How to boost tax collection

The government must go for fundamental reforms to replace the outdated and complex system with a simple, certain and low-rate taxation

How to boost tax collection

The prevailing tax system is unjust, outmoded and unproductive -- with high taxes, yielding low revenues and operationally complex, time-consuming and costly. Even after making tall claims of "extraordinary" (sic) performance, the revenues are still below the real potential which is not less than Rs8 trillion.

The collection of Rs3.1 trillion by the Federal Board of Revenue (FBR) last year was after blocking refunds of billions of rupees and taking advances of coming tax years. On the basis of this "exaggerated" collection, target for 2016-17 was fixed at Rs3.6 trillion.

It must be remembered that in a meeting held on December 3, 2016, the high-ups of the FBR "blamed the government’s tax policies for a whopping Rs117 billion shortfall in revenue collection". The FBR stalwarts claimed that the government’s decision to keep petroleum prices unchanged for the first five months of 2016-17, the fiasco on property front, weakened exports and low interest rates were key reasons for the shortfall in tax collection. The finance minister, while disagreeing on downward revision in the collection target, issued directions for making up shortfall.

According to then Chairman FBR, the target of Rs3.6 trillion was fixed assuming that petroleum prices would remain constant. How naïve he was!! He presented lame excuses that last year prices of petroleum products were higher by one-tenth. In addition, sales tax on high-speed diesel was 37 per cent compared to 31 per cent in 2016-17 till December 2016. Sales tax on motor spirit (petrol) was 21 per cent in 2015-16 compared with 14.5 per cent. As chap from Customs, Nisar Khan, had nothing else to think but squeeze maximum revenues from huge import and domestic supply of POL products -- laziness and lethargy of worst kind, making no efforts to recover income tax from the rich and mighty.

The finance minister rightly refused to accept the explanation of the chairman telling him that the impact of lower oil prices was only to the extent of Rs13 billion per month. But later Ishaq Dar extended full support to the FBR team by increasing prices of high-speed diesel and motor spirit from December 1, 2016. It is simply shocking that consumers have been compelled to pay 38 per cent more on oil compared with prices prevailing in the international market to make up for the revenue shortfall. Is this the way to improve economic growth?

The higher cost of petroleum products vis-à-vis international market has made us totally uncompetitive in international markets. Why our worthy finance minister on the demand of FBR wants further price hike in POL products. It is just for the sake of showing "better tax collection"! No matter if we destroy our exports. It is simply thoughtless and imprudent!! Despite doing this, the tax gap has widened substantially and the FBR by no means would be able to collect Rs3.6 trillion. All indications show that collection will be around Rs3.4 trillion and that too after resorting to the same old tactics -- block refunds, take advances and recovering illegal demands through attaching bank accounts.

The position for tax year 2016 is no better. Around two million rich are avoiding tax obligations by not filing returns or showing correct incomes, but millions having no income or incomes below taxable limit are robbed through withholding tax system.

No taxation without representation is a cardinal principle of democracy -- Article 77 of our Constitution says that no tax shall be levied for the purposes of the federation except by or under the authority of the Act of Parliament. The Supreme Court of Pakistan in Messers Mustafa Impex, Karachi v Government of Pakistan (2016) 114 Tax 241 (S.C Pak.) held that "neither a Secretary, nor a Minister and nor the Prime Minister are the Federal Government and the exercise, or purported exercise, of a statutory power exercisable by the Federal Government by any of them, especially, in relation to fiscal matters, is constitutionally invalid and a nullity in the eyes of the law. Similarly, budgetary expenditure or discretionary governmental expenditure can only be authorised by the Federal Government i.e. the Cabinet, and not the Prime Minister on his own."

Unfortunately, the prime minister and the finance minister are still violating the dictum of Supreme Court by levying and varying tax rates through Statutory Regulatory Orders (SROs). The latest example is SRO 292(I)/2017 dated April 30, 2017 through which against standard rate of 17 per cent under Sales Tax Act, 1990, high speed diesel is subjected to a rate of 33.5 per cent.

Obviously, the government is least pushed to go for lower taxes with broader tax base. Unless, it is done, collection will remain far below the potential. The entire business climate is destroyed by imposing around 70 withholding provisions. The FBR also wants more advance tax from those who perform better! For example, an importer having flourishing manufacturing unit is denied waiver from withholding if quantity of raw material exceeds 110 per cent from that consumed during the previous tax year! Such an anti-growth and anti-business provision [clause (72B), Part IV, Second Schedule to the Income Tax Ordinance, 2001] can only be conceived by the FBR stalwarts, completely oblivious to the fact that higher volumes will yield higher taxes in the end!

