The quest for tax reforms

Huzaima Bukhari & Dr Ikramul Haq

The Federal Board of Revenue (FBR) surpassed the revised targets for fiscal year (FY) 2020-2021 and for the first four months of the current FY (see details below) as elaborated by Chairman of FBR in a seminar held by PRIME Institute in Islamabad on November 17, 2021 where keynote speech was given by Dr. Arthur B.  Laffer on flat rate taxation and other issues regarding structural reforms for the prosperous future of Pakistan. In FY 2020-21, for the first time in the history of Pakistan FBR collected Rs. 4734 billion. It was laudable, but fell short of the original target of Rs. 4963 billion assigned when budget for FY 2021 was announced. FBR showed 18% growth over FY 1999-20 and 31% in the current fiscal year. In the remaining eight months, with this extraordinary growth rate, FBR can exceed the target of Rs. 5.8 trillion and even cross the figure of Rs. 6 trillion—a quantum jump in two years.

FBR Collection: October 2020 to October 2021

										Rupees in million
Revenue Head	Oct-2020				Oct-2021					Growth
	Gross	Refund		Net	Gross		Refund		Net	Absolute	%age
Income Tax	110,305	64		110,241	143,859		1,916		141,943	31,702	28.8
Sales Tax	167,452	15,144		152,308	223,365		22,861		200,503	48,195	31.6
Federal Excise	22,445	0		22,445	25,817		0		25,817	3,372	15.0
Total IR	300,202	15,208		284,994	393,041		24,777		368,263	83,269	29.2
Custom Duty	53,894	1,690		52,204	75,635		3,833		71,802	19,598	37.5
Grand Total	354,097	16,898		337,199	468,676		28,610		440,066	102,867	30.5
Revenue Head	Up to Oct-2020				Up to Oct-2021					Growth
	Gross	Refund		Net	Gross		Refund		Net	Absolute	%age
Income Tax	477,155	4,243		472,912	626,389		2,743		623,646	150,733	23.9
Sales Tax	646,301	59,121		587,180	903,702		74,677		829,024	241,845	42.1
Federal Excise	80,891	0		80,891	96,752		1		96,751	15,860	21.3
Total IR	1,204,347	63,364		1,140,983	1,626,843		77,422		1,549,421	408,438	35.8
Custom Duty	208,989	2,569		206,420	304,682		13,118		291,564	85,144	41.9
Grand Total	1,413,336	65,933		1,347,402	1,931,525		90,540		1,840,985	493,582	36.6

Collection vs Target – Oct 2021				Rs. in Million
Revenue Head	Target	Collection	Diff	Achieved %
Income Tax	136,600	141,943	5,343	103.9
Sales Tax	168,000	200,503	32,503	119.3
Federal Excise	27,000	25,817	(1,183)	95.6
Total IR	331,600	368,263	36,663	111.1
Custom Duty	65,200	71,802	6,602	110.1
Grand Total	396,800	440,066	43,266	110.9

Collection vs Target – Up to Oct 2021
Revenue Head	Target	Collection	Diff	Achieved %
Income Tax	565,900	623,646	57,746	110.2
Sales Tax	692,400	829,024	136,624	119.7
Federal Excise	95,200	96,751	1,551	101.6
Total IR	1,353,500	1,549,421	195,921	114.5
Custom Duty	254,000	291,564	37,564	114.8
Grand Total	1,607,500	1,840,985	233,485	114.5

The tax-to GDP ratio, however, went down to 11.5% under the coalition Government of Pakistan Tehreek-i-Insaf (PTI) in FY 2020-21, according to Summary of Consolidated Federal and Provincial Fiscal Operations, 2020-21, available on website of Ministry of Finance (MoF). The FBR, according to Summary of Consolidated Federal and Provincial Fiscal Operations, 2020-21, collected taxes of Rs. 4764 billion and all the provinces together of Rs. 508 billion only. The MoF took figure of direct taxes of Rs. 1731.8 billion, which included contributions for Workers Welfare Fund (WWF) and Workers Profit Participation Fund (WPPF).  FBR showed this figure in its YEAR BOOK 2020-21 at Rs. 1726 billion (net) depicting growth of 13.3%.

FBR is a highly ignored institution. Successive governments, civil and military alike, have failed to provide it with basic logistic facilities, what to speak of modern tools to bridge monstrous tax gap through widening tax base. In this background and amid the sluggish economic activities during most part of FY 2020-21, due to the third deadly Covid-19 wave, surpassing even the difficult third revised target of Rs. 4691 billion by Rs. 41 billion (FBR’s Press release) was highly laudable as discussed in detail in Historic collection by FBR, Business Recorder, July 2, 2021.

