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Tax misconceptions

There has been no prime minister during the past three decades who has not blamed poor macroeconomic performance on those who do not pay taxes – tax evaders who are clearly engaged in an illegal activity and tax avoiders who use the existing loopholes in the tax structure to avoid paying taxes – even though their successors accuse them of engaging and/or being complicit in these activities.

In his first address to the nation as the Prime Minister, Imran Khan urged wealthy Pakistanis to start paying taxes maintaining that “it is your responsibility to pay taxes. Think of this as a jihad that you need to pay tax for the betterment of your country.” He has reiterated this refrain time and again interspersed with appreciation of the Federal Board of Revenue (FBR) for raising the annual tax collection compared to the year before. In November 2021, with no evidence of a public-led ‘tax jihad’ in sight, the Prime Minister went a step further and lamented that “rising foreign debt coupled with low tax recovery has become a national security issue because the government does not have enough resources to run the country.”

What the prime minister ignores is the obvious solution: slash expenditure, especially non-development current expenditure which was 4.2 trillion rupees in 2017-18 (with an additional 120 billion rupees budgeted for Benazir Income Support Programme itemized under development expenditure outside the Public Sector Development Programme – an item now included in current expenditure) to 7.5 trillion rupees in the current year’s budget (with only 250 billion rupees earmarked for BISP) – or a rise of an unprecedented 75 percent.

The Prime Minister’s contention that Pakistanis are one of the most charitable people in the world is borne out by empirical evidence, reflected in his personal success in launching Shaukat Khanum Memorial Hospitals, yet he needs to understand that decisions relating to taxes or selecting the country to invest in are taken by a different part of the brain, like their counterparts in other countries. In other words, the practice of evading and/or avoiding taxes is to secure and strengthen the financial health of the individual and/or the firm while it is the responsibility of the tax collecting arm of government to ensure that there is minimal evasion and implement laws that plug all loopholes that allow for avoidance.

Unlike in the developed world, Pakistan’s tax system continues to be abused as the politically influential people ensure that the tax structure remains inequitable (through heavy reliance on indirect taxes whose incidence on the poor is greater than on the rich as opposed to direct taxes), unfair (heavy reliance on import tariffs specifically on petroleum and products, cooking oil which impact on a poor man’s budget a lot more than on a rich man) and anomalous (with different taxes levied on items procured by different entities).

The question then is, what percentage of collected taxes are direct (on income based on the ability to pay principle)? The following table shows that notwithstanding crediting the levy of withholding taxes on services/products under direct taxes rather than under sales tax (a practice strengthened during the PML-N tenure through widening the amount payable by the non-filers as opposed to the filers) the percentage collected under direct taxes has remained remarkably consistent.

With respect to indirect taxes any reduction in reliance on sales tax has been adjusted by a rise in customs collections. For the current fiscal year budgeted estimates have been taken as the actual impact while the finance bill (amendment) approved by parliament end of December has not yet been tabulated by the FBR with confusion prevailing over whether the government’s claim that the 343 billion rupees withdrawal of exemptions would have minimal impact on collections as the bulk would be refunded or the claim made in the 24 January Monetary Policy Statement that “with the passage of the Finance (Supplementary) Act that withdraws certain tax exemptions, the fiscal deficit is projected to be around 0.5 percent of GDP lower than previously expected for FY22. Together with recent policy rate increases and accounting for the usual lagged impact of fiscal measures, this additional fiscal consolidation should help further moderate the pace of domestic demand growth, and thus improve the outlook for inflation and the current account in FY23.”

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Year Tax Direct Withholding Indirect Sales Customs

as taxes tax as % of taxes % of tax as % of as % of

%of % of direct taxes total taxes indirect indirect

GDP total taxes taxes

taxes

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2007 9.2 39.4 49.2 60.6 60.3 25.8

2010 8.8 38.2 56 61.8 62.9 20.7

2012 9.4 39.2 58 60.8 70.3 19

2015 9.4 39.9 63 60.1 69.9 19.7

2018 11.1 39.7 65 60.3 64.4 26.4

2020 9.6 38.1 72 61.9 64.5 25.3

2021 9.9 36.5 72 63.5 65.9 24.8

Budget

estimates 37.4 62.6 68.7 21.5

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The need to raise direct taxes as a component of total collections is clear however, the number of tax return filers is around 2 to 3 million and they are the focus of the FBR at present. Reports suggest that under 2.2 million (one third of those with valid tax numbers) are on the active tax payers list because: (i) all those filing their returns are not required to under the law, for example, students and widows, and their decision to file  is to take advantage of the lower withholding taxes applicable on purchase of several services/products relative to filers; (ii) farm income remains outside the ambit of the FBR as per the constitution; and (iii) those who continue to operate in the parallel economy are estimated at over 50 percent.

The solution to get the high income non-filers into the tax net was first presented during the Zardari-led PPP government (2008-13) with the FBR eyeing detailed data available with National Database and Registration Authority (Nadra) covetously – data available given that computerized national identity cards are required to open a bank account, travel, purchase property or vehicle, etc. This led to the realization that Nadra’s terms of reference disallow it from sharing information with a third party (FBR) and the two subsequent administrations – PML-N and the incumbent – have continued to eye this seemingly low hanging fruit.

Shaukat Tarin, the fourth finance minister of the Khan tenure if one includes Hammad Azhar’s interim appointment, stated while launching the National Tax Directory by the FBR in January 2022 that: “I am giving this good news to unregistered taxpayers that we will reach them in the coming few weeks and we will tell them what’s their income and how much tax they have to pay… We will go to them [unregistered taxpayers] with data and provide them with [the details of] their tax returns. We will connect them with a panel of auditors from the private sector for consultation if they believe there is some error [in the details provided to them], if they still don’t pay the law will take its own course.”

Nadra Chairman recently clarified that “the artificial intelligence engine would determine tax liabilities based on data of registered and unregistered persons and standard deviations would be minimum only when filers and non-filers data is available for analysis.”

FBR sources have revealed to Business Recorder that Nadra surreptitiously shared data with FBR last year as well as this year and has prepared a profile of high net worth individuals which is currently being reviewed by FBR. A new amendment is in the works which would allow FBR to share income tax statement and wealth statement with Nadra.

The intent of the FBR is to create a portal of these high net worth individuals and send them an SMS warning them to clear their tax dues. Failure to respond may lead to electricity/gas/phone disconnections. However, the tax payer can seek legal remedy which is almost certainly going to include a stay order that in this country can remain in place for decades.

To conclude, it is not clear how long it will take to effectively implement this policy and generate taxes with the International Monetary Fund (IMF) expressing skepticism over the capacity of FBR to meet the budgeted revenue generation by declaring it “unrealistic” accounting for the passage of the December 2021 finance supplementary bill with another one reportedly in the works in the FBR.

Anjum Ibrahim, "Tax misconceptions," Business recorder. 2022-02-14.
Keywords: Economics , Annual tax , Business Recorder , Tax payers , Sales tax , Income Tax , Imran Khan , Pakistan , IMF , FBR

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