Comprehensive Essay on Tax Reforms in Pakistan

Introduction:

Taxation has always been a vital part of any modern society. From time immemorial, we have seen governments taxing their citizens in order to finance their expenditure and for other constructive purposes. The tax structure of any country plays pivotal role in the country’s economic development. Revenue collection is not the sole purpose of tax system but it is also a tool that is utilized to reinforce or eliminate activities and pursuits that are determined by the legal system.

Tax is described as follows:-

“A tax is a compulsory payment levied by the government on individuals or companies to meet the expenditure which is required for public welfare”.

Canons of Taxation:

Adam Smith in his book “The Wealth of Nations” came up with some standard characteristics that any country’s tax laws must possess in order to be perceived fair in the eyes of the citizens of that country. Those characteristics were:

I. Ability to Pay:

Any person should be liable to pay that amount of tax which he is capable of paying. No person should be subjected to more burden than he can bear.

II. Convenience:

The time and place of paying taxes should be extremely convenient so that the taxpayer should not have any undue difficulty in paying the tax that he is liable to pay.

IV. Economy in Collection:

The costs that shall be incurred in collecting the taxes should be minimized in order to allow the government to collect as much net revenue as it can.

V. Certainty:

The tax laws of a country should not be complicated and the tax collector must not have the power to charge an extra tax or reduce any person’s tax liability.

Taxation system of Pakistan:

Like other countries there are two types of tax prevailing in Pakistan. One is Direct tax and other is Indirect Tax.

It is argued that a direct tax is one that cannot be shifted by the tax payer to someone else, whereas an indirect tax can be.

A direct tax is primarily on income and is collected directly from taxpayers. And indirect taxes include sales taxes and a well defined mechanism is formulated to deal and collect indirectly etc.

Fiscal Policy (budget estimates for 2009-10)

(% of GDP)

	2000-01	2001-02	2003-04	2004-05	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11
Total Revenue	14.2	14.9	14.3	13.8	14.2	14.9	14.6	14.5	14.0	14.3
Tax Revenue	10.9	11.5	11.0	10.1	10.6	10.2	10.6	9.5	10.1	10.5
Non-Tax Revenue	3.3	3.4	3.3	3.7	3.6	4.7	4.4	5.1	3.9	3.8
Total Expenditure	18.3	18.5	16.7	17.2	18.5	19.1	22.2	19.9	20.3	18.0
Overall Deficit	4.3	3.7	2.4	3.3	4.3	4.3	7.6	5.3	6.3	4.0

(Economic survey of Pakistan)

Current Economic Situation in Pakistan:

It can be said that a flawed tax system of Pakistan is a primary reason for the persistent budget deficits that Pakistan has to face every year.  Apart from the fact, the government is adopting a non serious attitude in reducing the losses of the public sector enterprises such as PIA, Pakistan Railways and Pakistan Steel Mills. Moreover, Pakistan is borrowing from international financial institutions is also a direct consequence of its failure to collect significant amounts in tax revenue. Hence, if Pakistan is able to increase its tax revenue significantly, she shall definitely be able to avoid borrowing from institutions such as WB and IMF that impose tough conditions.

Tax-to-GDP Ratio of Pakistan

2000-01 TO 2009-10

(% of GDP)

Years	Direct Taxes	Indirect Taxes	Surcharge/ Levy	Total Taxes	FBR Revenue	Share of Direct Taxes
2000-01	2.99	6.89	0.73	10.61	9.42	28.18
2001-02	3.20	6.41	1.23	10.83	9.11	29.54
2002-03	3.17	6.94	1.41	11.53	9.57	27.49
2003-04	2.92	6.84	1.09	10.84	9.25	26.94
2004-05	2.72	7.01	0.41	10.14	9.05	26.82
2005-06	2.82	7.06	0.67	10.54	9.36	26.75
2006-07	3.85	6.41	0.74	11.00	9.76	35.00
2007-08	3.79	6.47	0.34	10.60	9.83	35.75
2008-09	3.46	6.00	0.99	10.44	9.08	33.14
2009-10	3.66	5.83	0.90	10.39	9.05	35.23

Source: Ministry of Finance, Government of Pakistan

Tax Reforms in Pakistan:

Some reforms are being presented that can help in the improvement of the tax system in Pakistan. These reforms would have long lasting impacts on the existing tax system of Pakistan.

Formation of Intelligence Tax Bureau:

There is an immediate need for a Tax Intelligence institution. This should have substantial powers to inspect financial data from anywhere. It must be embellished with latest and modern technology and highly professional team. They should have proper job security and independence as well.

