The story of taxation or its virtual absence in Pakistan is old and has been heard many times over. The country has survived without internal taxes because foreign aid kept flowing in instead. A rentier state [our strategic advantage] has not felt the urge for tax reform like for instance a non-rentier state may have.
Yet, the importance of taxes for a country's economy cannot be overstated. It's a classic chicken and egg case; taxes are required to provide public goods and public goods must be there as an incentive for more taxes. But since the only example that we have created in this country is that of exemptions, today, nobody is willing to pay taxes. And since there are no taxes, there are obviously no public goods.
Meanwhile, the debate around taxation has continued; there are no willing taxpayers and therefore the governments have had to rely on indirect taxation. To an outsider, though, the figure may seem shocking -- the registered taxpayers count to about 2.75 million Pakistanis from among the country's estimated 16 million population. From CBR to FBR, the only change that has come about in recent years is that of nomenclature.
The reason why all the ills of our taxation system have been thrown open once again, at this point in time, is because of the huge economic crunch in the wake of the worst ever floods. Flood Tax is the new buzz word. Why must the foreign taxpayer alone pay for our floods when we don't do it for ourselves, seems to be the logic behind the institution of such a tax which remains all in the air so far. True, the provinces shall levy the tax if at all but how shall they go about it is still not clear. Will it be on the existing small community of taxpayers only or on immovable property, a one time levy or a yearly exercise, will Punjab impose it or only Sindh?
Besides, if the suggestions afloat are anything to go by, it is erroneous to assume a person with an annual earning of 3 lakh rupees as rich; a ten percent surcharge on his income may be too much to bear in these times of inflation.
All these questions are yet to be decided while a set of economists have pointed at the deep rot that ails the economy. No amount of flood tax collected can fulfil the huge loss wreaked by floods, they say. The government needs to do a lot more.
In an interview with TNS, Hafiz A. Pasha has made an invaluable suggestion -- instead of a one time levy and calling it flood tax, here is an opportunity for a permanent reform. He would like the government to reintroduce Wealth Tax Act of 1963 which was abolished by the Musharraf government in 2001. At a time when the rich of the country get away without paying taxes, this could be a popular move, he says, and have a symbolic significance. It is an annual tax, very Islamic in that way like Zakat, and you can capture the agricultural assets through the wealth tax, he suggests.
Others may have their own ideas but the government must lend them all an ear before it makes any decisions. The floods have indeed provided a window of opportunity to bring in the much-needed reforms in taxation in a more equitable way. It's the government's job to create that consensus now.
"The focus has to be on improved governance"
-- Dr Hafiz A Pasha, renowned economist and Dean of School of Social Sciences,
Beaconhouse National University
By Farah Zia & Ammara Ahmad
The News on Sunday: What do you think of the idea of flood tax imposed on the small community of taxpayers instead of expanding the tax base? Is there a need to have this flood tax at all, considering what people like Shaukat Tarin have been saying?
Dr Hafiz A Pasha: Yes, indeed. As the way the budget in Pakistan is structured today, there is a lot of fat and waste. The best example is, of course, what people like Shaukat Tarin and others have given -- the massive amount of money we are throwing out in the form of subsidies to the public sector enterprises, which conservatively estimated comes to about 250 billion rupees. Now there is no flood tax that can generate anywhere near that amount. So the more efficient way is through improving the workings of the government and that can be done fairly quickly. Then the extravagance, large budgets for the Prime Minister's house, the PM secretariat, the presidency, the vast cabinet and all these expenditures add up.
Therefore, before you go for any form of significant additional taxation -- be it flood tax or anything else -- you have to be able to demonstrate first that whatever revenues you collect or generate from the people will be used well. This is becoming a far more serious issue than I remember in the last twenty to thirty years.
TNS: The flood tax is seen as more of a political compulsion for the government because of the question that why should the foreign taxpayer pay instead of the local one?
HAP: No, the international community would be far more impressed if we are going to take serious action against corruption, particularly because the issue is one of using well the resources generated either domestically or internationally. So, if you can set a proper accountability mechanism and ensure less corruption in the system, that improves your chances of getting more support, much more than some kind of a one-time levy.
TNS: It seems corruption is the buzzword but in public sector enterprises a lot of expenses are incurred because of over-staffing and general mismanagement?
