The decision to impose a withholding tax on banking transactions across the country has started to backfire – as predicted. Presenting the budget for the current financial year, Finance Minister Ishaq Dar had announced the controversial decision to impose a 0.6 percent withholding tax on bank transactions by non-tax filers. The decision led to strikes by traders across the country, which had complained that the tax would target them unfairly since they are used to keeping money circulating every day. While an agreement with the government appeared to have been struck by some trader groups to start filing tax, news reports indicate that the monthly transactions of commercial bank branches in commercial hubs have fallen by 87.5 percent. The reports indicate that traders have started operating their business via cash or through a parchi system to avoid the daily tax deductions. The information from banking officials operating in key wholesale markets suggests that the decision to impose a withholding tax is set to be a failure. The markets surveyed include Akbari Mandi in Lahore and Jodia Bazaar in Karachi. Banking officials have reported that traders have begun to withdraw their bank deposits and have now stopped issuing banking instruments for sales and purchases, including cheques, online transfers, demand drafts, etc.
The government’s inability to anticipate this response from traders should be considered a serious failure. The decision to impose a withholding tax on banking transactions would only encourage an increase in undocumented transactions in the economy. It seems the government has forgotten that until the 1980s, traders preferred to operate outside the banking system since it kept most of their economic activities untraceable. One mechanism to tax the same sector would be to strictly monitor the movement of cash and ask FBR officials to trace earnings. The current strategy will only push more and more people towards rejecting the banking
system, which has already shown a major reduction in investment in private credit. If the trend continues, then the government is going to succeed in causing major problems in the economy. Apart from disinvestment in banks, the measure is going to increase the undocumented economy and could end up actually decreasing tax collection. Another unanticipated crisis is that if traders start hoarding money, that may create a cash shortage in banks. Already Rs5,000 notes are becoming increasingly hard to get hold off. While there is no major crisis in sight as yet, the reports coming from banks in major markets suggest that imposing a withholding tax on banking transactions was the worst possible strategy the government could have used to bring more people into the tax net. The cost has been to increase the undocumented economy and decrease bank transactions. Is this a cost worth paying?