Rethinking Pakistan's Tax Policy

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The salaried class and small and medium enterprises are disproportionately burdened, as evidenced by the exorbitant tax rates in the Finance Act 2024. Some individuals may now work six or seven months just to cover their tax obligations.

2024-10-14T11:11:00+05:00 Furqan Ali

“There’s nothing like the sight of an amputated spirit.” 

--said Lt. Col. Frank Slade (played by Al Pacino) in the movie titled Scent of a Woman (1992)

Likewise, Pakistan’s taxation landscape has remained a hurriedly mutilated superstructure caused by bad policy-making; which in turn is caused by, inter-alia, perennial weak fiscal architecture, shallow policy orchestrations, lethargic post-colonial administration, extractive dispensations, and deepening of the elitist pockets. This then culminates in the failure of public value for all especially the working class and those at the social peripheries.

Historically, the legitimacy of the imposition of taxation has been the bedrock of the power matrix. The Mughals cemented extensive revenue collection, funding public value creation in addition to exorbitant luxuries for the ruling class. This legitimacy was later confiscated by the British Raj, replacing the Mughal taxation system in the Eastern Province and eventually the entire apparatus. In other words, the revenue mobilisation apparatus of a country is squarely correlated to her sovereignty and vice versa.

Our purpose today is to evaluate the current tax structure against the generally accepted principles of a good tax system and the policy reforms that could alleviate the pauper's burden while leading to an improved revenue mobilisation mechanism and sustainable economic growth.

The general principles, which are non-mutually exclusive and may overlap, as per the Organisation for Economic Co-operation and Development (OECD, are: Efficiency, Certainty and Simplicity, Effectiveness and Fairness, and Neutrality.

Efficiency” in the tax system necessitates minimal cost for tax collection and filing for the taxpayer as well as the tax authorities. The taxation legislation is in itself nothing less than labyrinthine in its own right. From multiple tax regimes like Normal, Final, Minimum, and Fixed Tax Regimes in Income Tax and GST to further, extra, reduced rate and whatnot in Sales Tax, to incessant use of exemptions, tax credits, and frequently changing Statutory Regulatory Orders (SROs); it is virtually impossible for a mortal to file his/her return without being well-versed in the legal cosmos of the taxation system.

The World Bank's Ease of Doing Business Report (2021) ranked Pakistan at 108th position, whereas India was 62nd. Moreover, the World Bank in its recent report titled “Business Ready” placed Pakistan in the fourth quintile, which indicates  a challenging business environment characterised by relatively weak regulatory frameworks and public services, constraining the operational efficiency of businesses. This signifies how less conducive our government’s policy is towards business entrepreneurs vis-à-vis our neighbouring counterpart and the world. 

It is further estimated that it takes 594 hours to comply with provisions of tax law (withholding tax compliance time is not included) in Pakistan, while in India, it takes only 243 hours. This highlights how complicated it is for businesses and entrepreneurs to compete globally, as most of their resources are wasted just to comply with the legal framework in Pakistan, a stark contrast to the government’s “ease of doing business” mantra. 

Coming to the taxman’s side, according to an estimate by the Tax Reform Commission (TRC), field offices collect merely 5% of the total tax revenue. Simply put, if the FBR were closed today, the Ministry of Finance and Revenue Affairs would still be able to raise 95% of current tax revenues. Second, the administrative costs, overheads, and salary expenses of certain field offices (especially those located in smaller cities) far exceed the amount they collect; and rubbing salt to the wounds, it is estimated that the FBR employees' salary expenses are more than double those of other government officials.

The World Bank in its recent report titled “Business Ready” placed Pakistan in the fourth quintile, which indicates a challenging business environment characterised by relatively weak regulatory frameworks and public services, constraining the operational efficiency of businesses.

Certainty and Simplicity” are crucial for a robust taxation system. It is essential for taxpayers to easily understand the tax regime and rely on its persistence to streamline decision-making. Simplicity would also ensure minimal compliance costs. The excessive withholding provisions, estimated at around 60 (while collection stands at around 68% of the revenue collected via this regime), indicate that instead of taxing a taxpayer’s income, a presumptive approach of taxing the transaction itself at the point of occurrence has been adopted. In other words, tax collection is advanced by extracting revenue at each step of the transaction.