We neither have a centre of excellence for fiscal research and administration nor trained staff to counter massive tax evasion and avoidance. It is heartening that a committee is now formed to formulate a single IRS code merging all the tax laws administered by Inland Revenue Service, namely, Income Tax Ordinance, 2001, Sales Tax Act, 1990, Federal Excise Act, 2015 and Sales Tax on Services Ordinance, 2001 for Islamabad Capital Territory (ICT).  This will be a milestone provided that simplification of tax codes is made and singly page tax return is devised without declaration of assets and liabilities (see details in Simplification of taxes for growth—III, Business Recorder, April 2, 202 .

  The FBR YEAR BOOK 2020-21 mentions as under:

“FBR’s revenue collection has also evinced a remarkable growth during FY 2021. After two lean years FY 2019 and FY 2020 ending with a growth of -0.4 and 4.4 percent, FBR revenue collection recorded a growth of 18.4 percent during FY 2021. In absolute terms, FBR collected Rs. 4,734.2 billion, which is Rs. 736.8 billion higher than FY 2020. The achievement is historical as it is for the first time that FBR’s collection has surpassed the psychological target of Rs. 4 trillion. The revised target has been surpassed by around 1 percent. Sales tax and customs recorded growth of 24.1 percent and 19.3 percent, followed by direct taxes 13.3 percent and FED 11.6 percent”.

[underlined for emphasis]

In FY 2020-21, FBR collected only Rs 1692 billion as income tax showing a shrinking share of direct taxes in total collection of Rs 4764 billion that is merely 3.6% of GDP. It could have been 7% of GDP alone if agricultural income tax from the rich and mighty absentee landlords was collected on their actual incomes and collection by FBR was exclusive of monstrous tax expenditure of Rs. 2.3 trillion in FY 2018-19 and 2019-20. The present Chairman FBR has rightly asked provinces to join hands to plug evasion of agricultural income tax by the rich landlords and his efforts must be supported. Taxing “agricultural income” is the sole prerogative of provincial governments under the Constitution of Islamic Republic of Pakistan [“the Constitution’]. All four provinces have laws for imposition of agricultural income tax (AIT) the share of which, in total tax revenue of Rs. 4.75 trillion in fiscal year 2019-20 (11.4% of GDP) was only (0.06 % of GDP). Share of agriculture in GDP of Rs. 44.7 trillion was around 19%.

Results for the first four months of the current fiscal year showing growth of 28.8% under the head income tax after paying off refunds of Rs. 1916 million, confirms the necessary corrective measures. If FBR collects Rs. 5000 billion income tax in next two years, it will be a great leap forward. How to collect this amount is discussed in detail in Towards Flat, Low-rate, Broad and Predictable Taxes (PRIME Institute, December 2020) and Tax Reforms in Pakistan: Historic & Critical Review (PIDE, Islamabad).

In sales tax, federal excise and custom duties, due to rampant corruption and inefficiencies, the total collection is much below the actual potential. In FY 2020-21, FBR collected Rs.1990 billion under the head sales tax, Rs 277 billion under federal excise duty and Rs. 765 billion under custom duties. Total indirect collection of Rs 3032 billion was pathetically low. It should have been at least Rs 5000 billion. The total tax collection at national level in FY 2020-21 was Rs. 5272 billion whereas all the provinces together contributed only 1.1 percent of the GDP and share of agricultural income tax was as low as 0.06 percent of GDP. There is thus an urgent need for fundamental structural reforms to harness the actual tax potential as suggested in the seminar held in Islamabad on November 17, 2021 and endorsed by Chairman FBR in his speech as well as conveyed to Prime Minister of Pakistan by Dr. Laffer in a meeting the next day.

The total current expenditures (both federal and provincial consolidated) in FY 2020-21 were Rs. 10,400 billion that is 22% of GDP. A country having tax-to-GDP ratio of 11% incurred cost of debt servicing of 12% GDP alone in FY 2020-2021. This exposes its national security vulnerability and even bulk of defence expenditure was through borrowed funds. In these circumstances, can we continue with huge tax expenditure for the militro-judicial-civil complex and their pensions met from further borrowing—both internal and external?      

If existing tax gap is bridged, our revenue collection can reach Rs. 10 trillion (direct taxes Rs. 7 trillion and indirect Rs. 3 trillion) which could change the entire fiscal scene. We would have enough money for current expenditure (must be reduced drastically through lean federal and provincial governments and ending wasteful expenses), development and public welfare outlays—government would be able to retire debts in just a few years and we can easily become a self-reliant economy. However, this dream for Pakistan can never be realised unless all sections of society are taxed according to their actual ability to pay at lower rate with broadest possible tax base. The tax policy must be used as a tool for rapid industrialization and creation of job opportunities rather than funding inefficient governments.

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The writers, 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)