Present
Scenario:
Pakistan is a country of
180 million Population, according to the most recent population survey done by
the government of Islamic republic of Pakistan (In reality the population is
over 190 million). It is the second biggest country in South Asia and ranked
sixth in the world in terms of population. Moving on with the prestigious
ranking given to the Pakistan because of which Pakistan is in the limelight of
world media. Pakistan is ranked tenth out of so many countries in the failed
state index. Plus Pakistan is ranked forty-second in most corrupt nations in
the world. But Pakistan is not all about the bad things in fact we have more
good things to cherish about. God has blessed Pakistan with one of the largest
gold and copper deposit in the province of Baluchistan in Pakistan. Plus
Pakistan is ranked twenty-ninth in the world for the largest natural gas
reserves. Pakistan is also placed in the top ten countries with the largest
coal reserves in the world.
After having so many
blessings from Allah, we are not able to contain our economic problems. Thus
the conclusion is that we have the resources but we don’t have the will. Which
further compel me to say that Pakistan is administratively weak or not being
administrated properly. Our government is unable to perform its duty or functions
properly that is why Pakistan is lagging behind its real potential.
Presently Pakistan is
stuck in many problems because of the internal as well as external factors, but
these internal factors contribute to 80% of these problems. Firstly Pakistan
has a huge fiscal deficit. The government of Pakistan is forced to borrow money
from the State Bank of Pakistan when revenues fell short of expenditures done
by it. Secondly Pakistan is stuck up in huge problem of load shedding of
electricity and gas. Pakistani economy has suffered a lot due to this problem which
resulted in closure of majority of the industries. This problem can be
contributed by weak reforms and administration of this sitting government as
well as previous governments. Pakistan does not have the funds which are needed
to invest in the electricity projects. Thirdly Pakistan also faces a huge
problem of smuggling. Many of the Pakistani products are smuggled to
Afghanistan and elsewhere which causes huge loss to tax collection and GDP (Gross
Domestic Product) of Pakistan. Smuggling can also be contributed due to wrong
policy of heavy taxation of goods by taxation authorities in Pakistan which
force people use this alternative. Fourthly Pakistan has low GDP. Pakistan has
a GDP of $291 billion which is far less than the actual potential of what
actually Pakistan can produce after having all the resources.
Well according to me the
above mentioned problems are contributed by one major problem that is tax
policy. We can solve all the above economic problems and many more through a
viable, conducive and practical taxation system, free from errors, influence
and mistakes.
Scope of Assignment:
The purpose and the scope
of this assignment is to provide proper tax reforms which are practical in
implementation, true and fair in sense and rational in thinking. I will Start off
with discussing the major indicator of the tax in the economy (tax to GDP
ratio), moving on to the tax structure of Pakistan and then problems associated
in the present tax reforms, and then suggest proper reforms through proper
research.
Tax to GDP Ratio:
What is tax to GDP ratio?
It is the ratio of tax collected against the national gross domestic product
(GDP). Tax to GDP is a major indicator of tax situation in a particular
country. Usually a high tax to GDP ratio is considered good over a low ratio. Pakistan’s overall tax-to-GDP ratio has
remained stagnant at around approximately 10-11% and in fact, has shown a
decline in recent years. Today Pakistan has a lower tax-to-GDP ratio than other
Asian countries like Sri Lanka (13 percent), India (16 percent), Indonesia (15
percent), Malaysia (14 percent), Thailand (17 percent), Philippines (14
percent), and South Korea (16 percent). Pakistan has one of the lowest Tax to
GDP ratios in the world which is currently standing at 8.6% as compared to the
Sweden, which has one of the world’s highest Tax to GDP ratio which stands at
round about 54%. The following graph gives an overview of the economies of South
Asia plus some other countries of the world.
Many International
Financial Institutions like IMF and the World Bank Often force Pakistan to
increase its tax to GDP ratio in order to lower the fiscal deficit. But the
taxes which they tell us to apply directly affect a common man and bring food
inflation. Thus the tax to GDP of a country can be increased if a rational tax
policy is applied, which is currently not happening Pakistan.
