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Dr. Ikramul Haq & Abdul Rauf Shakoori
The financial viability of any country is dependent on its revenue generation capacity. Governments collect revenues through various sources such as taxes on incomes and/or assets, consumption and transfer receipts from natural and artificial persons. However, significant importance is attached to collection of direct taxes as it is linked with ‘ability to pay’ principle. Unfortunately, the successive governments in Pakistan—civilian and military alike—have been meeting tax revenue targets through imposition of regressive indirect taxes, even in the garb of income taxation. Consequently, Pakistan has witnessed unabated increase in the cost of doing business, high inflation and rising tide of wealth/income inequalities.
The governments’ inability to introduce an efficient and just tax system that can cater for the country’s needs often leads to a vicious debt trap where the gap between revenue and expenditures is bridged through borrowings. This compromises ability of the state to spend on the welfare of its citizens. It also hampers provision of basic facilities like health, education and infrastructure. Developing economies like Pakistan have been facing a formidable challenge in establishing an efficient tax policy framework. A huge portion of economy is still operating informally making it difficult for the governments to generate real potential of tax at federal and provincial levels.
In Pakistan Economic Survey for (2021-22) by Ministry of Finance and Annual Report 2021 (State of the Pakistan’s Economy) issued recently by the State Bank of Bank (SBP), a bleak picture of the economy is predicted for 2023—it should be a serious cause for concern for all. There is a consensus now that growth potential of the country is fast depleting. Tax revenues which were 13.4 percent of GDP during 1990s were reduced to 10.3 percent of GDP during 2000s. After falling into single digits in fiscal year (FY) 2007-08 and onwards, it again grew around 10.8 percent of GDP in FY 2017-18. However, post-2018, it has again decreased to an average of 9.5 percent. The Revenue Statistics in Asia and the Pacific publication 2022 by OECD unveils that the average tax-to-GDP ratio in the 28 Asian and Pacific economies in 2020 was 19.1 percent—significantly lower from OECD’s average of 33.5 percent. It is worthwhile to mention that our tax-to-GDP ratio was 10.4 percent in 2020 that was 8.8 percentage points lower than that of Asia and Pacific and 23.2 of OECD’s average.
It is well-established that Federal Board of Revenue (FBR) and provincial tax authorities over the period of time have collected overwhelming taxes through indirect mode—taxing goods and services at exorbitant rates rather than taxing incomes and assets. Indirect taxes take away larger share of the earnings of the poor than that of the rich.
During FY 2021-22, sales tax was the highest revenue spinner of FBR contributing about 41 percent share in total tax collection. If we include minimum taxes imposed on imports, contracts etc. under the Income Tax Ordinance, 2001 (“the Ordinance”), the ratio is as high as 70 percent. In FY 2021-22, the direct taxes collected by FBR were Rs. 2284.9 billion, constituting 37.2 percent of total tax collection—this included withholding taxes of Rs. 1534 billion i.e. 67% of total direct tax collection.
FBR Year Book 2021-22 contains an interesting analysis that during early 1950s, the main revenue collection source was customs duty contributing 66 percent of the total revenue while share of direct tax and sales tax was only 12 percent and 14 percent respectively.
Our tax-to-GDP ratio in recent years has gone down due to multiple reasons but major factors remain slow growth and ever-increasing size of informal economy. In their inability to broaden the tax base, tax policy design for FBR has been relying mainly to transactional changes like revision of tax rates or further extorting from the existing taxpayers and increasing rates of withholding taxes. Another impeding factor is the nexus between legislature and powerful elite of the country that has stunted the executive’s ability to grow financially. Taxing the rich and facilitating lower/fixed income earners or greenfield industries is always resisted by the powerful elites—militro-judicial-civil complex and unscrupulous traders—as it would eventually increase their tax burdens.
The continuous policy of appeasement reflects through multiple/frequent amnesties/immunities introduced by successive governments. Such schemes testify to flaws in the existing system confirming the governments’ inability to trace and track potential tax evaders and taxpayers who remain off the record. Instead of penalizing criminals, the state facilitates and incentivizes them causing the compliant ones to feel cheated losing faith and accentuating grip of the powerful on the system. Those having access to corridors of power maneuver the legislature for protection of mutual vested interests. It is also an incontrovertible fact the tax amnesties in recent past were extended to those sectors that lack potential for export-led growth e.g. real estate sector etc.
On the other hand, key contributors of formal economy have been excessively burdened with heavy taxes obstructing their ability to generate capital and employment ensuring economic growth and expansion. The classic example of this is imposition of enhanced super tax of 10% on airlines, automobiles, beverages, cement, chemicals, cigarettes & tobacco, fertilizers, iron & steel, LNG terminal, oil marketing, oil refining, petroleum and gas exploration and production, pharmaceuticals, sugar and textiles on income exceeding Rs. 300 million in addition to 29% corporate tax. The better course would have been windfall gain tax or excess profit tax after public debate.
In the same manner, insertion of section 7E in the Ordinance through Finance Act 2022 retrospectively for tax year 2022, in fact reintroduction of wealth tax on immovable property at the rate of one percent of fair market value, camouflaging it as deemed rent, reaffirms continuation of imprudent tax policy, besides being a patently unconstitutional measure.
Such shortsighted and anti-business measures have unfortunately been the hallmark of our tax policy for decades. In the last few years, we have witnessed that aggressive steps taken by the government have not only increased the cost of doing business but also created survival issues for the common man.
The policy of meeting fiscal needs by imposing additional and/or oppressive taxes is a flop idea. Additionally, import ban has added further miseries for the manufacturing industry as well as small traders. The orthodox approach of our policymakers has failed to harness the benefits of real tax potential. They also do not realise that the traditional revenue generation measures are not enough to meet demands of the fifth largest populous country in the world.
In the era of fourth industrial revolution, we have to incentivize the tech sector and need to invest and educate our new generation so that in coming years we can compete with the global world as highlighted in Towards Flat, Low-rate, Broad and Predictable Taxes (PRIME Institute, Islamabad, published in December 2020), Tax Reforms in Pakistan: Historic & Critical Review (PIDE, 2020) and PIDE Reform Agenda for Accelerated and Sustained Growth [2021]..
It is high time that in 2023 all stakeholders should work together to restore the trust/confidence of existing/potential investors/taxpayers in the system. The governments—federal and provincial—should reconsider their approach of extracting the maximum from limited pool of people rather than look for new avenues of revenue generations so that the desired results can be generated with lower tax rates on the widest possible base to fill these huge fiscal gaps.
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Dr. Ikramul Haq, Advocate Supreme Court and writer, is Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow 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 recently coauthored a book, Pakistan Tackling FATF: Challenges and Solutions with Huzaima Bukhari.