Fair taxation

“The Laffer Curve, by the way, was not invented by me; it has its origins way back in time. For example, the Muslim philosopher Ibn Khaldun wrote in his fourteenth-century work The Muqaddimah: It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessment.”-Dr Arthur B. Laffer, noted economist known to have invented Laffer Curve, has made this observation in his book, Return to Prosperity, co-authored with Stephen Moore, senior economics writer for the Wall Street Journal.

One of many factors for increased income and wealth inequalities in Pakistan is regressive and unjust taxation. Incidence of taxes on the poor during the last 25 years has increased substantively (35%), while on the rich it has decreased by 18% for the same period. Since the coup d’etat of July 5, 1977, regressive taxes have gradually been replacing progressive ones. The real brunt came in 1991 during the regime of Nawaz Sharif, who became politician (sic) with the patronage of military junta, when many regressive taxes were introduced to benefit the rich. The presumptive taxes, made part of income taxation, facilitate the rich to pass the burden on the end users. The tax evaders were also facilitated with laws like the Protection of Economic Reforms Act, 1992 that considerably eroded the tax base.

In the garb of giving protection to foreign currency accounts and remittances, for which no question can be asked by tax authorities, the rich and mighty till today enjoy the unprecedented opportunity to decriminalize their untaxed money. The final nail in the coffin of progressive taxation came during the Musharraf-Shaukat era when wealth taxation was abolished and personal income tax rates were slashed for the rich. After the 18th Constitutional Amendment, the right to levy progressive taxes like gain on immovable property, estate duty, wealth tax on immovable assets and gift tax was transferred to the provinces and since 2010 not a single province has utilised the same to increase their resources and spend the money for public welfare, wealth redistribution and alleviating poverty.

The rich-poor divide in Pakistan amongst many other factors has its roots in the regressive taxation but unfortunately, no systematic or comprehensive study has been conducted to determine comprehensively all dimensions of the rich-poor divide vis-à-vis the impact of regressive taxation. A study conducted by Talat Anwar [Role of Growth and Inequality in Explaining Changes in Poverty in Pakistan, The Pakistan Development Review, 2010, vol. 49, issue 1, pages 1-17] provides estimates of various inequality indices in Pakistan wherein the Lorenz Curve and Gini Coefficients have been most commonly used.

According to Anwar, studies on income inequality in Pakistan show different estimates arising due to the following five important factors. Firstly, different studies use different data sets, some based on Household Income and Expenditure Surveys, others that make use of income tax data, and some other studies splice the two sets of data. Second, while some studies consider inequalities in income, others consider inequalities in the consumption expenditures. Third, while some studies are done for Pakistan as a whole, others examine income inequalities in both the rural and urban areas. Fourth, some studies report income inequalities across households; others report inequalities across population or earners. Fifth, some researchers classify data by deciles prior to estimation of Gini-coefficient; others employ income intervals that are not uniform. This study confirms that income inequality in 2000-2007 had been the maximum compared to any time period in the history of Pakistan. The poorest 30% lost their share while the richest 20% gained in both the urban and rural areas.

This study also notes that good policies without good governance would not benefit the poor. “For example, in Pakistan the periods of highest levels of resource allocations did not result in improvement in social indicators underlining the fact that spending money without addressing the underlying structural causes of poverty would not reduce poverty. This was not a Pakistan-specific problem; it was common to most South Asian countries. The issues of governance that needed immediate attention included not only the design of policies and structures of governance but also a clear understanding of issues of resource allocation versus resource utilisation. Transparency of public sector expenditure and accountability in resource allocation therefore was of foremost importance. Political accountability was also essential to eradicate bad governance practices. Secondly, regressive tax structures followed by poorly constructed subsidies made for an inefficient system. There is a need for correct and efficient targeting of subsidies. Poor governance structures exacerbated leakages and missed targets, completely sidelining the poor even from accidental benefits,” the study suggests.