Federal Board of Revenue
and Tax Structure:
Basically the institution
which was responsible for the all the tax related things is Central board of
revenue, whose name is was changed to Federal board of revenue in 2007. Key
functions of FBR include formulation and implementation of the taxes, and
further to collect the taxes as per the rules and procedures.
Moving on to the tax
structure of Pakistan, basically there are two types of taxes in Pakistan. First
one is Direct tax and the second one is indirect tax. Direct taxes are taxes
which are directly taxable at a predetermined fixed rate like the Income tax
(there are different slabs of taxes for each income class) and the corporate
tax (which stands at straight 35%). Indirect Taxes are the taxes which are not
directly taxable to someone but it is tax due to the consumption or utilization
of any good, service etc. Some examples of indirect taxes in Pakistan are sales
tax, customs duty and levies, Federal Excise duty and Petroleum levy. In
Pakistan, government gets its tax revenue mainly from these two taxes. Today, Indirect
taxes contribute more than 60% in the total tax revenue while contribution of
direct tax is less than 40%. Bar chart below shows the Direct and indirect
taxes collected by the government in different financial years.
The above graph shows the
tax imbalance, in the face of high percentage of indirect taxes and less
percentage of the direct taxes. Some experts are of the view that the situation
should have been opposite. I think it does not matter, unless and until you are
getting the tax revenue. Turkey’s direct tax contribution is mere 22% in the
total of its tax revenue and it is booming economy.
Tax Reforms:
Taxes are considered as a
major source of income/revenue of state, in order to complete their obligations
towards the nation. Unfortunately the expenditure done by the government is
never fulfilled by the revenue earned by the government. Majority of this
reason lies in the current tax reforms which government has. Some of the taxes,
which are collected today, have been carried on since the ages of the British
rule in India. Some taxes are so strict and irrational that the common man will
happily opt not to give tax by indulging in non-legal practices. Last but not
the least the government has failed to expand the tax base by non-inclusion of
the people in the tax net at a good speed. I will try to tell major reforms
that will help in increasing the tax base and that will not hit common man with
severity which is the case in the present tax reforms.
Tax the services sector
strictly!
Services
sector is the only sector which contributes mostly to the GDP of Pakistan. The
total contribution of services to GDP is almost 55%. Today, this sector is
going strong when the industries and the economy as a whole are going through
the crisis like situation. It is pity that, the most of the services sector is
out of tax net. Once this sector starts coming into the tax net, the tax
revenue of the country will start going up, hence increasing tax to GDP ratio
of Pakistan. The taxing of this service sector will help in increasing the
direct tax over indirect tax and it will document the services sector to a
greater extent.
Two-third
of the services company does not file income tax return and those who file it,
only one-third declare profits, which means that you only end up getting tax
from one-ninth of the tax base. There is a huge list of the companies in the
services sector which are out of the tax ambit, Majority of them are financial
services and business services Company. Today because of the security situation
in the country, the private security companies are booming. Today, Private
security companies have strength of security guards which is more than the
police force of the country. These companies alone can provide billions in
sales tax and income tax. Then there is management, accounting, engineering and
other consultancy companies which can yield significant revenue when they will
be taxed. Then there are unauthorized automobile and automobile parts dealers
which are not in the tax net, the whole Badami bagh is filled with them.
Another example is Yarn Markets (sotar
mandi) of Faisalabad and Karachi, in these markets, daily business of billions
of rupees is done, but as they are not in the tax net, potential revenue to be
earned is never realized. They should be brought into the tax net.
According
to me the tax authorities should go after the companies, who are providing
corporate services instead of firstly going to corner grocery stores. By this
way the majority chunk of services sector can be brought in the tax net. Later,
as a long term strategy, the tax authorities should go after the small fishes
of the services sector like these grocery stores. In India the government has
imposed a separate services tax, which alone by this tax, puts one percent to
their tax to GDP ratio. But that services tax cannot be brought to Pakistan
because, firstly the people are not paying the primary taxes on their income
and sales, how come they will be happy to give another tax in the name of
services tax. People will happily like to stay out of the tax net because of
this. This will also burden the people with indirect tax which will be also
unfair.
