Is Pakistan's Tax System Beyond Reform?

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Pakistan's fiscal crisis is a direct consequence of a fundamentally broken tax system, which overburdens the poor and salaried middle classes to grant exemptions to the wealthy and powerful.

2024-08-31T17:11:00+05:00 Dr. Ikramul Haq

My personal experience has shown that the business community genuinely wants to pay taxes but is often intimidated by the system…. A rough estimate suggests that there are 119 taxes in Punjab, 82 in Sindh, 54 in Khyber Pakhtunkhwa, and 12 in Balochistan. With such a multitude of taxes, how can we possibly encourage those outside the tax net to voluntarily come forward and join a system that appears burdensome?—The need for tax reforms, Kashif Anwar, President Lahore Chamber of Commerce, Business Recorder, August 25, 2024

There is a general consensus in Pakistan that the prevailing tax system is unjust, oppressive, extractive, outmoded and unproductive—with numerous high-rate taxes, yielding extremely low revenues, and operationally time-consuming, complex, cumbersome and costly. Even after making tall claims of “extraordinary improvements and initiatives” by successive governments, revenues are falling below the assigned targets and financial needs of state, the debt burden is rising beyond sustainability and the fiscal deficit is assuming alarming heights. In the fiscal year (FY) 2023-24, the ratio of tax-to- GDP was just 9.5 percent—one of the lowest in the world.

The perpetual failure of the Federal Board of Revenue (FBR) to meet assigned targets, even when revised downwards, is highly lamentable, as it is also after blocking refunds of billions of rupees and taking advances, not even due, of coming tax years. Despite calling the attention of the Auditor General of Pakistan towards this figure fudging, no action is taken till today to ascertain the factual position.

Dozens of high-rate taxes and non-tax levies, both at the federal and provincial level, yielded low revenues at the national level - a pitiful Rs. 13.27 trillion, against a total expenditure of Rs. 20.48 trillion. This is our real malady and dilemma. 

The successive governments, civilian and military alike, were least pushed to replace the outdated, oppressive and complex system and faulty tax policy with a simple, certain and low-rate. On the contrary, the worthy finance ministers of all the regimes were rather pressurizing the tax collectors to become more and more ruthless in meeting targets, regardless of its disastrous impact on economic growth and inflation.

The performance of the FBR in enforcing the law - section 114 of the Income Tax Ordinance, 2001 -  requiring all persons having taxable income to file income tax returns is pathetic! It is evident from the simple fact that about 120 million citizens paid advance adjustable income of 15% as mobile users—both prepaid and post-paid—during the fiscal year 2022-23, but the active individual taxpayers (who filed returns for tax year 2023) as per FBR’s website (the list is updated every Monday) was 3,680,813 as on August 26, 2024. Over sixty percent of these “filers,” showed nil income or below the taxable limit, just to avoid higher rate of withholding tax applicable to non-filers! The total number of return filers as per latest update on the active taxpayers list (ATL) by FBR was 5,418,226.  

According to the Pakistan Telecommunication Authority (PTA), the total cellular and broadband subscribers as on June 30, 2024 were 193 million (79.44% mobile density), 135 million mobile broadband subscribers (55.61% mobile broadband penetration), 3 million fixed telephone subscribers  (1.06 teledensity) and 138 million broadband subscribers (57.05% broadband penetration).

The figures for July 31, 2024 are: total cellular/broadband subscribers were 193 million (79.46% mobile density), there were 136 million mobile broadband subscribers (56.15% mobile broadband penetration), 3 million fixed telephone subscribers  (1.06 teledensity) and 140 million broadband subscribers (57.61% broadband penetration).

Around 120 million unique mobile users paid advance/adjustable income tax during the FY 2023-24 while 100 million had no income or income below the taxable limit! FBR failed to register all taxable individuals. The number cannot be less than 20 million based on available data for FY 2023-24, after getting information from telecoms about their handset, travelling history and quantum of bill etc. Had FBR done this, the monstrous tax gap in income tax returns filers could have been bridged. It could have also helped in registering the entire taxable population as return filers. This step was deliberately avoided by the FBR to retain a justification for extorting 15% or 75% oppressive advance income tax from the poorest of the poor.

The real potential of retail outlets in Pakistan, if taxed at sales tax rate of 4% and income tax at 1% of gross receipts, could net US$15 billion annually

The above figures prove beyond any doubt that with effect from July 1, 2024, the entire taxable population and even those having no income or income below taxable limit are paying advance and adjustable 15% income tax as filers and 75% as non-filers, being prepaid or postpaid mobile and broadband users. In the face of this undeniable factual position, the FBR and others part of their bandwagon are still labelling Pakistanis, especially the traders these days, as tax cheat!

