The peculiar case of taxation

And Pakistan’s present predicament

International Monetary Fund’s (IMF) ninth review was successfully completed some days ago. We missed targets to the two key quantitative performance criteria on Net Domestic Assets (NDA) of the State Bank of Punjab (SBP), the fiscal deficit target and the indicative target on tax revenue.

Yet, according to IMF, Pakistan’s economic projection for 2015-16 seems to be rising positively. The GDP is expected to grow by almost 4.5 percent; inflation wouldn’t be increasing until the end of the fiscal year. At $15.2 billion, foreign exchange reserves are considered satisfactory, rising by $1.7 billion in the first quarter of 2015-16.

But to burst the bubble, the future of Pakistan, which is habitual of taking loans for paying loans, is not as optimistic as portrayed.

Failure to meet the targets means Pakistan needs to work harder on its revenue generation, which, if rumours are to be trusted, would be through an increase in indirect taxation.

The first quarter Federal Bureau of Revenue (FBR) revenue target managed to fall short by Rs40 billion. Only 0.3 percent (500,000) of Pakistanis pay direct tax according to a report by advocacy group Research and Advocacy for the Advancement of Allied Reforms (RAFTAAR).

The report found that Pakistan’s tax revenue collection has remained flat for the most part of the last decade. With a tax-to-GDP ratio of 9.4 per cent, Pakistan falls close to the bottom in the ranking of countries on the basis of revenue collection.

The main cause of this low ranking, the report states, is a narrow tax base, with only about 10 percent of those employed paying tax, and a twisted tax structure, with 68 percent of the tax revenue being generated from indirect taxes. (Indirect taxes work by increasing the price of goods and services, so when consumers buy the good they pay a definite tax).

IMF and debt

A report by the Economic Affairs Division (EAD) for the Senate Finance Committee revealed that successive governments during the last 10 financial years obtained loans of $22.7 billion from multilateral institutions. The World Bank and Asian Development Bank were the main donors with the assistance of over $8.3 billion each.

Pakistan’s tax revenue collection has remained flat for the most part of the last decade. With a tax-to-GDP ratio of 9.4 per cent, Pakistan falls close to the bottom in the ranking of countries on the basis of revenue collection

The report did not include loans obtained from IMF during the past decade. If IMF loans were included then the figure would cross $45 billion.

IMF has a specific mandate. It was designed to help countries caught in a temporary balance of payments difficulties. Pakistan has had 12 IMF programmes since 1988, more than any country in the region. IMF has the right to examine the budgets of every borrowing country and influence changes in the economy.

All of the 12 waivers signed with the IMF have revolved around two objectives:

  1. Close the gap between revenue and expenditure to control the deficit
  2. To raise the level of the foreign exchange reserves

Not to our surprise and experiences, Pakistan has been struggling to fulfil these objectives for more than two decades now.

Raising revenue means establishing new taxes on consumptions i.e., the General Sales Tax (GST). Raiding the foreign exchange reserves means to boost export competition, therefore freeing the currency from political influence. But to achieve these goals, it’s necessary to improve the tax machinery and to grant autonomy to the SBP so that they can manage the reserves.

1609Taxes and mistrust

RAFTAAR states that Pakistan’s public debt has reached Rs17 trillion, which is a significant increase from Rs6.3 trillion (2008), adding that the trend would continue unless the state increases its revenues. Pakistan’s economy is financially fragile because there is insufficient revenue. “Any state that doesn’t collect enough taxes is unsustainable,” it said.

FBR has introduced an e-filling system to attract taxpayers but these steps, though in the right direction, aren’t enough. Due to the lack of tax returns, indirect taxes are implemented. This is why almost 68 percent of tax revenue is driven from indirect taxation.

This means more is paid for fuel and electricity than other regional countries because of the surcharges added; consequently, burdening people with lower incomes that pay as much tax as high earners.

RAFTAAR further claims only 900,000 file their income tax returns and 400,000 of those declare nil returns.

Theoretically, direct taxation, in developing countries like Pakistan, is of significant benefit for the economy, people and the state. It’s the only way to make sure the richer segment of the society is taxed properly and the poorer are provided with the needful. This trickle-down effect of taxation helps a smooth flow of money within the society, making sure each citizen is given at least the minimum requirement of the standard of living, i.e., free education, shelter, etc.