Tax agriculture Income:
Agriculture
economy of Pakistan stands at around $40 Billion. Agriculture is the third
biggest contributor to the Gross Domestic Product of Pakistan with almost 25% of
Contribution. Agriculture sector of Pakistan employs 45% of the total
labor/man-power. Another fact regarding the agriculture sector income is that
its contribution to the national exchequer is almost negligible.
After the creation of Pakistan, one of the issues
which have always stayed alive and died and then came to live is the issue
regarding taxing the agriculture income. Whenever a new government comes to
power they always raise this issue, but then this issue is killed every time.
There could be many reasons behind this, first the government does not want to
make farmers angry, who are main voting strength of these leaders. Secondly
there is a huge lobby, in fact feudal lobby, which does not want any reduction
in their income. Mainly these feudal lords make up the leaders who sit in the
parliament, so they always have the power to oppose the issue of tax on
agriculture income. In order to change the tide in favor of revenues, the tax
on agriculture income is very important.
Pakistan
was almost near to imposing the tax on agriculture income, in the tenure of
Pervez Musharraf through the AIT Ordinance but the ordinance was not
implemented in the full spirit and reasons are obvious as mentioned above, the
political leaders who are also the lawmakers derive majority of their income
from the agriculture sector does not want any cut in their incomes. This has
resulted in over burdening other sectors with taxes and deprived nation with
the building of infrastructure and other future growth prospects. However some
provinces introduced some taxes to tax the agriculture income because of the
constant say of World Bank and the IMF but these introduction was a mere show
to these financial institution, for example the main hub of agriculture in Pakistan
Punjab just projected revenue from agriculture to be Rs. 1 billion and worse is
the case with the Khyber-Pukhtunkhawa who have projected to earn only Rs. 21
million from the agriculture income. The collection of agriculture income tax
should be made one of the foremost priorities of Federal Board of Revenue.
At the initial stages the farmers which have
land excess of 45 acres or agriculture income more than Rs. 400,000 should be
taxed and liable to pay income tax. In the long run, the people who have less
acre land or income then the land and income mentioned above should be included
in the tax net. By this the small farmers won’t be affected from the taxes and
instead the big farmers who are the rural elite, whose conditions have improved, which can be evident from the consumption expenditure
will be bearing the taxes after decades of tax holidays. Furthermore, any
expense in the face of farming should be allowed as deductions like electricity
bills, fertilizer and seeds expense. By taxing the agriculture income people
won’t be able to get opportunity to indulge in malpractices, like people who
had factories and agriculture land, they used to show nil income from factory
and added that factory income to the agriculture income to evade taxes because
agriculture is not being taxed as compared to income from factory. The
agriculture income tax if implemented has potential to earn approximately Rs
20-25 Billion for the tax authorities.
Eliminate corruption and
improve efficiency:
Out
of the population of almost 190 million, there are only 2.8 million registered
taxpayers in the country, out of which one-fourth of the tax payers are
non-complaint which merely makes up only 2% of the population paying the taxes.
Tax payers derive their income from the salary while the other half derives
income from business, property and other sources. But as each passing day,
these people who use to file tax returns is decreasing reason being, the
country’s tax authorities are mainly inefficient and corrupt. The corruption in
Federal Board of Revenue has also played its part in taking Pakistan to the 42
rank in the corruption perception index. According to the Transparency International
Pakistan (TIP), the most corrupt department in Pakistan is the Federal Board of
Revenue.
There
was a huge cry by the World Bank to introduce the TARP (Tax Administration
Reform Project), which according to it will help in increasing the tax base and
tax collection efficiency and infrastructure. You can introduce any reform to
increase the tax, but unless and until, you won’t address the grass root
problem of corruption and inefficiency of tax machinery, no increase in revenue
will take place. Instead under TARP our tax to GDP dived to 8.6% from 13.2%,
plus a lot of money was wasted in hiring of legal experts and consultants to
oversee TARP. Many people got to earn fortune in the form of kickbacks from the
companies which were hired. World Bank in its recent report said that about Rs
600-700 billion are not realized in annual collection of revenue mainly because
of corruption and inefficiency of the tax machinery.
