March 4, 2002	Monday	Zilhaj 19, 1422

IN THE late 1980s, Pakistan’s economy was faced with serious imbalances between domestic demand and aggregate supply, leading to macroeconomic instability.

Faced with this situation, the government embarked upon a reform programme to restore macroeconomic stability on the one hand and to achieve high economic growth on a sustained basis on the other. A set of liberalisation and deregulation policies were initiated, which included tax and trade reforms, foreign exchange and investment deregulation, financial sector reforms and privatization. The reduction of fiscal deficit, however, formed the cornerstone of the reform programme, with a major focus on tax reform and resource mobilisation.

The Tax reform aimed at broadening the tax bases, improving tax compliance, rationalizing tax laws, reducing corruption and strengthening tax administration. Elimination of whitener schemes, introduction of agricultural income tax, broadening of GST, and removal of exemptions have broadened the tax base. The launching of tax survey drive and documentation of the economy has been a major step forward. Two main reports, one on tax administration and the other on income tax law, have been prepared by experts commissioned by the government. The institution of tax ombudsman has also been introduced to facilitate taxpayers.

Basic reasons for low yield of income tax in Pakistan have been a plethora of exemptions and concessions traditionally justified as incentives for investment, saving, exports and regional development. Other important reasons are large-scale evasion in income reporting and a large informal sector. The result is that collection of income tax has remained largely confined to the industrial and financial sectors, to public limited companies and multinationals, to corporate profits and salary incomes, and to the metropolitan cities of Pakistan. During the 1990s, the focus of tax reform has been broadbasing of direct taxes through extension of withholding and presumptive taxes with the objective of reducing tax evasion and minimising compliance costs of taxpayers.

Withholding taxes represent ad hoc deductions at the point of accrual of income with subsequent adjustment on the basis of assessment by the tax agency. Such measures do prevent tax evasion but are prone to misuse and corruption in refunds if the rates are too high. Despite those inherent difficulties, withholding taxes did work, increasing the share of direct taxes in tax revenues from 13.9 per cent in late 1980s to 21 per cent in the l990s. Direct tax-to-GDP ratio also improved from 1.9 per cent to 2.9 per cent during this period, though it is still far less than the developing country average of 7 per cent.

As already discussed, Pakistan’s tax structure relied heavily on taxes on international trade. First, high statutory tariffs justified on the basis of protecting infant industries has led to a high degree of across-the-board protectionism, including inefficient industries. This has led to a large- scale diversion of