HAP: Well, a part of it is due to inefficiency and mismanagement. Corruption can be equated with nepotism. If you have a situation where a person is not even an FA and is appointed as the chairman of the Oil and Gas Development Corporation that reeks of nepotism and obviously that person is not qualified. This is the largest corporation of Pakistan and one of the top hundred companies of the world. I think what people conclude from this is that if you appoint cronies, they will try to please whoever has appointed them and the end result is that there is incentive for extracting rents. So the system must be seen to be doing the right thing, in appointing the right people in the right place, having independent boards of directors, taking decisions on the basis of business considerations. Yes, there is a certain amount of inefficiency and over-employment. The three things add up and there is a huge hole. We are spending more on the power sector of Pakistan than we spend on public education. This just doesn't add up.
So, the focus has to be on improved governance. That is why people like me who are otherwise prone to argue that the tax to GDP ratio of Pakistan is low and that we should try and raise it have come to realise now that you can only substantially raise the tax to GDP ratio when the writ of the government is there and when people are actually willing to pay more in the form of taxes on the assumption that whatever they contribute will be used well.
TNS: But they say that politics is patronage. The government sees political benefit in making these appointments?
HAP: I don't think good politics means patronage because, beyond a point, it is patronage that begins to destroy democracy. For example, we have in many democracies a system of confirmation hearing. I mean the appointment of the chairman of OGDC should go to some committee in the Senate and that gentleman should be subjected to intensive cross-examination. How much does he know about the oil and gas sector? What is his business background? What kind of executive responsibilities has he held in the past? All these things have to be considered. If you want a country that runs reasonably well and is a democracy, then you will need some degree of meritocracy. Otherwise there will be a complete breakdown of the system, and that is precisely what is going to happen today.
TNS: What will it take for Pakistanis to start paying their taxes?
HAP: What is happening in Pakistan is that, because of the rising perception of waste and corruption, tax compliance is breaking down. Now far more questions are asked about accountability by the taxpayers. The media has contributed to this and there is a common perception, whether you like it or not, that there is more wastage and corruption. And the willingness to contribute and pay taxes has diminished in the system. So before you go about raising tax revenues, you have to improve this tax compliance and attitude of the people to be taxed more.
So the writ of the government, in that sense has been affected. The first thing we have to do is to get our act together in terms of trimming the government, making it more efficient, getting rid of people who were found guilty as per the NRO and so on. It is very important that the perception improves and people come forward.
TNS: Is it not true that there is a culture of not paying taxes?
HAP: There is this culture but that has been compounded by these additional factors. There have been times in our Pakistani history when our tax to GDP ratio was significantly higher. And one of the reasons why it has come down is primarily because during the Musharraf period we saw a relaxation in the fiscal effort. The government was getting a lot of money from abroad and was not worried about tax revenue and there was no emphasis on collection. Now it is compounded by this negative perception about governance. The result is that from about 13 to 14 percent in twenty years, your tax to GDP ratio is below -- close to 10 percent.
TNS: What about the corruption within the state structure and systems that encourages tax evasion in customs, income tax etc?
HAP: They are all mixed up. You see way back in the early 1990s we tried to bring this reform which was basically that we tried to simplify the tax system and remove discretion and arbitrariness from the system. So we came up with a vast regime of presumptive and withholding taxes in Pakistan's income tax system. And lo and behold, it worked! And in the early 1990s we were able to mop up a fairly large increase in the income tax revenue. It went up from about 1.5 percent of the GDP to 3.5 percent. So we understood the psychology of the taxpayers -- they didn't want to be harassed and didn't want to have a too sophisticated and complicated system and be at the mercy of the tax officials. So we came up with these improvisations.
For example we put a tax of 10 percent on the interest income collected at source and left the rest. Then we said to the commercial importers -- it was a shady, informal sector o--o that once the consignment comes in, we are assuming that the profit is about 20 percent, so we charge them a 2 percent or a 4 percent of presumptive tax and let them get out of the system.
TNS: But that system continues?
HAP: It does continue to this day and that is what has saved you because 60 percent of your income tax revenues are from that system even today. So that kind of reform which minimises contact with the tax officials helped. Now we have to go for a self-enforcing system. The great merit of VAT is that it is essentially self-enforcing. So you have to design your tax reform and your tax system which in effect reduces the scope of discretion and corruption.
