October 22, 2007	Monday	Shawwal 9, 1428

Sustaining the economy on a high growth path requires macroeconomic stability and increased public spending on social sector and infrastructure development. Balancing these objectives is a major challenge facing fiscal reform in emerging economies like Pakistan.

Given the relative downward inflexibility of public expenditure due to large outlays on defence, debt service and civil administration, fiscal reform must focus on revenue mobilisation on a sustainable basis by improving the taxation structure.

A number of studies have analysed the tax reform experience of developing countries like Korea, Mexico, Colombia, Turkey, Indonesia and Sri Lanka. Prominent among these are Burgess and Stern (Taxation and Development, 1993), Ahmad and Stern (The Theory and Practices of Tax Reform in Developing Countries, 1991), Gillis (Tax Reform in Developing Countries, 1989), Perry Guillermo (Fiscal Reform and Structural Change in Developing Countries, 2000), and the World Bank (Lessons of Tax Reform, 1991).

These studies observed three main pre-reform conditions which also prevailed in Pakistan: over-reliance on a particular base (trade in the case of Pakistan), narrow tax bases and weak tax administration characterised by inefficiency and corruption.

Tax reform in these countries, as in Pakistan, aimed at (a) broadening the base of direct taxes coupled with effective tax rate reduction; (b) effective taxation of domestic goods and services in value added tax mode; and (c) trade liberalisation and tariff reforms. The main objective was to shift the incidence of taxation from trade and investment to consumption and income. As the major thrust of tax reform is resource mobilisation, developing direct taxes remains one of the foremost priorities.

The base of income tax has remained narrow due to exemptions and concessions, large-scale evasion and a huge informal sector. The result is that collection of income tax remains largely confined to industrial and financial sectors, to public limited companies and multinationals, and to corporate profits and salary incomes.

The focus of reform has, therefore, been broad-basing of direct taxes through greater documentation of the economy, extension of withholding and presumptive taxes, and removal of exemptions. A system of universal self-assessment with system-selected audits has also been introduced through a new income tax law in 2001.

Over-reliance on trade-related taxes has been another problematic area. High statutory tariffs protected inefficient industries, created an anti-export bias and encouraged smuggling. An opaque and complicated tariff regime, characterised by numerous duty slabs and exemptions, bred corruption and rent-seeking.

As a result of trade liberalisation and tariff reforms, quantitative restrictions have been removed, negative list restricted to items prohibited for religious or security reasons, maximum tariff rate reduced drastically, and trading of agricultural and petroleum products de-regulated.

Sales tax is largely collected at import and manufacturing stage. In the first half of the 1990s, there was a substantial broad-basing of the manufacturing component. The coverage of GST was completed in 1998-99 by its extension to the retail stage. The standard GST rate was also enhanced from 12.5 per cent to 15 per cent. Sales tax is being implemented in the value added tax mode (VAT).

A major thrust of the recent reforms has been in the area of tax administration. These include restructuring of tax administration along functional lines, business process re-engineering and automation, and establishment of one-window units in major cities for facilitation of taxpayers. The use of technology in a paperless environment without human interference aims at enhancing transparency.

These reforms, initiated since the early 1990s and intensified from 2000 onwards, have transformed the tax structure. Substantial progress has been made in moving the base of taxation from trade and investment towards income and consumption. The share of direct taxes in total taxes has increased significantly while within indirect taxes, the structure has changed profoundly with the share of trade-related taxes going down and that of sales tax increasing substantially.

There has been a buoyant growth in tax collection fuelled by a fast growing economy over the last few years. However, tax to GDP ratio has remained broadly unchanged. Tax reforms may have resulted in a more efficient system of taxation of existing taxpayers, but the number of taxpayers has not increased enough to achieve an increase in tax to GDP ratio.

Large parts of agriculture and services sector still remain outside the tax net, reflecting political difficulties in taxing these sectors. This brings out the need for deepening reform by way of broadening the tax base, improving documentation and enforcement, and revamping the tax administration.

Raising tax to GDP ratio through broadening the tax base remains central to achieving fiscal sustainability and to meet the rising demand for social and development spending, while continuing to reduce the debt burden.

The base of direct taxation should be expanded through effective enforcement measures against evasion of income reporting and by bringing more people in the tax net. The information collected in the Survey and Documentation exercise should be made use of. The remaining exemptions and concessions should be phased out. Expansion of direct taxation will not only yield revenue but will also have positive income redistributive effects.

Taxation of agricultural income remains the weakest area of implementation. Exploiting this large potential tax base requires political will and due diligence in developing a simple and effective assessment system. At present this is a land tax in practice yielding meagre revenue. Although law for charging it on income is in force since 2000, its implementation remains weak. It would be important to make a serious beginning in this area without further delay.

Equally important is the consolidation and deepening of GST. Stronger measures to enforce documentation of the economy and full implementation of GST should be accorded the highest priority.

Sales taxation of services is a provincial subject under the Constitution, while GST on goods falls within the federal domain. Services are presently taxed either through provincial law with the Central Board of Revenue as collection agency or by the federal government in the excise mode. The provincial governments do not have the capacity to implement this tax, while the federal government lacks the incentive to give it the priority it deserves.

There are definitional and technical issues like territorial attribution as well, which pose implementation problems. As services is a growing sector of the economy, it would be appropriate to work out the legal, procedural, and implementation modalities to realise its full potential.

The issues of multiple taxation by different levels of government, particularly those impinging upon investment, need to be ironed out through inter-governmental consultations.

Tax administration reforms, with a particular focus on fundamental changes in human resource management and increased application of information technology to achieve greater efficiency and transparency in business processes, must be strengthened.

Efficient use of technology will result in minimum taxpayer interface, simplify procedures, and reduce compliance costs. Tax administration reform should not only aim at upgrading skills and improving incentives but also on transforming the organisational mindset and culture.

The second generation of tax reforms should focus on these areas to develop a tax system which is elastic and responsive to economic growth on the one hand and addresses equity and income redistribution issues on the other.