One of the major factors behind non-corporatisation and documentation of economy is extremely high corporate tax, the third highest in the world, according to a World Bank report, Toward a More Business Friendly Tax Regime: Key Challenges in South Asia. Less than 25,000 companies file tax returns in Pakistan. According to latest report of State Bank of Pakistan, the active taxpayers increased from 0.76 million as on June 30, 2013 to current 1.01 million, but "the number is still low in comparison with the employed labour force of 57.4 million". Some 196,000 entities are enrolled in the sales tax system but only 35,000 actually pay any tax as the rate is too exorbitant and corruption is rampant. Money collected from customs in the name of sales tax is shared by collectors and businessmen -- state and people suffer and they enjoy illegal enrichment!

The World Bank’s report says: "Good taxpayers -- like likes of tobacco and telecom, for example -- are subject to disproportionate pressure from tax administrations because tax administrations are guided primarily by revenue targets, which are set at the beginning of the year. Top level tax officials then pressurise their subordinates who in turn force good taxpayers to contribute more revenue. Refunds to exporters are often postponed particularly in the last quarter of the financial year. Furthermore, VAT is not always fully refunded."

The report goes on to say: "Administrative burden of tax compliance is hardest in Pakistan where firms have to make 47 payments and spend 594 hours (or 74 man days per year) dealing with tax regulations compared to 12 payments and 175 hours in high income OECD countries. Eighty seven per cent time spent on dealing with taxes (or 514 hours per year) in Pakistan is spent on VAT compliance."

According to IMF Country Report No. 16/2, Pakistan faces significant challenges in realising its tax revenue potential and thereby providing the much-desired fiscal space for growth-enhancing priority spending on infrastructure, education, healthcare, and targeted social assistance. While the tax revenue-to-GDP ratio has increased by 1.5 per cent over the past three years to 11 per cent, it remains significantly below comparator emerging market economies and the tax effort expected for the country’s level of development.

"The historical development of tax ratios confirms underperformance in revenue mobilisation, with the tax-to-GDP ratio currently 1.4 percentage points below its peak of 12.4 per cent of GDP in 1996. Pakistan has the potential to mobilise additional tax revenues by an amount as much as, if not more than, it currently collects: its tax capacity is estimated to be 22.3 per cent of GDP, which implies a tax revenue gap of more than 11 per cent of GDP", the report observes.

According to Economic Survey of Pakistan 2015-16, by the end of 2015, our population was 195.4 million, out of which 77.93 million constitutes urbanites while 117.48 million live in rural areas. The dependent population of children under the age of 15 years was 35.4 per cent whereas 4.2 per cent people were above 65 years. Out of total population, 30 million were below poverty line earning less than two dollars a day. Our labour force, among the tenth largest in the world, was around 61 million, out of which 57.42 million were employed. Rural labour force of 42.3 per cent was earning below taxable income or agricultural income falling outside the ambit of Income Tax Ordinance, 2001.

Reading all these figures together, the total persons liable to income tax could not be more than 10 million whereas the government is extorting income tax in the form of withholding tax from 90 million unique mobile users alone!

Failure to harness the real potential of Rs8 trillion is the main issue -- see detail in paper Towards Flat, Low-rate, Broad & Predictable Taxes’, published by Prime Institute, a public policy think tank. For collecting tax of Rs8 trillion, we need to lower taxes and broaden tax base. The government must go for fundamental reforms to replace the outdated and complex system with a simple, certain and low-rate taxation.

Pakistan’s real dilemma is that the rich and mighty are not paying taxes according to their ability. In 2014, 2015 and 2016, less than 4000 persons paid tax between Rs1,000,000 and Rs10 million. In 2014 just 3,663 declared tax of over Rs10 million and this position worsened in 2015 as per Tax Directory 2015.

The position for tax year 2016 is no better. Around two million rich are avoiding tax obligations by not filing returns or showing correct incomes, but millions having no income or incomes below taxable limit are robbed through withholding tax system. Adding insult to injury, they are denied their rightful refunds and deprived of social benefit they deserve for money they pay.

How to boost tax collection