December Issue 2015

“Pakistan needs to bolster revenues through broadening the tax base and improve compliance in order to generate resources for reducing public debt, while it must increase spending in priority areas such as public investment, health and education.” IMF Statement March 11, 2015.

According to the World Bank report, Ease of Doing Business in Pakistan 2015, it takes 594 hours to pay taxes in Pakistan. Add to this, the responsibility of withholding taxes and the burden of paying taxes is just enormous.

According to another World Bank-supported study, Paying Taxes 2015, out of 186 countries surveyed, Pakistan ranked 172 in difficulty of tax compliance. The Federal Board of Revenue (FBR) not only has a very low tax base but for those who are paying taxes, tax compliance is complex, time consuming and full of ethical pitfalls.

The government had constituted a Tax Reform Commission in September 2014, which has now completed its task. A draft report has been prepared which for the time being has been kept confidential. But some of the following extracts were leaked to the media:

“The tax to GDP ratio of Pakistan is one of the lowest in the world; in 2013-14 the tax to GDP was 8.9%. The number of return filers during the tax year 2013 was about 8,81,500. The number of sales tax filers in the country in June 2014 was about 101,000 and out of this about 47,700 were non-filers. Hence the tax base in the country is extremely low and there is an urgent need, on the one hand, to broaden the tax base and on the other, to deepen the tax base.

“In a social democracy, the most important objective of taxation is to provide economic justice, which relates to distribution of tax burden and benefits of public expenditure while maintaining vertical and horizontal equity. Taxation of the rich for the benefit of the poor is at the core of social democracy. It encompasses, besides redistribution of wealth, such questions as treatment of weaker sections of society e.g. women and children, minorities, the disabled and unemployed. All these elements are missing in our polity and tax policy.

“Unfortunately in Pakistan, successive rulers, both military and civilian, used taxes as a tool to extort from the masses as much as possible for their own comforts and luxuries. By resorting to repressive tax laws, they make the rich, richer and the poor, poorer. Our financial managers are caught up in a dilemma. On the one hand there is a mounting pressure to reduce fiscal deficit through improved collections, and on the other they are not ready to abolish innumerable tax exemptions and concessions available to the rich and mighty. They have no will to plug revenue leakages.

“Our politicians lack willingness or vision to achieve a sensible balance between income, capital and consumption taxes. They serve bureaucrats, who conveniently go for ill-designed social programmes convincing politicians that these would attract more votes. The country actually needs more investments in creating human capital (e.g. education, vocational training and health), and necessary public infrastructure to increase productivity of the economy. It is, by no means, an easy task in Pakistan but things are improving as the public is becoming increasingly critical of the laxity of politicians. They are now better informed about the impacts of undisciplined public finance.

“Independent observers are providing tax data and surveys showing how the rich and mighty are thriving on their money. They are also exposing figure fudging by FBR, which during fiscal year 2013-14 collected only Rs. 2254.5 billion against a projected figure of Rs. 2266 billion, in which over 70% comprised regressive taxes. Excessive and regressive taxation prevent individuals and businesses from taking full advantage of opportunities related to new knowledge-based economies. Taxpayers should ideally share the burden of protecting those who are less privileged in the society, either through well-designed social protection but not through excessively rigid job protection measures and inflexible labour regimes that penalise productivity. That is why a fair and transparent tax system is so essential for maximising economic growth.

“In Pakistan, the poor are subjected to heavy and harsh taxation to finance luxuries of elites enjoying free perquisites, benefits, including purchase of valuable state-owned plots in prime locations at throw-away prices. The way they waste and plunder taxpayers’ money is no secret. The country is surviving on bailouts from IMF due to perpetual failure of the ruling elite to tax the rich and mighty that matter in the country. Revenues worth trillions of rupees have been sacrificed by governments — civil and military alike — since 1977, extending unprecedented exemptions and concessions to the privileged classes. Prior to the 18th Constitutional Amendment in April 2010, the federal and thereafter the provincial governments have shown little interest in collecting progressive taxes e.g. Estate Duty, Gift Tax, Capital Gain Tax etc.

“The historic decision of taxing ‘agricultural income,’ passed by the Federal Parliament in the shape of the Finance Act, 1977, was thwarted by the military regime of Gen. Zia-ul- Haq. Through this law, the Parliament amended the definition of ‘agricultural income’ as obtaining in section 2(1) of then Income Tax Act, 1922 to tax big absentee landlords. This was a revolutionary step to impose tax on agricultural income at the federal level for the first time in the history of Pakistan, but ruthlessly foiled by a military ruler.

