A few days ago, the Central Board of Revenue announced that in the 10 months of the current financial year it has collected Rs384.76 billion out of a budgeted target of Rs460.6 billion.

The remaining amount of Rs111.9 billion, it was hoped, would be collected in the remaining two months of the financial year. In the corresponding period of the last year (end April 2002), the collection stood at Rs306.1 billion. In the last two months of the proceeding financial year, Rs98 billion were collected, representing 32 per cent of the total collection.

The remainder of the current year’s budget (Rs.111.9 billion) represents 24.29 per cent of the total collection. Relying on the historical trend of collection, the claim of the CBR authorities does not appear to be frivolous. If the CBR does succeed in achieving the budgetary target, it will be for the first time in recent memory, as no such achievement saw the light of day in the last 12 years.

The debilitating trend of failing budgets was arrested, to a large extent, by the growing contribution of sales tax. Since the financial year 1999-2000, this tax has become the biggest contributor to the federal exchequer, as reflected in Table 1.

Table 1: Sales tax receipts in total tax revenues

The growth in ST collection has been phenomenal. From a paltry collection of Rs23.51 billion in F.Y. 1992-93, it already had gone up to Rs166.6 billion in FY 2001-02. The growth had further risen when compared with the growth in collection under all taxes. Table 2: Sales tax receipts in total tax revenues

Barring two years (1995-96 and 1997-98), the growth in ST far outstripped the growth in collection under all taxes and with a colossal margin; 61.85 to 0.20 per cent (1999-2000), 43.42 to 24.22 per cent (1994-95) etc. This exceptional growth calls for an in-depth study.

Pakistan has had various ordinances\acts to administer sales tax. The law which currently holds the field is Sales Tax Act, 1990 which provides for a value-added type of tax (VAT), applied at each point of exchange of goods or services from primary production to final consumption. It is levied on the difference between the sale price of goods and services and their cost at an earlier stage (value added). Up to financial year 1997-98, it was levied only at manufacturing and import stages.

From the following year, its net was extended to wholesalers and retailers. From 1999-2000, tax was also levied on services. All these steps surely contributed to higher sales tax collection. But one measure which had the three-fold effect of increasing the revenue, reducing the evasion and encouraging the organized sector is little known outside the circles of tax collectors and tax payers.

It all started in 1995 when some steel pipe manufacturers approached the then chairman, CBR and the then Member, ST (who happens to be the chairman now) with the complaint that the unorganized sector which does not pay any sales tax on the finished goods, was presenting an unfair competition to them. On examination of the situation, it transpired that, though only 30 per cent of the installed capacity of steel pipe manufactures was in the organized sector, it was paying 90 per cent of sales tax from this source.

In other words, 90 per cent of sales tax on steel pipes was being collected on only 30 per cent of the production, the rest was being evaded. This state of affairs resulted not only in the loss of revenue but also a back-breaking addition by a factor of 15 per cent to the cost of production in the organized sector. Logically, an effort to stamp out evasion was required. But logic is not the stuff our national life is made of. Realizing their handicap, the CBR knew that trying to root out evasion can not bear immediate results and the matter of providing relief to the organized sector was urgent.

After a great deal of thought, they came up with the novel idea of enhancing the sales tax from 15 to 20 per cent on the raw materials. On the finished goods ,the rate will remain at 15 per cent. Thus those paying tax on the finished goods will pay lesser tax at this stage, because the tax paid at higher rate at the earlier stage will now be adjusted. This equation can be elucidated by following illustrations.

The additionality was thus reduced from Rs7.50 to Rs2.50 and also the unfair advantage the unorganized sector had by not paying Tax on finished goods by an identical margin. In the first illustration, the loss of revenue is Rs7.50 on the sale proceeds of the unorganized sector which is reduced to Rs2.50 in the second illustration.

Despite the loss of some liquidity experienced by the organized sector in paying sales tax, with higher rate on raw materials, it welcomed the move because it reduced the advantage of unorganized sector had over it to a large extent. Now the playing field was level for both sectors.

Characteristically,the new experiment was associated with some hesitation. The procedure was applied only on 5 items when it was introduced for the first time in 1995. The list of items gradually grew. At present the rate of 20 per cent is being levied on approximately 214 raw materials.

The system can work profitably only under certain conditions. Firstly, it will apply only if higher rate is applied at the raw material stage and not on finished goods. Secondly, it can be advantageous when only some manufacturers are paying sales tax on their finished goods and the others are not. If the whole sector is documented and the evasion is minimal, there will not be any advantage. On the contrary, it can have adverse effect by reducing the liquidity of the manufacturers without the consequent benefits.

The opposition to this procedure, surprisingly, came from the functionaries of the ministry of finance and the arbiters of our economic fate, the World Bank. Their reason for opposing the procedure was that the deviation was against the fundamental principle of value added tax regime. This is yet another example of their dogmatic approach without comprehending the peculiarity of circumstances prevailing in the country.

Undoubtedly, sales tax has come to the rescue of our faltering revenue targets, as it is by far the biggest contributor to the federal exchequer. However, being an indirect tax, it is regressive in nature and hits the poor adversely. The three indirect taxes—- sales tax, custom duties and central excise—, together contribute 67.78 per cent of the national budget. It does not augur well for the economic health of the nation as all indirect taxes are anti-poor. They hit the poor much harder when their capacity to pay is taken into account. Unless we somehow manage to increase the share of direct taxes, the gap between the haves and have-nots will continue to grow and our poverty alleviation strategy will remain only a pipe dream.