Whenever
we hear the name of customs the first thing which comes to my mind, and I think
will come to other peoples mind is corruption. This is the present state of our
institutions which is the lifeline of the country. People working in these
institutions have no regard or respect for the public, of whose pockets they
are paid to serve the people, instead they create problems for them. One of the
example of corruption can be illustrated below.
In Faisalabad, a gang had
opened bank accounts in the name of fake business units and they used original
refund books and voucher books to claim fraudulent claims. These illegal refund
claimers have shown themselves as the manufacturer of the cloth, yarn and
business individuals of yarn and cloth market. Fake National tax Numbers and
inactive tax registration numbers had been used to obtain illegal tax refunds.
A larger number of genuine refund books were printed in by tax authorities of Faisalabad
from Karachi and they were issued to the bogus refund claimers all with the
connivance of tax officials.
The
above event shows the massive corruption taking place and the extent to which
the tax officials can go to earn some extra black money by being disloyal to
people who give them salary to run their homes.
In
order to finish of the inefficiencies and reduce corruption to a tolerable
level massive steps needed to be taken. Firstly, the customs department which
is heavily involved in the under-invoicing and mis-declarations should be
revamped at war footings. Beside this competent and dedicated personnel should
be hired. Most importantly the hiring should be done solely on merit, so that
deserving and clean people could serve the country. Furthermore, the people who
make up the tax machinery should be held accountable and their performance
should be monitored regularly. An intelligence division should be made within
the Directorate Intelligence and Investigation, in order to keep check on the
employees. Moving on, any abuse of
authority if observed should be punished suitably. In order to come with the
conducive environment in which everyone does his own work and do it properly
the senior management should set an example for the juniors. Plus to generate
honesty and reward hard work in the tax machinery, anyone who is doing good
work should be given incentives plus any one who uncovers any major tax evasion
or scam should be given 25% of the detected amount.
These
steps can be a good starting point in order to eradicate corruption and bring
efficiency to the tax machinery. This steps will also contribute to about
300-400 billion to the yearly tax revenues, which can be spent on the welfare
of the people of Pakistan.
Quick Disposals of
Refunds:
In
Pakistan there are sectors which are zero rated, which means any sales tax they
give is refunded back by the government. But this issue is not as easy as it
sounds. Because of the inefficiency in the tax machinery and unwillingness of
the tax authorities to provide relief to the businesses, this issue has become
grave in nature. In fact this is one of the biggest issues for the exporters
whose sales tax refunds are delayed and keep piling on. This additional burden
to industries sometimes creates severe liquidity problems for them and it
becomes difficult for them to operate and conduct any business. This in return
affects the country in the form of fewer exports. Once I was talking to an
person who use to file sales tax refunds for a textile spinning mill said to me
that, “government ka moo sher ke moo
jaisa ha, agar kuch iss main gaya tou bahir nahin aata” He was referring to
the tax refund scenario, there is common perception that if anything which will
go to the government, it won’t come back. By this perception about the sales
tax refund, how and why the people will register them with the tax authorities?
In order to eradicate the problem of the sales tax refund the government should
hire more efficient people to clear and disburse the refunds through a reformed
Expeditious Refund System, which would transfer refunds electronically and
automatically after all checks have been performed, this will speed up the
process, so people could get relief and don’t get discouraged by the system.
Implement Value Added Tax
(VAT)
VAT
is the tax which is imposed, when there is any value addition taking place in
each stage of supply chain of goods. It is basically a multistage tax. The tax
burden is evenly distributed at the each and every phase of value addition
unlike sales tax, in which the all the tax is Bourne by the end consumer,
making things expensive by only taxing the end stage of the supply chain.
Questions on Implementation of Value added tax has been around in Pakistan for
years. Many governments have come to power, they tried to enforce the VAT but
as per the case of agriculture income some lobbies oppose it for their own
well-being at the expense of the whole country. Usually government back tracked
from VAT because, implementation of VAT could make trade bodies unhappy, and these
trade bodies are the major vote bank and economic strength of these political
parties.
