AT present, the general sales tax is being collected in VAT mode, with multiple rates ranging from the standard 17pc to 45pc (on light diesel oil).

Concessionary rates of 2pc, 3pc and 5pc are applicable on the import and supply of goods of five export-oriented sectors: textile, leather, carpet and surgical and sports goods. Other goods subject to reduced rates include sugar, black tea, fertilisers produced from imported LNG and cotton seed oil etc.

Some countries have a single VAT rate while others have multiple rates. This gives rise to the question whether the VAT/GST system with multiple rates or a single-rate system is more efficient.

Multiple sales tax rates have discouraged tax compliance, as indicated by the decrease in the GST-to-GDP ratio from 79.6pc in 2000 to 56pc in 2011. This is because the rate differentiation entails the need to ensure that the products are correctly categorised.

The gross compliance ratio (GCR) went down from about 36pc in 2003 to 25pc in 2011, with an average of 31pc during the period. This is significantly lower than the global average of 65pc.

One important reason for the increased non-compliance with the GST in Pakistan is the higher compliance cost to businesses, as the time taken to pay GST is 514 hours — much higher than the world average.

Abolishing multiple rates in favour of a single GST rate can help improve the efficiency and ffectiveness of the GST system

On the other hand, the cost to comply with the VAT in other developing countries (to say nothing about developed ones), is also much lower. For example, the VAT compliance cost in Nepal and Bangladesh in terms of time required for making payments is 122 hours and 162 hours respectively.

At the same time, the multiple rate system increases opportunities for tax avoidance and increases the cost to the government for administering the VAT. It is empirically proven that multiple rates tend to reduce VAT compliance, increase tax evasion and compromise the equity goals normally attached with the multiple rate system.

The inability of the administration to apply the law is considered an important issue hindering the efficiency of the GST system.

Rate differentiation has also increased illegal input tax adjustments and inadmissible refunds. Resultantly, the GST gap was estimated at Rs755bn in 2012 and the effective GST rate was reduced to 3.9pc as opposed to the statutory rate of 16pc.

The extent of illegal input tax adjustment and inadmissible refunds can be gauged from the fact that increase in exports sale in 2011 and 2012 was 37.36pc and 31.56pc over the base year of 2010, while the increase in refunds was 114.32pc and 82.21pc.

Multiple rates are often justified on equity grounds. However, exemptions of basic necessities are also justified to achieve equity goals. In view of widespread poverty, most of the basic necessitates, including agricultural products, are kept out of the GST net in the country.

However, the multiple GST rate system has not contributed to equity. Empirical evidence over the period of 1991 to 2002 shows that the GST incidence at the bottom 20pc appeared to be very high and rose further for the middle classes, but came down for the richest segments of the population.

This suggests that a higher proportionate GST tax burden is borne by the poor and the middle classes as compared to the richer segment.

Thus, abolishing multiple rates in favour of a single GST rate can help improve the efficiency and effectiveness of the GST system. Furthermore, the introduction of a single rate at the import stage can discourage illegal input tax adjustments and also minimise the margin of profits for making fake or flying invoices.

Published in Dawn, Business & Finance weekly, November 9th, 2015

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