All efforts in the name of tax reforms (so-called) failed miserably as these were patchworks. Re-engineering and redesigning of tax system has not been given any serious thought till today. The Sisyphean task of improving and reforming incorrigible tax machinery, mainly through donors' money, is still on the agenda of our policymakers.
Since Pakistan tax system is shrouded in masteries through myths and mystifications, in this series an effort is made to unveil all these and present what the reality is. Starting from reforms to misleading claims about narrowed (sic) tax base all myths are discussed and busted. In the end some viable and pragmatic solutions are suggested for public debate-it can be adopted as part of Election Manifesto by any party-to evolve a system that best suits our peculiar culture, socio-economic milieu, and business environment. If adopted this can accelerate the growth, provide jobs and ensure funds for rapid infrastructure development and public services.
Existing tax structure & fiscal restraints: Presently, all broad-based and buoyant sources of revenue are with the federal government and contribution of provinces in total tax revenues is 6 percent-in overall national revenue base (tax and non-tax revenue) it is around eight percent. This has made them totally dependent on the federal government for transfers from divisible pool-the National Finance Commission Award as envisaged in Article 160 of the Constitution. What makes the situation more disturbing is the fact that right of provinces to levy sales tax on services is encroached by federal government through levy of presumptive taxes on services under the Income Tax Ordinance, 2001, sales tax on gas, electricity and telephone services and excise duty on a number of services.
Before the independence, the provinces had the exclusive right to levy sales tax on goods and services within their respective physical boundaries. This was snatched from them in 1948 and was never restored. In the given circumstances when a federation like Canada and a union like India are moving towards harmonised sales tax on goods and services, there is a need to debate the issue in public and Parliament for reaching a consensus.
It is an established fact that federal government even after levying all kinds of irrational and expropriatory taxes has miserably failed to reduce the burgeoning fiscal deficit. It reached the figure of Rs 1.8 trillion in fiscal year 2015-14 and since then every attempt to bring it down to 4 percent of GDP has not succeeded.
The Federal Board of Revenue (FBR), the apex revenue authority at the federal level, has persistently failed to tap the actual tax potential and bridge the tax gap. For the last many years, it could not meet even the budgetary targets what to speak of realising the real revenue potential, which at federal level alone is not less than Rs 8 trillion.
Tax gap of a country is measured by the amount of tax that remains uncollected due to non-compliance with tax laws. Pakistan Tax Gaps: Estimates by Tax Calculation and Methodology, a joint study of FBR, Andrew Young School of Policy Studies at Georgia State University and World Bank, provides in detail, tax gaps by type of tax and describes the methodologies and data used for such estimates. The report prepared in December 2008 by Rubina Ather Ahmad (FBR) and Mark Rider (Andrew School) says that views expressed "are of the authors and not of the Government of Pakistan". For fiscal year 2004-2005, according to this report, Pakistan's federal tax gap was Rs 409.5 billion or approximately 69% of actual tax receipts of Rs 590.4 billion. Terming this as "conservative estimate", the report claims direct tax gap at Rs 262.8 billion (around 143% of actual collection of Rs 183.1 billion) and indirect tax gap at 146.7 billion (36% of actual tax collection of Rs 407 billion). In 2008, the data selected was for fiscal year 2004-2005 and tax gap was estimated at 45%. Since then tax gap has increased and according to FBR's own admission it is not less that 70% of actual tax potential.
Tackling twin menaces of underground economy and tax evasion has always been a failure in Pakistan. In fiscal year 2015-16, FBR collected Rs 3.3 trillion against documented GDP of around US$ 300 billion. The underground economy is driven by many aspects of poor fiscal policy, and as highlighted by Dr Arthur B. Laffer: "it isn't just high tax rates that indicate whether illicit trade activity will be a problem, but rather high tax rates coupled with other factors such as affordability, level of corruption, effectiveness of enforcement, and cultural and societal reasons."
The collection of taxes at federal level is much below the actual potential and the way it is collected creates doubts and suspicion. In 2014-15, as in the past, FBR failed to meet the third revised target. The original target of Rs 2810 billion was first reduced to Rs 2691 billion and then to Rs 2605 billion. The claim by Finance Minister that FBR exceeded the target for fiscal year 2015-16 was also contested by many. In a report, it was alleged that Rs 195 billion collection on account of non-tax revenue "is shown as 'other taxes' to claim higher tax collection". It is further alleged that "Rs 30 billion on account of Natural Gas Development Surcharge (GDS) is accounted for as 'other taxes' whereas it was placed under non-tax revenue till 2013-14".
