April 30, 2007	Monday	Rabi-us-Sani 12, 1428

The government has set a revenue target of Rs1 trillion for the next fiscal year and has indicated that the current year’s target of Rs835 billion will be exceeded. Apparently, this sounds like an impressive achievement. The government sources maintain that the rise in government revenues can be attributed to overall economic growth as well as to better administration of taxes.

A fair and equitable tax system is one of the most important features of modern nation state’s political economy with the ability to tax and spend being one of the most potent sources of its power. Tax administration and reform is an ongoing process and directly affects the lives of individuals and businesses on a daily basis. Yet, it is not the subject of as much public discussion and scrutiny as it deserves.

Pakistan has practised a security state model of governance where the military establishment has chosen to operate a lax tax regime to allow the feudal aristocracy, big business magnets, land and stock speculators and other such vested interests to mint money without much regard to the law so long as they support the military rule and keep the bureaucrats ‘happy’.

Over the decades, this regressive and corrupt system of taxation has failed to mobilise domestic resources and, as a consequence, increased dependence on foreign aid for even routine development expenditure that otherwise could easily be financed by the government revenues had Pakistan’s rich been paying their due share of taxes. Has this changed much during the last seven years?

A National Security Council meeting, held on February 24, 2000 and presided over by General Musharraf, had decided “to broaden the tax base, reduce the number of taxes, slash their rates, bring tax dodgers to book and induct the army to undertake documentation of the economy.”

Seven years later, on February 23 2007, General Musharraf approved Central Board of Revenue (CBR) 10-year taxation plan, "Vision-2016" at a meeting in Islamabad. The plan aims to take tax-GDP ratio to 14.5-15 per cent by 2016-2017. General Musharraf directed the CBR “to reduce the burden of indirect taxes on the poor segments of the society, reduce number of taxes, broaden the tax-base and raise tax-GDP ratio for bringing potential sectors into the tax net.” The President also told the CBR officials to “bring those sectors into the tax net, which are contributing to GDP, but their contribution in taxes is comparatively less.”

Since 2001-02, the tax-to-GDP ratio has fallen from 9.42 per cent to about 9.25 per cent despite growth in the absolute amount of taxes. During the last fiscal year of the previous civilian government, that is 1998-99, the tax-to-GDP ratio was 11 per cent and the ratio of direct taxes to GDP was 3.85 per cent. Both indicators have since deteriorated to 9.25 per cent and 2.91 per cent respectively. The government’s own statistics do not support its claim that it has done a better job of collecting taxes than its civilian predecessors.

During the current fiscal year, the total revenues have increased by 21 per cent to Rs597 billion for the nine months from July 2006 to March 2007 detailed as follows:

The direct taxes, as reported, have driven the growth in tax collections. The corporate sector accounts for nearly 80 per cent of direct tax collections that include income and withholding taxes. However, the tax collections from the corporate sector remain concentrated in just six industries that account for nearly 83 per cent of all tax collections from the corporate sector. Oil and gas (36 per cent), banking (31 per cent), and telecommunication (9 per cent ) are the three largest contributors while all other sectors account for the remaining 24 per cent.. The three were in the public sector for a long time and have been partially privatised in the recent years. While their profitability has no doubt contributed to the growth in the taxes, the growth remains dependent on these sectors.

The industries traditionally dominated by the private sector appear to have contributed little to the growth. The textile sector does not make it to the top six sectors contributing to the direct taxes despite being the largest industry. Neither does cement nor sugar industry. If these industries are unprofitable and inefficient, why do their owners continue to stay in business?

If they are profitable, what is the justification for not paying their due share of taxes? This points to a serious imbalance in the structure of our taxation system that continues to be under the undue influence of powerful lobbies and vested interests. Seven years later, the decision to “broaden the tax base and induct the army to undertake documentation of the economy” has failed to make any dent in their influence.

Recently, the Institute of Chartered Accountants of Pakistan, in its pre-budget suggestions for 2007-08, argued that “in order to broaden the tax base it was necessary to provide incentive to the normal regime and abolish withholding regime for corporate sector. The present system promoted non-documentation of economy.”

Withholding taxes, a major component of direct taxes, account for about 42 per cent of the total. Contracts, imports, salaries, telephone bills, exports, bank interest, cash withdrawals, and electricity bills account for about 85 per cent of the withholding taxes and virtually all the burden is passed on to the consumers.

The structure of the indirect taxes suffers from similar inequitable distortions. Oil and gas sector accounts for 38 per cent of all sales taxes (domestic and imports) placing a heavy burden on the consumer. It is an easy way out to meet revenue targets but the cost to the economy is high in terms of the contribution of high energy costs to higher inflation, lesser industrial competitiveness, and lower spending power of the consumers in the middle and lower income groups.

What is perhaps not fully appreciated that the consumer spending power and industrial/commercial competitiveness are two principal engines of economic growth and an inequitable taxation system that hurts these two is not in the country’s long-term interests.

The current tax regime favours the special interest groups at the expense of consumers and a limited number of industries. Take the case of large landowners who account for a large number of our parliamentarians, federal and provincial ministers. Whenever the issue of taxing agriculture income is raised, the issue of federal and provincial subjects under the constitution is cited as an impediment as if we truly follow the constitution or if Pakistan is actually run as a federal state.

This is one of the great ironies of the army-dominated security state that whenever something suits the interests of its kleptocrats, even extra-constitutional means are used to achieve its ends. But excuses are made when it comes to making important policy changes that strike at the core interests of the establishment. As long as the people and the media let them get away with this, it is difficult to see how fundamental reforms can take place – reforms that would bring the politically influential landowners under the tax net.

Equally serious is the issue of implied whitening of untaxed incomes. The exemption of capital gains on property and stock trading from income tax has created a money-laundering haven and represents a strong disincentive to invest money in productive sectors of the economy.

Apologists for the exemption of capital gains on stock trading list many reasons; a major one being prospect of capital flight. This argument is based on a misleading and erroneous perception in that a significant percentage (60-70 per cent) of the trading volumes is attributable to the so-called ‘badla’ trading, which enables the stockbrokers to trade stocks by borrowing on extremely generous terms that are not available elsewhere. Therefore, it is unlikely that the short-term local traders would move offshore particularly in an international environment where it has been become difficult to open and maintain bank accounts that do not meet tighter compliance and transparency standards. Capital gains from stock trading are estimated to have ranged between $3 to 3.5 billion in 2006. A portion of this money is believed to have found its way in property.

It is preposterous to argue in favour of a taxation regime that exempts incomes running into billions while puts most of the real burden of taxes on lower and middle income groups. Only under a truly representative democracy, one can hope to have real reforms of the tax system in the long run because the military regimes (supported by the landed aristocracy and the big business and served by a generally pliable judiciary) have failed to address the core issue of fairness in administering the fiscal regime; an issue that lies at the heart of the current economic and social imbalances in a country where 74 per cent of the people survive on daily income of $2 or less; a condition generally considered as poverty.