Initial developmental efforts are generally marked by inflationary tendencies in an economy. Inflation, if uncontrolled, may thwart all development plans and bring misery to the poor. A reasonable degree of price stability should be the primary concern of a government’s economic policies. The overall level of economic activity in an economy depends upon aggregate demand, relative to capacity output.
At times, the level of aggregate demand may be insufficient to secure full employment of labour and other factors of production. At other times, aggregate demand may exceed available output at full employment level. Government intervention in both the cases becomes essential to correct such disequilibria in the economy.
The evaluation of our existing tax system with reference to the foregoing objectives is a difficult task because various other policies (like public expenditure policy) may be geared to achieve the same objectives. To what extent the redistributive objective has been served and the extent to which tax policy plays a relative role are difficult questions to answer. Moreover, the various objectives of tax policy may not always work harmoniously. Rather, they are often in conflict with each other if not mutually exclusive. Since the tax system of a country grows out of the interaction between political judgement and economic rationale, the process of compromises and tradeoffs is influenced by political expediency and economic logic, the former, in most cases, having the upper hand. In fact, political requirements and economic thinking change with time, giving new directions to tax policy. As Richard Bird has observed, “Tax reform is, therefore, a never-ending process, not something that can be brought about once and for all and then forgotten.”
Bridging tax gap
A country’s tax gap is measured by the amount of tax that remains uncollected due to non-compliance with tax laws. ‘Pakistan Tax Gaps: Estimates by Tax Calculation and Methodology’ (http://aysps.gsu.edu/isp/files/ispwp0811(1).pdf), a joint study of Federal Board of Revenue (FBR), Andrew Young School of Policy Studies at Georgia State University and World Bank, provides in detail, tax gaps by type of tax and describes the methodologies and data used for such estimates. The report released in December 2008 under the name of Rubina Ather Ahmad (FBR) and Mark Rider (Andrew School) warns that views expressed “are of the authors and not of the Government of Pakistan.” It is shocking that FBR on the dictates of World Bank initiated this study and when final report was released it disassociated itself-this is typical of our government – always non-committal and hesitant to take any responsibility. After disowning this report, in 2013, FBR is still struggling to bridge the large tax gaps which are the direct result of its persistent inefficiency, incompetence and rampant corruption.
For fiscal year 2004-2005, according to this report, Pakistan’s federal tax gap was Rs 409.5 billion or approximately 69% of actual tax receipts of Rs 590.4 billion. Terming this as “conservative estimate”, the report claims direct tax gap at Rs 262.8 billion (around 143% of actual collection of Rs 183.1 billion) and indirect tax gap at 146.7 billion (36% of actual tax collection of Rs 407 billion). In 2008, the data selected was for fiscal year 2004-2005 and tax gap was estimated at 45%. Since then tax gap has increased significantly and it can safely be concluded that it is not less that 70% of actual tax collection. This report and many others do not take into account the real tax potential of Pakistan and therefore estimates of tax gaps are under-assessed.
The real tax potential of Pakistan, by a very conservative estimate, is Rs 8000 billion. However, the target for the current fiscal year at the time of budget announcement was fixed at Rs 2381 billion and it is now reduced just to Rs 2018 billion. However, FBR is finding it difficult to even meet the three-time revised budget.
Who is responsible for the prevailing pathetic state of affairs? Our debt burden is increasing monstrously, fiscal deficit is getting beyond control, inflation is crushing the poor, taxes are being evaded and avoided by the rich and whatsoever little is collected, is mercilessly wasted by those who matter in the land. Domestic debt and liabilities continue to witness a rising trend and reached a new high of nearly Rs 9 trillion as on May 30, 2013 due to a widening budget deficit and fall in tax receipts, according to the latest statistics issued by the State Bank of Pakistan. The State Bank in its report stated that financing of fiscal deficit through domestic channels has raised concerns regarding debt sustainability of the economy. A heavy reliance on expensive short-term debt has increased the debt servicing burden of the country. Pakistan has been reeling under a revenue deficit for the past six years, implying that a larger part of public borrowings, which financed the government’s current expenditures, did not add to the repayment capacity of the economy.
In view of the size and magnitude of public debt, a high fiscal deficit is inevitable – our total debt and liabilities have increased to Rs 15.1 trillion, or 68.4%, of GDP, while debt alone stood at Rs 14.4 trillion, or 65.3% of GDP. Fiscal deficit reached 8.5% of GDP in 2011-12, against the original budget target of 4%, reflecting both revenue and expenditure slippages, including higher subsidies mainly to clear arrears in the power sector – the situation is worsening in the current fiscal year as FBR has miserably failed to collect even Rs 2000 billion.
It is a great tragedy that while country is caught in debt trap, the rich and the mighty are not only refusing to pay due taxes, but are also living an emperor-like life at the taxpayers’ expense and on borrowed funds. They are the de facto beneficiaries of the state’s resources – generated mainly by the landless tillers, industrial workers, professionals and white-collared employees.
