More growth, more taxes – III

The realistic and correct working of tax gaps in Pakistan is not possible unless the quantum of loss of revenue of trillions of rupees caused by all governments since the first military era of Ayub Khan is not taken into account. Successive governments-civil and military alike-have extended unprecedented exemptions and concessions to the rich and mighty, some of which are mentioned below:

— Ayub Khan, Ziaul Haq and Musharraf abolished all the progressive taxes, eg, Estate Duty, Gift Tax, Capital Gain Tax on immovable property and Wealth tax etc.

— The historic decision of taxing “agricultural income”, passed by the Federal Parliament in the shape of Finance Act, 1977, was thwarted by the military regime of Ziaul Haq. Through this law, the Parliament amended the definition of “agricultural income” as contained in section 2(1) of the Income Tax Act, 1922 then in existence, to tax big absentee landlords. This was a revolutionary step to impose tax on agricultural income for the first time in Pakistan, but foiled by a military dictator, supported by Mullahs, who were funded by big landlords and businessmen. It is now well-established that pro-people economic policies of the Bhutto regime posed a great threat to neo-imperialists and their gumashtas in Pakistan.

— Zia’s rule continued for 11 long years and that of General Musharraf for nearly 9 years, but absentee land owners (including mighty generals who received state lands as gallantry awards or otherwise!) did not pay a single penny as agricultural income tax.

— Taxation of “agricultural income” is the sole prerogative of provincial governments under the 1973 Constitution of Pakistan (“the Constitution”). All the four provinces have enacted laws to this effect, but total collection in 2013 was less than Rs 2 billion (share of agriculture in GDP in 2013 was about 22%).

— Non-taxation of long-term capital gains at stock market-exemption is meant for the rich and mighty and not for the small investors who lose more money than they make due to maneuverings of big players-caused annual loss of billions of rupees to the national exchequer [loss from 2007 to 2013 alone was more than Rs 512 billion as admitted by the government in Economic Surveys of Pakistan]. Despite, this so-called tax incentive, market billions of rupees of the small investors are being gobbled up by big fish-once small brokers are now owners of many banks and investment companies and bid for vital national assets when privatisation offers are made! From 2011 onwards a nominal tax is imposed on capital gains if holding is less than a year and that too as a separate block of income. Full and proper taxation of the big sharks is still a distant dream due to influence of the mighty whose benami accounts are managed by big brokerage houses. Annual tax gap under this one head alone is Rs 125-200 billion.

— Tax losses for exempting (in fact not taxing) speculative transactions in real estate are to the extent of billions of rupees per annum. According to Economic Survey of Pakistan 2012-13, the loss for fiscal year 2011-12 was Rs 700 billion.

— Multinational Companies (MNCs) through abusive transfer pricing mechanism deprive Pakistan of tax loss of over Rs 200 billion every year.

— Wealth Tax Act, 1963 was abolished through the Finance Act 2003 on specific demand of Shaukat Aziz before taking charge as Finance Minister of Pakistan. He was fully aware of the fact that by virtue of his status as resident in Pakistan, his world assets would attract provisions of the Wealth Tax Act culminating into substantial tax liability annually. Repeal of this progressive law, especially suitable to Pakistan where enormous assets are created without showing income, was shown to be justified despite tremendous revenue losses, distortion in the social set-up and the resultant misery inflicted on the majority of the people of Pakistan. From 2010, the right to levy wealth tax, to the extent of immovable property, is devolved to the provinces and they are least pushed to tax the rich landowners as they dominate the parliaments.

— In 2002 before its abolition, wealth tax was the only progressive tax left in Pakistan with tremendous potential for growth, if exemption given to the rich absentee landlords were scrapped. This became obvious immediately after its repeal when billions of rupees (estimated at US $60 billion) started pouring in from all over the world, remitted by all and sundry without any fear of being investigated, courtesy amnesty given under section 111(4) of the Income Tax Ordinance, 2001. Influx of enormous wealth was directed to the stock exchanges and real estate markets where hungry sharks continued to devour the small investors through unholy maneuverings; or was used to artificially enhance prices of immovable property. With no wealth tax to pay, both these avenues helped to increase individual wealth but dreadfully stripped the entire nation of its right to live in peace and economic prosperity.

— From 2003 to 2010, according to a conservative estimate, we have lost Rs 400 to 500 billion worth of wealth tax that could have been imposed on unaccounted/untaxed wealth amassed by those already enjoying the privileges of a luxurious life.

— Section 111(4) of the Income Tax Ordinance, 2001 protects tax evaders as they can whiten untaxed income through an extremely simple and easily available procedure by going to a money exchanger and getting fictitious foreign remittance in his account after paying a nominal premium of 1% to 2% of the entire proceeds! The loss caused due to this provision alone in the last five years is nearly Rs 275 billion.

The above are just a few areas showing how much tax loss we have been incurring perpetually. In ‘Pakistan Tax Gaps: Estimates by Tax Calculation and Methodology’, no effort was made to take into account all these factors to correctly determine total federal tax gap.