The other thing we have to do of course is that we have to take action against the corrupt officials. Now there is a list of corrupt officials in the FBR in the NRO and no action has been taken against them as yet. They should all be charged and sent home. But this didn't happen. The largest group of corrupt officials in NRO is from the FBR.
TNS: How would you evaluate the performance of FBR?
HAP: Very weak. During the Musharraf time, there was a lot of growth, some 6-7 percent and continued for a number of years but the tax to GDP ratio did not rise. In fact it fell slightly. There are a number of reasons why it fell. First, many more exemptions were granted in the system. For example, in 2001, he removed the wealth tax which was not a revenue generator. It was a signal of equity in the system. It was also a way of detecting income tax evasion because you link wealth with income. For example, these declarations by the revered members of our parliament, who on the average are quite well off, would have become the basis of the wealth and income tax assessment. Then they brought down the tax rates dramatically. Very importantly, certain sectors where there was massive increase in income were not touched like property income, the stock market. There were capital gains of 500-600 billion rupees annually tax free from the stock market but there was no tax. It has come this year in the budget for the first time now that the market is falling.
TNS: What stops the government from imposing taxes?
HAP: In the case of Musharraf, there was less pressure to develop the tax system. One reason was that when you have 'manna from heaven' coming in from outside, why would you bother about taxing locally. With all this money coming in, there was less pressure on the budget. Secondly, military governments give favors to buy loyalties. then and there to buy loyalties. So they had selected certain segments of the society and the patronage of that kind, political patronage, was done through exemptions and concessions in the country. I mean was there any logic in bringing down the tax rates on the banks from 58 percent to 35 percent at a time when the profits of the banks increased by 12 times. Banks continued to enjoy cartel type benefits. And that one decision cost us 20 billion annually. The exemption on the capital gains on shares cost us over a 100 billion annually. So the end result is that you slacken the tax administration.
These are hard numbers based on research. The story of Pakistan is one of missed opportunity. The scope for tax reform, which the Musharraf government had, was never utilised. In an economy which is not growing, how many additions can you have in it? People and the middle class are financially crushed and you will add to their taxes? How do you raise the tax to GDP ratio at this time? You can't possibly ask people earning Rs 3 lakh a year to give 10 percent surcharge on income tax considering the kind of inflation we have.
Precisely what stops the revenue authorities from tracing tax evaders and forces them to take whatever the country's powerful elite say on its face value?
By Shahzada Irfan Ahmed
The recent warnings of international donors and the US to Pakistan to broaden its tax base have given a spur to the ongoing debate about reforming the country's tax system. The International Monetary Fund (IMF) went to the extent of withholding around $1 billion of funding as the country had not met a number of economic criteria, including the reformation of the existing tax system.
Like always, the Federal Board of Revenue (FBR) has once again expressed its resolve to bring more and more people under the tax net. But it seems the enthusiasm will soon fizzle out and the already registered taxpayers will have to bear the burden of any additional taxes, if imposed. Besides, the FBR achieved partial success in increasing the share of direct taxes in total revenue collection and indirect taxes continued to be the major component.
According to the quarterly review of the FBR, released at the end of June 2010, the FBR has been able to collect around Rs 1,329 billion during the fiscal year 2009-10 against the target of Rs 1,380 billion and the tax-to-GDP ratio has been recorded at 9.1 percent. It further says that direct taxes have constituted 40 percent of total tax receipts during the year.
Similarly, sales tax -- an indirect tax -- has been a major revenue generation source of the country during 2009-10. It constitutes around 65 percent and 39 percent of the collection of indirect taxes and total federal taxes respectively during 2009-10.
The question that arises here is as to what stops the revenue authorities from tracing tax evaders and forces them to take whatever the country's powerful elite say on face value. One wonders why can't they question people about their unexplained income and assets and call explanations if their spendings do not conform to their known sources of income.
There is no rocket science involved in digging out potential taxpayers who are currently out of the tax-net, says Shahzad Azam Khan, Convener of Lahore Chamber of Commerce and Industry (LCCI), Committee on Finance and Taxation. According to him, the simplest way is to ask for utility bills from households as they speak of the lifestyle of a person and his financial position.
Shahzad tells TNS that he knows many people who pay more than Rs 50,000 in electricity bills but do not pay the income tax. He insists it's impossible for importers, exporters, manufacturers and salaried persons to remain out of the tax net: "They cannot function if they do not document themselves."
