THE ‘ease’ of tax collection and its compliance linked to the appropriate tier of government has emerged as a key issue for the 9th National Finance Commission (NFC).
The issue arose from experiences gained in implementing the 7th NFC award. Of the four NFC working groups, the first has been entrusted with a study on resource mobilisation at the federal and provincial level, and the second, on benefits of devolved versus integrated tax structure. Their initial proposals are currently under intense stakeholders’ debate.
Instead of opting for the ‘ease of collection’ approach to boost revenues, the federal government has taken recourse in easier but questionable ways to collect regressive taxes like the withholding tax, which accounts for 75 per cent of direct tax revenues.
The inter-governmental fiscal relationship should be redesigned to ensure revenues expand as fast as essential expenditures to fund an equitable and sustained economic development
This has not helped the federal government to ease mounting fiscal constraints. In the last NFC meeting on Jan 24, the federal finance secretary asked the NFC members of minority provinces to review their opposition to a proposal by the centre.
The proposal included centre’s appropriation of 7pc of the gross divisible pool for the security and uplift of Fata, Azad Kashmir and Gilgit-Baltistan. Punjab has not come up with its own response to the issue so far.
A study by the Working Group-11 headed by Sindh, Devolved versus Integrated Tax Structure - Evaluation of the Tax Collection in Pakistan, has noted that the experience of integrated structure has so far resulted in low tax-to-GDP ratio and does not provide sufficient revenue for inclusive sustainable development.
And the combination of devolved spending and centralised financing through grants and tax revenue sharing leads to vertical fiscal imbalance.
Sindh’s proposals include the devolution of a number of integrated taxes such as ’very low-yielding wholesale and retail taxes (post- importation and post-production supply). These, defined as a services component of the GDP in the country’s National Income Accounts, are still collected by the centre.
Some fresh thinking in the NFC may lead to partial or full devolution of wholesale and retail tax. What is stated to be the ‘close proximity’ of the provinces and their ‘knowledge of the tax base’, can help boost revenues from these levies at the sub-national level.
In the initial NFC meetings, former finance minister Ishaq Dar was inclined to accept the proposal, without mulling the complete devolution of these taxes. Another candidate for ease of collection is sales tax on goods. Sindh holds the view that devolution would increase revenues.
The federation has opposed the proposal but agreed to a detailed study on its implications. It cautions against the ‘associated risks’ and the ‘probability’ of lower tax collection by the provinces because of segregation of tax collection from tax policymaking- primarily under functional domain of the centre- and disagreements among provinces.
It also suggests that to reduce the risks of future shortfall due to devolution, the provincial governments should focus on building a human resource base and upgrading technologies in their infant sales tax collection authorities.
Sindh has built its case on the following grounds: a) overall tax collection will increase due to improved efficiency demonstrated by the provinces in sales tax collection on services; (b) lower compliance cost for taxpayers; (c) potential high coverage of underdeveloped sectors; (d) greater fiscal effort by provincial revenue authorities equipped by online payment; and (e) additional revenue raised at the provincial level to be shared under the existing NFC formula.
Punjab, which heads the Working Group-11 on resource mobilisation at the federal and provincial level, supports Sindh’s move to secure the right of the provinces to collect sales tax on goods. But two smaller provinces—KP and Balochistan- fearing loss of revenue, have some reservations.
There is plenty of room to devolve the collection of a number of taxes to the sub-national level under the 18th Amendment while retaining the need-based NFC formula for horizontal and vertical resource distribution.
Some other issues in inter-governmental relations include: the federal government levying and collecting capital gains tax on property, which was devolved to the provinces under the 18th Amendment, and the collection of royalty on natural gas and crude oil by the centre.
There is also an overlap in provincial and federal jurisdictions that reduces tax collection at the sub-national level, resulting in double taxation. A study by the experts quotes advance tax on property transactions, and withholding tax on motor vehicles and services as examples.
In many cases the rates of such WHT and advance tax are higher than provincial taxes. The inter-governmental fiscal relationship should be redesigned to ensure that revenues expand as fast as essential expenditures to fund an equitable and sustained economic development.
Published in Dawn, The Business and Finance Weekly, February 26th, 2018
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