Pakistan does not need any borrowing at all, if the rich and the mighty are taxed according to the established norms of democratic dispensation of justice. The dire need in today’s Pakistan is to reduce inequalities through a policy of redistribution of income and wealth by taxing the rich and mighty. Higher rates of income taxes, capital transfer taxes and wealth taxes are some means adopted for achieving these ends in all democratic countries. In Pakistan, there has been a gradual shift from equitable to highly inequitable taxes. The shift from removing inequalities through taxes to presumptive and easily collectable taxes has destroyed the fundamental principle of horizontal and vertical equity. The equity principle can be held to be satisfied when the overall classification of individuals into categories is reasonable and broad enough to contain many individuals within each category and there is equality of treatment within each category.

Taxes and poverty

There is a direct link between growing poverty in Pakistan and distortion in tax base since 1991, when a major shift was made by introducing presumptive taxes (indirect taxes in the garb of income tax). The lack of judicious balance between direct and indirect taxes has pushed an overwhelming majority of Pakistanis towards the poverty line. According to official figures, in fiscal year 2012-13, the share of indirect taxes rose to 62% and that of direct taxes dipped to 38%. It once again confirmed that the taxation system in Pakistan is highly regressive. The government statistics wrongly accounted for in direct tax collection that portion of income tax collection which in fact was indirect in nature (fixed tax on imports, supply of goods, contracts and services and rental income). In reality, after adjustment of these collections, the share of indirect tax was not less than 78% in the total collection.

For social justice and pro-people economic development, the government, through tax policies, must discourage certain activities, which are considered undesirable, for example, excise duties on liquor and tobacco and special excise on luxury and semi-luxury goods. Such measures act as deterrents in avoiding a spill-over of these items and creating disturbance in the society as a consequence. For achieving the cherished goal of establishing an egalitarian State, we need to take the following steps through the ability of the taxation system to influence allocation of resources:

— transferring resources from the private sector to the government to finance public investment programme;

— directing private investment into desired channels (rapid industrialisation) through heavy taxation of colossal income earned by absentee landlords-cum-pirs from orchards and exploitation of labour of their murids (blind followers);

— influencing relative factor prices for enhanced use of labour and economising the use of capital and foreign exchange;

— increase the level of savings and capital formation by enhancing investment resources for economic development. In Pakistan we find a reversal of this principle. Recent years have experienced flight of capital, closure of huge industries and recession in the trade market. Lack of consistency in the tax policies have forced the business community to move towards safer havens depriving the country of invaluable capital. Similarly, foreign investors feel shy to make use of the tremendous Pakistani talent that goes to waste for lack of proper funding.

— protect local industries from foreign competition through the use of import duties, turnover taxes/VAT and excise. This has the effect of transferring a certain amount of demand from imported goods towards domestically produced goods. 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 unfortunately and thanks to IMF-imposed economic wizards (sic), our dependence on imported products has been hit with an upward surge in the recent years. Due to the introduction of harsh tax measures and misadministration, our industrial sector has suffered so badly that instead of being able to export our goods we are forced to import in order to cater for the demands of the nation.

— stabilise national income by using taxation as an instrument of demand management. Taxation levels could be used to eliminate inflationary or deflationary gap in the economy. Taxation reduces the effect of the multiplier and so can be used to dampen upswings in trade cycle.

The poor and helpless masses of Pakistan desperately owe explanation from all those in power:

— Why the privileged are continuously being favoured and thriving on the money collected as “tax” (sic) from their own poorer brethren?

— Why it is that ordinary taxpayers having income of more than Rs one million are required to submit annual wealth statements whereas rich and mighty politicians, who have exempt agricultural incomes, have not yet made public, declarations of their assets?

— Why do they hesitate from paying wealth tax but charge taxes and levies of Rs 38 per litre on petroleum products knowing very well that these are consumed by the general masses?

— Why not subsidise the poor and make good the loss by levy of wealth tax on the rich?

— Why not monetize all the perks and perquisites of government employees, judges and those working in state-owned corporations and ask them to live amongst the common people rather than in fortified (cordoned off) GORs and palatial houses?

— Why not curtail unnecessary and extravagant expenses on the civil-military establishment starting from the President House, to fill up the void?

— Why not reduce the number of ministers/advisers instead of following policy of appeasement and doling out public offices as if this nation was not burdened enough by worthless and incompetent bureaucrats?

