“Taxes are critically important, but there’s no reason to assume the government must raise taxes whenever it wants to invest in our economy.”—Stephanie Kelton in The Deficit Myth
On the eve of yet another ritual exercise of announcing federal budget for fiscal year 2024-25, expected on June 7, 2024, there is a need to re-evaluate Pakistan's tax policy and system. Tax revenue may change through automatic response of the tax yield to changes in national income or through the imposition of new taxes, revision of the bases or the rates of the existing taxes, tax amnesties, stricter tax compliance and other administrative measures backed by legal action.
Changes in the tax yield resulting from modifying tax parameters (bases, rates etc.) are called discretionary changes. Variations in the tax yield flowing from the combined effects of automatic responses as well as discretionary changes constitute the buoyancy of a tax. It is computed by dividing percentage change in tax yield by percentage change in national income. The Pakistani experience in this regard has been very disappointing as admitted even in government publications, in almost every Economic Survey, issued for fiscal year 2015-16 to 2022-23, in the following manner:
“Although successive governments have made attempts to narrow the revenue-expenditure gap by taking new fiscal measures in the federal budgets, little improvement has taken place in the overall fiscal deficit. Why is it so? Pakistan tax system is still characterized by a narrow and punctured tax base, over reliance on import-related taxes, high taxes on the one hand and tax concessions and exemptions on the other, and weak tax administration. The combined effect of these structural weaknesses resulted in low and stagnant tax-to-GDP ratio on the one hand, and tax elasticity and buoyancy on the other. Such a tax system has severely hampered resource mobilization efforts in the past despite a series of discretionary measures taken in almost every federal budget to reduce the widening gap between revenue and expenditure.”
Buoyancy estimates assess the overall success of government measures to increase tax revenues while elasticity coefficients indicate the inherent responsiveness of a tax system to changes in national income. In the absence or weakness of elasticity attribute of the tax system, a government will have to revise tax rates and tax bases every year to keep the share of tax revenue in national income undiminished.
Such frequent changes, as done in Pakistan, complicate tax laws, reduce administrative efficiency and are also politically inexpedient. This is what happened in Pakistan since 1977. It is high time that we must go for a paradigm shift in our tax policy and overhaul tax system to avoid these kinds of negative effects. Therefore, the tax structure should be redesigned so as to impart a reasonable degree of elasticity to the tax system.
It is necessary to use the forthcoming budget as a tool for change and not as guardian of status quo. In taxes, we need to bring some fundamental structural and operational changes. Mere amendments here and there will serve no useful purpose.
Taxation is a potent instrument to shape and influence the socioeconomic polices of a country. It is therefore imperative for us to formulate a nationally acceptable tax policy keeping in view our own peculiar conditions. Our tax policy must take into account the present stage of our economic development, the objectives of economic policy, and that the priorities of economic policy continually change with the changing economic, social, and political milieu.
It is necessary to use the forthcoming budget as a tool for change and not as guardian of status quo. In taxes, we need to bring some fundamental structural and operational changes. Mere amendments here and there will serve no useful purpose. The first and foremost objective must be to raise resources for public authorities for administration and development. Taxes are the main instrument for transferring resources from private to public use. By designing an appropriate tax structure, resources can be raised from those who are holding them idly or squandering them on luxury consumption.
According to Roy Tyrone Gobin [1947-2022], who after acquiring his PhD at the University of Illinois in 1978 with a dissertation on tax policy in Caribbean markets was employed as a professor at Loyola University in Chicago, “The revenue criterion is usually the dominant consideration, since governments in developing countries have become increasingly aware of the active role which budgetary measures can play not only in initiating and promoting growth but also in maintaining political power. Not only are higher revenue levels needed, but also tax yields should be increased at a faster rate than income, if infrastructural investments and social welfare expenditures are to be financed without generating unacceptable inflationary pressures or increasing reliance on foreign assistance.”
The revenue performance is in fact the best and optimal use of resources. Since the composition of investment is an important determinant of growth rate of the economy, public policy must discourage the flow of resources to low priority areas so that they could be diverted to vital sectors of the economy.
Distributive Justice
Distributive justice or economic justice is an important function of tax policy. Economic justice relates largely to distribution of tax burden and benefits of public expenditure. It is a component of the broader concept of social justice, which encompasses, besides distributive justice, such questions as treatment of women and children, and racial and religious tolerance in a society. Tax policy is a democratic method to influence the distribution of income and wealth on desired lines.
