Turnover tax to bring evasion down 70 percent: study

LAHORE: Turnover tax – a type of value-added tax – on goods and services have the potential to bring the incidences of evasion down by around 70 percent in Pakistan, said an international study, indicating that the indirect taxation can largely recoup the annual loss of Rs3.3 trillion. 

“Unlike profit taxes, turnover taxes cannot be evaded by over-reporting costs,” the London-based International Growth Centre (IGC) said in a report. “In high evasion environments, turnover taxes may generate higher tax revenues than profit taxes.” 

An International Monetary Fund’s estimated the country’s current tax capacity at 22.3 percent of GDP, whereas its tax-to-GDP ratio stands at 11.5 percent. This wide gap brings a leaked amount of staggering Rs3.3 trillion compared with Rs500 billion mentioned previously as the tax evaded amount. 

The research centre, funded by the UK Department for International Development, said the gains to revenue efficiency from increased compliance significantly can outweigh lost production efficiency.

“Ineffectual tax policies contribute to higher levels of corruption, evasion, and ineffective political structures,” it said. 

IGC researchers have worked in close partnership with the tax authorities in Pakistan since 2010, developing innovative ways to boost revenues.

“Taxes increase government accountability and encourage better governance, public service delivery and enforcement of law and order for the protection of citizen rights – essential ingredients for economic growth,” it said.

“Inability to tax is both a symptom and cause of underdevelopment. In countries with large informal economies, tax policies must account for gaps in monitoring, reporting, and administration to overcome barriers to tax enforcement and collection.”  The IGC further said in countries where tax morale and enforcement are weak, tax administrators may exert low effort and/or be susceptible to corruption. “One of the key reasons for this is in many developing countries, incentives for civil servants are poor,” it said. “Pay is relatively low and not tied to performance and career advancement opportunities are limited or uncertain, and there is a substantial scope for corruption or abuse of power.”

Low motivation among tax collectors contributes to low tax collection and reduces funding for public services, which in turn undermines tax morale. 

To address this problem, the excise and taxation department of the Punjab successfully tested several innovative schemes focused on improving tax collector performance as part of a multi-year collaboration with IGC researchers.

Developing country governments are often characterised by poor public service delivery. Without the benefits of public goods and services, citizens have few incentives to pay taxes. Tax collection requires effective enforcement mechanisms.  Developing economies have a higher proportion of self-employed workers, smaller and less complex firm structures and a less sophisticated financial sector. Many of these characteristics are interrelated and may partly explain why the scope for tax evasion tends to be greater in developing countries.

The prevalence of these constraints in developing countries has meant that tax policies designed with the assumption of widespread coverage and availability of third-party reported information trails have proven highly ineffectual for tax revenue generation.

Both developed and developing countries collect some proportion of their tax revenues from self-reported information, such as inheritance taxes, customs duties, excise taxes, or income from self-employment. As a result, all governments face similar enforcement barriers while collecting tax liabilities on self-reported income.

Developing countries usually have higher percentages of self-employed workers and thus rely much more on self-reporting for income tax revenue generation. As self-reported income is easier to manipulate, tax evaders can report artificially lower earnings to reduce their tax liabilities, which is much harder to do for third-party verified income

Developed countries have historically promoted ‘second-best’ approaches to improve the efficiency of tax collection in the face of information constraints. 

Commonly recommended policies include taxes on consumption, progressive income taxes, profit taxes, and value-added taxes on goods and services.