FBR’s resistance to tax reforms

Fiscal consolidation should be as growth-friendly as possible. In general, tax base-broadening reforms are identified as growth-oriented reforms. To the extent that they reduce distortions to economic decisions on work, saving, investment and consumption, they should increase output and improve social welfare-Choosing a Broad Base-Low Rate Approach to Taxation, OECD Tax Policy Studies No. 19

Federal Board of Revenue (FBR) has miserably failed to achieve the real tax potential, which is not less than Rs 8 trillion, despite imposing all kinds of oppressive taxes. Whenever there is a demand or debate about simplification of tax codes and improvement in tax administration, the worst resistance comes from some known stalwarts of FBR, who think they are the ultimate wizards and nobody else has a right to talk about tax base-broadening reforms aimed at accelerating economic growth, promote investment, boost up savings and to ensure fiscal consolidation. These self-acclaimed wizards must read ‘OECD Tax Policy Studies No. 19’, crux of which is quoted above.

Though many authors, including ourselves, have presented suggestions – ‘New Tax Model’, Business Recorder, August 28, 2015, for reforming the existing tax system and raising taxes to the level of Rs 8 trillion at federal and Rs 4 trillion at the provincial levels, our more-loyal-than-the-king stalwarts sitting in Ministry of Finance & FBR want “advice” and “assistance” from the IMF and the World Bank that have miserably failed in the past.

The present tax system and policies are detrimental for economy, social justice, business and industry. Those who possess more economic power (income and wealth) should contribute more to the public exchequer and vice versa. The ability-to-pay principle is regarded as the most equitable and just method of taxation and emphasized upon primarily for its redistributive role. In Pakistan, our rulers have completely deviated from this principle which is in fact, a constitutional obligation of the government. Political economy of tax reforms must be studied from this fundamental perspective, if some meaningful change in the nation’s life is desired.

The government’s yearning for “more and more taxes” has become a point of irritation for the citizens who argue that mere collection of more taxes is no answer to existing maladies. The internal and external debt will keep on rising unless the government goes for all-out reforms. Voicing this concern, Nadeem ul Haque, former Deputy Chairman of Planning Commission and ex-Vice-Chancellor of Pakistan Institute of Development Economics (PIDE), in his article Reform or face fundamental ascendency, emphasized:

“the state must first provide the social contract, ie, good law and order and security of life. It must dismantle the rent seeking that protects the rich… Rent seeking relies on three main components: state subsidies, licensing and regulation; special perks and privileges for ministers and army and civil service employees and land distribution system that allows the poor man’s land to be acquired for the elite especially the army and civil service”.

An equitable tax system is one under which tax payments are based on the amount of benefits received from government services-the Scandinavian social democracy model is a good example to quote and follow. In social democracies, the costs of government services are apportioned amongst individuals according to the relative benefits they enjoy. In economic terms, this is called “benefit principle” that pre-supposes determination of the incidence of public expenditure before deciding distribution of tax burden.

The government should launch programmes, financed mainly through taxes, to solve the twin problems of unemployment and poverty. These welfare-oriented schemes may also include free medical and educational facilities, low-cost housing, and drinking water facilities, land improvement schemes, and employment guarantee programmes. Once people see the tangible benefits of the taxes paid, there will be better response to tax compliance. Taxes cannot be collected through harsh measures and irrational policies. The government must demonstrate by its action to the taxpayers that money collected from them is spent on collective welfare.

One of the main tools of tax policy is to increase the level of savings and capital formation in the private sector partly for borrowing by the government and partly for enhancing investment resources within the private sector for economic development. In Pakistan, we have failed to achieve this goal. Recent years have experienced closure of large industries and stagnation in growth. Besides corruption and incompetence of FBR, inconsistent tax policies have forced the business community to search for safer havens abroad, depriving the country of invaluable capital. Similarly, foreign investors are reluctant to avail the tremendous Pakistani talent that goes to waste for lack of proper funding.

