpayers’ money for welfare of society as a whole and incentivizing growth and economic well-being of every individual.
In the wake of Constitution (Eighteenth Amendment) Act, 2010 [“the 18th Amendment], the fiscal management, both at federal and provincial levels needs fresh thinking. The federal government, having all buoyant and broad-based taxes is not tapping the real tax potential even though the country is heavily indebted. On the other hand, provinces, which are almost entirely dependent on the NFC Award, have failed to raise their own sufficient resources for increasing needs of the ever-growing population.
The provinces must participate in national tax policy and collection apparatus as their share in NFC Award is larger than the federal government and Article 156(2) requires federalised and not centralised economic planning. There is a dire need for a new tax model entailing harmonised sales tax on goods and services and its collection through a single national agency as well as low tax rates on broader base, though distribution would be strictly through Article 160—all participating in retiring debt burden that would eliminate fiscal deficit.
This model analyses the structural and operational weaknesses of the existing tax system at federal level and suggests alternate solutions in the following areas that require fundamental reforms:
Complex Income Taxation: Simple, Flat-rate Taxation
Distorted/Multiple Sales Taxes Single-stage Sales Tax
Customs/SRO Culture Single-rate Customs Duty
Agencies National Tax Agency
Inefficient Appellate System Federal Tax Tribunal
These fundamental reforms will provide the basis for an alternate tax system. Tax reforms without a fair and efficient tax administration can never be enforceable. For this a new tax collecting agency, National Tax Agency (NTA), is proposed.
The officers of the Federal Board of Revenue (FBR) have reportedly suggested the name: Pakistan Revenue Board (PRB). Our suggestion is that this body, whatever may be the name, should not only be responsible for collection of taxes for federal, provincial and local governments but also to administer various social and economic benefits and incentive programmes, otherwise tax compliance will remain a distant dream. People must get free education, quality healthcare, decent housing/transport plus social security schemes, such as disability allowance, old age benefits, income support, child support, pension, just to mention a few, in lieu of paying fair taxes.
The NTA can be assigned the task of collecting all taxes for the federation (levied in terms of Article 142 read with the Fourth Schedule to the Constitution of Pakistan by federal and provincial parliaments). This is necessary for reducing the monstrous size of multiple collecting agencies at federal and provincial levels that are marked with inefficiencies, incompetence and corruption and creating unnecessary compliance cost, rather than operating under one-window. Presently, taxpayers have to deal with multiple tax agencies adding to their cost of doing business.
A well-equipped, automated and efficient tax agency is imperative to facilitate the citizens for discharging their tax obligations through one-window operation and also to disburse all tax-related benefits (pensions, social security, income support etc.). The non-existence of tax-related benefits is the most neglected area of our discourse on reforms.
The existing four-tier tax appellate system has also failed to deliver. The problems faced by taxpayers in appeals/references speak volumes of the ineffectiveness of various judicial forums that have been assigned the statutory obligations to safeguard them against unjust imposition of taxes. The revenue authorities are also unhappy with the tax appellate system as tax disputes take years for settlement. Therefore, in order to make the appellate system more responsive, the existing tax tribunals dealing with direct and indirect taxes need to be restructured.
The proposed model proposes a two-tier tax appellate system where first appeal goes to National Tax Tribunal with the right of another appeal in the form of intra court appeal. Subsequently, if any substantial question of law needs consideration, it can be referred to the Supreme Court by way of leave to appeal. This would help in achieving uniformity of decisions since at present, High Courts in different provinces sometimes differ on identical questions of law and it takes years for final authoritative pronouncement by the Supreme Court. The two-tier tax justice system can ensure expeditious settlement of tax disputes, preferably within a year’s time of first order.
Income taxation at the moment is highly complex and fragmented. There is classical taxation under various heads of income, while many transactional taxes, presumptive and minimum taxes have been added to distort the entire concept of personal income taxation. The proposed model suggests simple and flat rate taxation of 10 percent for all individuals with alternate tax of 2,5% of net wealth, whichever is higher and for companies and other entities tax at 20 percent.
The right to levy sales tax on goods rests with the federal government and that on services lies with the provincial governments. The segregated tax is causing lot of issues as to what constitutes “services”, “goods” and how to tax “composite work contracts involving both goods and services. Presently, federal sales tax on goods is fraught with exemptions, multiple rates and complicated procedures for various kinds of goods. The same position prevails with the provincial tax codes where telecommunication services are taxed at 19.5 percent in addition to 12.5 percent advance income tax paid by the subscribers and levy on activation.