“During Zia’s rule of 11 years and that of General Musharraf for nearly nine years, absentee land owners (including mighty generals who received state lands as gallantry awards or otherwise!) did not pay a single penny as agricultural income tax or wealth tax. Taxation of ‘agricultural income,’ at present, is the sole prerogative of provincial governments under the 1973 Constitution of Pakistan. All the four provinces have laws to this effect, but total collection in 2013-2014 was less than Rs. 2 billion (share of agriculture in GDP was about 22%).

“No one has calculated how much tax loss Pakistan has suffered perpetually  since 1977 on account of non-taxation of agricultural income alone as suggested under the Finance Act, 1977. If we add total loss of revenue through various exemptions, non-taxation of benefits given to State Oligarchy and through Statutory Regulatory Orders (SROs) issued during the last four decades, the number comes to over Rs. 100 trillion. This explains how unprecedented concessions to the rich has made the state poorer, rendering every citizen of this country to enormous indebtedness. We would not have required any borrowing at all, if tax losses were historically not incurred.”

In A Case Study of Pakistan, prepared by Dr Hafiz Pasha, the author contends that the ultimate litmus test for future tax reforms in Pakistan will be collecting more taxes from the rich and the powerful.

According to Pasha, today, the rich enjoy wide-ranging exemptions and concessions, low effective tax rates and can engage in tax evasion with a degree of impunity, frequently in connivance with the corrupt tax administration. The consequence is low direct tax-to-GDP ratio, which has kept the overall tax-to-GDP ratio at extremely low levels in relation to other countries in the region.

Currently, the direct tax-to-GDP ratio is 3.2 per cent. The figure for the same is 11 per cent in Malaysia, eight per cent in Thailand and six per cent in Turkey, India and Indonesia. Pakistan’s share of direct taxes in total tax revenues is 33 per cent, as compared to between 45-60 per cent in many Asian countries.

Dr Pasha’s study reveals that only about one-third of the 60,000 companies in operation file returns and among those, less than half declare taxable profits. Also, it is estimated that about three million people in Pakistan earn more than the exempted income of Rs. 400,000 annually – but only one-fourth actually file returns. In effect, only one in 260 people file a return in the country as compared to one in 40 in India.

The tax base for corporate income tax, according to Dr Pasha, is eroded by almost half due to exemptions, deductions against labour and charitable contributions, and lower (presumptive) taxation of exports, etc. While many of these are in the nature of fiscal incentives, they have an implied revenue loss of almost Rs. 160 billion.

Dr Pasha maintains that the root cause of failure of the taxation system of Pakistan is the very limited taxation of the rich and powerful. In addition, there are over 1,900 statutory regulatory orders (SROs) which create many holes in taxes like GST, customs duty and excise duties. The SROs largely benefit strong pressure groups and lobbies.

The total revenue collection in the first quarter of the current year amounted to Rs. 937 billion. Of this, tax collection was Rs. 723 billion and non-tax Rs. 213 billion. Provincial contribution in tax collection was Rs. 59 billion and non-tax Rs. 15 billion. The total revenue was 3.1 per cent of the GDP during the same quarter whereas tax revenue alone was 2.4 per cent and non-tax revenue 0.7 per cent of the GDP.

The shortfall of Rs. 40 billion during the first quarter of the current year, as revealed during a joint press conference of Finance Minister Ishaq Dar and IMF Mission Chief Harald Finger, may be projected to a Rs. 200 billion shortfall for the entire year – an amount that unless met through new and enhanced taxation measures would not lead to the release of subsequent tranches as the IMF, earlier this year, began imposing pre-tranche release conditions due to sustained failure of the government to meet some of its quantitative and structural targets.

Indeed, over the last few years, targets for revenue collection and expenses have been missed because of under-estimation of subsidies and transfer payments to provinces, under-estimation of interest payments on debt and over-estimation of FBR tax revenue.

Another flawed policy was the announcement of unrealistic revenue targets. The rise in the budgeted tax revenue was envisaged at 20 per cent for the current year while the real revenue growth can be projected at no more than seven per cent, according to Dr Pasha.

The claim by the government that only luxuries would be taxed to mobilise the additional Rs. 40 billion to make up for the shortfall of the first quarter is too hollow because there does not appear any space to impose higher taxes on luxury items and it would only end up creating incentive to encourage smuggling, further depriving the exchequer of its legitimate tax revenue income. The government’s extra reliance on fuel, a major input of most of the productive sectors, as a source of revenue has rendered these sectors inordinately costly.

