The case for rapid industrial expansion through corporatisation
here is a need before finalising the federal budget, expected to be presented on June 9, to re-evaluate the tax policy. Taxation in Pakistan has been oppressive, lopsided and counterproductive—with only 2 percent corporatisation of all business. By heavily taxing the corporate sector, successive governments have been encouraging the undocumented sector.
Now, the Reforms and Resource Mobilisation Commission (RRMC), constituted by Finance Minister Muhammad Ishaq Dar, has also proposed some anti-corporate proposals like the taxation of undistributed profits on which companies have already paid taxes.
As per figures for April 2023, the number of registered companies in Pakistan is 191,924, showing an annual addition of less than 25,000. In countries like Malaysia, Indonesia and Turkey, the numbers run into millions. If Pakistan is to discourage an undocumented economy, it needs rapid industrial expansion through corporatisation. Taxation can play a key role in the process by reducing corporate tax rate to 20 percent. For non-corporate business entities, the rate should be a flat 40 percent. Sales tax should also be single-digit as is the case in Japan, Vietnam and Singapore etc.
Taxation should serve as a catalyst for industrial expansion and economic growth. It should help create more jobs. In Pakistan, ill-directed, illogical, regressive and unfair tax regulations, coupled with an import embargo, are causing a dampening of the industrial and business growth.
The stress on meeting the revenue targets, without evaluating its impact on the economy, has crippled trade and industry. Had successive governments concentrated on economic growth instead, there would have been a substantial rise in taxes. It is impossible to enhance revenues while the economy stagnates. Over-taxing an ailing economy, as has been done in Pakistan, is bound to destroy the revenue system as well.
Fixing revenue targets in isolation and without making necessary efforts to improve productivity and economic growth has been our real dilemma. Investors are unlikely to be attracted to a country where there is no security of life or property, notwithstanding the availability of some tax benefits.
The Federal Board of Revenue creates uncertainty by introducing statutory regulator orders, withholding undisputed refunds, making excessive tax demands and resorting to all kinds of negative tactics to meet its budgetary targets.
Such actions by the tax machinery are detrimental for business. Despite these repressive actions, the FBR has failed to meet even revised targets in the past, what to speak of realising the real revenue potential, which is Rs 16 trillion, if not more, at the federal level alone.
Economic managers must concentrate on increasing productivity, efficiency and growth — these alone can ensure more revenues for the state. Successive governments’ onerous tax and regulatory policies have pushed millions of people below the poverty line. Pakistan needs to move quickly and decisively to reverse this trend.
The revenue performance is nothing but the best and optimal use of resources. Since the composition of investment is an important determinant of the economy’s growth rate, public policy must discourage the flow of resources to low priority areas and divert those to vital sectors. By imposing higher taxes on luxuries and other low priority items (such as open plots, expensive cars and jewellery etc), the government can dissuade the consumption and production of such items and ensuring the release of resources for high priority sectors.
The primary function of a tax system is to raise revenue for the government for public expenditure. Therefore, the first goal in development strategy as regards taxation policy is to ensure that this function is discharged effectively.
The performance of the Pakistani tax managers has been highly disappointing. As a result, fiscal deficit has remained high for several decades and the revenue targets fixed annually having been subject to downward revision. At 9 percent currently, the tax-GDP ratio is very low.
Taxation should serve as a catalyst for industrial expansion and economic growth. It should help create more jobs. Unfair tax regulations, coupled with an import embargo, are dampening the industrial and business growth.
The second equally important function is to reduce inequalities through a policy of redistribution of income and wealth. Higher rates of income taxes, capital transfer taxes and wealth taxes are some means adopted for achieving these ends. In Pakistan, there has been a gradual shift from equitable taxes to highly inequitable ones — from removing inequalities through progressive taxes to presumptive and minimum taxes (easily collectable) — has destroyed the very philosophy of taxes. This deviation has effectively transferred the burden of taxes from the rich to the poor.
Economic justice relates largely to the distribution of tax burden and benefits of public expenditure. It is a component of the broader concept of social justice, which encompasses, besides distributive justice, such questions as treatment of women and children and racial and religious tolerance in a society.
Tax policy is a democratic method to influence the distribution of income and wealth along the desired lines. Main ingredients of this policy can be (a) progressive direct taxation of income, wealth and property transactions, (b) taxation of commodities (customs duty, excise levy and sales tax) purchased largely by high-income groups, and (c) subsidies (negative taxation) on goods purchased by low-income groups. In Pakistan, moving from progressive taxation to regressive taxation is particularly dangerous as the society is already divided on economic, political, geographical and religious grounds.
Our income tax potential is around Rs 10 trillion. If there are 20 million individuals having an annual taxable income of Rs 1.5 million (a very conservative estimate), the total income tax collection comes to Rs 7,000 billion. If we add income tax from corporate bodies, other non-individual taxpayers and individuals (having income between Rs 600,000 and Rs 1,000,000), the gross figure comes to Rs 10 trillion. The FBR collected only Rs 2,209.6 billion as income tax during fiscal year (FY) 2021-22.
Another shocking fact is the dismal performance of FBR’s field officials in collecting direct taxes in FY 2021-22 through their own efforts (4.4 percent). Out of a total collection of Rs 2,284.9 billion under the head of direct taxes, they collected just Rs 101 billion (out of the current demand, Rs 65.8 billion and out of arrears Rs 35.2 billion). This shows the state of affairs prevailing in the FBR where some of the officers are getting double salaries, bonuses and honoraria.
Out of the total income tax collection of Rs 2,209.6 billion, the FBR received Rs 1,534.3 billion (69.43 percent) from withholding tax agents. In this area as well, massive corruption is prevailing with the connivance of tax officials — many withholding tax agents collect/ deduct taxes and do not deposit the receipts in the government treasury. Else, the payer and the payee join hands to deprive the exchequer of billions of rupees with the connivance of corrupt tax officials. The real potential of withholding taxes, based on estimates of total GDP for FY 2021-22, was Rs 3,500 billion.
Due to rampant corruption in the collection of sales tax, federal excise and custom duties, the total collection in FY 2021-22 was only around 55 percent of the actual potential. In FY 2021-22, the FBR collected Rs 2,532.2 billion under the head of sales tax, Rs 320.7 billion under federal excise duty and Rs 1,010.7 billion in custom duties. The total indirect collection of Rs 3,836.6 billion was distressingly low. Sales tax collection alone should have been Rs 5,000 billion and total indirect taxes Rs 7,000 billion.
Weak enforcement, partly on account of corruption, is the real malady of our tax system. Tax codes are mindlessly amended each year through finance bill and in between, by way of SROs. The solution lies in a complete re-engineering of the system [the roadmap is given in Towards flat, low-rate broad and predictable taxes, revised and expanded edition 2020, PRIME], being deferred year after year in the name of short-term compulsions.
The writers are lawyers, adjunct faculty at Lahore University of Management Sciences (LUMS), and members of the Advisory Board and senior visiting fellows of Pakistan Institute of Development Economics (PIDE)