On the other hand, he says, whole-sellers and retailers dealing in smuggled goods can get away with paying no taxes in the absence of documents pertaining to the merchandise. They cause immense losses to the registered importers, local manufacturers and the national exchequer by evading customs duty as well as sales tax.
Shahzad says under-invoicing of imported goods, in connivance with the tax officials, helps people save import duties. If one quotes the price of an imported product costing Rs 10 million to be Rs 5 million one instantly saves 50 percent import duty.
He says that it's in public knowledge that the people are doing businesses worth millions everyday on simple pieces of paper (parchis). These parchis are treated just like cash in wholesale markets but no tax official takes cognisance of this irregularity. The reason, he says, is that top businessmen are highly influential and they also bribe tax officials to keep their transactions undocumented.
A tax expert based in Islamabad, who regularly deals with revenue officials and advises taxpayers, tells TNS on conditions of not being named that the reason why the FBR is not interested in increasing its tax base is that it focuses on collection of indirect taxes. He says indirect taxes put equal burden on a millionaire as well as a beggar since both of them pay the same amount of sales tax on the purchase of a similar project.
He says this simply leads to the exploitation of individuals according to Article 3 of the Constitution of Pakistan which says: "The State shall ensure the elimination of all forms of exploitation and the gradual fulfillment of the fundamental principle, from each according to his ability to each according to his work." This means that direct taxes must be preferred as they are levied on the basis of a person's individual worth and income and the ability to pay, he adds.
The expert suggests that the FBR should be given the powers to hold tax audits freely and without interferences from above. He says the position on ground is that every other rich person has direct links with top politicians or bureaucrats and approaches them whenever inquired by tax authorities.
He says there are laws that empower tax officials to a great extent but they are hardly put to practice. For example, he says that Section 111 of Income Tax Ordinance empowers tax officials to enquire people about their unexplained income and assets and assess tax applicable on them. Though wealth tax is no more this law makes holders of unexplained wealth questionable.
The tax expert adds that the FBR randomly selects taxpayers through computer balloting for tax audit but many of them go to the court against their selection. Even those who are ready for audit negotiate with the FBR as to which documents the officials can demand and which they cannot. This makes thorough audit difficult as officials are denied additional documents in case of confusion, he concludes.
Nadeem Sardar, a Karachi-based chartered accountant, tells TNS that tax consultants and lawyers are not always meant to manipulate laws although they quite often take benefits from lacunae and exemptions in tax laws. He says the structure of our tax law is quite complicated; therefore, the businessmen, especially those who are not well-educated, need experts' assistance.
Nadeem says the FBR also understands the issue and that's why it has formed a Facilitation And Taxpayers Education (FATE) to help taxpayers.
He says the purpose behind the move, as explained by the FBR, is to promote cultural change in the department. The board, he says, also wants tax officials "to adopt a more assisting and facilitating attitude towards taxpayers rather than traditional confrontational mode."
"People of Pakistan are the most heavily taxed"
-- Dr Ikramul Haq, researcher, legal historian, tax adviser and author of books on tax laws and socio economic problems
By Ather Naqvi
The News on Sunday: How important do you think is the proposed Flood Tax in the present circumstances considering that the needs are immediate and the structural reforms being suggested by economists are long-term?
Dr Ikramul Haq: In these kinds of emergent situations, governments are justified in imposing one-time special levies on the rich people. Its incidence, however, should not be on the poor and the middle classes that are already overtaxed.
Although no blueprint of such tax is made available till today by the government, flood tax on the rich will certainly be a positive move. It will not only help raise funds for the rehabilitation of the flood victims but can also go a long way to manifest the political will of the rulers about internal revenue generation rather than looking towards foreign loans, aids and grants all the times.
TNS: What, in your view, are the structural reasons for the absence of an effective tax regime in our country? What about the corruption within the state structure and systems that encourages tax evasion in customs, excise, income tax etc?
IH: Our political culture supports racketeering and rent-seeking. Tragically, this social evil is doubly compounded as it necessitates greater and greater tax burden on law-abiders. The ultimate cynicism that can afflict a society must surely be the acceptance of corruption as a way of life. Unfortunately, after six decades of independence, this is precisely where the Pakistani society has been heading to. The darkest side of the picture is that the persons who are capable of checking this distortion, the politicians and bureaucrats, are unlikely to oblige: for it would sever their financial lifelines. Those who spend huge amounts of money in general elections cannot afford to counter this menace.