Pakistan is not a poor country – the State’s kitty is empty because of the unwillingness of the rich to pay taxes, colossal wastage of taxpayers’ money on unproductive expenses and non-exploitation of vital natural resources. Absentee landlords (they include mighty generals who have been allotted State lands under one pretext or the other during the last many decades) have been resisting proper personal taxation on their enormous income and wealth. In the wake of floods, the President promulgated an Ordinance on March 15, 2011 to levy 15% surcharge on existing taxpayers and enhance indirect taxes on poor growers and common man instead of taxing the rich. An unholy anti-people alliance of the trio of indomitable civil-military complex, corrupt and inefficient politicians and greedy businessmen – controlling and enjoying at least 90% of the state resources – contribute lower than 3% towards the national revenue collection. This tax gap has not at all been discussed in ‘Pakistan Tax Gaps: Estimates by Tax Calculation and Methodology’, a study which is nothing but an eye wash.
The gigantic and useless government apparatus – doing nothing for public welfare – is also busy wasting whatever taxes are collected. The army of ministers, state ministers, advisers, consultants, high-ranking government servants (sic) is not willing to cut down their perquisites and privileges. They are not ready to live like the common man by surrendering unprecedented perks and privileges they are enjoying at the cost of taxpayers’ money. For their luxurious life they are burdening the poor, property-less masses with more and more taxes. Time and again we have made a case for monetizing all perks and perquisites and right-sizing of government departments and corporations, but civil-military complex and their cronies in politics are not ready for such reforms.
The existing exploitative, rotten, regressive, ill-directed and unfair tax system is widening the existing gulf between the rich and the poor – leading to gang wars, crimes, commotions and break down of the entire society. The sole emphasis on regressive indirect taxes [even under the garb of income taxation through presumptive and minimum tax regimes on goods and services] without evaluating their impact on the economy and lives of the poor masses and lack of political will to tax the rich and mighty, is the real dilemma of our state – not scarcity of resources or narrow tax base (nearly sixty million active mobile users are paying exorbitant sales tax at 19.5% and 10% income tax). Equity demands higher taxes from those who have higher income and wealth, but in Pakistan since 1991 all tax policies have been aimed at decreasing tax burden on the rich but increasing its incidence on the poor.
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 2012 was less than Rs 2 billion (share of agriculture in GDP in 2012 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 2012 alone was more than Rs 412 billion as admitted by the government in Economic Surveys of Pakistan]. Despite, this so-called tax incentive, market crashed many a times and billions of rupees of the small investors were 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 2011-12, 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.
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 date, 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.
In the last three years alone, revenue loss on account of taxing income from property at reduced rate is estimated at Rs 480 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.
The Pakistani State 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.
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 towards 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.
Independent tax judicial system
Present 4-tier tax justice system should be reformed and there should be an independent National Tax Court [for details read ‘Need for National Tax Court’, Business Recorder, May 6-7, 2011]. There cannot be two opinions that an efficient tax judiciary ensures that demands arising out of legitimate tax assessments, which can stand scrutiny of law, are not unnecessarily locked up in litigation. As long as there is pending litigation in relation to a particular tax levy, there is a natural, and quite understandable, desire on the part of the taxpayer not to pay the pending disputed amount. An efficient tax judiciary resolves disputes quickly, quashes demands which are not legally sustainable, and thus segregates serious tax demands from frivolous tax demands, while also giving finality to legitimate tax demands. This in turn ensures that the taxpayer cannot resort to dilatory tactics for paying these genuine and legitimate tax demands which have received judicial approval. An efficient tax judiciary thus helps removing impediments from collection of tax demands by the State, which, once again, results in greater resource mobilisation.
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 2011-12, 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.
People’s aspirations and demands
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 exempted 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 and those working in state-owned corporations and force 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?
New vision for Pakistan
Based on above facts and figures, revenue target for the next fiscal year (2013-14) 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 quagmire of “debt prison”.
One hopes that in the new budget under the new regime, mindless changes in tax codes and procedures will be avoided as these cannot improve tax collection. These only give more leverage to tax administration and open new vistas of corruption for the unscrupulous. The real weakness of tax system is due to FBR’s incompetence and inefficiency, poor enforcement and rampant corruption. It is obvious that tax evasion is not possible without the connivance of tax collectors or due to their incompetence and apathy.
The new government must remember that amending of tax codes each year through Finance Bill and in between, by way of statutory regulation orders (SROs) is not going to serve any useful purpose-this is not a solution but part of problem. The solution lies in converting FBR into an autonomous body run by an independent Board of Directors comprising the professionals and answerable directly to the Parliament and not the headquarters of the ruling party. FBR must be insulated from all kinds of political influences. Enforcement of tax laws without any fear or favour should be the first and top most priority of the new government if it wants to bring the country out of the present economic mess. It should couple with expending taxes for the benefit of masses and stop wasting funds on white elephants-monstrous public sector enterprises sleaze with inefficiency and corruption-so that public can see that the elected government is a responsible one and cares for them. This will promote tax culture and restore the faith of people in tax system. Voluntary tax compliance can be improved only through a strong deterrent system where the compliant taxpayers are respected and rewarded, and the evaders are exposed and punished under the law.
(The writers, tax lawyers and partners in HUZAIMA & IKRAM (Taxand Pakistan), are Adjunct Faculty at Lahore University of Management Sciences)Huzaima Bukhari and Dr. Ikramul Haq, "Tax proposals – II," Business recorder. 2013-06-02.
Keywords: Economic system , Economic policy , Economic crisis , tax system , Tax policy , Taxation , Taxes , Inflation , Pakistan