Tax collection figures for 2014-15 & 2015-16: Income tax collection in fiscal year 2014-15 was Rs 1033.7 billion and projection for 2015-16 was Rs 1307 billion. The actual collection, reported by FBR, is Rs 1220 billion-showing shortfall of Rs 87 billion. Collection of sales tax in 2014-15 was Rs 1088 billion and projection for 2015-16 was Rs 1230.3 billion. By raising sales tax on POL products from 17% to 30-50%, the government managed to collect Rs 1329 billion in 2015-16. Customs collection in 2014-15 was Rs 306 billion and projection for 2015-16 was Rs 348.5 billion. After levying regulatory duty on over 300 items, it was increased to Rs 404 billion in 2015-16. Federal Excise collection in 2014-15 was Rs 162 billion. Against projection of Rs 200.9 billion, actual collection for 2015-16 was Rs 177 billion.
In another report, it is observed that "after withholding all the tax refunds during the last fiscal year and forcing companies to pay advance income tax, the Federal Board of Revenue (FBR) announced on Friday that it had achieved the tax revenue collection target of Rs 3.1 trillion set for Fiscal Year 2015-16." It further says that "FBR was holding more than Rs 250 billion in tax refunds during the last fiscal year. The tax refunds were kept to maintain the tax revenue target agreed with the IMF."
The meeting of target by FBR through "undesirable means" was also highlighted in yet another report as under:
"...that the overall collection of Rs 3.1 trillion was a result of one of the largest clandestine operations, as the FBR took over Rs 150 billion in advance taxes from oil and gas, telecommunications and banking companies. The government also blocked payment of over Rs 250 billion genuine refunds of the taxpayers".
It is obvious that on the one hand FBR is facing the challenge of bridging tax gap and on the other collection figures are not reliable. The way forward is suggested in a study published by Prime Institute. This study, available on http://primeinstitute.org, can be considered by policymakers and all the stakeholders. The study gives a detailed roadmap for low-rate, predictable taxes that can accelerate economic growth and yield substantial revenues for the government-much more than what is being presently collected.
The failure to tap real tax potential poses a tough challenge to both the federal and provincial governments. Poor performance of FBR adversely affects the provinces as they are overwhelmingly dependent on what the Centre collects and transfers to them from the divisible pool. Provinces are not ready to collect taxes wherever due and generate their own resources after establishment of local governments as envisaged under Article 140A of the Constitution. Centre is unwilling to grant the provinces their legitimate taxation rights while it collects too little to meet their overall financial demands. The size of the cake-divisible pool-is so small that nothing substantial can be done to come out of debt enslavement and to spend adequately for the welfare of the people, no matter to which part of the country they belong.
The track record of FBR shows remote possibility of collecting even Rs 6 trillion in the next three years to give enough fiscal space both to the Centre and the provinces to come out of the present economic mess, thus providing some relief to the poor as well as trade and industry. Under the given scenario, federation-provinces tax tangle will continue unchecked and further taxation through local governments, when elected, would not serve any useful purpose-there will be no relief to the people, rather tax burden will increase manifold. Thus, Pakistan will remain in debt enslavement and more and more people will be pushed below the poverty line. If we want to come out of this crisis, the parliament will have to reconsider the prevailing social contract between federation and the provinces. Provincial autonomy and local self-governance without taxation rights and equitable distribution of income and wealth is meaningless. We cannot overcome perpetual economic crises unless the provinces are given true autonomy; ownership of all resources; generation of own revenue and exclusive right to utilise it for the welfare of their denizens.