Also, unrealistic tax laws and complicated procedures have encouraged corruption and a burgeoning, uncontrollable underground economy which is now responsible for institutionalising racketeering.
In tandem with this silent conspiracy is the fact that the laws against the racketeers are usually not enforced, and if they are, the penalties are laughable (NAB's handling of Mansoorul Haq's case is a classic example). Large-scale tax evasion and the existence of a large black economy, resulting in loss of revenue to the state, tend to reduce the built-in elasticity of a fiscal system to the extent that the tax evaded income is spent on goods and services that help to generate inflationary pressures and raise the prices of real estate.
TNS: What is the way to broaden the tax base and what have been the irritants or resisting factors so far?
IH: There are certain myths attached to the issue of tax base in Pakistan. The number of income taxpayers is around 60 million (every mobile user when making payment for prepaid or postpaid services to a mobile company is subjected to 10 percent income tax on the amount he pays). However, the number of registered taxpayers is less than 2 million. Tax managers sitting in Federal Board of Revenue (FBR) have been persistently claiming that the tax base of Pakistan is disappointingly narrow and the majority of the people do not pay income tax. The reality is quite the contrary. The people of Pakistan are the most heavily taxed (rather over-taxed) in the entire Asian region as per official facts and figures. As far as the tax base is concerned, not only total taxable population but millions of those earning below taxable incomes are paying taxes at source or through voluntary filing of returns. FBR has failed to register all the potential taxpayers who pay more that Rs 50,000 per annum as mobile bills. Had it been done we would have by now at least 30 million people having National Tax Numbers (NTNs) and filing returns regularly. There is no resistance to paying taxes as the majority of the people are already paying income tax at source. They do not file returns being fearful of FBR officials who then force them to pay gratification rather than taxes. It is due to FBR that the people are scared of being registered on the tax roll. In civilised countries, one is honoured to be a part of the national tax roll. In Pakistan, it is a trauma even for those who pay billions as tax -- FBR officials keep harassing them to extort money for self-aggrandizement. Thaana (police) culture prevailing with force in the FBR is the real cause of people's reluctance to file tax returns. Any person who files true income or complies with tax laws is disbelieved and becomes a victim of arbitrary actions of tax officials. On the contrary, by greasing the palms of taxmen one can remain outside the tax roll -- majority prefers to exercise this option. There exists an unholy alliance between tax evaders and tax officials depriving the nation of revenues worth billions of rupees.
TNS: Having been associated with the field for a long time, what do you think are the reasons we've not been able to develop a culture of paying taxes? What will it take for Pakistanis to start paying their taxes?
IH: It is highly lamentable that although the ordinary people of Pakistan paid taxes of nearly Rs. 1,335 billion during the financial year 2009-10 (the figure was just 120 billion in 1993-94), yet instead of getting credit for it, they have been dubbed as 'tax evaders' by the FBR. On the other hand, all the successive governments -- military and civilian alike -- have miserably failed to cut their wasteful expenditure on personal perquisites and benefits. How the public revenues are plundered and wasted in this country by the so-called public representatives and the civil-military bureaucrats is an open secret. Defence and debt service alone are devouring the entire tax revenues of the State. Are the people of Pakistan responsible for mismanagement of the State's affairs? The answer is certainly 'No'. In fact, the rulers and vested interests do not pay taxes due from them. The real culprits are thus the plunderers of national wealth who have accounts and assets outside Pakistan. According to conservative estimates, at least US$ 500 billion belonging to these criminals are lying in off shore banks.
TNS: You have been extremely critical of FBR in your articles. Quickly tell us how can it be reformed, if at all? What is the alternative?
IH: Federal Board of Revenue, according to all available data and indicators, is the most inefficient, incompetent and corrupt arm of the government. It is, in fact, managed by a band of mediocre and sycophant bureaucrats. FBR, responsible for the collection of federal taxes, has miserably failed to introduce any tax intelligent computerised system, despite the fact that it has a market-wage-oriented company, PRAL, at its disposal, to monitor the economic activities of corporate/business sectors. This failure coupled with corrupt practices (according to some estimates at least Rs. 200 billion go annually into the pockets of tax officials) has contributed to generation of enormous black money in Pakistan. The only way to reform FBR is to make it an autonomous body, the control of which rests with a professional Board having at least 50 percent representation from public. All the officers, recruited through the rotten CSS system, should be either compulsorily retired or given Golden Hand Shake. New professionals, as recruited by the State Bank of Pakistan and the Security & Exchange Commission of Pakistan, should be inducted on purely merit basis on market wages. They alone can ensure collection of taxes wherever due. Delegation of full financial powers to the FBR on the lines of the State Bank of Pakistan is the need of the hour. Such powers are absolutely necessary if the FBR is to discharge adequately its responsibility of running the tax apparatus efficiently.
