The Federal Board of Revenue (FBR) has invited income tax proposals from concerned stakeholders for the upcoming budget 2020-21 to bring certainty, predictability, efficiency, equity and progressivity in the taxation policy.
For this purpose, the stakeholders can submit proposals for promoting equity in taxation, removal of tax distortions and anomalies, broadening of the tax base, phasing out of tax concessions and exemptions, taxation of real income on a progressive basis, facilitation of taxpayers and ease of doing business.
Equity is one of the golden principles of taxation policy. Many empirical and non-empirical research studies have identified the pivotal role of equity in taxation to optimise societal welfare. Equity ensures taxation of real income on a progressive basis.
Horizontal equity requires that the taxable persons with an equal level of income must pay the same amount of tax for the tax period in which such income is earned. This aspect of equity develops the perception of fairness among taxable persons, especially small and medium ones, and so encourages them to ensure compliance of tax laws.
Vertical equity requires that taxable persons with different levels of income must pay different amount of taxes such that people with higher levels of income should be subject to higher taxes as a percentage of their income compared to those who fall within lower income brackets.
This is an opportunity for stakeholders to come up with concrete suggestions to assist the government in making the income tax policy more equitable
Vertical equity has a significant role in reducing income gaps between higher-income earners and lower-income earners during a specific period. So based on the concept of equity, a tax becomes proportional if all the taxable persons pay the same percentage of their income as tax. A tax is regressive when persons with higher income levels pay tax as a small percentage of their income and progressive if people with higher incomes pay a greater percentage in the form of tax.
Needless to mention that the overwhelming portion of tax revenue in advanced economies comes from direct taxes, which are effectively enforced. This could be a reason why the developed countries are successful in maintaining the lowest gap between higher-income earners and lower-income earners.
Contrary to this, developing countries like Pakistan collect a major portion of their tax revenues through indirect taxes and presumptive withholding taxes. It is pertinent to mention that the chairman FBR has recently made a statement that 90 per cent FBR income tax collection comes from withholding taxes and only 5-10pc comes from voluntary tax compliance.
It will be an uphill task for a state with a heavy reliance on indirect taxes to maintain equity and hence to optimise societal welfare. Importance of equity can also be estimated from the fact that governments explore various ways within an indirect taxation policy, such as targeted exemptions and zero-rating on essential items, for making indirect taxes less regressive.
Given the significance of equity in taxation policy, this is an opportunity for stakeholders to come up with concrete proposals to assist the government in making income tax policy more equitable.
To promote economic growth and achieve efficiency, the taxation policy must be neutral for all economic agents. Such a policy does not interfere with the allocation of resources and its application does not modify consumption and investment decisions.
Moreover, a neutral tax policy leaves production undistorted, achieves a broader tax base, taxes the broader base at lower rates, optimises tax revenue, enhances productivity and stabilises the economy.
Similarly, phasing out tax concessions and exemptions is imperative not only to prevent loss of tax revenue but also to broaden the tax base, to make the tax system simple and neutral, to increase tax compliance and to reduce risks to businesses. It is worth mentioning that during 2018-19, the government sacrificed income tax revenue of Rs141 billion due to tax exemptions and concessions.
A narrow tax base in terms of tax return filers remains the main concern of the FBR. Despite massive changes in the tax policy in the recent past, such as differential withholding tax rates for filers and non-filers and active taxable persons and non-active taxable persons, recently released data has shown 2.34 million tax return filers by January 31, 2020. Although this a 40pc increase in tax return filers over the same date last year, there is no reason to rejoice, keeping in view the potential pool of the taxable persons in the country.
To achieve neutrality, efficiency and progressivity, it is imperative that a tax system should have a broad base with all taxable persons in its net.
Last but not least, facilitation of the taxable persons and ease of doing business are important policy areas from an economic point of view. Empirically, better doing-business ranking is found associated with larger foreign direct investment (FDI) inflows.
Importantly, Pakistan’s ranking on the ease of doing business index has improved from 136 in 2019 to 108 in 2020. However, to stimulate business activity and to attract more FDI inflows, Pakistan has to further improve its position on the index, especially by making tax procedures and tax payments easier and business-friendly.
Published in Dawn, The Business and Finance Weekly, February 17th, 2020