It remains unclear why the government continues to rely heavily on raising taxes on existing tax payers, a small base by all counts and/or raising withholding tax component in direct tax collection which at present is more than 70 per cent of the total direct tax collection as they are neither collected by tax collectors nor indeed can be strictly defined as direct taxes as they are passed on to the consumers.

The need of the hour is for the government to immediately start implementing the proposals contained in the Taxation Reform Commission report and at the same time the provinces should start taxing farm incomes.

Taxation in Pakistan is a complex system of more than 70 unique taxes administered by at least 37 agencies of the Government of Pakistan.  According to the International Development Committee, Pakistan had a lower-than-average tax take. Only 0.57% of Pakistanis or 768,000 people out of a population of 190 million pay income tax.

According to a 2002 study, 99% of 256 respondents reported facing corruption with regard to taxation. Furthermore, 32% of respondents reported paying bribes to have their tax assessment lowered, and nearly 14% reported receiving fictitious tax assessments until a bribe was paid.

The following have been identified by various studies on the subject as the major reasons for the over-estimation and under-collection of tax revenues: a large informal underground economy; tax evasion; an extremely low tax base; incentive for dishonesty; extremely poor compliance and enforcement; lack of documentation; ad hocism in terms of economic and fiscal policy; the widening gap between the rich and poor; lack of consideration for values and integrity; serious under-performance by the IT support; SRO Culture; exemptions, concessions and reduction in tax rate; inadequate taxpayers’ facilitation; lack of training of FBR staff; weaknesses in terms of integrity of data; no effective concept of taxpayers’ rights; inadequate focus on technology and training of users, and lack of research and analysis

Revenue collection is influenced by the administrative capacity to perform key functions and the existence/absence of a comprehensive coherent tax code and adequate systems of registering taxpayers; monitoring, recording, and controlling payments and declarations in a timely manner; notifying taxpayers when they fail to file or pay on time; selecting and performing audits and collection activities effectively; taxpayer services and education; overall organisational development and management training in tax administration; streamlined processes; audit selection using clear criteria based on automated systems and good data; ongoing training; revenue forecasting for each tax type, taxpayer type, and geographic region, and an end-to-end IT system.

What is, therefore, needed to be resolved on a priority basis is improving the FBR culture and management capacity to willingly support the reform programme, mitigating the unsettling effects of frequent and ad hoc legal and administrative changes which provide opportunities for increased discretion and corruption, insufficient knowledge of taxpayers on their tax obligations and decreased motivation to comply with tax demands, strengthening the otherwise adversarial relationships between taxpayers and tax collectors by public advocacy in terms of enhancing taxpayers’ education and facilitation, encompassing a well-coordinated communications programme promoting development of greater compliance and user-friendly, supportive interface between the FBR and taxpayers, incorporating best international practices, including transparency, fairness, simplicity, automation, cost-effectiveness, quality-assurance monitoring programmes, easy-to-comply-with forms and document requirements compatible with a computerised operation.

Some of the steps experts have recommended to improve the situation include devising measures to enhance the taxpayers’ cost of evasion, reforming the entire tax collection system to prevent tax dodgers from going underground, strengthening the tax administration to increase its potential of discovering non-compliant taxpayers by field survey, better data-mining and analytics, enhancing the penalties for activities in the informal sector, all income irrespective of source has to be tapped and taxed, need for declaration of asssets including bank accounts held by resident Pakistanis overseas and undisclosed income outside Pakistan under a special law and regularising declared assets by payment of tax at specified rate, in case of non-declaration of assets outside Pakistan, the assets of equivalent value in Pakistan should be forfeited under the provisions of the law along with other severe penalties, discouraging cash and all bearer instruments, promoting use of banks and encouraging documentation.

The tax form should be massively simplified and should not be of more than two pages for small business tax filers. Additional annexures can be added if required for an individual’s stream of income. These forms should be made available both in English and Urdu.

FBR should work towards establishing a toll-free ethics line to encourage whistleblowers and each tax point should also have a secure complaint/suggestion box, where any citizen or FBR staff can offer suggestions or register complaints of malpractice and evasion of tax or duty.