People
are also against VAT also because they think this could increase the food
inflation, but in fact VAT will lower the food prices, for example the tax on
any packaged food will be taxed at each stage of value addition, which would be
VAT percentage will be applied on less prices in each stage not like the sales
tax on the total retail price or final price of that packaged food. Furthermore
the imposition of VAT will increase the documentation of the economy because at
each stage, where tax is been applied the company which is not being registered
with the tax authorities will not be getting any refund. This is the reason
according to many economists why people are against it, VAT will bring
documentation. This will encourage them
to register themselves in order to get the refunds which will be crucial to
operate their businesses. Hence increasing the documentation of the economy
will take place at more rampant pace which will result in increase in tax base.
I would suggest that Present sales tax (GST) should be replaced by a
comprehensive value added tax (VAT), which will be charged at the uniform rate
of 14%. It might not increase the revenue at the initial stage, but at least
there will be documentation of the economy. When there will be documentation,
the revenue will start to increase automatically. VAT will also accrue the
above mentioned advantages also. Presently VAT is applicable in more than 114
countries, and it is going fine plus contributing excessively to the revenue of
these countries.
The
introduction of VAT will obviously increase the tax to GDP ratio to a
respectable level and increase the revenue side of the government. It is not
necessary that we implement Vat on the directives of the IMF or The World Bank;
it is in our best interest to implement the VAT, if we don’t want to struggle
forever.
Initiate Strong Audits:
High
tax rates, unfair and complex tax rules have has kept Pakistan away from the
tax. In order to facilitate the taxpayers a new scheme was introduced in the
income tax ordinance called the universal self-assessment scheme (USAS). The
scheme was that the taxpayer had to assess their own income and file it
honestly. This scheme basically was introduced to minimize the contact between
the tax payers and the tax collector. Also the tax collector could not asses
the income tax filed by the taxpayer, hence slashing the power of audit. The
results of such scheme were catastrophic, the documentation and increase in
revenue which started to take place in the nineties, faded away with this
scheme. The tax compliance rate went down which can be show by the table given
below.
We
can see from the above table that the, as no. of NTN holders increased but
people who filed return didn’t increase at the pace at which the NTN increased,
which resulted in the decreasing compliance rate. As we can see the compliance
rate was 85.4%, at the time of introduction of universal self-assessment scheme
in the financial year 2001 and when we compare it with the financial year 2004,
we can see that the compliance rate came down to 49%. Majority of the part
played in this reduction of compliance rate was by the Universal self-assessment
scheme. The people especially the business community was happy with this
introduction because it gave them the opportunity not to pay the taxes.
The
whole point here was to tell that without proper audit, we cannot increase our
tax base and tax revenue, these schemes which were made on the foot prints of
foreign countries, are only successful there. Here in Pakistan where people
don’t want to give any tax because of habit, giving them more freedom without
audit will obviously reduce the tax returns.
According
to me in order to increase the tax revenue and increase tax base a random audit
of 25% of the tax base should be done, anything short of that number would be
of no use. Furthermore, the audit team should not be given so much power that
they misuse it, the powers should be that much, which would be necessary to
achieve the target. Furthermore, Chartered accountants from the private sector
should be hired to devise an audit plan and strategy. This would bring transparency
into the system. An old saying goes by if you cannot measure it, you cannot
manage it, a strong audit team would be an ideal to way to measure the wealth
and income of people, which will help in managing the tax resources of Pakistan
plus help in achieving the required tax
revenue and increase the tax compliance rate, which would be great.
Impose City tax:
I
was reading in the business recorder, that the real tax potential of Pakistan
is about 4 trillion rupees, but very less is actually realized. As a result of
which very less money is spent on the sector of health, education and poverty
alleviation. We can also observe this in
reality. It is also frustrating to see when we compare ourselves with the other
countries like India, Bangladesh, and Malaysia etc., who even do not have the
resources which we have. There are acute problems in the tax structure and
reforms as mentioned above which need proper cure.
