Money Matters

Why debt-financed tax reforms?

Money Matters
By Mehtab Haider.
Mon, 11, 19

Pakistan’s skewed and narrowed tax base largely continues to remain unable to meet the rising financing requirements of the country, swelling the budget deficit to alarming proportions amid mostly slowing economic and shrinking fiscal conditions.

Pakistan’s skewed and narrowed tax base largely continues to remain unable to meet the rising financing requirements of the country, swelling the budget deficit to alarming proportions amid mostly slowing economic and shrinking fiscal conditions.

The donor-funded projects also failed to yield any improvement in Pakistan’s tax collection machinery known as Federal Board of Revenue (FBR).

During the last Musharraf-Aziz-led regime, millions of dollars, provided by World Bank through loan and UK-based Department for International Development, in the shape of grants, to undertake reforms in the tax apparatus, went down the drain.

Now the Pakistan Tehreek-e-Insaf- (PTI) led regime has struck an agreement with the World Bank for a $400 million loan under Pakistan Raises Revenues (PRR) programme.

The World Bank argued that the PRR addresses a fundamental challenge for Pakistan’s development prospects: the chronic shortfall of revenues. No government can function if most of the country’s people and businesses do not pay their taxes.

Pakistan collects less in taxes than what it needs to cover the government’s main service delivery functions. The results are budget deficits, a growing public debt burden, and acute shortage of funds to invest in country’s infrastructure and human capital.

Pakistan has a tax base that in essence is quite scanty. This is due to exemptions and concessions for some large economic sectors and industries, including agriculture, construction, and textiles. Likewise, a lot of tax revenue is lost due to widespread tax evasion. In FY18 only 1.12 million firms and individuals filed and paid income tax. Recent estimates by the World Bank indicate Pakistan is collecting only half of the economy’s tax potential, leaving almost two thirds of General Sales Tax (GST) liabilities and more than half of income tax uncollected. For example, most retail traders do not pay taxes.

At the same time, Pakistan’s system is very complex and even people and companies, willing to pay their taxes, find it costs a significant amount of time and money to comply. For example, the division of the GST on services between the federal government that collects tax on goods and the provinces that collect it on services, means that firms that provide services across Pakistan need to file 60 tax returns a year only for GST and comply with different laws, regulations and administrative procedures for the federal level and each of the four provinces.

The PRR supports the simplification of the tax system by financing targeted results aimed at reducing the burden of the withholding regime on firms and individual taxpayers. It will help maximise transparency about the costs and benefits of tax exemptions. Importantly, PRR will help with harmonising tax collection principles and mechanisms across the federal government and the provinces.

The programme will also make it easier to pay taxes by supporting a single GST portal for the FBR and provincial tax authorities, and a risk-based tax audit system to reduce the frequency of audits for most taxpayers. It also finances automation in customs controls to accelerate border clearance for imports and exports. Finally, it strengthens tax authorities’ capacity to gather and analyse taxpayer information to effectively control tax compliance.

Harmonisation will enable GST collection through a single online portal, where firms will file, pay GST, and claim GST refunds for both goods and services at the same time. The GST harmonisation will help the FBR and provincial tax authorities to expand their tax bases and increase compliance by sharing taxpayer information.

This harmonization, however, does not require the concentration of the GST collection in a single tax authority for the federal government and the provinces. The PRR is based on the provisions of the 18th Amendment 2010 and therefore assumes the provinces will continue to collect the GST on services.

There is a need to analyse whether there is ownership of the proposed reforms within the folds of FBR or not, as the board envisages a deadline to start implementation on these reforms with effect from next budget on July 1, 2020.

The reform plan was a dire need of the time, but it caused confusion because it came into full swing from three different directions. The World Bank-funded programme envisages reform plan as the government has committed certain reforms with timelines to get a $400 million loan.

Under the International Monetary Fund’s (IMF) Extended Fund Facility, Pakistan has committed to carry out reforms in tax collection machinery. An IMF technical mission also visited Islamabad to suggest prescriptions for the same.

Thirdly, the Prime Minister’s Office has also sent out directives asking the FBR to launch the said reforms that need devising cohesion and establishing synergies.

The government will have to take the decision whether it is going to hire required professionals on contract basis or permanent staff will be recruited for the undertaking.

The multilateral creditors have suggested to the government to establish Pakistan Revenue Authority (PRA) with the mandate to collect taxes of both the federal and provincial governments under one umbrella. The PTI-led regime had deferred the implementation on PRA till the consensus is evolved with all stakeholders.

The FBR high-ups are likely to submit their reform package to the government in January 2020. The government will then have ample time to deliberate on all options over next six months so the implementation on reforms package would come into force from next budget with effect from July 1, 2020-21.

The reforms process cannot achieve success without complete ownership and devising a plan that proves a win-win for all stakeholders. The tax-to-GDP ratio also needs to be increased up to 17 percent by FY24 under the World Bank-funded programme. The plan has ambitious goals but it is a matter of the country’s survival to create fiscal space so that economy could stand on its feet, instead of relying upon on borrowed money, making debt completely unsustainable in years ahead.

The writer is a staff member