But, as usual, working on the book is not the Pakistani way. Avoiding tax has become a culture of the elite.

Doctor Akbar Zaidi, an economist, said while talking to DNA, that feels the elite should take up their responsibilities as the privileged class and do their part right.

“There should be name and shame, parliament should openly disclose who is and isn’t paying their taxes”, he said.

Though the name and shame idea are very appealing, Section 216 of the Income Tax Ordinance 2001 grants confidentiality to the taxpayer’s record and prohibits its disclosure. There are very specific circumstances listed in section 216 where taxpayers’ record can be disclosed. It can be through specific permission granted by the federal government under sub-sections (5) and (6) of Section 216 that the Parliamentarians’ Tax Directory and Taxpayers’ Directory of all the taxpayers can be published by FBR.

This makes it even harder to determine who aren’t fulfilling their moral duties truthfully. The common people hence feel they are being taxed more than others; and also that their taxes are being misused by the government.

Sohail Ahmad, former FBR chairman, stated while talking to DNA, “No one within the FBR has the guts to investigate the taxes of the elite.”

Due to the immense corruption of government officials, taxpayers excuse themselves saying they won’t see any real delivery even if they pay their dues. The government fails to achieve the revenue target and the resulting tantrums are faced by the commoner. This leads to a difficult situation where the finance ministry stresses on indirect taxation to try to bolster its coffers.

The indirect taxation of common commodities, the basic needs of life, increases and makes it harder for the layman to survive. This leads to inflationary pressures in the economy. The effects are hyper-inflationary in nature because this is a multiplicative element, not an additive, passing inflation to all every level.

To avoid this, the authority of the tax machinery should be accountable and monitored. There should be laws and intelligence should be involved. FBR should conduct strong audits to ensure that tax returns are filed religiously.

The comedy of tax reforms

Present and past governments alike have always tried to save their own skins first.

The government has yet to introduce any policy related to tax evasion or avoidance. Never has there ever been a discussion in court or in the assembly which would pressure legal actions against people who avoided taxes.

The current government, though, has taken numerous important decisions in terms of for tax reforms. Firstly, it has appointed an untainted chairman of the FBR, who understands what needs to be done

For starters, the agriculture of our country counts for almost 25 per cent of the GDP and employees around 40 percent of the total labour force. This industry of ours has never been taxed, to the extent that people who earn through other miscellaneous ways like to labour their work under agricultural income just to evade taxation.

The misconception that agriculture tax would increase food inflation is used to fuel the fears of the people. If the agricultural tax is introduced the feudal will be the one at a loss, who unfortunately are our ruling class. The agricultural tax would be imposed on the profits, not on the produce or salaries of the labourers.

Another case is the stock market and the real estate sector. The market is worth billions and in Pakistan, it is taxed poorly. The government definitely wishes well as it wants people to invest long term in stocks but does it do justice to the fiscals?

It would be wise to increase taxes in the short term and speculative investments in the stock market and where the stocks are held for more than a certain period of time. Equally, investment in real estate should absolutely be taxed; people who can make towns can certainly pay taxes.

Even with all the economic deficits in the country, the lavish expenditure doesn’t stop. New projects are seen rising every day. New packages are introduced to non-tax payers (e.g., the kisan plan) and weigh down the true payers.

A research conducted by FBR in 2012 stated, “A nation-wide list of 3.2 million Pakistanis had multiple properties, bank accounts, club memberships, etc, but did not possess a national tax number (NTN). If even half of this list is eligible to pay tax, and if the average annual tax liability of each of these people is a meagre Rs100,000 (US$1,000), the national exchequer would see an increase of Rs160b in the first year alone.”

The current government, though, has taken numerous important decisions in terms of for tax reforms. Firstly, it has appointed an untainted chairman of the FBR, who understands what needs to be done. Tariq Bajwa, the new chairman, has already started the process of cleansing the organisation’s senior ranks that had stained reputations.

Two important directories have been published by the government: one for parliamentarians, and the other for general taxpayers. It has also constituted a Tax Reforms Commission (TRC). Credit for these initiatives goes to the finance minister.

But are these steps enough? Is the FBR powerful enough to extract the required taxes?

Above all, is the ruling class willing to reduce Pakistan’s debts by lightening their pockets?


Originally Published in Pakistan Today

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