Pakistan is one of those very fortunate countries of the world that has an abundance of resources and a climate that is fit for simply any activity throughout the year. But thanks to donors’ agenda of over-emphasis on retrogressive taxation and incompetence of our economic wizards (sic), Pakistan’s dependence on imported products has increased manifold, whereas value-added exports have not been given any attention, let alone promoting high-tech industries capable of technological innovations-modern economies are knowledge-based and future is for those who can develop them as quickly as possible.

For technological transfers, rapid industrial growth and employment generation, foreign direct investment (FDI) is desirable. In Pakistan, when local investment is dying, expecting substantial FDI from China is like living in a fool’s paradise. Tax incentives play an important role in attracting FDI-which has nose-dived in Pakistan during the last decade.

Tax policy constitutes an important, if not a determinant factor, for favourable investment behaviour. Unfortunately, our budget-makers have always been preoccupied with revenue targets and have never bothered to provide some long-term investment-oriented tax incentives for infrastructure development, investments and employment generation, without which sustainable growth is not possible.

Foreign investors will not come to Pakistan as long as rotten and outdated structures exist and unsatisfactory law and order situation prevails. Due to these and other negative factors even the existing industrial units are closing down or working at low capacity. Nobody is willing to invest in special economic zones, where tax incentives are available. The main reason is lack of proper infrastructure and complicated bureaucratic structures. The result is an unprecedented decline in foreign direct investment during the last many years.

Pakistani industrialists – fearing loss of life and property, threats from extortionists, higher energy charges, rising costs of doing business and hostile tax policies – are shifting their capital abroad. Investors, both domestic and foreign, prefer a place that characterises stability, consistency and requisite infrastructure facilities – we lack all these at present. Tax incentives do matter but not as first priority-any feasible growth-oriented project can be profitable after paying reasonable taxes. In Pakistan, corporate taxation in 2017 is one of the highest and most complicated in the world – income tax and then tax on dividends, super tax, income tax on undistributed tax, turnover tax and alternate corporate tax.

Economic challenges faced by Pakistan are multiple and grim – we are trapped in a deadly debt trap, but there is no will on the part of the rulers to come out of it by tapping the real tax potential and stop wasteful and unproductive expenses. Our total debt as on June 30, 2017, was nearly Rs 30 trillion and it is increasing day-by-day due to sheer callousness of the rulers.

Pakistan also faces the herculean task of providing jobs to millions-on an average we need to create 2 million jobs annually for young people alone. For achieving this task we will have to ensure that economy grows at the rate of 8% to 10% per annum over a long period of time – for this we need investment of 20% of GDP. This challenge is also our great opportunity for economic progress. Majority of job seekers are young people, which are our greatest asset – imparting education and skills to them and creating matching jobs is the real challenge. This can be met successfully by assignment of taxes for productive investment and employment generation-our real engine of growth. The prevalent pessimism is due to attitude of the corrupt rulers and incompetent financial managers, who cannot think beyond their “interests”, what they are “commanded” or “trained” to think. They keep on telling us about the symptoms of illness in tax systems but never present solutions with road map to cure the real causes of illness.

Last week, in these columns, the draft of simplified income tax law was presented along with solid basis how it can fetch Rs 4000 billion whereas presently FBR is collecting less than Rs 1500 billion under the head of income tax. Simplification does not mean lowering of tax collection, rather the objective is to increase the same manifold.

This week, the emphasis is on sales tax. Businessmen say they are ready to pay sales tax on all transactions, but the input-output based value added tax (VAT) is not viable in Pakistan’s peculiar milieu. They allege that it has only created a powerful mafia-comprising unscrupulous traders, dishonest tax advisers and corrupt tax officials. Courtesy this mafia, the effective collection rate under sales tax is not more than 4% against the standard rate of 17%. Not only has VAT failed to take roots in Pakistan, its high rate and regressive nature is also proving disastrous for millions living below the poverty line who are bearing its agonizing burden.