We
can see that our cities have gone through rampant population bust, mainly
because of the movement of people from rural to urban areas, and high growth
rate of the population. Because of this increase in the population there has
been, increased need for the services, which government has failed completely
to provide to its people. In order to increase the tax, I would suggest that
there should be a city tax imposed on the people of an individual city. The tax
rate would be only 1%. It will be only obtained by those individuals whose yearly
salary is greater than Rs. 1,250,000. This would not put burden on the middle,
lower middle class and the lower class in a specific city. City tax should be
collected by the local government district bodies, who will collect on their
own and maintain the records of the people. This would allow deep penetration
in to the resources of the people plus the record shall be shared with the
Federal tax authorities, So that they can also know about the people’s record
and check whether he has a NTN number or not. This would help increase the
documentation from people. Plus the tax revenue collected will be spent
directly on the people and the development of the people. This would usher new
growth of development and by this federal and the provincial government will be
allocating less to the development expenditure of cities and they can divert
those funds to any other area of need.
Incentivize the Taxpayer:
It
is human nature that when he or she gets an incentive for example at work, the
efficiency and the end result of the employee work will improve. The same
theory should be applicable here also. The person, who is a regular tax payer
and there is substantial increase in tax paid every year by him, should be
given reward or there can be one-time reduction in the tax he/she pay or he can
be freed from any audit from the tax
authorities. This would encourage the tax payer to pay his taxes regularly.
Plus other people when they will see that the regular tax payer is being
rewarded, they will also pay taxes regularly. The tax authority should also
create a tax culture where a non-compliant irregular tax payer is discriminated
over a complaint tax payer. Such incentive scheme will be great starting point for
such thing.
Impose wealth tax:
Nowadays
there is great debate going on in America that the wealthy people of America
should bear more tax and contribute more to the tax revenues of the country, so
that money could be used for the welfare of the poor’s in these days of
recession. The democrats and many billionaires like Warren Buffet say that
there should be wealth tax. As mention earlier also, the rich and elite of
Pakistan does not pay any tax, but the middle class has to pay the tax for the
elites. Imposition of the wealth tax will help in removing this fact. A wealth
tax should be imposed on individuals who have income of more than Rs 7,500,000/yearly
at a uniform rate of 1.5%. This will increase the tax revenue and it will bring
balance to the society as elites will be paying more taxes then the lower and
middle class, hence distribution of wealth will be taking place.
Impose Capitan Gains Tax
on Immovable property
In
order to realize the actual tax revenue potential, the tax authorities should
find new ways to tax people which will not affect them directly. One way is to
impose capitals gain tax on the immovable property like land and houses. Almost
daily many people in Pakistan buy or sell any piece of land or house. The
person who does this business of buying home at less price and sells at a
greater price, earns millions if not billions, one example is of famous
billionaire Arif Habib who earned fortune by doing this business. Like the tax
imposed in the stock exchanges, a capital gains tax should be imposed whenever
a person earns money from selling any immovable property. The uniform rate of
5% should be charged of the capital gained. This is far less than the capital
gains tax which is being collected on immovable properties around the world,
for example in Myanmar, which is more backward then Pakistan collects around
40% of this specific tax, with Thailand collecting 37% and South Korea 35%. Our
neighbor India, charges 30 % on this specific tax. The percentage of this tax
is low but it will increase the revenue and improve documentation of land with
the tax authorities.
Conclusion
In Pakistan it is a
tragedy that the elite upper class, which most of the time are our rulers do
not pay the taxes, instead the middle or income class has to bear the taxes.
Here in Pakistan people don’t want to give taxes because a culture has
developed here. People say that the taxes that they would give will be used by
the politicians for their own benefit and nothing will be done for them.
Foreign institutions and experts who even do not know the culture, the problems
of the people and their conditions say take strict austerity measures by
increasing the tax and decreasing the spending by the government, which simple
stupidity.
I have tried to give some
major reforms which cannot be the savior for the government but they would
provide some extra revenue of about Rs 800-900 billion, which can increase the
tax to GDP ratio.
I would end up by saying that the cures of the
problems are not easy because the roots of our problems are deep and complex.
The government should hold a open public debate, in which through consensus a
comprehensive tax reforms should be created. The Projected tax revenue
collection of FBR for FY12 is around Rs 2100 billion, which is difficult to
achieve if FBR and the government does not take remedial and strict measures.
No doubt the situation is really difficult, but not impossible. We have to act
and now is the time to act!
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