Tax administration reforms project to be launched

The government would launch "Pakistan Tax Administration Reforms Project" to implement tax policy and administration reforms, trade facilitation and market access with the financial assistance of IDA during next financial year 2004-05. This project will be completed with the total cost of $225 million.
Under this project, an efficient and effective tax administration is a prerequisite if the tax system is to fulfill its revenue producing potential. Thus, tax administration is a major tool in government's efforts for pursuing a sound fiscal policy and achieving an optimum tax level.
The Tax Administration Reform Project (TARP) seeks to support the reforms initiated by the government for improving tax administration.
The overriding objective is to raise tax revenue through improved compliance with tax laws and broadening of the tax base; improving effectiveness, responsiveness and efficiency of tax administration through institutional and procedural reforms; improving collection through transparent and high quality tax services; and strengthening audit and enforcement procedures.
This Project follows the successful completion of an IDF Grant, which was extended to the Government in 2000 to facilitate development of implementation plans for institutional reform of the Central Board of Revenue (CBR).
TARP supports continuation and effective implementation of the reforms initiated to enhance the capability of the tax system.
SPECIFICALLY, PROJECT OBJECTIVES INCLUDE:
1. Improving efficiency and effectiveness of revenue operations: Creating a new CBR that is autonomous, transparent, efficient and organised around functional lines, that encourages self assessment as well as a fair and equitable process of tax administration and appeals.
This will include modernising tax operations for faster and reliable processing of tax returns, increased capacity of record keeping and management of data through effective integration of business processes with information systems.
In addition, this will include improvements in staff productivity and morale through adoption of best practice policies for recruitment, training, performance evaluation and compensation.
2. Improving collection through transparent and high quality tax services: Promoting voluntary compliance with tax and custom laws through an intensive taxpayer education and facilitation programme, re-engineering of CBR's business processes and reorienting its operational culture towards a transparent, service-oriented organisation.
This will include building effective-working relationships with taxpayers and minimising contact between taxpayers and tax officials to reduce discretion on part of tax officials as well as opportunities for corruption.
3. Improving trade facilitation through modern and internationally acceptable customs procedures:
Introducing simplified, modern and risk based import and export clearance and related procedures.
Bringing this system in line with internationally acceptable standards for improving trade facilitation.
4. Strengthening audit and enforcement: Ensuring compliance through a risk based audit system as well as fair and effective enforcement mechanisms that directly respond to changes in the environment using information technology and a new intelligence and risk management system.
5. Rationale for Bank's Involvement Bank support would provide high-quality technical advice based on world-wide and regional experience in tax administration; convey credibility and transparency to the reform effort; strengthen the hands of the pro-reform elements in the Government and CBR; and promote efficient and effective use of the resources supporting the Government's programme.
DESCRIPTION: The proposed Project will support the Government revamp the tax administration system. It would support initiative to redress major shortcomings in tax administration through investment in human resource and information technology, modernising collection and audit procedures, fostering voluntary compliance, and strengthening the institutional framework for tax enforcement.
The Government is committed to fundamental reform of institutions, incentives and accountability to breakout from a vicious cycle of high rates, predatory administration, tax evasion and low revenues to a virtuous cycle of lower rates, equitable tax structures, fair administration, voluntary compliance and higher revenue.
CBR reform is an important pillar of Government's broader strategy for reforming public sector institutions.
Similar reforms have also been initiated at the State Bank of Pakistan, Securities and Exchange Commission of Pakistan, WAPDA, and the Office of the Auditor General.
In addition, the Government with Bank assistance is in process of preparing a wide-ranging public sector capacity building programme which aims to enhance the skill base of its key ministries, agencies and regulatory bodies in an effort to introduce broad based civil service reforms.
As its commitment, the Cabinet approved the reform strategy for CBR which allowed it to prepare a comprehensive reform programme.
In addition, the Government established a Cabinet Committee for Federal Revenues headed by the Finance Minister which not only gives CBR autonomy to implement the reform programme but to institute mechanisms which would sustain the reforms once they have been implemented.
THE PROPOSED PROJECT IS DESIGNED AROUND A COMPREHENSIVE REFORM STRATEGY AND INCLUDES THE FOLLOWING SEVEN COMPONENTS: (i) Management and Institutional Development; (ii) Improving Revenue Operations; (iii) Strengthening Revenue Services; (iv) Creating a Tax Compliant Culture; (v) Adopting Responsive IT Systems; (vi) Infrastructure Up-gradation and Development; and (vii) Project Management and Implementation.
According to a project report, since the beginning of the nineties, successive governments have tried to reform Pakistan's tax system.
These attempts, however, have yielded limited results and the tax to GDP ratio has remained in a narrow band, between 12 to 14 percent for almost two decades.
In developed countries, tax revenue as a percentage of GDP ranges from around 30 to 50 percent, with an average of 38 percent.