Since 1991, there has been a shift from equitable taxes to highly inequitable taxes. The equity principle is satisfied when the overall classification of individuals into categories is reasonable and broad enough to contain many individuals within each category and there is equal treatment within each category. This has been ignored in the prevailing tax system. A commercial importer having turnover of Rs 10 million is paying the same rate of tax as a very rich person in the same category having import of Rs 500 million. In their case, income tax withheld at source is full and final discharge of tax liability and no income determination is required to apply progressive rates as is the case for many other businesses, property income earners and even salaried persons. If the State wants flat rate taxation, it should be for all and not for a few selected sectors of category of taxpayers. The commercial importers and contractors pass on entire tax burden (indirect and so-called direct) to the consumer/clients and thus pay no income tax. This shows how the regressive tax system is favouring the rich and putting undue tax burden on the poor or end users.

The rich and mighty also have been enjoying tax exemptions and concessions. The Chairman Federal Board of Revenue before a hearing conducted by Senate Standing Committee on Finance & Revenue on May 13, 2014 admitted that Rs 500 billion were lost annually by way of tax waivers. It means loss of Rs 5 trillion to national exchequer in ten years! It is obvious that collection of these were funds could have saved us for reckless borrowing. Large part of this could have been utilised for education, health, transport, infrastructure development etc. Even the funds that were collected were largely spent (wasted) on debt servicing and for providing privileges and benefits to the powerful sections of society. Had these were spent wisely, the present mess (debt trap) could have been averted.

Taxation challenges, especially improving tax-to-GDP ratio, must not be viewed in isolation. These must be analysed from the social justice point of view as well. State needs to end inequalities and ensure fair and equitable allocation of resources as part of tax reforms agenda. The foremost objective of rational and just tax system should be collecting funds for public spending (judiciously and not for the luxuries of the militro-judicial-civil complex and political elites) and providing basic facilities of health, education, transport, housing and recreation to all citizens. Taxation should not be for favouring somebody or penalising a segment of society. It should be for common good, for welfare of all, for establishing an egalitarian State.

It is highly lamentable that millions of Pakistanis are living below the poverty line but huge amounts are spent on personal comforts and luxuries of President, Prime Minister, Governors, Chief Ministers, ministers, state ministers and high-ranking civil-military officials. Unfair tax system, like the one prevailing in Pakistan, promotes inequalities. Wealthy individuals escape taxes, and burden is shifted to ordinary citizens through taxes on labour and consumption. As a result, wealth and power are being increasingly concentrated in the hands of a few, even less than one per cent of the population of Pakistan.

The vast majority of Pakistanis is helplessly witnessing the violations of human rights, like right to food, housing, education or health. Income inequalities in Pakistan have increased sharply since 1990 and the trend continues unabated. The main factors that govern personal income distribution include: distribution of assets; functional income distribution; transfers from other households, government and rest of the world; and tax/expenditure structure of the government. In Pakistan, on the contrary, the single most devastating factor for increased income and wealth inequalities remains the regressive taxation. Study of Pakistan from this political economy perspective is very crucial as society is fast moving towards dehumanising characteristics due to income/wealth disparities and rising poverty.

The question is why even after all kinds of taxes (income-based, consumption based and even transactional), Pakistan is facing huge fiscal deficit as well as acute income and wealth inequalities, scarcity of essential commodities, non-affordability of eatables, power shortages and lack of essential social services. The present taxation in Pakistan is neither yielding large revenues (the size of pie is so small that both the federal and provincial governments have fiscal problems) nor serving the purpose of redistribution of wealth.

The ‘Great Divide’ in today’s Pakistan between the rich and the poor is assuming alarming proportions and one of the main factors for this is a lack of political will to tax the people according to their ability to pay and non-fulfilment of promised made in Article 3 of the Constitution of Pakistan which says:

“State shall ensure the elimination of all forms of exploitation and the gradual fulfilment of the fundamental principle, from each according to his ability to each according to his work”.

The way forward is implementation of Article 3 in letter and spirit. Taxation system should conform to the principles enshrined in this and others related Articles of the Constitution to ensure fair and just socio-economic order. Fair taxation alone can ensure growth, employment and equity. Direct taxation should be the main focus to achieve these goals as regressive taxes are not only detrimental for growth, these give rise to poverty and income/wealth inequalities.