Malice Towards None & All: A Distorted Tax Base & An Extractive State

Pakistan's tax system is designed to rely on regressive taxation, continuing to take progressively larger percentages of earnings from low-income families while sparing the ultra-rich. The elite not only avoid tax obligations, but the State provides them ...

Malice Towards None & All: A Distorted Tax Base & An Extractive State

Pakistan, being a chronically resource-constrained country with a tax-to-GDP ratio that is pathetic even in comparison with similarly placed countries, should be focusing on improving its revenue performance by adopting tailor-made policies, rather than following donor-driven strategies that may have worked in entirely different environments or making efforts to appease the powerful lobbies who are not themselves paying their due taxes.” - Former Member Inland Revenue (Policy), Federal Board of Revenue (FBR), in Broadening the tax net-II: A solution to taxation woes?

Tax offices and tax officers, in the wider world, are fast becoming faceless and nameless. But in this day and age, we are still caught in the legacy of decadent tax structures, procedures and methods. The rest of the world is not much different from us, and so, if we make policy choices which are totally divergent from the rest of the world, our growth, development and financial independence will remain a distant dream only. Dr. Hamid Ateeq Sarwar, Career Civil Servant & Public Policy Practitioner, in Anatomy of Pakistan’s tax system.

Fiscal consolidation should be as growth-friendly as possible. In general, tax base-broadening reforms are identified as growth-oriented reforms. To the extent that they reduce distortions in economic decisions on work, saving, investment and consumption, they should increase output and improve social welfareChoosing a Broad Base–Low Rate Approach to Taxation, OECD Tax Policy Studies No. 19, 2010 

Two outstanding and experienced tax officials (one retired and other serving), both of whom performed duties as Member of Inland Revenue (Policy), FBR, in their recent articles (cited above), have raised many important and fundamental questions related to tax policy and tax administration in Pakistan. They have suggested solutions as well to remedy the persistent maladies faced by the apex revenue authority.

Dr. Iqbal, in his two-part series, published in a local English daily, mainly opposed the narrative that mass (indiscriminate) registration could solve the problem of optimizing tax collection. He pleaded that tax avoidance by multinationals (through abusive transfer pricing etc.), underreporting of incomes by the rich and amnesties extended to untaxed assets stashed abroad are critical areas. According to him, due to faulty tax policy, false or manipulated narratives by vested interests and imprudent prescriptions of foreign lenders and donors, amongst other factors, FBR has failed to improve its performance in tapping the real tax potential.

In support of his “narrative”, Dr. Iqbal quoted a policy brief [Why Mass Tax Registration Campaigns do not work, No. 2, July 2023] by the International Center for Tax & Development (ICTD). On the basis of his experience and this study, his conclusion is that “the findings of the report are probably applicable more in case of Pakistan than any other developing country. We have witnessed many such campaigns and their spectacular failure, since at least the 1990s, but the narrative in support of such maneuvers gets stronger and stronger due to its vigorous peddling by the interested parties and the absence of empirical studies to evaluate the results of each successive campaign in terms of revenue dividends.” 

Dr. Hamid, in his well-written and convincingly-argued piece has aptly pointed out, “In the form, our tax system has all the fancy attributes of modern taxation, like e-filling, audits, value chain taxation, recovery methods, etc, but in essence, it remains devoid of horizontal equity, clarity, low deadweight loss, and ease of compliance.”

While correctly diagnosing the main ailments inflicting our tax system, especially after the imposition of presumptive and minimum tax regimes in 1990s, Dr. Hamid summed up brilliantly: “Our tax system, on the other hand, largely remains a state extraction mechanism with large efficiency losses, narrow and shallow base, high degree of horizontal inequity and minimal compliance. Most of the taxes are collected by the mediaeval gate-keeping tax collection method, which collects taxes as the transaction passes through an entry/exit point.” The following extract from his article is an eye-opener for our policymakers and those who matter in the Land of Pure:

“It appears that maximum incentive for tax evasion stems from horizontal inequity, where fear of being thrown out of the market compels businesses to understate their revenues. This sort of system re-enforces non-compliance by itself. This divergence from the principles of modern taxation started in the early 1990s and since then we have been reverting to even cruder methods of tax collection, which the world last resorted to in the 18th and 19th centuries (albeit in a physical form, as opposed to the virtual and remote methods available now). There is change in form, not substance. If we look at our income tax, it has major policy gaps in taxation of gains of real estate, agricultural profits, business incomes of so-called, non-profit organizations, and various area/sector exemptions.”

It is not taxing the people according to their ability to pay, but relying mainly on indirect taxes that are regressive, as these take a much larger percentage of earnings from low-income families than from high-income earners.

The contributions by Dr. Iqbal and Dr. Hamid have raised some important points and need further research, inquiry, consideration and critique. Hopefully, the researchers in various universities will be guided by tax gurus in their institutions to examine their work and write research papers for further debate. These articles and available published work can be good starting points for further research in the recently-introduced ‘International Centre of Tax Excellence’ vide section 230J, inserted in the Income Tax Ordinance, 2001 by the Finance Act, 2023, which has yet not started functioning for lack of prescribed rules. Many believe that it is yet another bureaucratic move to grab more high-ranking posts in the centre as “at least fifty per cent of the employees shall be serving Inland Revenue officers having at least 5 years of experience of tax policy or tax administration” [section 230J(9)].  

Unfortunately, policymakers sitting in the Ministry of Finance (MoF) and top tax administrators in FBR always make a totally fallacious assertion that “less than two percent of the population of the country pays income tax.” It is shocking that even the top brass of FBR does not know the difference between a “taxpayer” and “return filer.” They remain keen on retaining a higher rate of taxes, both under income tax and sales tax laws, on a narrowed, distorted tax base, rather than imposing lower taxes on broader base.