Distorted tax base & fiscal consolidation: Fiscal consolidation should be as growth-friendly as possible. In general, tax base-broadening reforms are identified as growth-oriented reforms. To the extent that they reduce distortions to economic decisions on work, saving, investment and consumption, they should increase output and improve social welfare-Choosing a Broad Base-Low Rate Approach to Taxation, OECD Tax Policy Studies No. 19
The policymakers (sic) sitting in the Ministry of Finance and FBR always make a totally fallacious assertion that "only 0.9 percent of the population of the country pays income tax". It is shocking that even the top men of FBR do not know the difference between a "taxpayer" and "return filer". Secondly, they are keen to retain higher rate of taxes (both under income tax and sales tax laws) on narrowed tax base rather than imposing lower taxes on broader base. It has been mentioned many times ['Of taxpayers & non-filers', Business Recorder, October 27, 2016, 'The tax base', Business Recorder, November 2, 2012, 'Ailing tax system', Business Recorder, August 21, 2015 and 'Improving tax compliance', Business Recorder, November 16, 2012] that there are 90 million unique mobile users who pay advance income tax payers in Pakistan but returns filers are pathetically low (merely 1.3 million by end of May 2017).
In fiscal year 2015-16, exporters paid income tax at source of Rs 24.8 billion and salaried persons paid tax of Rs 92.3 billion. Importers paid at source Rs 179.7 billion and contractors Rs 220. Out of gross collection of Rs 1270 billion under the head income tax (refunds issued were of Rs 47.5 billion only), collection after raising demand was just Rs 10.4 billion (0.8% of total collection). Collection through withholding taxes was Rs 919.5 billion, advance tax was Rs 302.3 billion and tax paid with returns was Rs 38.4 billion.
The poor collection under income tax head testifies to the fact that it is not tax on total income base, but indirect tax on many items that include many others, consumption, expenditure, investment, and in many cases just transactions that are devoid of any income-yielding activity. For example, a person sells a house of his brother who lives abroad and on withdrawing cash on his instruction has to pay tax under section 236P of the Income Tax Ordinance, 2001. A salaried person, after paying tax under section 149, is compelled to pay tax on cash withdrawal (section 231A). In 2015-16, collection under section 231A (cash withdrawal) was Rs 28.6 billion and under section 236P (non-filers) was Rs 21.6 billion. On commercial/industrial electricity bills advance tax collection was Rs 25.5 billion and from mobile users it was Rs 47.6 billion.
It is an irrefutable fact that about 7.5 percent of the country's workforce, approximately 4.5 million, earns taxable income of Rs 400,000 or above. However, tax returns received by FBR for tax year 2015 were only 1,064,108. Out of these, 90% filers paid income tax less than Rs 10,000! The issue is not only that of low return filers but also total gross under or non-reporting.
Tax base under indirect taxes (sales tax and excise) is also extremely narrow. About 82 percent of entire sales tax and federal excise duty comes from the top 100 companies. In fiscal year 2015-16, total collection of sales tax (import) was Rs 683.6 billion out of which share of POL was Rs 209 billion (30.5%). In sales tax (domestic) total collection was Rs 668.9 billion out of which share of POL was Rs 349 billion (52.17%).
Failure to harness the real tax potential ('Oppressive taxes & unabated outflows', Business Recorder, February 20, 2015) is the real dilemma of our policymakers. The existing tax structure is not only detrimental for economic growth but also not yielding required revenues for the State. The economic managers have failed to realise that excessive taxation on savings does not increase government revenues. Once income has been taxed then savings and transactions should not be taxed. Is there any country in the world where banking transactions and withdrawal of cash are being taxed like it is done in Pakistan?
The donors and lenders (IMF, ADB, World Bank and DFID etc) never mention the oppressive side of our tax system and non-availability of public services. They are fond of discussing "low-tax-to-GDP ratio" in isolation. Initiatives like Research and Advocacy for the Advancement of Allied Reforms (Raftaar), funded by Britain's Department for International Development (DFID), keep on emphasising need for more revenues, without pointing out where the taxpayers' money goes to.
Raftaar has pointed out that "more than 53% of federal government's expenditure is incurred on interest payments, defence, and the wage bills". But then why does it still want to support the incorrigible FBR. Paying proper taxes or filing returns, people say, is meaningless and unjustified when the State is indifferent towards public welfare and elites blatantly show apathy towards their fundamental needs.
Our rulers live lavishly while Pakistan ranks at 146 out of 187 countries in the latest Human Development Index (HDI). Not less than 25 million children out of school in Pakistan in gross violation of Article 25A of the Constitution-see detailed judgement of Supreme Court 2014 SCMR 396 re Petition regarding miserable conditions of schools. Raftaar and other initiatives like, Make Tax Fair, Pakistan Tax Justice Network, Tax Justice Coalition etc, must campaign for a just tax system.