According to a research paper, Pakistan’s Taxation System — A Critical Appraisal, by Maria Inam and Shah Khan (Journal of Managerial Sciences Vol. II, Number 1), “Corruption in the tax administration is a two-way street. For each corrupt FBR employee, there is a corrupt private sector person who is indulging in corruption either willingly or under duress. The findings of the task force in 2001 suggest that a large majority of the private sector justifies non-payment of taxes because of  the dismal or simple non-performance of the government in its duties. Many respondents to the task force survey mentioned other countries where the state ensures provision of decent quality infrastructure such as health, education, social security, roads and, above all, security of life and property.

“Lack of tax culture or tax education is the next most important cause of corruption in the private sector. Respondents felt that this is because of unnecessarily complex systems of taxation and poor quality of management in the private sector. This results in easy manipulation of private business by unscrupulous tax functionaries. Some in the tax administration also echo this: “Outsiders cannot understand our systems. Even after a year of training, I have great difficulty understanding the sales tax system.”

“The next important reason cited for corruption in the private sector is high tax rates. People gave the example of reduction in customs duties (because of WTO), which has resulted in less corruption in the Customs Department as the motivation to evade duties is reduced. Many examples were given where the collection went up once the rates were reduced.

“Finally, many respondents cited greed and lack of accountability as a major reason of corruption by the private sector. They see many leading businessmen and rulers getting away without paying any taxes. Hence they feel they should try the same.”

Who’s Paying Taxes?

Collecting tax at source is hardly a difficult task and it may explain why the government, in the form of the Finance Ministry and Federal Board of Revenue (FBR), relies almost exclusively on salaried individuals and indirect taxes to raise revenue. This is why, for the month of October, the government raised the sales tax on diesel from 17 per cent to 50 per cent before trimming it by 2.5 percentage points the following month. For petrol and kerosene oil, there were similar increases. Meanwhile, the sales tax on just about every consumer product and service has also risen during the tenure of the current government.

Looking at the figures for annual tax collection during the last three fiscal years, about 60 per cent has been through indirect taxes, an inversion of the statistics of most other economies.

During the 2011-12 financial year, revenue collection was at Rs. 1,964 billion and out of this the indirect portion was Rs 1,203 billion while in 2013-14 and 2014-15 the net collection was Rs. 2,254 billion and Rs. 2,810 billion , respectively, and where the share of indirect collection was Rs.1,377 billion and Rs. 1,630 billion.

According to many analysts, the FBR is directly responsible for tracking down less than one per cent of the total amount of tax revenue it collects. This is because the overwhelming amount of revenue is directly given to it. Take for example, the money collected through the use of cell phones. As per the Pakistan Telecommunication Authority, there are 121 million phone subscribers. If 75 per cent of these are using prepaid connections then they have to pay a 35 per cent tax every time they recharge their phones. The other 25 per cent using postpaid connections have to pay a withholding tax on their bill.

The rich, meanwhile, simply do not pay the income tax due. In 2014, as admitted, by the FBR, only 15,000 individuals filed tax returns showing a taxable liability of more than Rs. 1 million. Still, the finance ministry has been boasting of how it has managed to get the total number of tax returns filed to increase considerably in the last couple of years. But, as against a current target of getting one million tax returns filed, there have only been approximately 400,000 returns filed so far this year — and that too after the government thrice extended the deadline.

According to the Tax Reform Commission, nearly 38 per cent of tax returns in 2013-14 were filed with zero taxes paid, since they are below the minimum income threshold to be liable for taxation or were filed by companies declaring losses or miniscule profits. Thus, withholding taxes, which are collected directly at source, equal around 65 per cent of the total collection of income tax. Bilal Asif, head of research at Habib Metropolitan Financial Services, says that the tax authorities always find the easiest and simplest way to earn revenue. And cutting taxes at source and through indirect sources saves the FBR from the hassle of going after the rich and powerful.

The service sector has a share of the economy that is estimated to be between 56 to 58 per cent, but its contribution to tax revenue does not match that. Property, too, has been used as an asset to park illegitimate wealth, where sale values are rarely questioned. There has been a tremendous increase in the value of property in major metropolitan centres and a corresponding boom in construction but tax from this sector has not matched this surge. People simply mark down the value of properties on paper and settle the difference informally through cash. For example, if a bungalow is sold for Rs. 2 crores, the sale will be reported to the land registry for a total of one-fourth of its actual value, thus costing the treasury a significant amount in taxation it should have collected.

The size of the black economy is believed to be twice the size of the documented economy so a tax authority worth its name could increase tax collection by as much as 200 per cent. But with the political will lacking, an equitable tax system remains a pipe dream.

This article was originally published in Newsline’s December 2015 issue.