Ultimate tax haven

Published May 13, 2016
The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.
The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

THE ‘Panama Papers’ have focused attention on 600 or so Pakistanis who have set up shell companies in offshore tax havens to manage their wealth and taxes. The bulk of these compatriots are legitimate businessmen and wealthy individuals whose riches should not be begrudged — as long as their sources of income and assets are legal, have been declared to authorities and any tax due has been paid. (Politicians and holders of public office fall under a different category. By virtue of their holding or contesting for public office and trust, they should naturally be subject to greater scrutiny).

But what about the roughly four to five million Pakistanis who should be filing their tax returns and paying income tax — but don’t? Only 1.1 million Pakistanis file a tax return, while roughly 600,000 out of these deposit some amount under the voluntary income tax regime. That’s 0.24pc of Pakistan’s population — or one person for every 375 citizens. This compares with 2.7pc for India. (While around 60 million Pakistanis have income tax deducted on their use of telecom services or via their electricity bills, these deductions are nominal and not a substitute for paying through a tax-filing and assessment regime.)

Here are some amazing statistics on the extent of tax evasion and non-compliance in Pakistan from the last published FBR tax directory. These have been compiled by RAFTAAR, a group of Pakistani economists who are advocating for tax and economic reforms.

Pakistan is an onshore tax-free paradise for millions.

1.9pc of the total population is registered for income tax, or around 60pc of the potential tax base;

However, only 0.45pc of the total population filed a tax return, corresponding to 15pc of the potential tax base;

0.24pc of the population actually paid income tax as part of the tax-filing and assessment regime, a total of around 534,000 citizens, or one in every 375 Pakistanis;

Out of these, only 36,838 Pakistanis paid more than Rs500,000 in personal income tax for the year ($4,800 or more);

The bulk of the income tax collection is from the corporate sector, which contributed 77pc of total income tax receipts in 2013-14, while personal income tax receipts amounted to 23pc of total income tax collected for the year.

Out of over 65,000 companies registered with the SECP, around 25,000 filed a tax return (approximately 38pc of the total). Of these, 40pc did not declare a profit.

1pc of companies accounted for 79pc of corporate income tax collection 14,000 doctors in the country filed a tax return out of approximately half a million practising Around 5,000 practising lawyers filed a tax return out of nearly half a million registered Exemptions to the rich and powerful riddle the tax system, which is undermined further by weak enforcement and large-scale non-compliance. Indirect taxes, such as sales tax on petroleum, supply the large bulk of government revenue, while a narrow base of large, formal-sector companies accounts for most of the rest.

The resulting tax system is highly inequitable and unfair — and, increasingly, unsustainable. Some of the key consequences of Pakistan’s current tax policy and tax system are:

A pernicious effect on economic growth and investment, as a rising tax burden on a narrow pool of large corporate taxpayers in the formal sector, in conjunction with the costs imposed by withheld tax refunds, is stalling new investment by businesses. This, in turn, is hurting the creation of badly needed new jobs in a stagnant economy.

There is growing evidence that the current tax system is lowering compliance and increasing informality in the economy. This will eventually hurt investment prospects of the economy, as well as reduce the quality of jobs available as the formal sector shrinks and the informal economy grows. A less vibrant and less formalised economy is likely to hurt social mobility of the labour force in the long run.

Because of the narrow and inequitable tax base, a large part of the population is denied access to a decent level of public services, as cash-strapped governments face funding shortfalls due to low tax collection, in combination with the appropriation of limited spending towards more affluent areas and segments of society.

The current tax system perpetuates inequality in society. Despite massive capital gains in equities and real estate in recent years, both these asset classes of the rich are sparingly taxed. This tax treatment promotes tax-free asset accumulation by the richest, widening inequality further.

The tax system also works against the poor, vulnerable and less affluent in Pakistan in a myriad of other potent ways, including via the imposition of an ‘inflation tax’. Inflation is caused both by massive government borrowing to cover its budgetary shortfall, as well as by the increasing reliance on indirect taxation of consumption, including by the poor.

Hence, any which way one looks at Pakistan’s tax situation, it is clear that it is deeply messed up; is hurting the country’s economic growth and development; is extremely inequitable and unfair; favours the wealthy while hurting the poor; and is highly unsustainable.

Without deep, meaningful and sustained reform which aims to bring all Pakistanis with incomes above the legal threshold into the tax fold, irrespective of source of income, while simplifying the tax regime and reducing the discretion of the tax authorities, our current economic malaise is likely to worsen.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Published in Dawn, May 13th, 2016



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