Our successive governments have been taxing the poor and giving extraordinary benefits to the rich. Abuse of taxpayers' money for personal comforts and luxuries of the ruling elite is the main malady. The government's yearning for "more and more taxes" has become a source of irritation for the citizens who plausibly argue that they get nothing in return and their plight is worsening every day.
Irrational taxes have failed to solve any problem-debts, both internal and external, are rising and high inflation is crushing the poor. We need all-out reforms and complete overhauling of the system. Voicing this concern, Nadeem Ul Haque, ex-Deputy Chairman of Planning Commission, in Reform or face fundamental ascendency, emphasised:
"The State must first provide the social contract ie good law and order and security of life. It must dismantle the rent seeking that protects the rich. Rent seeking relies on three main components: state subsidies, licensing and regulation; special perks and privileges for ministers and army and civil service employees and land distribution system that allows the poor man's land to be acquired for the elite especially the army and civil service."
Political economy of tax reforms: The debates and discourse concerning political economy of tax reforms in Pakistan lack objective analyses and rational approach as evident from the latest book, published by Oxford University Press, The Role of Taxation in Pakistan's Revival, edited by Jorge Martinez-Vazquez & Musharraf Rasool Cyan. The book contains nine chapters, which are in fact, studies conducted for 7-year-long [December 7, 2004 to December 31, 2011] Pakistan Tax Administration Reform Programme (TARP), carried out with total cost of US$149 million, out of which US$ 102.90 million came as loan from World Bank. The book confirms why TARP was a great failure-on its conclusion not only did tax-to-GDP ratio fall substantially, there was a tremendous decrease in the number of return filers. After reading the book, an irresistible conclusion which can be drawn is that prescription of the World Bank (WB) and the International Monetary Fund (IMF) suggesting "more taxes" without growth, equity and delivery of social services to the citizens is a lethal pill, based on a diagnosis by a quack rather than by a qualified physician.
Imposition of regressive, high rate taxes, especially sales tax on essential items, in an underdeveloped, informal and struggling economy has been the tax policy of Pakistan, on the dictates of the IMF and the WB and the disastrous results are before us-see detailed analysis in Illogical Taxes, Business Recorder, September 18, 2015.
None of the studies in the book has highlighted the most painful aspect of Pakistan's oppressive and unjust tax system. On the one hand, the State is least pushed to provide free education and health facilities and on the other, individual income taxation is insensitive to family circumstances to determine ability to pay, in utter violation of Article 3 of the Constitution of Pakistan.
In civilized, democratic countries income tax laws recognise the cost of living alone or with family-expenses to nurture children are always taken into account. The laws, thus, allow deductions/allowances according to the size of a family. In Pakistan, FBR not only denies any such allowance or deduction, but extorts advance income tax even from the lower-income earners and their family members having no income on facilities like mobiles. Adding insult to injury, FBR expects them to file tax returns to get the money withheld as refund, whereas the cost to get it is much more than the amount due and chances of harassment after filing return are obnoxiously high.
The so-called "experts" on Pakistan's taxation system, at home and abroad, do not try to comprehend the basic elements of a repressive system, let alone suggesting ways to reform it. Their popular slogan is more taxes to improve tax-to-GDP ratio, but no concern for utilisation of money collected as taxes and its ruthless abuse for providing extraordinary perks and perquisites to the ruling elites. They want what is prevalent in the West without studying and considering the mundane realities of Pakistan where the State is not providing even security of life and property, what to speak of taking care of fundamental needs of all citizens-the denial of fundamental right of free education to children under Article 25A is the most glaring example of State's apathy.
The real issue of taxation in Pakistan is lack of a judicious balance between direct and indirect taxes. Appeasing the rich and mighty and lavish spending on comforts of elites is the main cause of the huge budgetary gap. Such wrong policies are continuously increasing miseries of the people, 12.7 percent of Pakistan's population now lives below $1.25 per day, which is categorised as extreme poverty-World Development Indicators (WDI) 2015. Non-collection of taxes from the rich and generously extending exemptions/concessions is the root cause of our unjust tax system.