Dr Arthur Laffer, in his keynote address at the “Africa 2025” Conference, held on November 23-24, 2015 in Casablanca aptly pointed out: “A tax system’s function should be solely to raise enough revenues in order for government to perform its requisite tasks. While all taxes are bad, some taxes are worse than others. So what you want your government to do is to collect taxes in the least damaging way possible, but still able to raise the requisite amount of revenues for government to function effectively. In addition, because of the damaging consequences of taxes, government should spend as little as possible in achieving its objectives. Efficiency in government spending is essential for economic prosperity”.

Over the period of time, our tax system has become rotten, oppressive, unjust and target-oriented. There is a dire need for discussing the philosophical framework, principles of equity and justice, which should be the main concern of our tax policy; not simply achieving of targets. Our fiscal managers want to meet budgetary targets through oppressive taxes, shifting incidence on the poorer segments of society and exempting the rich. We must enforce income tax and reduce progressive taxes. Undoubtedly, 17% VAT-type sales has proven anti-growth and its impact on business and industry has been destructive.

Presently, collection of sales tax is concentrated in a few commodities. This is confirmed by the fact that petroleum products alone contribute around 44 percent of the total sales tax domestic collection. Just 10 items including POL and natural gas yielded 73 percent of the total domestic net sales tax in 2015 and 2016. Against the prescribed rate of 17%, the effective sales tax rate for total domestic sales is 4.55 percent. This rate is 6.81 percent, 7.96 percent, 8.36 percent and 13.56 percent for top 40, 30, 20 and 10 sales tax paying entities respectively. This shows that domestic sales made by more than 99 percent of taxpayers, contribute sales tax at effective rate less than 4.55 percent.

In our study, ‘Towards Flat, Low-rate, Broad & Predictable Taxes, available at the website of PRIME Institute (https://primeinstitute.org/towards-flat-low-rate-broad-and-predictable-taxes/), we suggested a simplified Harmonised Sales Tax (HST) by federal government and provinces that can yield not less than Rs 5 trillion – Rs 3 trillion for federal government and Rs 2 trillion for provinces. Our legislators and policymakers did not even bother to study it, what to talk of debating it. Indian Parliament that has been discussing the idea of one nation one tax (HST on the pattern of Canada) since 1999 finally implemented a comprehensive dual Goods and Services Tax (GST) on July 1, 2017.

Potential of single-digit (5%) sales tax on goods alone is higher than what is being collected by FBR. This is highlighted by Ashfaq Tola, member of Tax Reforms Commission (TRC), in a comprehensive study. It is unfortunate that Mohammad Ishaq Dar, who is facing a trial before the Accountability Court, is not making the report of TRC public. Dar may be fond of “secrecy” in his personal financial affairs, but has no right to keep secret the report of TRC that was meant for stakeholders and not for him alone!!

The government should seriously consider the demand of the Federation of Pakistan Chamber of Commerce & Industry for single digit harmonised sales tax, subject to two conditions: first, there would be no refund and second, that all of them would pay income tax on their real income, but in no case less than 2.5% on their net wealth at the closing date of tax year. This kind of alternate minimum tax is imposed on the rich in many countries, notably the US in recent years.

Sales tax collection and compliance can be improved by introducing HST and enforcement through one single tax collection agency – National Tax Agency (NTA). No agenda of tax reforms can succeed with the present mindset prevailing in FBR. The Implementation Committee of TRC knows it better than anybody else.

The present tax agencies at federal and provincial levels are the only sources of irritation and impediment for better collection. NTA having competent staff with the help of Integrated Tax Intelligence System (IT IS) can easily capture all inflows and outflows and correlate sales tax collections on goods and services with income tax returns and monitor all transactions at every level. In the next week, we will present a comprehensive model of proposed NTA for Pakistan.