Tax credits and citizens’ response

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CAN offering tax credits help shape the behaviour of citizens so that they engage in specified social/economic activities? To answer this question, one needs to look into the existing tax credits offered and their impact on various economic and social transactions.

In the budget 2016-17, the government announced a tax credit to those parents who pay the education fees of their children. This tax credit is a part of an overall set of tax benefits offered to citizens, and include tax exemptions and deductible allowances. These measures are designed to promote certain transactions in order to spur economic growth and transfer benefits to the common man..

Among these tax benefits, a tax credit is a special form of tax incentive in which the tax liability of a taxpayer is reduced by a certain amount. Practically, tax credit is awarded to a taxpayer for incurring certain expenses or indulging in some transactions. For example, in the US, tax credit is provided to taxpayers on buying books and to encourage a reading habit amongst its citizens. Similarly, in many western countries, clean energy tax credits are available to those citizens who use fuel-efficient cars that have less polluting effects on the environment.


The combined total of these tax credits awarded to individuals is estimated below Rs10bn in a financial year


In Pakistan, certain tax credits are available under the Income Tax Ordinance 2001 to both individuals and businesses. These tax credits are available for i) donating to approved welfare organisations ii) investing money in shares and securities iii) paying life insurance premiums iv) contributing to a pension fund v) working as a full time teacher or researcher vi) disabled persons vii) zakat payment and viii) senior citizens with an income of up to Rs1m.

Tax credits, though large in number, have not resulted in shaping the behaviour of citizens so that they engage in the above mentioned transactions or incur the related expenses. The combined total of these tax credits awarded to individuals is estimated below Rs10bn in a financial year.

This ineffectiveness of tax credits in modifying the behaviour of citizens is largely due to their design and structure. For example, a taxpayer with a taxable income of Rs1m makes a donation of Rs25,000 to a welfare organisation, gets a tax credit of Rs900 only, through a formula of average relief. Similarly, a taxpayer with a taxable income of Rs3m, on investing Rs100,000 in shares in the stock market with a holding period of more than two years, gets only Rs1600 in the form of tax credit.

A complex methodology has been developed by the Federal Board of Revenue to grant these tax credits which ultimately reduces the financial gains for the taxpayers.

There is a need to properly restructure the tax credits system by offering attractive discounts to the citizens for engaging in desired social/economic activities. The FBR should conduct in-depth research to identify motivational factors that, once implemented, can encourage taxpayers to engage in economic transactions, and hence, avail tax credits.

The writer teaches business taxation at AIOU, Islamabad

Published in Dawn, Business & Finance weekly, July 11th, 2016

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