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Recourse to conventional wisdom

June 17, 2013

IF you thought the new Nawaz Sharif government had the will, plan and mandate to tax the untaxed and under-taxed businesses, you were in for a disappointment. Politics trumped economics on June 12 — again.

The government took the easier path of dealing with its revenue troubles: tax the poor and salaried classes further, directly and indirectly, and spare the wealthy. Even where it has tried to tax the powerful, it did so indirectly. The tools used — presumptive or withholding/advance income taxation — were from the 1990s.

The PML-N manifesto promises to increase the tax-to-GDP ratio from under nine per cent to 15 per cent in five years and reduce tax rates by expanding the net rather than taxing the already taxed people and sectors. It also pledges to increase the share of direct taxation in revenues. But little movement has been made in this direction in the budget, which compelled many like economist for Standard Chartered Bank Sayem Ali to wonder: “How is this budget different from the previous ones?”

The government targets to raise its tax revenue 22 per cent to Rs2.59 trillion next year to trim fiscal deficit by 2.5 per cent to 6.3 per cent of GDP and finance its development plan and liquidate circular debt in the power sector to curtail blackouts. The target includes new measures to rake up additional revenue of Rs202 billion, mainly through one per cent raise in sales tax and substantial increase in tax rates for all income brackets. It also raises existing rates or imposes several direct and indirect taxes to help broaden the tax base.

“New revenue measures amount to admission by the government of its inability to bring structural changes and remove distortions in the country’s taxation system and make it fair and equitable by taxing all incomes irrespective of the source,” asserted Vice President of the ICAP Naeem Akhtar. “The purpose of implementing a tax should be to document the economy, reward honest taxpayers and burden evaders. The proposed measures don’t serve any of these objectives. Rather they increase the burden on salaried taxpayers,” he argued.

Income tax measures, including those imposed in indirect tax mode, will produce additional funds of Rs83 billion and increase in sales tax Rs63 billion. Another Rs35 billion will be raised by plugging income tax and sales tax leakages.

“Most new measures, especially increased sales tax and direct taxes in indirect mode, will fuel more inflation at the cost of low income groups,” argued a Karachi-based financial analyst who did not give his name. He was of the view that direct tax in indirect mode has seldom helped document the economy.

“Take the example of agricultural tax. The country collects less than Rs1billion from it despite a potential of over Rs50bn” he said. “Such measures will generate some revenue for Ishaq Dar but will not help larger objective of documentation.”In developed economies greater emphasis is laid on collection of direct taxes, which form 70 per cent of their tax revenues. In Pakistan, it is the other way round and indirect taxes are major revenue source as their share is above 60 per cent of total tax revenues.

The most significant effort to add new taxpayers to the net include implementation of two per cent tax on taxable supplies made to unregistered companies and five per cent additional sales tax on unregistered commercial and industrial consumers of electricity and gas with bills of Rs15,000 per month.

Despite additional measures, the tax revenue target appears to be on the higher side and ambitious. Therefore, Ali thought collection could fall short of the estimates owing to narrow tax base and resultantly push deficit wider. “I see deficit jumping to 6.8-7 per cent of GDP against the estimated 6.3 per cent,” he said.

While salaried taxpayers face higher taxes, major relief was announced for the corporate sector by bringing down corporate tax to 30 per cent from 35 per cent, starting from 2014-15, and substantially reducing taxes on non-corporate business.

Akhtar was not happy with the government’s decision to drastically cut tax rates for non-corporate businesses by increasing the number of tax slabs and decreasing minimum tax rate as it amounted to facilitating tax thieves. “On the one hand the government is asking the salaried people to pay more and on the other it is giving relief to the corporate and non-corporate business.” He also questioned the wisdom of raising sales tax rate on local sales of five zero-rated sectors including textile, leather, surgical goods and carpets from two per cent to 17 per cent. “The FBR was finding it difficult even to collect two per cent sales tax from these sectors. How will it collect 17 per cent now? This shows lack of policy consistency,” he asserted.

Additional tax measures are not only inflationary in nature; they are also feared to discourage investment. For example, the finance act proposes extension in tax holiday for the operators of special economic zones from five years to 10 years, but withdraws this incentive for investors putting up industry in such zones. More importantly, the government proposes to halve the accelerated depreciation on investment of plant and machinery to 25 per cent. “How do such actions fit in the government’s scheme to woo investment to simultaneously stabilise and grow the economy?” wondered Akhtar.