Bad amnesty

The real function of income tax in Pakistan is not to finance expenditures on citizens by government, but to victimise political opponents and reward supporters.

For the government, the problem is that taxes collected are low; for citizens, the taxes are unfair and unjust. Any proposal for economic reform that ignores these realities, as the four ordinances promulgated recently do, does not begin to address the problems it tries to solve.

Promulgated on April 8, two ordinances are new and two amend existing laws. The latter amend the Protection of Economic Reforms Act (PERA), 1992 and the Income Tax Ordinance (ITO), 2001. The former provide amnesty to the declaration, respectively, of undeclared foreign and domestic incomes (and assets – although being wealth not income, assets attract no tax). The aim ostensibly is to stem capital flight and increase tax revenues. They will do neither and create new problems.

The government’s dilemma is that it must raise tax revenues, while protecting foreign exchange reserves. Ordinarily, this wouldn’t be an insurmountable problem. But under PERA residents are permitted to hold and transact in foreign exchange, with immunity from any inquiry, declaration or questions by tax authorities and the State Bank.

These two provisions enable tax evasion – through foreign currency accounts (FCAs) and legalise capital flight – to more predictable and stable, and less corrupt, tax jurisdictions. The fatal flaw in the reforms package is that the PERA amendment leaves this regime intact, merely prohibiting non-filers from depositing cash in their FCAs.

What is needed is to gradually dismantle the PERA regime, bring the foreign exchange market within the banking system, do away with licensed money changers and make the tax system less corrupt and more stable and predictable. But due to foreign attachments of influential citizens, PERA cannot be touched. Consequently, the ITO amendment and the two amnesty ordinances are a gamble on scaling back the scope of income tax, in the hope that tax evaders will be induced to declare their domestic and foreign assets and income, so they can be taxed in the future.

The ITO amendment has two features. One: the income tax regime has been scaled back by raising the exemption limit (thrice the old amount) and drastically lowering tax rates, leading, for example, to a reduction of 78 percent in tax liability on a monthly income of Rs150,000, or 69 percent on Rs500,000. Two: every resident taxpayer whose foreign income exceeds $10,000, or foreign assets $100,000, is now required to file a ‘foreign income and assets statement’ (FIAS). Anyone who should file a FIAS is also to file an income tax return. The two amnesty ordinances, with minor variations, provide for declaration of assets and incomes in return for exemption from further taxation, correction of books of account, and assurance that the information provided would be confidential and inadmissible as evidence.

Will this inhibit capital flight? Unlikely. Restricting cash deposits in FCAs for filers will diminish these deposits and lead to a diversion of transactions to informal channels or through intermediaries. Together with the FIAS requirement, market uncertainty has increased. This is visible in the spread of the rate at which dollars are bought and sold in the open market, which has widened from a stable spread of about 30 paisas before the recent depreciation of the rupee to a widely fluctuating spread nearing one rupee. Overall, the rising uncertainty has increased the vulnerability of our foreign exchange reserves.

Will tax revenues increase? Certainly not. The immediate impact of reduced taxes will be a revenue loss of perhaps Rs80 billion to 100 billion, and a reduction in the number of tax filers. The receipts from amnesty seekers are likely to be minimal. Not only because the term of the existing government expires in weeks, but also because these three ordinances constitute exactly the kind of inquiry, declaration and questions prohibited by PERA. This blatant conflict in four ordinances issued on the same day does not inspire confidence and is bound to be challenged in courts. Consequently, this will increase and not decrease corruption and unpredictability in the tax regime.

Moreover, the shift in tax structure toward ‘indirect’ taxes (on transactions) away from ‘direct’ taxes (on people) is contrary to policy objectives and best practice. Finally, the gift of huge tax savings to the rich, those who benefit most from government, is unconscionable. It should attract public interest litigation if it is not repealed.

Over the years, income tax laws, rules and orders have become a patchwork of contradictory and inconsistent provisions. When laws are opaque, rules ambiguous and information concealed, corruption thrives. In this environment, as a sense of injustice and inequity among taxpayers rises, compliance falls, tax yields decline and in desperation the state resorts to partial remedies, like proliferating withholding taxes, that completes the vicious circle.

The president should repeal the four ordinances and instruct the government to present more thoughtful proposals in the forthcoming budget. Major reforms, of the exchange and taxation regimes, to be implemented over a longer term should be left to the next government.

The writer is a retired economist.

Email: arshadzaman@yahoo.com