Taxing non-filers

Updated April 05, 2018

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WE are now told by the government’s revenue adviser that the next budget will seek to increase the tax charged to non-filers of income tax returns whenever they conduct a bank transaction, purchase insurance or buy a new car.

Apparently, this is a move to try and increase the gap between what filers and non-filers pay when conducting any transaction for which, it is argued, the government has provided an enabling infrastructure.

Know more: Here’s how you can file your income tax in Pakistan

When this tax was first introduced, back in the budget for fiscal year ending June 2015, then finance minister Ishaq Dar presented it as a measure designed to promote tax compliance, or as a ‘documentation measure’.

It was coupled with an amnesty scheme for non-filers, the idea being that from now onwards there will be a cost to doing business if you are a non-filer of tax returns, and there is an easy way into the tax net through the amnesty scheme. With these two measures combined, it seemed as if the government was serious, but the feeling did not last long.

Some amount of homework had been done. For example, they found that out of 2.8 million commercial electricity connections given across the country, only 0.6m were filers of tax returns. Since most commercial connections are given to traders and shopkeepers (along with offices and service centres), it was concluded that the majority of traders in the country were non-filers, and that they could be reached with penalties through their electricity bills and use of bank accounts.

Then a scheme was announced, where using simple formulas, the tax authorities could compute what the trader wishing to avail the benefit of the amnesty scheme (they did not call it an amnesty scheme, but that’s what it was) would have to pay to be able to become a filer of tax returns, and put his or her name on the Active Taxpayer List. Failing to do so would mean no name on the ATL, and therefore a liability to pay 0.4 per cent on all banking transactions.

Traders refused to avail the scheme, and by the time the first deadline passed, only 2,500 traders had supposedly signed on to it.

Things did not quite work out. Traders refused to avail the scheme, and by the time the first deadline passed, only 2,500 traders had supposedly signed on to it. So the deadline was extended, once, twice, and then practically indefinitely, yet no measurable increase in the number of traders stepped forward to enter the tax net.

At the time when the scheme was announced, finance minister Ishaq Dar said in his budget speech that a number of key ‘principles’ would guide the tax effort in that year. First, that the share of direct taxes in overall taxes would be increased, and second that the “incidence of tax measures will be on those outside the tax net and those already in the net will be protected”.

Of course, this did not work out either. At the time when this measure of penalising non-filers of tax returns was announced back in June 2014, the ratio of direct taxes to total tax revenue came in at 38pc at the end of the fiscal year, as per revised figures. By the end of fiscal year 2015-2016, the last year of his time, the ratio had dropped to 36pc, even though the rate and coverage of the withholding tax on non-filers had increased in the two years it remained operational.

Not only that, the tax “led to an increase in currency in circulation” along with a decline in business deposits according to an impact assessment done by the State Bank in 2017. Meaning people preferred to switch to cash rather than enrol themselves as taxpayers. “Currency in circulation grew 21.5pc on average during July 2015 to June 2017 against an average growth of 14pc recorded in the past 11 years” before the imposition of the tax.

Business deposits as a proportion of total deposits in the banking system also fell from 27.6pc at the start of the period when the tax became operative to 25pc. “This shows that the imposition of the withholding tax on banking transactions apparently defeated the purpose for which it was imposed”, which was to discourage the cash economy.

In short, in all three metrics for its success, the idea of using withholding taxes to penalise non-filers is a futile exercise. It lead to no appreciable increase in the filings of Sales Tax returns, although some increase in filing of individual income tax returns did take place, mainly because many of those salaried individuals whose income tax was already being deducted at source but were not filing their returns, decided to start doing so just to avoid the penalty. This does not count as a broadening of the tax base.

It did not increase the proportion of direct taxes to total tax revenue, a key objective outlined by Dar in his budget speech when this tax was announced. Instead, that proportion declined over the years the tax has been operational.

It also did not lead to a decrease in the ratio of cash in circulation to bank deposits, which would have been an important metric for assessing whether documentation was taking place (though not the only metric). Instead, it resulted in the opposite: the accumulation of even greater cash hoards outside the banking system.

Let’s also add that the tax has been a meagre revenue measure. The State Bank found that the tax when applied on cash withdrawals from the banks, and on banking transaction, yielded 0.9pc and 0.6pc annually to the FBR tax revenue since July 2015. Perhaps in response to this meagre contribution, the government has increased the scope of the tax over the years, applying it on car purchases, insurance, profits on securities and so on.

Now we have the revenue adviser announcing that this tax will be ramped up further. He should first point out one area in which this tax has been successful, except for yielding paltry amounts of revenue without much effort, before he is allowed to proceed.

The writer is a member of staff.

khurram.husain@gmail.com

Twitter: @khurramhusain

Published in Dawn, April 5th, 2018