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Tax-to-GDP debates

“We have achieved the highest tax-to-GDP ratio and Pakistan’s economy has been stabilising due to prudent policies of my government”-Prime Minister Nawaz Sharif purportedly claimed during a meeting with Managing Director Christine Lagarde of the International Monetary Fund (IMF) in Washington on October 21, 2015. The above statement of Prime Minister is diametrically opposite of what is stated by the Auditor General of Pakistan in his latest report.

According to a report [Tax-to-GDP ratio reaches lowest level: AGP, Business Recorder, October 21, 2015], the Auditor General of Pakistan has made “astonishing disclosure that the tax-to GDP ratio of Federal Board of Revenue (FBR) reached its lowest level on the conclusion of the international donor’s funded Tax Administration Reform Project (TARP)”. The report further reveals that for fiscal year 2014-15, Pakistan was “one of those countries which have the lowest tax-to-GDP ratio in the world”. Tax-to-GDP ratio, the report says, did increase slightly in 2013-14 as compared to 2012-13 but a comparative analysis of the statistics regarding this ratio in the recent past shows “disappointing results”.

According to the report, “from 2009 to 2011 there was a steep fall and the ratio that declined to 8.52 % of GDP. There was some increase in 2011-12 up to 9.07% while in 2012-13 it again decreased to 8.13%.” The report says: “It is worth mentioning that FBR initiated TARP in 2005, one of the main objectives of which was to improve tax-to-GDP ratio. When the project ended in 2011, the tax-to-GDP ratio reached its lowest level in more than two decades”. The report by Auditor General of Pakistan reminds FBR that in 1998-99, tax-to-GDP ratio was 12.6 %, which was the highest in history and, at that time, there was no reforms agenda like TARP!

Auditor General of Pakistan in his report has mentioned that tax-to-GDP ratio is one of the primary indicators used to gauge the health of a country’s economy. Several possible reasons for a low tax-to-GDP ratio in Pakistan included narrow tax base, large undocumented informal sectors, small contributions in taxes from major sectors ie agriculture and services as compared to their share in GDP, low tax compliance, widespread exemptions, absence of efficient tax system, structural deficiencies in tax administration system and weak audit and enforcement functions of the FBR. Auditor General of Pakistan has suggested that if FBR wants to increase the tax-to-GDP ratio it must concentrate on broadening its tax base and ensuring enforcement and compliance of law. It is really strange that in the presence of this report, our Prime Minister, his Finance Minister and other “financial experts” were trying to convince the IMF that “all is well”.

We have already examined the failure of TRAP and other steps taken by FBR towards improving tax-to-GDP ratio in Political economy of tax reforms, Business Recorder, October 16, 2015. In this column we observed: The existing tax system is not taxing the rich 15 million and main collection is from indirect taxes. Resultantly, income and wealth distribution disparities are rapidly widening in the country leading to social and political unrests. In 2014, the number of tax returns filed was less than 900,000 while a decade back the number was above two million. Track record of FBR shows remote possibility of collecting even Rs 6 trillion-though the actual potential is not less than Rs 8.5 trillion-in the next three years to give enough fiscal space both to the Centre and the provinces to come out of the present economic mess, thus providing some relief to the poor as well as trade and industry. Under the given scenario, efforts are needed both at federal and provincial levels to enlarge the size of the pie by shifting to flat rate growth-oriented taxation-see details in Chapter 16 of Return to Prosperity by Arthur B. Laffer & Stephen Moore.

We unendingly face a question from our students at home and abroad, “Why is Pakistan among the lowest tax-to-GDP countries in the world?” Our Prime Minister Nawaz Sharif on assuming the power for the third time gave unprecedented tax waivers and concessions to the non-filers and tax evaders, but his amnesty schemes miserably failed as it only yielded Rs 1.3 billion! [‘Ruling elite letting down FBR’, Business Recorder, May 9, 2014]. In these columns we have been trying to explain a host of reasons for the poor tax collection, but people retort strongly by asking us “Do you know how rulers play havoc with the taxpayers’ money”? Their response makes us speechless as reality is too obvious and bitter. They insist on calculating cost to national exchequer in providing tax-free perks and perquisites to militro-judicial-civil-complex and public office holders in the form of palatial residences, army of servants, expensive cars, golf courses, rest houses etc. They call on first ending this colossal wastage of funds and money spent on fruitless foreign tours, state banquets etc and then debate the issue of low tax-to-GDP ratio-‘Incorrigible elite’, Business Recorder, September 12, 2014.