Interestingly, the Withholding Tax regime, like many other prevailing maladies, is a colonial legacy. Initially, it was exploited solely to capture income from salaries, interest on securities, dividends, and super-tax on bonus shares. However, its implementation expanded notably post-90s, following diminished US interest in Pakistan after the ousting of the Soviet Union. To address revenue challenges, the state adopted this egregious methodology to address the challenges of meager revenue conflation.

A study calibrates Pakistan’s tax collection cost to be 0.73%, compared to the world average of 2.5%. Ex-facie, this looks good, but when we factor in the costs incurred by businesses due to the delegation of duty, Pakistan’s national tax collection cost gallops to 3.5-4%—probably the highest in the world. The delta being spent by Pakistani entrepreneurs, between 1.5-2%, represents the national dead-weight loss. Moreso, arbitrary amendments via Finance Acts and SROs (without supervision of the legislators) have somewhat opened floodgates for discretionary exemptions and credits. Given the hyper-intricate structure, as mentioned above, the taxpayer is most often unclear about his/her legal obligations, thus negatively affecting collection and increasing compliance challenges.

Effectiveness and Fairness”: It appears that paying taxes is reserved for the urban lower-middle class, who fund the lavish lifestyles of the elite. For instance, as per MLDA's reporting, there is a potential of around Rs4 trillion in the retail, agriculture, and real estate sectors enjoying amnesties. Only 114,000 firms out of the over 3.5 million commercial and industrial firms are registered and paying GST. Moreover, according to the Tax Justice Network (TJN) report from 2019, large corporations avoid taxes through profit shifting and transfer pricing, amounting to $10 billion. In contrast, the salaried class and Small and Medium Enterprises (SMEs) are disproportionately burdened, as evidenced by the exorbitant tax rates in the Finance Act 2024. Some individuals may now work six or seven months just to cover their tax obligations.

The cardinal principles of a just, fair, transparent, and equitable tax system lie in the principle of tax “neutrality”: the very base of taxation should be applied uniformly to all businesses and consumers engaged in similar transactions in a particular geographical area (such as a state, province, or county). For instance, amnesty schemes add to the problem. In 2018, 135 individuals named in the OECD database availed PML-N's tax amnesty, declaring Rs62.4 billion in assets and paying only Rs2.9 billion, while their actual liabilities were Rs43.7 billion—receiving a Rs40.8 billion relief. Similarly, 56 people availed PTI's scheme, declaring Rs31.8 billion in assets, paying just Rs1.7 billion, and receiving a relief of Rs20.6 billion.

The lack of a “fair” playing field is obvious from the previous paragraphs: those affluent enough to hire shrewd accountants, or those belonging to ruling sectors like real estate or agriculture, have been able to exploit the whole system. This leads to a lack of trust among good taxpayers. Why should they be part of the undocumented economy? If in return, they are receiving paltry public service delivery and, even more, repression and oppression by the state?

The Federal Board of Revenue (FBR) needs reform, with redundant staff removed, and the remnants of colonial administration addressed. 

To undo our country’s revenue system’s  mutilated soul, we must align its tax policies with the universally accepted principles of good taxation. This means the decimation of withholding provisions and shifting from a presumptive regime taxing transactions to one that taxes income. Stability and laminar amendment, if required, in the legal framework and ward off from churning SROs. Structural reforms, such as aligning provincial agricultural income tax laws with federal tax frameworks as per the latest IMF programme, are crucial.

There is an urgent need to go after elites, improve public service delivery to foster taxpayer confidence, and streamline bureaucracy to remove inefficiencies. Rather than attempting Broadening of Tax Base (BTB) schemes in a frenzied manner like the Tajir Dost, a gradual, well-planned integration of the undocumented sector should be pursued. The Federal Board of Revenue (FBR) needs reform, with redundant staff removed, and the remnants of colonial administration addressed. Ultimately, Pakistan needs a fairer, more transparent, and simpler tax system that encourages compliance, fosters sustainable economic growth, and achieves fiscal sovereignty.

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