Massive tax evasion in Pakistan is a self-evident fact of our economic life, verified by a number of independent studies and the unanimity of expert opinion. Taxes are evaded, irrespective of their genre, whether direct or indirect.

But the baleful wrath of our economic elite in this country is reserved for the direct taxes. We are witness to a systematic, deliberate and premeditated extermination of direct taxes one after the other.

It would be recalled that our taxation system included such direct taxes as estate duty, gift tax and wealth tax. All of them were sacrificed at the altar of the avarice of the rich and the powerful. A decrepit wimp, Income tax, continues to exist, that too does not deserve to be called a direct tax in our context as 39 per cent of its collection is of the nature of an indirect tax. A few years ago, an attempt was made on this poor tax by floating the idea of abolishing it completely and replacing it with yet another indirect tax called payment value tax. The effort has not succeeded so far, but only so far. Because one does not know what havoc will be played with our taxation system by the privileged.

Yet another example is the postulate recently advanced, that there are no direct or indirect taxes because all taxes whether on income or expenses are passed on the consumers depending on the nature of market. As a corollary to this argument, it was asserted that sales tax (and by implication all other indirect taxes) is not regressive in nature. This piece is an attempt to prove that direct taxes, in their true nature, are not passed on to the consumers and that sales tax is indeed a regressive tax.

It is almost banal to repeat the truisms about direct taxes that they provide for payment of equal taxes by people in equal positions (horizontal equity) as well as a proper pattern of unequal taxes amongst tax-payers with unequal incomes (vertical equity), that they have progression in tax structure (higher incomes has higher rates) and that their incidence can not be shifted in almost all case. I wish to dwell on only one characteristic of direct taxes which is that their incidence can be not shifted.

It was propounded that all taxes are shifted sooner or later to the consumer depending on the nature of the market. Even the income tax on salaries is made part of the salary package in a supply-starved labour market. Two presumptions emerge from this formulation. They are; that the producer/seller has a complete monopoly in the market and the labour-market is starved of supply. These conditions exists only once in a blue moon. Let us consider some practical examples.

A direct tax for example Income Tax, has a progressive structure of taxation in which tax is levied at increasing rate as the income rises. To illustrate: suppose income tax on an income of Rs1,00,000 is Rs25,000,the tax on an income of Rs2,00,000 will not be Rs50,000 but Rs60,000 because with the increase in income, the rates of taxation will also rise. Further, the income tax is levied after the end of the financial period. It means that during the currency of the financial year, the tax-payer will not be aware of its tax liability.

Another important feature worthy of note is that no two tax-payers can have equal liability of income tax. It does not depend on their respective volume of turn-over but on their income, which can vary, many times immensely due to the efficiency (or lack of it) of operations other sources of incomes, unforeseen occurrences like a fire or an accident and windfalls. How can this liability be shifted when the tax payer is not even in know of his liability. The indirect taxes, on the other hand, are levied as a percentage of the value of the goods or services being taxed. Their liability is known even before the transaction takes place. Hence the ease in the shifting of their incidence. In many transactions the element of an indirect tax, say sales tax, is shown separately in the bill.

Let us now examine whether the incidence of a direct tax can be shifted in a longer run if at all, this can happen only after the liability of income tax is finally determined. Given our system of delays in assessment, appeals and counter-appeals (there are four appellate forums available to the aggrieved party, may it be the Income Tax-payer or the Income Tax department) may take as many as ten years for the determination of final liability.

Will a tax-payer be able to shift a liability now which he incurred ten years ago? Let us suppose for the argument sake, that the final liability is determined at the earliest possible point in time that it is soon after the end of the financial year. Can it be shifted in such a case? The answer is a resounding no. It has been already pointed out that the Income Tax liability enormously differ from tax-payer to tax-payer. Now if they try to shift their liability to the consumers by including it as a factor in their sale-prices, the sale-prices would differ in the same proportion as do their respective tax liabilities. Can a person earning higher income and paying higher income tax charge higher prices from his customers? The answer is once again a no. Or else he will be thrown out of the market, his riches turning into rags. The conceivable situation when Income Tax can be shifted is a perfect monopolistic situation, which we all know almost never exists. Whenever goods or services become too expensive because of a monopolistic situation, the consumers shift to economically interchangeable goods and services.

At the same time competition emerges as the market, like nature, abhors vacuum. This shifting of incidence of liability becomes even more preposterous in case of other direct taxes. Imagine a producer/supplier charging higher than the prevalent market rates for his products because he just inherited some property from his late father and paid Estate Duty, or he is richer than others and paid a substantial amount in Wealth Tax.

Another point which should be kept in mind is that the amount of tax which is shifted also becomes taxable. In many cases, the addition can push the income to a higher tax bracket which may result in greater tax burden than what was shifted earlier.

The same situation will ensue if income tax is made part of the salary package, and the employee may not be a gainer at all. Besides, how many employment-seekers can dictate their terms by asking that the element of income tax be made part of the salary package? And wonder of wonders, where does a supply-starved labour market exist, especially in a country like Pakistan which adds 3.1 million persons to its population each year?

All indirect taxes, including Sales Tax, are regressive in nature. Let us first define what is “regressive taxation”. It has been defined by Collins Dictionary of Economics in the following words:

“a structure of taxation in which tax is levied at a decreasing rate as income rises. This form of taxation takes a greater proportion of tax from the low-income tax-payer than from the higher income tax-payer. Indirect taxes such as value- added tax or excise duty become regressive when taken as a proportion of total income. The burden of taxation is proportionately greater on the less affluent members of society and can not be considered an equitable tax”

Even those items which are not subjected to sales tax, like unprocessed foodstuff, books, cattle feed and medicines contain the element of sales tax paid on the consumption of gas, electricity, telephone and transportation. When such items are not directly subjected to sales tax, they become proportionately more expensive for the poor. Whenever a tax is paid by the rich and the poor in identical monetary value, it becomes regressive because it represents a greater proportion of the income of the poor.

The unfortunate part of our fiscal policy is that the contribution of direct taxes is steadily declining. According to CBR’s figures, their share was 35.1 per cent in the financial year 1997-98. If has gone down to 31.58 per cent during the current financial year. This figure will further come down if we take into account the surcharges on gas and petroleum which are in the nature of indirect taxes but are not included in CBR’s collection. Besides, income tax, implausible as it may appear, contains a large chunk of indirect taxation. According to my calculation indirect taxes contribute 82.22 per cent to the collection of various revenues and surcharges. The disturbing fact is that the trend is on the rise. The result is that, despite macroeconomic stability, poverty is growing in Pakistan. In the year 90-91, 26.8 per cent Pakistanis lived below poverty line, which is gone up to 31.8 per cent this year. Arguably, there appears to be a positive correlation between the rise in indirect taxation and poverty.