TNS: How do you compare the tax system of Pakistan with other South Asian countries such as India and Bangladesh? Can we learn from their example or from any other country in the world with similar conditions?
IH: Pakistan's tax system, like its political system, is not comparable with any other country. All countries have problems, but there exists a desire to find their solutions. In Pakistan, however, we are collectively destroying the established structures. Now, like many other institutions, FBR is in total shambles. If the apex revenue authority is marred with inefficiency, incompetence and corruption then no system or model can work successfully. Look at the results we have achieved after five years of foreign-funded Tax Administration Reform Programme (TARP). The tax-to-GDP ratio has declined from 13.4 percent to 8.9 percent, corruption and non-compliance have increased manifold. India and Bangladesh are much better off as far as enforcement is concerned. We are collecting one-third of our actual tax potential. Bangladesh successfully implemented Value Added Tax (VAT) in the early 80s whereas we are still confused about it in 2010. India mopped up 9,000 billion of rupees through tax amnesty scheme and nearly 3,500 billion rupees through Kar Vivad Samadhan -- a one-time de-logging of tax litigation scheme that reduced pendency in courts substantially.
We can learn a lot from India which rejected the IMF-World Bank tax reform project. Through public debate and consensus, Indians in recent years have made significant structural and operational changes, improving tax compliance as well as 8 percent increase in tax-to-GDP ratio in just one year. Pakistan got a large sum of money from the World Bank (over 100 million dollars) and best advice was also available for TARP, but the outcome is nothing but further deterioration -- infighting has been triggered between Income Tax and Customs Group. This has resulted in negative growth in real terms in collection of sales tax in the current fiscal year.
TNS: What should be the ideal ratio of direct to indirect taxes in a sound economy and how would you evaluate the merits or otherwise of both?
IH: The shrinking share of direct taxes in the overall collection of taxes should be the immediate cause for concern for our policymakers. It is now well-established that there is a direct link between growing poverty in Pakistan and distortion in tax base since 1991, when a major shift was made by introducing presumptive taxes (indirect taxes in the garb of income tax). The lack of judicious balance between direct and indirect taxes has pushed an overwhelming majority of Pakistanis towards the poverty line. The following table depicts a horrifying picture:
In developed countries, the higher tax-to-GDP ratio is primarily due to the higher level of revenue from social security, payroll taxes, corporate taxes and taxes on domestic consumption while the taxes from international trade and non-tax revenue are lower. In contrast, in the developing countries, the major portion of revenue comes from indirect taxes, particularly taxes on international trade and domestic consumption, while direct taxes have a lower share. Pakistan's tax-to-GDP ratio is even below that of Sri Lanka and Thailand, which proves beyond any doubt the failure of fiscal managers and tax collectors.
There should be a judicious balance between direct and indirect taxes. The burden of indirect taxes, constituting nearly 75 percent of total collection is too high in Pakistan.
The burden of all these indirect taxes has been passed on to the end consumers. These kinds of taxes take a very small portion of a rich man's enormous income and a very large slice of a poor man's meagre earning. It shows that ill-directed, illogical, regressive and unfair tax system is widening the existing divide between the rich and the poor.
The sole stress on indirect taxation (even under the garb of income taxation through presumptive tax regime on goods and services) without evaluating its impact on the economy and the life of poor masses is a lamentable policy. In the name of higher growth in tax collection, the economic and social fabric of society is being torn apart.
(The interview was conducted on email)
Why on earth do the Pakistanis refuse to pay taxes?
By Shujauddin Qureshi
"Our taxation system is exploitative in nature and puts a heavy burden on the honest tax payers," says Dr Shahid Hasan Siddiqui, a senior economist and an individual tax payer himself.
People have to pay heavily on account of indirect taxes, whereas direct taxes are very low -- about 25 percent -- of total taxation, because a large portion of the population is not included in the tax net and there is widespread tax evasion. Hence, the tax collectors have to transfer the burden of taxation on to the common man who is already faced with a high rate of inflation, frequent increase in utility charges and transport fares, etc.
