Even compared to other economies at a similar stage of development, Pakistan’s undocumented economy, as a fraction of our total economy, is unduly large. This large undocumented economy not only hampers our government’s ability to generate enough taxes but also results in inequitable taxation, where the rich don’t pay their fair share of taxes.
Economists mostly think that from the standpoint of economic efficiency and equity it is better to have direct taxes – that is, to tax income and wealth. However, given the disproportionate size of our undocumented or ‘black’ economy, we are unable to fully tax wealth or income. Thus we end up taxing consumption and trade, called indirect taxation. Indirect taxes generally impose a larger loss to the economy per rupee raised in taxes and, worse still, since the poor are not able to save, they affect the poor most adversely. Finally, given that the rich have the ability to hide their wealth, they end up paying very little taxes in proportion to their income.
To address these issues, the last PML-N government took two big steps. The first step was a huge reduction in individual income taxes. More particularly, we exempted the first Rs100,000 per month in income from taxes completely and for the next Rs100,000 income we kept the tax rate at only five percent. Beyond that, we kept the tax rate of ten percent increasing to 15 percent only for monthly incomes above Rs400,000.
The PTI government not only imposed Rs90 billion of new indirect taxes but also hiked the individual tax rate to 29 percent and increased the number of tax brackets as well, thus again adding complexity and burden back to the system. The relief given by the PML-N to our middle-class and salaried people has thus been taken back.
I now want to talk about the second step we took – a step not much understood – that I think is the most fundamental tax reform ever undertaken in Pakistan. This reform was the doing away with the so-called ‘DC rate’ and ‘FBR rate’ – that is, minimum rates dictated by the provincial and federal governments respectively for registration of property. Henceforth, we announced that land buyers may register their property at any rate they decided but that the federal government would have the right to buy their property at twice the declared rate.
This meant that property owners could register their properties for at least half the true market price for fear that registering the property at less than that would leave them vulnerable to government buying their property.
For the next two years, we progressively tightened the rule so that after two more years the federal government could buy the property at only 50 percent more than the registered value, forcing the buyers to register their property for at least two-thirds of its real value. We didn’t go beyond that as the actual market value fluctuates and we didn’t want to give the government extortionary powers.
Why do I think this is the most significant tax reform ever undertaken in Pakistan? Consider the fact that home ownership is the biggest store of wealth for most rich individuals in Pakistan. And the official value of homes is normally about 20 percent or less of the real value of the house. This huge store of undocumented wealth is what drives and enlarges our whole ‘black’ economy.
Let’s look at a typical example. A person sells his home in any posh area of any large city. A two-kanal or 1000 square yards home here, built say in 1980, is probably worth Rs12 crore. And yet it is probably registered for no more than Rs50 lakhs. Typically neither will a buyer have Rs12 crore in ‘white’ or declared wealth nor would a seller want the registered price to be Rs12 crore as s/he would then have to pay seven percent in provincial taxes and also about three percent in advance income tax and other ‘whitening’ charges to the FBR. So they both opt to keep the registered price at say Rs1 crore or so, and pay provincial and federal taxes of about Rs10 lakhs. The buyer will typically send out Rs1 crore, the official price, abroad through a hawala and get an official remittance back whitening his/her money to pay the official amount. For the unofficial Rs11 crore he will pay from the benami account of, say his maali, to the benami account of some thela-wala operated by the seller.
(These days, of course there is welcome accountability of the people who are operating benami thela-wala accounts but no accountability of the people running benami accounts in the names of their maalis. But, as you can see from the above example, it is patently unfair to hold only one side accountable and not the other. I think there should be across-the-board and fair accountability for all).
Another measure we announced with the amnesty scheme was to require anyone getting over Rs1 crore per year in foreign remittance to file their income tax returns. This allows the government to ensure that the facilitation we accord to foreign remittance is not being used to whiten wealth.
But the big step we took was to allow the federal government to buy any property at twice the registered price. The registered prices of properties will now get close to the market value and Pakistan’s huge undocumented economy will become documented over time.
Interestingly, even though people routinely undervalue their properties, there is no income tax advantage from doing so, as we don’t impose tax on profit if a property is owned for more than three years. People do this just to hide their wealth and minimise provincial taxes. Our solution to that was simple. We reduced the federal advanced income tax to only one percent and asked the provinces to reduce provincial taxes also to only one percent. And we knew that any province that did not comply with our request would see a huge decline in property registration and loss of revenue. So we were sure the provinces would follow our lead.
This provision of the federal government being able to buy the property is now the law of the land. And yet, even after four months of the law going into effect, the federal government hasn’t implemented this law. This is a shame. The PML-N had already taken a huge step towards increasing the tax net, going for more direct taxes, and most importantly, unleashing the enormous capital stuck in unproductive land ownership. This will bring much wealth into the documented, productive economy and create further employment, income and taxes.
All the government now has to do is to implement this new law. I hope for our country’s sake that they soon start to do so.
The writer has served as federalminister for finance, revenue andeconomic Affairs.