Our tax potential is around Rs 8 trillion. If there are 10 million individuals having annual taxable income of Rs 1.5 million (a very conservative estimate), total income tax collection comes to Rs 3,750 billion. If we add income tax from corporate bodies, other non-individual taxpayers and individuals having income between Rs 400,000 to Rs 1,000,000, the gross figure comes to Rs 5000 billion. FBR collected only Rs 715 billion as income tax in 2012-13 (total direct tax collection is shown at Rs 739.7 billion which included income tax and other direct taxes ie capital gain tax, workers welfare fund and workers profit participatory fund. The contribution of income tax in total direct taxes is around 97%). About 35% of direct taxes are indirect taxes collected under the garb of presumptive taxes. Thus not only is there a whopping gap of Rs 2784 billion in income tax alone, but the actual contribution of direct taxes much lower than what is claimed by the FBR: “direct taxes have contributed 38% in the total tax receipts collected during FY12-13”. In the income tax collection of Rs 716 billion, presumptive taxes are at least Rs 250 billion, thus actual income tax collection is not 716 billion but Rs 466 billion – its share in total revenue comes to around 24% and not 38% as claimed by FBR.

Another shocking fact contained in Year Book 2012-2013 is the dismal performance of FBR field officials in collecting taxes through their own efforts by employing forensic audit techniques, using third party information or utilising data collected by FBR over a period of time, about the rich and mighty who do not even bother to file tax returns. Figures contained in FBR’s Year Book 2012-2013 show that out of total collection of Rs 739.7 billion under the direct taxes, collection on demand was just Rs 89,427 billion-a decline of 31% as compared to collection on demand of Rs 130 billion in 2011-12. This alone confirms the pathetic state of affairs prevailing in FBR where officers are getting double salary, bonuses and honourariums – ‘Politics of plots and perks’, Business Recorder, July 12, 2013collected only Rs 746 billion as income tax in 2011-12.

Out of total direct tax collection of Rs 739.7 billion, FBR received Rs 436 billion (59%) from withholding agents. In this area as well, massive corruption is prevailing with the connivance of tax officials – the withholding agents collect/deduct taxes and do not deposit in the government treasury, or the payer and the payee join hands to deprive the exchequer of billions of rupees with the connivance of corrupt tax officials. The real potential of withholding taxes, based on estimates for total GDP for FY 2012-13, was not less than Rs 1200 billion.

Similarly, due to rampant corruption in sales tax, federal excise and custom duties, the total collection in 2012-13 was only 25-35% of actual potential. In fiscal year 2012-13, FBR collected Rs 841 billion under the head sales tax, Rs 119 billion under federal excise duty and only Rs 239 billion under custom duties. Total indirect collection of Rs 1939 billion was pathetically low. It should have been at least Rs 5000 billion [for bridging the tax gap we have already given concrete proposals in ‘Recouping tax losses’, Business Recorder, July 13, 2012].

If existing tax gap is bridged, our revenue collection can reach Rs 8500 billion (Rs 3500 billion direct taxes and Rs 5000 billion indirect taxes) which could change the entire fiscal scene and fate of the nation. By collecting this amount, we can easily meet current expenditure, development and public welfare outlays-government requiring no internal or external borrowing would be able to retire debts in a few years as done by the Hungarian government-‘Learn from Hungarians’, Business Recorder, August 16, 2013. However, the dream of making Pakistan a self-reliant economy can never be realised unless the mighty sections of society (Riasti Ashrafiya) are taxed as per Article 3 of the Constitution which says: “The 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 militro-judicial-civil complex (higher echelons and not the lower staff) represents less than 1% of entire population but enjoys unprecedented perks, perquisites and benefits at the expense of taxpayers’ money – ‘An elitist Pakistan’, Business Recorder, July 26, 2013. The mighty landowners exploit labour of landless tillers and unscrupulous industrialists and traders exploit poor urban workers to amass more and more wealth. Additionally, they create artificial hike in prices of essential items to snatch back whatever little is earned by the poor and the fixed-income classes. The prevalent tax system protects them and shifts burden on the working classes of Pakistan-‘FBR: new chairman, old challenges’, Business Recorder, August 2, 2013 and ‘Politics of plots and perks’, Business Recorder, July 12, 2013.

Based on above facts and figures, revenue target for the coming fiscal year (2014-15) should not be less than Rs 8 trillion. This is achievable provided the mighty segments, identified above, are taxed according to their capacity, number of tax filers are substantially increased, equitable and rational policies are devised with the backing of the masses, tax machinery is completely overhauled and all exemptions and concessions available to the privileged sections of society are withdrawn. If taxes are collected to this extent, Pakistan can become a self-reliant economy and easily move towards an egalitarian State. This is the only way to get out of the present quagmires of “debt prison” and political enslavement. One hopes that in the coming budget, second under the present regime, mindless changes in tax codes and procedures will be avoided as these cannot improve tax collection. The real weakness of tax system lies in poor enforcement that includes corruption, which is not possible without the connivance of tax collectors. Tax codes are ruthlessly amended each year through Finance Bill and in between, by way of statutory regulation orders (SROs) – this is not a solution but part of problem. The need of the hour is complete re-engineering of the system and long due structural reforms, which are deferred year after year in the name of short-term compulsions.

(Concluded)

(The writers, tax lawyers and partners in HUZAIMA & IKRAM (Taxand Pakistan), are Adjunct Faculty at Lahore University of Management Sciences)