Although the government claimed in 2003, when the GST rate was at 15 percent, that it would reduce the rate gradually, bringing it down to 5 percent, due to shortfall in revenue collection and increasing budget deficit the GST rate has only been on the increase. Today, it has been raised to 17 percent.
It is a common observation that in Pakistan the tax payers are not satisfied with the tax collection system, thanks primarily to corruption in the setup. The tax payers do not receive any better services or any infrastructure development in their areas; instead, they see the government's lavish spending and the bureaucracy's plundering of public money in connivance with public representatives. The largest-ever federal cabinet, the purchase of luxurious cars, sumptuous dinners, foreign tours and increase in salaries of government employees and defence personnel are some reasons why the common man avoids paying direct taxes. Whereas the government has abolished the Wealth Tax and there is no tax on agriculture income, even though the landlords claim they pay some revenues on agriculture.
Another frequent complaint is that a large portion of the population is out of the tax net. This includes filthy-rich landlords who also sit in the parliament and rule the country but do not pay taxes. "They even discourage any legislations regarding imposition of the agriculture tax," maintains Dr Siddiqui.
On many an occasion, the subsequent governments have claimed to impose farm tax particularly under pressure from multilateral donors like World Bank, IMF and Asian Development Bank, but no government has had success in imposing such a tax.
Agriculture constitutes about 21 percent of Pakistan's overall economy, whereas the contribution of this sector in the overall taxation is just one percent and the contribution of the service sector is 26 percent against its share of 53 percent in GDP.
Most of the parliamentarians have been resisting the imposition of agriculture tax, a fact admitted by the government in a letter to IMF seeking an excuse for not being able to impose farm tax in 2009.
According to the income tax return figures provided by the Election Commission of Pakistan, the Prime Minister and 25 federal ministers do not pay any sort of direct taxes including Income Tax or Agriculture Tax. "The fact is that the government does not have the political will," says Abid Ali Habib, a corporate tax payer.
Corporate sector complains that it pays multiple taxes but every time the government puts the burden of taxation on the registered tax payers. A Federal Board of Revenue (FBR) report indicates that only 2.75 million Pakistanis or 1.6 percent of the country's estimated 160 million people have acquired National Tax Numbers (NTN). This means that a large number of potential tax payers are still out of the tax net.
Among the NTN holders, only about 2 million file their returns on annual basis, the report says. "The worst sufferers in the current taxation system are the salaried people, whose income tax is deducted directly from their salaries every month. For others, there are many 'opportunities' to evade taxes," says Muzaffar Hussain, a banker.
Another predicament the salaried class is faced with is that it pays a variety of taxes in advance, such as Withholding Tax on telephone (including cell phone) bills, at the time of payment of excise duty on vehicles or booking of new vehicles at the time of withdrawal of more than Rs 25,000 from bank accounts etc. But they are unable to reclaim that presumptive tax amount because they fail to file their annual returns. Even if they file their returns, they do not possess enough documents to claim the refunds. Those who file their taxes through professional tax lawyers, however, get some benefits of refunds of withholding taxes.
As a matter of fact, despite its tall claims and futile efforts as well as putting the latest equipment and systems in place through donors' funds, the FBR has miserably failed to achieve the tax collection targets every year, particularly during the last fiscal year. The government had fixed a tax-collection target of Rs 1.38 trillion, but it ended up getting Rs 1.33 billion. This year, the government has fixed an ambitious annual tax collection target of Rs 1.6 billion, which is also difficult to meet because of heavy dent to the economy after flash floods across the country and the worsening law and order situation in different parts of the country. The tax collection figures in the first two months of the current fiscal year also corroborate the fact.
Besides the salaried class, the businessmen and the industrialists are also not happy with the current taxation system. They complain about rampant corruption in the tax collection machinery which ultimately causes heavy losses to the public exchequer.
Pakistan is among the countries with very low tax-to-GDP ratio --still in the single digit. Every year, the government tries to bring it to 20 percent but fails to meet the target. According to official statistics, the country's tax-to-GDP ratio was merely 8.9 percent during the fiscal year 2009-10 as against the actual target of 9.2 percent. Economists and tax experts believe the main cause of this low ratio is rampant tax evasion and a poor tax collection system. However, last year, it also led to the poor law and order situation in the country.