They would be able to perform certain tasks:

• Monitor the online transaction between banks to companies, companies to companies and customer to company and dealing with foreign financial institutions.
• Intercept the financial dealings of companies with local dealers, clients and agents.
• Major task of this to reduce the money laundering across globe.
• Getting financial data of Pakistani citizens from foreign countries.
• Make check over officials who directly deals with the collection and assessment of tax.
• Data Provision of those persons who evade tax and its basic purpose should be to expand the numbers of taxpayers.

Through this kind of bureau, a transparent tax system can be established. It will increase the number of taxpayers and boost the performance of tax official as well. Corruption in tax collection can also be reduced while having a public complaint department where they receive complaints from the public about corruption and they will secretly investigate the matter.

Reformation of Legal procedures:

In Pakistan, no one ever convicted or sent to prison on the matter of tax evasion.  There is a direct need to impose strict legal implications upon those people who evade tax at high level. The inland Revenue commissioner should be given legal power or Government can give instructions to the police to act on the advice of the commissioner.

It is commonly observed that in FBR every single and common letter or document needs signature of the Commissioner, Additional commissioner, Deputy Commissioner and Assistant commissioner. This results in the wastage of much time and makes system and performance weak of FBR as well. Substantial rights and powers should be given at every level. However, critical matter should be approved by more than two officers including the Commissioner.

Savings Tax:

A savings tax can also be proposed that will tax the savings of people in bank accounts. Such a tax will discourage people from keeping their money idle in bank accounts and instead encourage them to invest all that money in productive ventures in order to generate employment opportunities in Pakistan. Furthermore, the government can launch financial instruments as an alternative investment. All the funds derived by the government through such instruments can be used to finance national infrastructure programs such as dams, bridges and schools etc. Such a savings tax will ultimately lead to an increase in aggregate investment and consumption and allow Pakistan to extract itself from the recession into which it has fallen over the past several years.

Agricultural Tax:

The most important and perhaps the biggest flaw present in the tax laws of Pakistan is that agriculture which accounts for around 25% of the GDP and provides employment to around 40% of the total labor force is contributing not even a single penny to the national exchequer. Big landlords that earn millions from agriculture are not taxed in any way and those people who earn any other miscellaneous income also try to label that as agricultural income just to evade tax. Hence, if we want Pakistan to curtail its persistent budget deficit, we will have to collect taxes from all the different sectors of the economy. As far as the details concerning such an agricultural tax is concerned, we can tax it similar to business income where all the expenses incurred in order to derive that income are allowed as deductions. For agricultural income, expenses such as cultivation and harvesting of crops can be allowed as deductions from agricultural income. Small farmers and those people who indulge in agriculture on a subsistence level can be exempted from such a tax.

Another point to be noted over here is that some people in Pakistan have this misconception that any agricultural tax would lead to an increase in food inflation. However, it should be clear to all of us that the tax which is being proposed will be imposed on the profits that people earn from agriculture. This agricultural tax will not be imposed on the agricultural produce as what happens in a sales tax. Hence, to create false fears of food inflation just to exempt big landlords from paying taxes would be highly inequitable and unless Pakistan decides to tax all those segments of the society which can afford to pay their due share of taxes, Pakistan will continue to face the problem of budget deficits and ever mounting public debt.

Capital Gains Tax:

During the past decade, hundreds of people became millionaires and even billionaires in Pakistan by investing in the stock market and in the real estate. The boom in the stock and the real estate markets came and went, but those people who earned abnormal profits by investing in both these markets were not taxed to the extent that they should have been. Even now one can see that people who hold shares of listed companies for more than a year are completely exempt from paying even a single penny in tax.  It can be argued that the government wants to encourage people to invest for the long term in the stock market. However, providing a complete exemption is clearly not logical and economically feasible in such economically trying times for the Pakistani government.

It would be a logical proposition to advise the government to start taxing stock market investments where the holding period is greater than a year and furthermore, the government should increase the tax rate on short term and speculative investment in the stock market which only makes the market more volatile. All these measures are extremely crucial in an environment in which the government is facing a fiscal squeeze and every single penny of tax collected by the government is extremely important. Similarly, investment in the real estate should also be taxed so that all those people who can afford to invest in such properties pay their due share of tax.

Corruption:

All the above mentioned reforms will surely increase the tax revenue being collected by the Pakistani tax machinery. However, the problem and menace of corruption if not eliminated will lay to waste all the efforts of any party or institution to increase the tax revenue of Pakistan. Corruption is the reason due to which a hefty portion of our tax revenue is wasted away and is not spent on social development and national infrastructure projects. Hence, in order to ensure that all the measures that have been cited above must also be complimented with some other ancillary measures in order to make sure that no hurdle is put in the path of the greater tax collection in Pakistan. Some of those measures can be:

I. Firstly, the customs department which is heavily involved in the under-invoicing and incorrect declarations should be revamped at war footings.