It is aptly highlighted in Choosing a Broad Base–Low Rate Approach to Taxation [OECD, Tax Policy Studies No. 19 of 2010] that fiscal consolidation should be as growth-friendly as possible. The tax base-broadening strategy in Pakistan has never been perceived or discussed as “growth-oriented reform” by official quarters and lenders and donors. It is highlighted in Tax Reforms in Pakistan: Historic & Critical View, PIDE Reform Agenda for Accelerated and Sustained Growth and Towards Flat, Low-rate, Broad and Predictable Taxes that tax reforms should increase output, improve social welfare and must be aimed at reducing distortions in economic decisions on work, saving, investment and consumption.

The prevailing tax system is unjust, outmoded and unproductive with high taxes, yielding low revenues made worse by complex, time-consuming and costly operational procedure. It is not taxing the people according to their ability to pay, but relying mainly on indirect taxes that are regressive, as these take a much larger percentage of earnings from low-income families than from high-income earners.

Our policymakers remain keen on retaining a higher rate of taxes, both under income tax and sales tax laws, on a narrowed, distorted tax base, rather than imposing lower taxes on broader base.

Let us try to determine a rational income tax base. According to the 2023 official population census, our population is 241,499,431. The dependent population of children under the age of 15 years as on June 30, 2022 was 35%, while 4% people were above 65 years. Out of the total population, 70 million were below the poverty line, earning less than two dollars a day. Our employed labor force is around 65 million – a majority of it based in rural areas [42%] that earned below taxable income or agricultural income falling outside the ambit of Income Tax Ordinance, 2001. Analyzing all the above figures (juxtaposed), individuals liable to income tax and eligible to file returns for tax year 2022 could not have been more than 20 million. However, 120 million unique mobile users, since total subscribers as on June 30, 2023 were 191 million, paid 15% advance and adjustable income tax, though return filers remain 4.3 million. It means that all adults in Pakistan who have biometrically verified mobile connections were paying income tax, whether they earn taxable income or not! If all of them file returns, not less than 100 million will be entitled to refunds. Hopefully, Dr. Iqbal and Dr. Hamid will discuss this aspect of the tax base in their future works.     

Failure to harness the actual tax potential of this country is our real dilemma. The existing tax structure is not only detrimental for economic growth, but is also not yielding required revenues for running the business of the State. The country’s economic managers have failed to realize that excessive taxation on savings does not increase government revenues. Once income has been taxed, then savings and transactions should not be taxed. Is there any country in the world where banking transactions and withdrawal of cash are being taxed like it is done in Pakistan?

Sparing the ultra-rich who are deliberately avoiding tax obligations, and offering them unprecedented amnesties and asset-whitening schemes, while taxing millions having incomes below taxable limit is a gross violation of Article 3, 4 and 25 of the Constitution.

Lenders and donors, ranging from the IMF, ADB, World Bank to the DFID, never mention the oppressive side of our tax system and non-availability of public services. They are fond of discussing the “low tax-to-GDP ratio” in isolation. Successive governments have been taxing the poor and giving extraordinary benefits to the rich. The abuse of taxpayers’ money for personal comforts and luxuries of the ruling elite is our main malady.

The government’s yearning for “more and more taxes” has become a source of irritation for citizens who argue that they get nothing in return and their economic plight is worsening every day. Irrational and oppressive taxes have failed to solve any problem—debts, both internal and external, are rising and runaway high inflation is crushing the poor. We need all-out reforms and complete overhauling of the system. Voicing this concern, Nadeem Ul Haque, Vice-Chancellor of PIDE, in Reform or face fundamental ascendency, emphasized that “the State must first provide the social contract i.e. good law and order and security of life. It must dismantle the rent seeking that protects the rich. Rent seeking relies on three main components: state subsidies, licensing and regulation; special perks and privileges for ministers, the army and civil service employees and a land distribution system that allows the poor man’s land to be acquired for the elite, especially the army and civil service.”

Elites and the rich are not sharing the burden of taxes due from them—the rich and mighty are not paying taxes according to their ability. From tax year 2013 to 2023, less than 40,000 paid income tax between Rs. 1 million and Rs. 10 million, and less than 5,000 declared tax over Rs 10 million.

Sparing the ultra-rich who are deliberately avoiding tax obligations, and offering them unprecedented amnesties and asset-whitening schemes, while taxing millions having incomes below taxable limit is a gross violation of Article 3, 4 and 25 of the Constitution. Why should poor people having incomes much below the taxable limit but paying 15% advance income tax as mobile users, hire a tax adviser to file return and pay money to get refund? In any case the cost will be much higher than the refundable amount, and that too is never paid by FBR!

FBR has failed to tax those who have amassed mammoth wealth, allowing some to avail generous amnesties. Had they been taxed at normal tax rates, collection could have reached Rs. 16 trillion. This target is still achievable, provided that collection is fully automated, the tax machinery is overhauled, leakages are plugged and all exemptions, concessions and waivers to the privileged classes are withdrawn. Banks, WAPDA, PTCL and mobile companies that collect advance taxes on behalf of FBR are fully computerized. By using their database, the FBR can easily determine a fair tax base and tax due from the ultra-rich, which they are avoiding or evading. Provisional assessments and recoveries can be made in respect of persons with substantial incomes and in some cases paying higher advance tax as non-filers.

The writer, Advocate Supreme Court, is Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE)