Budget in the making: tax payers in the dock?

In developed countries government expenditure and revenue are considered as an embedded social contract, whereas, in developing countries, it is the opposite. Neither the revenue nor the expenditure side of the public budget is structured in a socially balanced way

 By Dr Noor Fatima

Debate on the fair taxation is heating up. No doubt expectations are rising. It has become a matter of dialogue as well as challenges for revenue generation. To come to point straightway is it always high earners who pay the highest rates of taxes on income? This assertion might contradict what we expect of progressive tax systems. On that score, is it progressive tax system all which matters most? In many developing countries the people of low-to-middle-income brackets find themselves exposed to higher income tax. In developed countries government expenditure and revenue are considered as an embedded social contract, whereas, in the developing countries, it is opposite. Neither the revenue nor the expenditure of the public budget is structured in socially balanced way. The better off do not pay much taxes and the poor do not benefit from the opportunities. The unfair distribution of resources already for the last 60 years is further worsening through unfair tax system.

Is it about how much rich and poor pay taxes or they don't pay or it is about how much has left afterwards? That is the question. Partly answer is that Pakistan's tax system resembles with other developing counties where indirect taxes have more share in the GDP then indirect sources. Pakistan indirect taxes have more than 80 per cent contribution whereas direct taxes are around 20 per cent. Whereas in developed countries share of directed taxes is about 70 per cent that explains the basis of the regressive tax system in Pakistan. A tax is considered progressive if the burden of share is smaller on poor than rich and it is called regressive when major share of tax proceeds is coming from poor households, is larger than their share in income or consumption.

Actually the issue of collection of tax through direct and indirect tax became relevant in the context of the priority of the policy of poverty reduction, growth and income distribution. The lower income groups would ultimately be more affected by tax burden if it is based on the indirect collection policy, because it ultimately increase the price of the commodities and affect the overall CPI and purchasing power. The tax-to-GDP ratio of 10.04 per cent, is the lowest among countries of identical income levels. That too, is derived largely from indirect taxes, custom duties, excise taxes, and sales tax whose indices fall proportionately on all income classes. Following figures show that during the structural adjustment time period of 1988 to 1998 the trend of taxes remained regressive in Pakistan. This also show that basically tax burden had gone negatively lower for the higher income group. The tax ratio from self-reliant tax payers was lesser than the estimated amount due to tax-evasion, exclusion from tax net and corruption in the tax administration. The other reason of small base of tax from higher income group is the policy of the concessions, discretionary powers, exemptions from custom etc. It resulted in tax disparity increasing between the rich and poor. Although, it was vowed by "Vision-2016" that an increase in tax-to- GDP ratio will be made to 15 per cent by 2017. While due to inefficient system, in 2001-02 the tax to GDP ratio reduced from 9.40 per cent to 9.25 per cent, despite growth in overall amount which raised from Rs489.8 billion to 597 billion. (See Graph)

A target 1.2 trillion is given to Federal Bureau of Revenue (FBR) in next financial year. Apparently target is impressive to the extent that it can contribute in the higher growth activity, but keeping present deteriorating macro-economic indicators, it seems to be quite ambitious. As the budget support is driven by the quantum of the economic activity and volume of resources. If we keep on sucking the resources from the present economic activities, it is hard to meet this target, unless there is an expansion in economic activity as well as tax net.

The current tax structure leads to an anti-poor and anti-growth system, as it is based on indirect taxes and largest portion is from GST, which put burden on salaried & fixed income classes. Such indirect tax puts further inflationary pressure and hurts the poor as well as consumer spending which drivers the economic growth. Though, it is not all the progressivity of a tax which matters in evaluating its role, the tax's economic efficiency, administrative efficacy, and revenue-raising potential to finance government expenditures also matters. Present tax system since decades is not able to mobilise domestic resource to enhance the tax net that was the reason that even current expenditure was also met through the aid money in decade of 1990s. The nominal direct tax collection which is suppose to drive the economic growth, remain concentrated only on utilities as well financial institutions.

As per the recent statement of Chairman CBR there are 25,000 registered corporate taxpayers, only 4,600 are tax payers. The point is that if these companies run their business why can not they pay their taxes? Major reason leads to the loopholes in the tax system. The major receipts of taxes on account of government purchases are in built by the supplier in their invoices, which ultimately results transfer of money from one pocket of government to another. Present tax regime has the traits of favoritism for few interest groups at the cost of fixed income group which are bound to pay taxes through GST. That reduces the consumer spending and power, which takes the economy to depression. Therefore, it is essential to keep revenue and expenditure as socially equitable.

The other steps that would suitable for broadening tax net, would be encompassing more sectors of the economy for revenue generation. The foremost sector is tax on agriculture income. Presently the share of agriculture sector in tax is 1.2 per cent. It is amazing in a country where 40 per cent richest landowners own 70 per cent of arable land. Moreover, the high taxes can force companies for informal economy, which is still largest portion of unaccounted economic activity. The tax policy is not fully appreciating the fact that there are only 2 per cent of population of Pakistan which are paying taxes, because the tax policy is keeping the big potential of tax revenue out of tax net. Therefore, more the indirect taxes, more the burden on poor and less on richer classes. The tax policy has to consider that one person might be ready to pay Rs50 as tax but he might not be ready to pay 1 rupee 50 times. Therefore number of tax reduction will make the process simpler. A high tax rate creates tax evasion. Similarly reduction in privileged group would enhance the revenue.

GST as a policy always emphasised by the IMF in economic policy reform, but what is overlooked is that it is workable only in those countries where investment as well saving rate is high, the implementation in the country like Pakistan where the saving is already low even as compared to its neighbor countries, is leading to regressive policies due to GST. There is significant difference in the developed culture societies where social security is the major cushion for the poor and Pakistan where the GST is a federal levy.

In any case social awareness is growing and it is now widely understood that government policies are warranted to reduce the poverty and steer the economic activity. For too long social system has served the privileged classes and further marginalising the already burdened classes through indirect taxes would not do any good to the revenue. One can learn from the example of East Asian countries and also from the successful tax reform of other countries like Turkey and Egypt where income tax revenue grew with the volume of GDP even with the rate cuts, and added one million of tax payer in the first year of reform 2006 with the 610 K. Their tax administration improved so as the employment as well investment.

In the efforts to have 'progressive' approach in fiscal term, tax administration has to keep more direct contact with the tax payers. Other efforts is to bring the informal economy into tax net, formalising the tiny business, though one should not expect a major share of taxes from such business, as their competitiveness stems from low cast. The other part of informal economy is the volume of under ground economy. As per the critical evaluation of 'underground Economy and Tax evasion in Pakistan', by M. Ali Kemal, the under ground economy is accounted as total 35 per cent of the GDP whereas the quantum is Rs1500 billion. If we can formalise such part of informal economy, we can use these enhanced resources to fight poverty. There are several starting point as well pre-requisites for reforms in tax system Though it is an establish fact that high priority should be given to direct tax but our financial policies are tailored as per the wishes of IFIs which marginalised the poor and through the gains in lap of rich.

After all, it is rich who finally take advantage of legal and illegal loopholes of the tax code. What is required is the fair not flat tax as it will not raise tax rates on the lower classes to pay for tax reduction for the rich. That can be done similarly on all of the benefits of the flat tax proposals--in terms of simplicity, economic efficiency, and the fairness of the tax base. The wealthy can and should pay a bit more at the margins of their luxurious lifestyles.