II. Besides this competent and dedicated personnel should be hired. Most importantly the hearing should be made solely on merit, so that deserving and clean people could serve the country.

III. Furthermore, the people who make up the tax machinery should be held accountable and their performance should be monitored regularly. An intelligence division should be made within the Directorate Intelligence and Investigation, in order to keep check on the employees.

IV. Moving on, any abuse of authority if observed should be punished suitably. In order to come with the proper environment in which everyone does his own work and do it properly the senior management should set an example for the juniors.

V. Plus to generate honesty and reward hard work in the tax machinery, anyone who is doing good work should be given incentives plus anyone who uncovers any major tax evasion or scam should be given 25% of the detected amount.

Hence, measures like these can lead to the creation of a control environment in the tax machinery of Pakistan that will ultimately lead to the increase in tax revenue being collected and a lot less money being wasted due to corruption.

Furthermore, in today’s environment it is crucial for the FBR to conduct strong audits in order to ensure that the tax returns filed by the taxpayers on self – assessment basis are accurate and complete and these returns do not in any way understate the income of the taxpayer.

In order to facilitate the taxpayers a new scheme was introduced in the income tax ordinance called the universal self-assessment scheme (USAS). The scheme was that the taxpayer had to assess their income and file it honestly.

This scheme basically was introduced to minimize the contact between the taxpayers and the tax collector. Also the tax collector could not assess the income tax filed by the taxpayer, hence slashing the power of audit.

The results of such scheme were catastrophic, the documentation and increase in revenue which started to take place in the nineties, faded away with this scheme. That is why strong audits are extremely necessary for the negative aspects of USA to be eradicated.

Reduction in Non – Developmental Expenditure:

Non – developmental expenditure that eats up the most of the funds that Pakistan is able to generate include the defence expenditure and the unnecessary and lavish expenditure that our politicians waste on their luxurious lifestyles.

Hence, it would be useless to implement tax reforms if all that money is to be wasted on such non – developmental expenditure. It could be argued that in such tense times, it would not be advisable for Pakistan to reduce its defence expenditure. However, some tough decisions will have to be taken in order to reduce the budget deficit of Pakistan. Even the American military has decided to cut its defence expenditure considering the weak state of America’s economy.

Elimination of Black Economy:

Finally, another big problem that Pakistan is facing, which is a big cause of lower tax collection is a lack of documentation. As the government does not have sufficient data on the incomes of people, it is obvious that it finds it really difficult to tax them as well.

However, there is also a solution to this problem. If the government could get serious in making the tax system work properly, NADRA has its solutions in a single click. As Nadra issues the CNIC and that CNIC include a unique ID number.

Nowadays, nothing is possible without the use of CNIC. Suppose if you are going to open a bank account, you will require your CNIC. If you are spending something from your credit card, it includes your CNIC and moreover if you are buying an airline ticket, you require a CNIC.

Nowadays, about everything requires a CNIC. If the government wants, with just a single click, you could easily track, who is doing what, how many bank accounts does he have and how many of them are actually declared, what is being earned and what is being spent.

If the government wants, any information can be collected from the CNIC. Hence, such a measure if taken by the government can resolve the problem of documentation in Pakistan’s economy and result in more tax being collected as the government will have at its disposal the record of the income and expenditure of its taxpayers.

Conclusion:

The entire discussion in this working paper and the research that was done to prepare this document was ultimately meant to arrive at a set of reforms which if implemented would definitely lead to increased tax collection in Pakistan and a smaller or even a balanced budget for Pakistan. All this would help Pakistan to avoid going back for lending purposes to the IMF and WB.

Finally, I would like to say that in today’s recessionary times when even the developed countries of the world are finding it really difficult to extract their economies out of their recession; it would be illogical of us to expect these countries to continue to provide aid to Pakistan.

It is time that we should stand on our own feet and stop expecting aid and help from the so called “Friends of Democratic Pakistan”. Only self – reliance would help us revitalizing our own economy and competing with the rest of the world.

Bibliography

• kalyan-city.blogspot.com/2010/12/what-is-tax-definition-adam-smith.html (accessed on 12/5/2012)
• slideshare.net/BASIT554/tax-structure-of-pakistan (accessed on 12/5/2012)
• finance.gov.pk/survey 0910.html (accesses on 11/5/2012)
• Saeed, Khawaja Amjad. (2007), “The Economy of Pakistan”, Oxford University Press, Karachi.
• Hussain, Mirza Munawar. (2010), “Introduction to Taxation”, IBP Publications, Lahore.
• Inam, Maria and Khan, Shah. (2008), “Pakistan’s Taxation System: A Critical Appraisal”, journal of Managerial sciences, Qurtaba University Peshawar.

By

Waqas Akbar Gondal