The ongoing tussle of government with the traders around so-called ‘Tajir Dost’ [traders’ friendly scheme] is also due to an imprudent and faulty approach of the FBR’s self-styled and self-acclaimed wizards! This scribe, as coauthor of an article, has highlighted this as under:

“The scheme’s major flaw lies in its disregard for the nature and scale of different businesses, highlighting a noteworthy oversight by the FBR. The S.R.O. 1064 (I)/2024 exemplifies the inefficiency and outdated methods of FBR officials in expanding the tax net. For instance, the scheme imposes the same rate of advance tax on a photocopy shop and a motor vehicle showroom situated in the same location, despite their vastly different business operations and income levels.

This ill-conceived approach of the FBR fails to account for the distinct dynamics and economic realities of various industries and business segments. By applying a uniform indicative income across diverse business types, the scheme overlooks the unique characteristics and financial capacities of each sector. As a result, it not only creates inequitable tax burdens but also demonstrates a lack of nuanced understanding and adaptability from the FBR in addressing the complexities of modern business environments”.

The proposed simplified bilingual (English & Urdu) income tax return for the retailers by FBR, who failed to file tax returns for tax year 2023, has conveniently ignored what was proposed in a column: “The real potential of retail outlets in Pakistan, if taxed at sales tax rate of 4% and income tax at 1% of gross receipts, could net US$15 billion annually.” This write-up takes cares of both income tax and sales tax at retail stage and collection can be phenomenal as well as documenting the economy.  

The real problem is a faulty tax system and a crisis of competence at the FBR.

It may be highlighted that what keeps the traders and others away from FBR is naked and brutal abuse of sections 122(5A) and 177 of the Income Tax Ordinance, 2001 to extract maximum revenue from existing taxpayers, which further alienates compliant taxpayers, increasing public discontent. It calls for reconsideration of FBR’s approach to tax collection, moving beyond outdated practices and focusing on modernizing the system. Key initiatives include implementing advanced automation system and developing a centralized database to improve audit efficiency and data accuracy. 

It is clear from the above that the real problem is a faulty tax system and a crisis of competence at the FBR. In fiscal year (FY) 2023-2024, against the assigned target of Rs. 9415 billion, FBR collected Rs. 9311 billion. According to the Summary of Consolidated Federal and Provincial Fiscal Operations, 2023-24, FBR collected Rs. 4.53 trillion as direct taxes, Rs. 3.99 trillion as sales tax, Rs. 1.10 trillion as custom duties and Rs 577.4 billion as federal excise duty. It is well-established that many withholding provisions in Income Tax Ordinance, 2001 bear the nature of indirect taxes that not only adversely affect salaried class and the poor but are also among the factors triggering high inflation that reached 31.5% in February 2023. 

Dozens of high-rate taxes and non-tax levies, both at the federal and provincial level, yielded low revenues at the national level - a pitiful Rs. 13.27 trillion, against a total expenditure of Rs. 20.48 trillion. This is our real malady and dilemma

In Pakistan, the ultra-rich are avoiding tax obligations, but millions having no income or incomes below the taxable limit, and middle-income salaried persons are being forced to pay advance income tax and denied their rightful refunds.

In the FY 2023-24, the debt servicing alone was Rs. 8.159 trillion. The federal government had net revenues (tax and non-tax) of Rs. 7.079 trillion, after transferring Rs. 5.263 trillion to the provinces. It borrowed funds of Rs. 1080 billion to meet burgeoning shortfall in debt servicing alone—thus entire defence expenditure of Rs. 1.859 trillion and others expenses were met from expensive borrowed funds.

Obviously, the government has no incentives to push for lower taxes with a broader tax base. Unless, it is done, collection will remain far below the potential that is not less that Rs. 34 trillion. The entire business climate is destroyed by employing over 50 provisions with respect to advance and withholding taxes, easy collection from petroleum products and big firms. Failure to harness the real tax potential is the main issue.

Pakistan’s real dilemma is that the rich and mighty are not paying taxes according to their ability. In tax years 2022 and 2023, less than 4,000 persons paid tax between Rs 1,000,000 and Rs. 10 million. In tax year 2023, less than 5,000 individuals declared tax of over Rs 10 million, and position will get worsen in tax year 2024. The higher taxes imposed through Finance Act 2024 will further incentivize people to evade taxes!

In Pakistan, the ultra-rich are avoiding tax obligations, but millions having no income or incomes below the taxable limit, and middle-income salaried persons are being forced to pay advance income tax and denied their rightful refunds, in gross violation of Article 4(c) of the Constitution that says:  “no person shall be compelled to do that which the law does not require him to do.”

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