In the absence or weakness of elasticity attribute of the tax system, a government will have to revise tax rates and tax bases every year to keep the share of tax revenue in national income undiminished. Such frequent changes, as done in Pakistan, complicate tax laws, reduce administrative efficiency and are also politically inexpedient.
The main ingredients of this policy can be (a) progressive direct taxation of income, wealth, and property transactions, (b) taxation of commodities (customs duty, excise levy, and sales tax) purchased largely by high-income groups, and (c) subsidies (negative taxation) on goods purchased by low-income groups. In Pakistan we have been moving unabatedly from progressive taxation to regressive taxation since July 5, 1977, on the dictates of foreign lenders and donors, and largely due to the vested interests of militro-judicial civil complex. This dangerous trend has resulted in civil strives, vast income and wealth inequalities and hostile polarisation in society.
The primary function of a tax system is to raise revenue for the government for its public expenditure as well as for local authorities and similar public bodies. So the first goal in development strategy as regards taxation policy is to ensure that this function is discharged effectively. The performance of the Pakistani tax managers on this account is shockingly disappointing as fiscal deficit, coupled with unsustainable servicing, has assumed dangerous proportions since 2008 and the revenue targets fixed annually were revised downwards many a times and even then the same could not be achieved!
The second equally important function is: to reduce inequalities through a policy of redistribution of income and wealth. Higher rates of income taxes, capital transfer taxes and wealth taxes are some means adopted for achieving these ends, but all these are missing in our tax policy.
It is a curious paradox of our situation that while money for worthwhile industrial and business growth and public benefits is scarce, there is colossal unaccounted cash supply circulating in the economy in search of further undercover gains.
In Pakistan there has been a gradual shift from equitable taxes to highly inequitable taxes after resorting to presumptive taxation in 1991-92 that was later made largely minimal in 2019 in utter violation of the 1973 Constitution and dictum laid down by the Supreme Court of Pakistan in Elahi Cotton Mills Ltd. and others v Federation of Pakistan through Secretary Finance, Islamabad [(1997) 76 TAX 5 (S.C.Pak)]. The shift from removing inequalities through taxes to presumptive, minimum and easily collectable taxes through withholding mechanism, especially at the import stage, has destroyed the entire philosophy of taxation. This deviation has effectively transferred the burden of taxes from the rich to the poor.
Stabilisation
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.
The unholy alliance between tax evaders, their advisers and corrupt tax officials has to be eliminated as a first and foremost step if we want to initiate any meaningful change in the tax system.
Since the tax system of a country grows out of the interaction between political judgment and economic rationale, the process of compromises and trade-offs 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 (a Canadian taxation giant), has observed, “Tax reform is, therefore, a never-ending process, not something that can be brought about once and for all and then forgotten”.
Countering Tax Evasion
It is a curious paradox of our situation that while money for worthwhile industrial and business growth and public benefits is scarce, there is colossal unaccounted cash supply circulating in the economy in search of further undercover gains. What is more tragic is that this social evil inherent in the tax system gets doubly compounded as it necessitates greater and greater tax burden on those who are law-abiding.
The most crucial problem faced by the country in the course of the fiscal reform program is that of devising astute and stringent measures to curb tax evasion so that we can distribute the burden of taxes fairly and justly between different persons in the same or similar walks of life. Honest taxpayers have to be safeguarded, as day by day they are being disillusioned by the fact that mighty tax evaders are not paying anything with the connivance of their friends and mentors in the tax machinery. The unholy alliance between tax evaders, their advisers and corrupt tax officials has to be eliminated as a first and foremost step if we want to initiate any meaningful change in the tax system.
Pakistan must have ‘Compulsory Public Disclosure of Taxes/Assets Law’ requiring the following to make their tax payments, assets and liabilities public: high ranking civil and military officials, all Senators, MNAs and MPAs, all Judges of the superior courts, any person who has availed loans exceeding Rs. 50 million from any financial institution, professionals like lawyers, doctors, chartered accountants, engineers, journalists, consultants etc.
The above privileged classes of society would act as an example for others. Their declarations would inspire common people to pay their taxes honestly. The State needs to wage an all-out war against burgeoning informal economy, money power and corrupt politico-administrative structures. This war must start from the privileged and wealthy classes as suggested above. The people of Pakistan have a right to know how these mighty sections of society amassed immense wealth without paying taxes. All public office holders who availed any tax amnesty of immunity, personally or through any proxy, should be proceeded with criminal charges as this is a confession that they were in possession of unexplained assets. The National Accountability Bureau Ordinance, 1999, effective from January 1, 1985, should be invoked in all such cases to punish the delinquents and bar them from holding any public office in the future.