In the book, edited by Jorge Martinez-Vazquez & Musharraf Rasool Cyan, even the internationally-acclaimed writers have failed to dislodge the claim of FBR that share of direct taxes is about 40% in total tax collection. They have blindly adopted the figures of FBR without examining their authenticity. They could not discern that under Pakistan's Income Tax Law, overwhelming collection is through indirect taxes that are camouflaged as direct taxes. These presumptive and transactional taxes have nothing to do with the income of a person-the incidence of these is passed on to the clients/customers.
In FBR Year Book 2013-14: concealing the truth, Business Recorder, November 7, 2014, it is established with facts and figures that share of direct taxes in GDP is continuously shrinking-during the last 20 years, it was never more than 4% of GDP. If the experts engaged by the IMF or the WB to suggest tax reforms could not analyse the data properly, what can one expect from the commentators talking about taxation system in different TV talk shows or writing columns/articles in the vernacular Press. No expert hired by the WB or the IMF as the book shows is aware of the reality, or has not intentionally highlighted it, that the main incidence of the taxes in Pakistan is on the middle-low-income groups, while the beneficiaries of taxpayers' money are rich members of the militro-judicial-civil complex and public office holders who get enormous tax-free perquisites and benefits. The State, captive in the hands of a few, is facing enormous challenges on fiscal front as parasitic elites have failed to deliver.
In our fiscal woes, there is also criminal culpability of IMF "bosses", who dictate our economic managers to follow their ill-prescriptions. They plead for more regressive taxes and do not care even if the federal government raises sales tax rate to the extent of 50% on high speed diesel oil, 30% on kerosene, 29.5% on light diesel oil, 26% on motor spirit excluding HOBC and 24% on HOBC through statutory regulatory orders (SROs)-see detailed comments in Constitutional violations in taxation, Business Recorder, October 9, 2015. They know that such actions not only burden the poor but also constitute open violation of Articles 77 and 162 of the Constitution of Pakistan. In their countries, they talk about "rule of law" and in Pakistan they ignore our rulers' blatant violations of the supreme law of land with impunity.
The Supreme Court in Engineer Iqbal Zafar Jhagra and Senator Rukhsana Zuberi v. Federation of Pakistan and Others (2013) 108 TAX 1 (S.C.Pak.) held that:
"Parliament/Legislature alone and not the Government/Executive is empowered to levy tax. As far as delegation of such powers to the Government/Executive is concerned, the same is for the purpose of implementation of such laws, which is to be done by framing rules, or issuing notifications or guidelines, depending upon case to case, as we have come across some of the cases noted hereinabove. But in no case, authority to levy tax for the Federation is to be delegated to the Government/Executive. Therefore, arguments so raised by learned counsel have no force and the same are repelled hereby."
The IMF in its parleys with the Pakistani team in Dubai had never raised the issue of violation of constitutional provisions and burdening the poor with unprecedented taxes on petroleum products. Why should they? They are mainly concerned with getting their own money back, no matter if it means sucking blood of the poor. The fault of course, mainly lies with our ruling elites, who beg before them, thrive on borrowed funds and taxes paid by the masses.
We should set our house in order and stop blaming lenders. An undeniable reality is that the Pakistani nation is the most heavily taxed in the entire region and the citizens get neither education nor health facilities from the State, what to speak of social protections like pension for all, out of taxes paid over the period of time. There is overwhelming reliance on indirect taxation [even under the garb of direct income taxation through presumptive tax regime on a number of transactions] without evaluating its impact on the economy and life of the less privileged sections of society.
In the face of declining income tax contribution (after excluding indirect ones levied under Income Tax Ordinance, 2001) to GDP, our Finance Minister and FBR officials have been making tall claims about "impressive" (sic) increase in taxes. The reality of this "impressive" performance was exposed in various columns, but the IMF and the WB remained mum as they were party to portraying all-good "projection saga"-FBR reforms-II, Business Recorder, August 3, 2015.
The existing tax system is not taxing the rich 15 million and main collection is from indirect taxes. Resultantly, income and wealth distribution disparities are rapidly widening in the country leading to social and political unrests. Under the given scenario, efforts are needed both at federal and provincial levels to enlarge the size of the pie by shifting to growth-oriented taxation-see details in Chapter 16 of Return to Prosperity by Arthur B. Laffer & Stephen Moore.
(To be continued tomorrow)
(The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences)
Copyright Business Recorder, 2017