"In my view, the people are reluctant to pay taxes because of a lack of trust in the tax collection machinery itself and rampant corruption," says Naim Qureshi, owner of a small company in Karachi.
Naim says that the tax payers fear their money will not be used for their betterment or on the development of the country. They would rather give money to charity and welfare works. The public donations during the Holy month of Ramzan to different charities and public welfare organisations, such as Edhi and SIUT, is proof of the fact that people do not have confidence in the government and its tax system.
A comparative analysis with Singapore and Malaysia
By Aziz Omar
Whereas in Pakistan tax collection relies heavily on indirect taxes such as the accursed General Sales Tax or GST, a country like Malaysia is able to generate substantial revenue without the imposition of GST as of now. Pakistan, even with the current base GST rate of 15 percent, (actual at 17 percent) has been only able to manage a meagre tax revenue to GDP ratio of under 10 percent, whereas Malaysia's tax revenue was more than 15 percent of its GDP. Yes, Malaysia does have a 5 percent service tax on goods on services for the past two decades and a 10 percent sales tax. Yet the former is only applied to certain services such as professional and consultancy services and the latter is a single-sales tax and so is only collected at the point of import or when the local manufacturer sells the goods for the first time.
The tax environment in Malaysia has, in fact, been geared towards a shift from income tax to service tax so as to promote investment, thereby contributing to economy through employment so that the people earn more and pay tax as they spend.
Even a developed country such as Singapore does not have a Value Added Tax (VAT) or GST in VAT mode. Instead, it's Goods and Services Tax, which currently stands at 7 percent, is a simple General Sales Tax and is only collected from customers by companies whose annual turnover exceeds $1 million. For companies which are only producing zero-rated goods and services which are being exported, no GST is levied.
Unfortunately, in Pakistan, the FBR is going full steam ahead in its plans to abolish the zero-rated GST on exports and is going to charge a full 15 percent whereby effectively crippling the local export oriented industries, which are already in a quagmire due to high input costs and choked utilities.
Singapore has a corporate tax rate capped at 17 percent and is single-tier in nature, hence making it competitive for attracting foreign direct investment and avoiding double taxation for stakeholders. In Pakistan, the basic corporate tax rate stands at 35 percent, whereas the effective one goes up to 42 percent, making it one of the highest in the world. No doubt most companies in Pakistan evade paying their due tax completely or pay laughably minimal taxes through abuse of the transfer-pricing mechanism or by having their financial statements doctored.
Transfer pricing basically refers to the determination of prices at which goods, services and intangible properties are transacted between related parties. For taxation purposes, this is not an issue as long as unrelated parties are doing business as market forces come into play for setting the commercial pricing in such transactions. However, the problem arises when the parties are related, such as sister companies or between a major shareholder and the respective corporation. The financial relations of such entities are likely to lead to the setting of prices that differ from independent commercial prices, whereby enabling the distortion of respective profits and tax liabilities. Singapore's tax authorities have stepped up their efforts to counter this with the internationally accepted arm's-length principle (derived from keeping somebody at arm's length) that implies that related parties, in the context of doing a business transaction, act as though they were unrelated to ensure that the prices set are similar when dealing with an independent party.
The Inland Revenue Authority of Singapore (IRAS) adheres to the arm's- length principle to regulate transfer pricing, and makes necessary tax adjustments in the instances of non-compliance that result in double taxation of the related parties involved. It also provides relevant literature and material on its website as well as consultancy services for corporate taxpayers to assist them in abiding by transfer pricing guidelines. The FBR of Pakistan has no such provision of specific material that details the features of transfer pricing and the arm's-length principle. In one of the very few instances of detecting abuse of transfer pricing, the FBR uncovered a case entailing Rs 500 million involving 12 pharmaceutical MNCs.
However, experts such as notable tax lawyers Dr Ikramul Haq and Huzaima Bukhari estimate that Pakistan incurs a loss of around Rs 200 billion annually through non-arm's length type of transfer pricing. They are also of the opinion that the FBR can easily collect tax revenue of up to Rs 5,000 billion (the 2010-2011 tax revenue collection target is Rs 1,780 billion against a fiscal budget of Rs 3,259 billion) through enforcing a culture of direct and progressive taxation, such as bringing back wealth tax and capital gains tax, especially on immovable properties, that were removed by previous regimes.