A new social contract between citizens and the government is imperative
The government of Pakistan Tehreek-e-Insaaf comes with a promise to tackle the menace of corruption in all its forms. It faces the chronic difficulty of improving the tax administration which is also marred with rent seeking. Most indicators in doing business indices point towards fragmented and complex tax regime -- a key factor creating difficulties for existing and new business persons, in turn also denting Pakistan’s prospects for attracting foreign direct investment.
A survey of failed start-up companies in Pakistan conducted by the Sustainable Development Policy Institute (SDPI) points towards three main findings: a) several start-ups are unable to meet the high compliance costs of taxation (e.g. each province in Pakistan has a different tax regime); b) as start-ups expand the burden of tax compliance also increases (e.g. several companies are unable to hire a fleet of accountants only to perform the task of filing taxes on a monthly basis); and c) a complex system of sales tax, customs and regulatory duties has prevented start-up companies to become exporting entities.
On point-c it is important to note that Pakistan’s list of exporting companies has largely remained the same over the past decade. This country is not producing new exporters and tax regime has a large role to play here. Perhaps Pakistan remains the only country which has imposed withholding tax on export proceeds even if the company is facing a loss. Besides there is a large number of other withholding taxes which are against the principles of a progressive fiscal regime.
In a recent convention organised by PRIME Institute, the audience was informed by Dr Ikramul Haq that currently Pakistan has 68 withholding provisions - many of which are not even understood by the most experienced tax officials, in turn resulting in arbitrary levies.
In the same convention Syed Shujaat Ahmed of SDPI informed that several withholding taxes which lead to increase in the cost of doing business in Pakistan are not found in regional or peer economies. These include withholding taxes on exports, cash withdrawals, utilities like electricity and telephone, profits from banking deposits, and contracts. He also suggested that it was important for all tax authorities in the country to only suggest imposition of taxes to the parliament after a through impact assessment which should inform how such taxes would affect poverty and inequality levels in the country.
Using data from Household Integrated Economic Surveys published by the Pakistan Bureau of Statistics between 2011-12 and 2015-16 his study demonstrates that withholding taxes (which were not adjustable for a large part of Pakistan’s population) ended up in reducing disposable income of citizens and contributed to higher poverty levels in the country. Those households who were under the poverty line in 2012 and still reported payments of several withholding taxes became poorer in 2016.
Who is to blame for regressive and arbitrary taxation in Pakistan? Ultimately the blame will rest with the parliament and tax authorities. In the case of latter none of the tax bodies in the country have a fully functional research unit which can advise the leadership regarding rising tax gap and incidence of direct and indirect taxes. As Huzaima Bukhari’s recent research informs us that under such a rudderless tax administration, most officials at Federal Board of Revenue (FBR) and provincial tax authorities are driven by the quarterly tax targets provided by their superiors.
Just to meet these targets, officials end up pestering the tax payers, in turn resulting in discouraging business activity across the country. Such destructive behaviour is resulting in poor quality of corporatisation in the country. A negative consequence has been the continued existence of a large informal segment of the economy which on most occasions ends up promoting cash-based undocumented businesses.
An evaluation of the past tax amnesty scheme by SDPI also reveals why the envisaged gains could not be realised. Most potential tax payers have reported the lack of trust as a single most important reason for not availing the amnesty.
As Pakistan’s traditional sources of foreign assistance are drying out, the country’s economic managers will need to tap the source of wealth still available inside the country.
Pakistan has large undeclared wealth lying in cash, prize bonds and certificates, undeclared foreign currency accounts, undeclared local currency accounts and undervalued real estate. This wealth can become part of the formal economy only if the predatory behaviour of tax administration is curbed. Unfortunately, this undeclared wealth is also a source of suspicion for Financial Action Task Force which has put Pakistan on the grey list.
In view of the above mentioned, it is imperative to take urgent measures which can put in place a new social contract between citizens and the government. Of course, citizens must realise their responsibility towards paying taxes. However, it remains the government’s duty to make the tax compliance process less cumbersome so that it does not result in excessive transactions cost to the tax payer.
It is also evident now that the federal and provincial tax authorities cannot work in silos. There is a need for an independent national tax authority which has internal capacities for research, forensic audit, outreach and deeper engagement with public. This authority is perhaps the only answer to, for example, the removal of double taxation currently seen in the case of several manufacturing and services supply chains operating in one or more provinces. Such an authority will also look into operationalising the MoUs between various tax authorities across the country who currently do not have a mechanism to discuss and coordinate their policy actions on a regular basis.
Second, an independent tax authority will also be responsible for recruiting, training and providing a career to a national tax civil service. All tax officials across Pakistan, even those who work for provincial tax authorities should be part of a single tax civil service cadre. This is important in an environment where the tax laws carry thousands of amendments and continue to be interpreted differently across the country.
Third, simplify the appellate system! Currently the complainant can be made to appeal to FBR’s Commissioner, appellate tax tribunal (whose website is out of operation), tax ombudsman and even high courts. Even after going through all these steps there is no certainty of decision. A related aspect is the need for judiciary to realise that taxation is a highly technical subject and they need specialised training on a regular basis to update their knowledge in this area.
Fourth, simplify tax laws and filing systems! There is a vast proportion of population that lacks access to personal computers, web-enabled smartphones, and internet. They cannot be expected to file online. Similarly tax codes have been heavily updated through amendments passed in the parliament. Reading, understanding and on several occasions wrongly interpreting documents having thousands of bylines and footnotes is creating distortions in the economy.
Tax codes with all amendments subsumed within the main section of the law should be abridged with a view to offer ease of understanding for all stakeholders. All updated tax laws should then be translated in Urdu and regional languages. A starting point could be to first simplify and reform the system of sales tax on goods and services. This can readily improve the estimation of turnover and income by revenue authorities.
The above mentioned remedial measures have been discussed in detail during the past 24 months in the public private dialogues conducted by local think tanks. International technical advice on comparative tax systems was also available from the Centre for International Private Enterprise and Friedrich-Ebert-Stiftung. The Tax Reform Commission of 2014 also left some decent advice for the then government.
Perhaps, it would be best to take some urgent executive decisions now, based on the available research and not resort to a task force approach to tax administration. Time is of essence here; forming more committees for providing the same advice received in the past goes against the new government’s ambitious first-100 day’s agenda.