Debate over tax-to-GDP ratio in Pakistan is lopsided. It does not take into account the fact that the Pakistani nation is the most heavily taxed in the entire region and in return the citizens even do not get clean drinking water, education, health and what to speak of social protections such as pensions for all, out of taxes paid over the period of time. There is an overwhelming reliance on indirect taxation [even under the garb of direct income taxation through presumptive tax regime on a number of transactions] without evaluating its impact on the economy and life of the less privileged sections of society. In the face of declining income tax contribution (after excluding indirect ones levied under Income Tax Ordinance, 2001), our Finance Minister and FBR officials have been making tall claims about “impressive” (sic) increase in taxes before the IMF and elsewhere. The reality of this “impressive” performance has been exposed in our various columns, but the IMF and World Bank remain mum as they are a party to portraying all-good “projection saga”-FBR reforms-II, Business Recorder, August 3, 2015.

We have provided even a detailed roadmap for reforming the existing tax system and raising taxes to the level of Rs 12 trillion at federal and provincial levels-New Tax Model, Business Recorder, August 28, 2015. But as mentioned in a previous column, Political economy of tax reforms, Business Recorder, October 16, 2015, our stalwarts sitting in Ministry of Finance and FBR want “advice” and “assistance” from the IMF and World Bank though they miserably failed in the past to reform our tax system-Mir kya sada hein beemar howe jis key sabab, usi attar key londey sey dawa letey hein (What a simple soul is Mir; he seeks cure from the healer’s boy who is the cause of his ailment).

It is tragic that in a country where billions of rupees are made in speculative transactions in real estate and shares, tax-to-GDP ratio is pathetically low and the government is least bothered to tax undocumented economy and benami transactions. The mighty sections of society are engaged in these transactions and FBR being their handmaid has no intention to tax them. The definition of ‘business’ given in the Income Tax Ordinance, 2001 covers “adventure in the nature of trade” and yet our tax machinery is sitting idle causing enormous loss to the national exchequer by not bringing adventures in the nature of trade in real estate into tax ambit and giving undue tax exemption on gains arising on speculative transactions in shares and stocks.

Pakistan’s tax-to-GDP ratio can rise to 20% in one year if we bring 1.5 million ultra-rich into tax net, heavily tax speculative transactions in real estate (it will promote construction industry as prices of land will come down), tax all speculative deals at stock exchanges (it will induce genuine investment in companies), withdraw money whitening provisions like section 111(4) of Income Tax Ordinance, 2001, withdraw all tax-free perks and perquisites given to militro-judicial-civil complex and public office holders and confiscate untaxed assets.

Higher tax-to-GDP ratio in the industrialised countries is primarily due to the higher level of revenue from social security, payroll taxes, corporate taxes and taxes on domestic consumption while taxes collected from international trade and non-tax revenue are lower. In contrast, in Pakistan the major portion of revenue comes from indirect taxes, particularly taxes on international trade and domestic consumption, while direct taxes have a pathetic share. Pakistan’s GDP-tax-ratio is even below that of Sri Lanka and Thailand, which proves beyond any doubt the failure of fiscal managers and tax collectors. As regards solutions to overcome this situation, comprehensive proposals and strategy to implement the same are available in 10-part series titled, “Essential tax Reforms”, Business Recorder, April 11, 2014 to June 3, 2014.

(The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at the Lahore University of Management Sciences)

Copyright Business Recorder, 2015

Huzaima Bukhari And Dr. Ikramul Haq, "Tax-to-GDP debates," Business Recorder. 2015-10-30.
Keywords: Economics , Income Tax , Financial statements , Tax planning , Fiscal policy , International trade , Agriculture , Management , Pakistan , Washington , Sri Lanka , Thailand , TARP , GDP , IMF , AGP , FBR