THE contours of Pakistan’s taxation crisis are well known by now. Only 0.3pc of the population pays income tax and files a tax return — one of the lowest ratios in the world. Around 7 million Pakistanis are estimated to be eligible to pay income tax, but only less than 0.5 million do. (Of course, millions of Pakistanis pay a small portion as income tax indirectly via deductions made on telecom services, for example. However, the focus of this analysis is on those well-off and tax-eligible Pakistanis who should be paying voluntarily via the tax-filing regime.)
Those at the top of the income food chain are delinquent in paying their due share of taxes, barring a handful, while the burden falls unequally on those at the bottom of the pyramid who pay via indirect taxation. Beyond the issue of vertical equity is the issue of horizontal equity — ie the same levels of income, but from different sources, are taxed differently. This occurs both due to favourable tax policy discriminating to the benefit of certain segments of the economy (such as agricultural income), as well as due to forbearance and undue restraint in enforcement in the case of powerful interests such as parliamentarians.
Around 75pc of the direct income tax collected is from businesses, and the rest from individuals. However, within businesses, only 21pc of the registered companies paid income tax, with the vast majority being tax non-filers. Tax evasion by individuals is on an even larger scale.
The state has to restore its moral authority to tax by taxing its elite constituents.
In terms of the major sectors of the economy, industry carries the burden of taxation by contributing an estimated 73pc to total tax revenue of the government. Agriculture has a share of less than 2pc in total tax collected, while the tax contribution of the services sector is less than half its share of GDP. Within the services sector, the bulk of the contribution comes from financial services and telecommunications. Traders, at the forefront of agitation against the 0.3pc withholding tax recently introduced by the government, account for 18pc of GDP — but only 1pc of tax revenue.
While 55pc of government tax revenue comes from indirect taxes, almost 70pc of the collection shown under direct taxes is in the form of withholding tax — ie tax collected on behalf of the Federal Board of Revenue (FBR). Hence, the FBR’s own efforts yield only around 13.5pc of yearly tax collection.
Given this dismal state of affairs, the government has made some noticeable — and praiseworthy — moves on the tax reform front. It has made a breakthrough by publishing tax directories of all tax filers and, separately, of parliamentarians. It has constituted an able Tax Reforms Commission, and appointed, recently, a revenue tsar.
It claims to have sent 185,000 notices to potential new taxpayers, while beginning a slow and gradual clean-up in the FBR. The audit function of the FBR has been re-activated after being disastrously put in cold storage for the past 10 years. If it does not relent from another breakthrough move, the government will have brought the renegade wholesale and retail trade into the tax-filing regime with its move of imposing a 0.3pc withholding tax on banking transactions of non-filers. Finally, under IMF pressure, tax exemptions amounting to over 1pc of GDP are being dismantled.
These measures are all long overdue and creditable. However, they fall far short of what needs to be done. As a result, the pursuit of delinquent taxpayers is taking precedence over non-filers; an increase in rates of tax is being relied on, including on petroleum products and imports of basic food items, instead of base-widening; existing taxpayers — especially larger businesses — are bearing the brunt of new measures as well as unreasonable demands via tax audits; and, tax refunds are being withheld illegally to meet revenue targets agreed with the IMF.
Perhaps most tellingly, despite progress, the FBR has not been restructured to the point where it induces confidence in taxpayers. In its current state, it remains a part of the problem rather than being a part of the solution. As a related aside, the FBR’s coercive and heavy-handed tactics against existing taxpayers have earned it an unprecedented accusation by the Pakistan Tax Bar Association — of maladministration.
The apparent lack of a strategic grand design in implementing tax reform is becoming painfully obvious. Tax reform in this country will only succeed when it is sequenced properly. Two things need to happen before the government or the FBR begin casting their tax net wider.
First and foremost, the state has to restore its moral authority to tax — and taxing its elite constituents via a direct tax on income is an imperative first step. Tax avoidance and evasion by the elites in Pakistan who are shirking from paying their due share is the elephant in the room. Hence, going after the non-taxpaying elites is a necessary pre-requisite to be able to successfully roll out wider reform of the taxation structure because of its signalling/demonstration effect.
Second, wide-ranging, credible and meaningful reform of the FBR needs to take place. The nexus with the political system needs to be severed, and the FBR needs to become a truly autonomous institution. In addition, it needs to undertake a full-fledged organisational development programme to align itself with its mission and goals. Finally, the FBR’s IT capabilities and platforms need to be significantly upgraded and better integrated.
Once equity and fairness in the tax system has been demonstrated by the state, enforcement as well as compliance will dramatically improve. The increase in direct income tax from those who can afford to pay should pave the way for a significant reduction in reliance on indirect taxation of the poor and less affluent.
These measures will set the stage for a modern, progressive and equitable taxation system.
The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.
Published in Dawn, August 7th, 2015
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