SOURCE: Organization for Economic Co-operation and Development. Developing countries average about 18 percent.
While Pakistan's 13 percent is well below the developing country average, it does not fare too badly when compared with other countries in the region.
It was mentioned that the low tax-to-GDP ratio of tax revenue in Pakistan is primarily due to inherent weaknesses in the tax system including: (i) inefficient tax administration, (ii) a narrow tax base, (iii) skewed tax structure, (iv) a complex and non-transparent tax system, and (v) corruption and tax evasion.
Inefficient tax administration: Despite previous reform efforts, many of the long-standing deficiencies in tax administration have not been rectified.
The tax department has suffered from profound institutional weaknesses related to poor management, weak human resources, low pay, lack of adequate systems of financial and physical control, low quality and quantity of tax auditors, unduly bureaucratic processes with excessive scope for discretion and rent seeking by individual staff, deteriorating physical infrastructure, lack of transparency in the collection of import duties, and resistance to change.
OTHER CRITICAL SHORTCOMINGS INCLUDE: (i) poor identification of non-filers and stop-filers; (ii) poor audit programme design, implementation, and sequential follow-up; (iii) poor use of databases for cross checking; (iv) absence of tax transit and audit/inspection controls in customs; and (v) a tax code with poorly defined and weak penalties and lengthy business liquidation procedures for tax defaulting businesses.
NARROW TAX BASE: Approximately 38.29 million men and women are employed in Pakistan. Of these, only about 2.14 million (5.59 percent) pay tax.
This ratio is quite low especially when compared with that of the US - 46 percent, the UK - 48 percent and Australia - 53 percent.
The tax base in Pakistan is narrow due to three main reasons. Firstly, a large proportion of the employed labour force is employed in small-scale agriculture or informal enterprises, which usually do not pay regular/fixed wages and if they do, these earnings are below the taxable threshold.
Secondly, the salary allowance and privileges of certain groups are given concessions under the Income Tax Ordinance 2001 and the Income Tax Rules 2002.
These include widows, pensioners, federal and provincial government employees, the armed forces, civil servants, research organizations, and those working in international development agencies.
Such concessions exclude a large number of individuals from paying income tax and effectively reduce income tax revenue.
Thirdly, many transactions in Pakistan are made on a cash basis and are not documented.
This makes it difficult to identify and register individuals and businesses and once registered, it is still difficult to assess income earned, corporate profits and turnover.
SKEWED TAX STRUCTURE: In most developing countries, where income distribution is uneven, it is easier to generate revenue by taxing usage of commodities rather than the wealth/income of the rich.
This mechanism, however, raises the cost of living for lower income groups. For countries trying to improve standards of living, this can prove counterproductive unless introduced with zero-rating on basic goods and services used by the poor.
Historically, the Government of Pakistan has relied heavily on indirect taxes to meet its fiscal needs.
While efforts have been successful in reducing this dependence, indirect taxation still constitutes nearly 65 percent of government's total tax revenue.
This is composed of sales tax 64 percent, customs 20 percent and the remaining 16 percent through central excise duty.
COMPLEX TAX SYSTEM: Pakistan's tax laws are complicated and the process of filing returns and collecting refunds cumbersome.
Moreover, the system is characterised by frequently changing and ad hoc legal and administrative arrangements.
This provides opportunities for increased discretion and enhanced opportunities for corruption.
Taxpayers in Pakistan often have insufficient or uncertain knowledge of their tax obligations and there is little support to help them understand the laws and/or motivate them to improve compliance.
This leads to a serious undermining of taxpayer confidence in the tax system, which in turn, filters through to lower tax revenue.
CORRUPTION AND TAX EVASION: In Pakistan, salaries and incentives for tax officials have been highly inadequate and fall far short of what officials could earn in the private sector.
In various surveys conducted to identify the root causes of corruption including perception survey carried out by the Task
Force on Tax Administration, poor compensation was cited as one of the primary reasons for corruption.
Other reasons include the discretionary powers of tax officials, lack of accountability, complex structure of tax system, greed and societal pressures.
In addition, the taxation system provided CBR employees opportunities to accept and/or demand bribes and fostered bribery and extortion.
There are broadly two levels of corruption: firstly, a smaller proportion of corrupt officers that extort the level of payments that no reward system can address; secondly, a larger proportion of officers are involved in corrupt practices, are doing so in order to feed, clothe and house their families.
Improving the compensation and reward system that is linked with performance, reducing discretionary powers, introducing tax assessment and collection procedures that do not involve contact of taxpayers with tax officials, training and education of tax officials and taxpayers, as well as adequate accountability mechanisms would help towards eradicating this ill from the system.
On the other side, the informal structure of the economy and non transparency of the tax code and tax collection practices also makes it easy to manipulate data and evade taxes.