The above harmful taxation, especially collecting 12.5% advance tax from millions of mobile and internet users having no income or income below taxable limit is unjustified, anti-growth and anti-investment.
According to latest data available on the website of Pakistan Telecommunication Authority (PTA), the total number of cellular subscribers as on December 31, 2020 is 176 million (82.34% teledensity), out of which 91 million are 3G/4G subscribers (42.43% penetration), 2 million basic telephony users (1.3 teledensity) and 93 million broadband subscribers (43.5 penetration). At present, the entire taxable population and even those having no income or income below taxable limit are paying income tax at source as mobile users, yet FBR, lender/donors/media are engaged in a vicious propaganda that people of Pakistan are tax cheats. This is highly lamentable.
In extreme days of financial hardships arising out of Covid-19 endemic, millions of mobile users, some of whom are even declared eligible for Ehsaas Emergency Cash Programme, are brazenly subjected to extortion by the Federal Government 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/immunities but the vast majority of population, even those living below poverty line, is forced to pay oppressive taxes. Adding insult to injury, they do not get in return even basic amenities of life (clean drinking water etc.), what to speak of free education/health care, decent living, and affordable public transport. The private sector cannot grow in these circumstances as there is no level playing field and excessive taxes create distortion in free market operations.
Another wrong notion is that traders and manufacturers do not pay income tax. The reality is that 4 million commercial/industrial electricity users are paying advance income tax and sales tax with electricity bills. Section 235(4)(a) of the Income Tax Ordinance, 2001 says that in the case of a taxpayer other than a company, tax collected up to Rs. 43,200 of a commercial electricity user shall be treated as minimum tax and no refund shall be allowed even in cases where losses are sustained, especially in the wake of Covid-19 endemic/lockdowns. Law recognises payers of advance income tax with electricity bills as “taxpayers”, but tax administrators and their bandwagoners call them tax chor (thieves) “defaulters” and “evaders” whereas State thieves—the mighty militro-judicial-civil complex, businessmen-turned-politicians, and powerful unscrupulous rich (mainly land grabbers) financiers of political parties—are given tax exemptions, concessions, waivers and amnesties.
The proposed model suggests single-stage, single-digit sales tax on goods by federal government at the rate of 5 percent across the board with no exemption, albeit exporters shall have zero-rated regime. The only exemption shall be on food, life-saving drugs, books, children’s garments and educational equipment.
Provinces can also consider imposing harmonised sales tax (HST) at the same rate on services, details of which require a separate study. Alternately, we should move towards unified sales tax on goods and services through national consensus whereby provinces give right under Article 144 to the National Assembly.
Under the current Customs Act, 1969, exemptions/concessions are granted to goods in three categories under Pakistan Tariff: (i) Fifth Schedule of the Customs Act and Statutory Regulatory Orders (SROs), (ii) Chapter 99 of Pakistan Customs Tariff and (iii) export promotion schemes announced from time to time.
There are over 5,000 effectively traded tariff lines and 2,448 tariff lines (33% are under 20% slab). In fiscal year, 2019-20, on 5,521-tariff lines additional customs duty (ACD) and on 2,075 tariff lines regulatory duty (RD) was charged. The heavy taxation at import stage (50% of FBR revenue is collected at import stage) provides incentive for smuggling, undervaluation, misreporting, mis-declarations and tax evasion. The SRO-based customs policy has rendered the actual tariff different from the standard tariff. As a result of this, customs tariff has multiple rates and several exemptions, and various “conditions and requirements” are to be fulfilled to avail those exemptions. This creates opportunities for the discretionary use of powers by officials, raising the cost of doing business and incentivising malpractices and mis-declarations for evading duties. Recognizing these problems, this simplified tax model proposes that there should be a single slab for all imports to end these undesirable practices.
The crux of proposed tax model is this: lower, predictable and broad-based taxes, administered through efficient tax apparatus enabling Pakistan to achieve fairness in taxation system. It will create incentives for better compliance and lead to accelerated economic growth. A paradigm shift is required to restructure the entire tax system to induce more investment, accelerate growth and ensure economic prosperity for the country benefitting all members of society.
The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)