Of taxes, taxmen, and tax havens

In these columns we foray into various aspects of the Economy. Generally, we find ourselves applauding the way structural reforms elude us, despite the several World Bank loans and IMF conditionalities. Our tone may have been irreverent, even supercilious, but we have tried to be constructive, without presuming to have all the answers – that we have left to our fellow scribes who are intellectually better endowed. Witticisms apart, our constant refrain has been to have the Q block return to the economic ministries their tool boxes. Hopefully, this won’t require a Zarb-e-Dar.

Today’s topic is far too serious for any tongue-in-cheek facetiousness. You don’t need a Conference of Birds to tell you that the tax system is broken. Policy has become a victim of revenue targets, tax administration obsessed with cat-and-mouse antics, and the government’s resolve to reform remains brittle. The target-driven tax policy is mono-focal, to the detriment of economic efficiency and equity. The only way that FBR can meet targets is through higher rates (incentivizing those out of the ‘net’ to stay out), and sheer highhandedness: delay refunds, collect in advance, and franchise out its functions to the withholding agents. It costs more to run the FBR than the taxes it (directly) collects! Here is the evidence. FBR tax-to-GDP ratio is stuck in the range of 8.5 to 9.5%, well below regional averages. FBR revenues finance less than half our total expenditure, obliging the government to borrow massively – the total debt and liabilities at the end of last fiscal stood at Rs 20 trillion, almost 80% of the GDP, and climbing. [Ministry of Finance uses a different definition of Public Debt, but even this works out to about 65%, breaching the 60% threshold under the Fiscal Responsibility Act, and the target of less than 52% as per Medium Term Debt Strategy]. Main reliance is on regressive indirect taxes. [Direct taxes are dressed up, courtesy the withholding taxes that account for 70% of direct taxes] ‘Collection on demand’, ie FBR effort, was less than 5% of total collection. The tax base refuses to respond to carrot or stick: of the 66,000 companies registered with the SECP, for instance, only one-third file returns; over the last fifteen years the number of sales tax registrants has increased four-fold to 100,000 but only a third file. Only ten ‘revenue spinners’ contribute 80% of domestic sales tax collection. Despite high applied rates the ‘effective rate’ (ie, on collection basis) is a mere 4.5%. The more buoyant sources like agriculture, real estate, remittances, etc, are either exempt or under-taxed. In customs duties the concessionary SRO regime covers about half the imports.

Yes, fiscal deficit is being shown to have declined to around 5% of GDP, but you don’t need to be a forensic accountant to know what’s behind it: creative accounting, bribing and bludgeoning the Provinces into throwing up surpluses, using the space provided by low oil prices to bolster receipts, passing the inefficiencies of the energy sector to the consumers in the name of subsidy-reduction, and such treasure troves as the State Bank profits that will continue to be obscene until the day government’s insatiable appetite to borrow from the banking system subsides. Plus, there has been divine assistance!

On top of high rates and weak enforcement we have the mind-boggling complexity of the system that scares away all but the most pious – or the ‘choice-less’. We would love to put the IRS officers through an exam on tax law, regulations, and processes – to validate Shabir’s law of informal economy: it is a function of High rates + System complexities + Weak enforcement.

A well designed tax policy covets much more than revenues, important as they are. It is the most effective means to ensure greater equity and egalitarianism and equality of opportunity. It catalyses growth, and directs investments to the more productive segments of the economy. It is at the heart of the ‘social contract’, and that is why how the tax dollars are spent has a crucial bearing on compliance.

Unfortunately, Pakistan’s dire straits do not permit ‘going for broke’ – to achieve in one go all four cardinal virtues of a sensible tax policy: revenues, equity and egalitarianism, inclusive economic growth (especially incentivizing investments in the preferred sectors and discouraging them in the less productive, less welfare-oriented ones) and using it as a means to provide legitimate social protection. We will have to prioritize. Over the short-term revenues may trump other considerations, but that does not mean that we jettison the basic principles of tax policy. Revenues and the ‘cardinal virtues’ are not mutually exclusive. Yes, you can have your cake and eat it too.

In our pursuit of a sane policy we can do no better than be guided by Laffer (of the Laffer curve fame) and Moore: “the best tax is one that has the lowest tax rate on the largest tax base.” In other words, small and big is the answer; small in terms of rates and big in terms of coverage. ‘Small’ becomes even more critical in a culture of weak enforcement: the ‘evasion margin’ becomes more attractive with high rates. Also, to quote Laffer again, “Excessive taxation is an equal opportunity tormentor.” Further, ‘small’ is our best bet for a broader tax base. The idea, surely, should be to gain in more tax payers what we lose in lower rates.

The other curse of the existing system – its complexity – will also be addressed through lower rates. The compulsion to have fragmentation and a spaghetti bowl of minimum, presumptive, transactional, and other taxes shall be reduced, as will the opportunities of an unholy alliance between the tax payer and the tax man. By reducing the complexities and the cumbersome procedures, to which a low rate will surely contribute, you will bring the system within the ‘competence level’ of the tax man as well. And if the government really wants the business community to concentrate on their business, rather than cultivate the tax machinery or research tax shelters, you would need to amalgamate the several tax collecting agencies into one.

Our thought process has been influenced by the provocative work of Bukhari and Haq [Towards Broad, Flat, Low-rate and Predictable Taxes]. We would not like to steal their thunder and let them take their message to a wider audience. Let us just say that all the brouhaha about the Pajama Leaks misses one essential point: why should people look for tax havens? If your system is riddled with exorbitant rates, double taxation, and a non-functional appellate system, it will take more than the Chief Justice to ‘fix the punctures’. Meanwhile, Dar, when do you plan to return the stolen tool boxes to their rightful owners?