In addition, the causes of corruption in the private sector include; lack of tax culture, high tax rates, greed, lack of accountability, fear of extortion or wastage of money paid in taxes.
However, the main reason for tax evasion cited in the surveys was belief of people that they do not get anything in return of the taxes paid.
Simplifying the tax system, educating the taxpayers, improving mechanisms for compiling data and keeping records along with appropriate collection and enforcement procedures can go a long way in addressing this problem.
Government Strategy Realising that increasing tax revenue is critical for fiscal development, the Government has adopted a two-pronged strategy: tax policy change to make the tax system more responsive to growth and easier to administer; and tax administration improvements to increase efficiency of collection. Specifically, the Government plans to make the tax policy more equitable, bring more taxpayers into the net, reduce the number of taxes, streamline the tax laws to make them taxpayer friendly, improve tax enforcement, and put in place a tax administration system which is efficient and responsive.
Government efforts to reform have been more concerted during the last few years. In June 2000 a Task Force, supported by the Bank, was set-up to review the problems of the Central Board of Revenue (CBR).
The Task Force presented a detailed report in May 2001 and recommended a complete shift in the tax system from assessment to a risk based system with simpler laws and procedures that relies on audit and reduces the contact of tax officials with taxpayers.
Based on this approach, CBR in November 2001 developed a broad strategy for reforms focusing on: (i) restructuring of CBR along functional lines and integration of income, sales and excise taxes, (ii) re-engineering and automating business processes and work-flows, (iii) establishing databases for reporting and audit purposes, (iv) introducing self assessment system for filing of tax returns, (v) improving services for the taxpayers, and (vi) strengthening the human resource base.
Simultaneously the Government made extensive policy reforms including change in organisational structure of CBR, which has provided management with some level of autonomy through the Cabinet Committee on Federal Revenues, to implement reforms and has allowed private sector induction at the top level.
Within this framework, CBR has increased the salary levels of about 150 staff working at pilot reform initiatives and as part of reform team.
These staff were selected through a competitive process of internal job postings.
In addition, job descriptions and a database of staff with their education and skills has also been developed.
This is a major step in determining training and capacity building requirements as well as identifying non-trainable staff and will be linked to the performance management system.
All these initiatives have given the 'change' signal and has helped create ownership for the reform agenda.
CBR, while it continued with its short term 'quick win' reforms, it also started preparation of a medium and long term reform programme with Bank assistance.
A Project Preparation Facility of US $2.9 million was processed in 2002 to support implementation of the reform initiatives as well as hiring of Maxwell Stamp to prepare a comprehensive strategy with implementation timelines and costs for the medium and long term reform programme.
Short term reform measures focus on design and testing of pilot schemes including the Large Taxpayer Unit (LTU) the Medium Taxpayer Unit (MTU), customs selectivity and post clearance audit, sales tax refund programme, universal self assessment scheme, human resource information management system and training and staff development.
The medium and long-term programme will focus on development of the reforms across the country and throughout CBR operations.
ESSENTIALLY THE REFORM PROGRAMME IS BASED ON THE FOLLOWING SEVEN INTEGRATED BUILDING BLOCKS:
1. While remaining a government department, the CBR will be provided with greater autonomy in determining its own policies and strategies in relation to recruitment, salaries, investment and operation methods.
2. Restructuring the CBR into a modern functionally based and integrated Revenue Authority.
3. The promotion of voluntary tax compliance and the re-orientation of its operating culture towards a transparent service-oriented organisation, through the implementation of a comprehensive taxpayer, and internal staff, education, training and facilitation programme.
4. The adoption of modern effective tax administration methods and policies through the re-engineering of its operating procedures.
In particular, the re-engineering will focus on: - Introducing a consolidated self assessment scheme; - Minimising the taxpayers - tax officials interface; - Adopting 'Selectivity and Risk Management' principles; - Replacing the present transaction based audit practice with the application of selective post return and clearance audit method across all taxes; - Systematic and comprehensive registration of taxpayers in a single register applicable across all taxes; - Widening of the tax base; - Amending as necessary to the Tax and Customs laws to enable reforms; - Introducing fair and equitable appeals and appeasement procedures; - Introducing stronger enforcement penalties; and, - Redesigning tax processes to reflect increased functionality and gradual integration of tax administration.
5. Increased use of information technology and systems, both proprietary and custom built, across all taxes to reduce processing times, increase administrative efficiency and transparency, and ensure that the benefits of shared information are reflected in increased levels of compliance.
6. Improvements in productivity of CBR staff and management through a comprehensive Human Resource Development programme to substantially raise staff skills and quality, levels and integrity into line with international standards through training, monitoring, restructuring and redeployment.
7. Rationalisation and refurbishment of accommodation, fittings and equipment to accommodate the new processes and programmes.