A better tax model

For the last two decades every year, we have been consistently suggesting in these columns some innovative budget proposals, stressing comprehensive structural reforms, as highlighted recently by Pakistan Institute of Development Economics (PIDE) in PIDE Reform Agenda for Accelerated and Sustained Growth, to achieve higher economic growth that alone can ensure revenue mobilisation leading to fiscal consolidation. The fourth budget of the coalition government of Pakistan Tehreek-i-Insaf (PTI), expected on June 11, 2021, in the existing scenario of heavy economic toll of Covid-19, especially the third deadly wave, is going to address a number of challenges.

The conventional proposals, suggesting changes in the existing tax codes, made every year before the annual budget by numerous bodies, prove futile, even counter-productive. For decades, policymakers of all governments, civil or military, ignored or sidetracked fundamental reforms to make the tax system fair and efficient. In five years of its rule [2013-18], the government of Pakistan Muslim League (Nawaz) [PML-N] did not undertake much-needed reforms in tax policy/administration.

Since August 2018, the PTI Government has also failed to restructure outdated tax system. Resultantly, on fiscal front, things have gone from bad to worse. The fiscal pre-Covid-19 deficit was higher than PML-N’s era. The current account fiasco was created by PML-N but before coming to power, PTI made tall claims of having “solutions” for every ill. The PTI government has offered none but keeps on blaming the PML-N for everything. This is a favourite mantra, starting from the Prime Minister to “spokespersons” participating in TV talk shows to workers on social media. Uprooting corruption is another one, without any success. All the ministers, state ministers, and technocrats working as advisers/special assistants have done nothing worthwhile for all-out reforms. In this article, we are, however, concentrating on tax reforms. In the coming articles, other areas will also be highlighted.

The existing functional system that replaced the circle-based system has failed miserably, it has rendered Inland Revenue Service (IRS) of the Federal Board of Revenue (FBR) ineffective. The other very important issue is lack of political will to tax the rich. The Income Tax Ordinance, 2001 relies heavily on withholding taxes, presumptive and/or minimum taxes, which in substance are regressive. These are collected at import stage or by dozens of withholding agents. Indirect taxes of over 20%, if we add indirect ones levied under income tax law, hurt the growth and the poor.

The policy of appeasement towards tax evaders is perpetuating under the PTI government through amnesties and asset-whitening schemes, waivers, exemptions and concessions. Since 2003, tax amnesties, exemptions, credits and benefits through Statutory Regulatory Orders (SROs), free plots and perks to the mighty sections of society have eroded income tax base substantially.

For determining taxation figures, economists take into account statistics related to formal and documented economy but no serious study is available about size of parallel economy. The real challenge is how to tax it. It is evident from the fact that the wholesale and retail sectors contribute about 19% to the GDP but their share in taxes is just 3.7% of the total collection. The rich absentee landowners paid agricultural income tax of only 0.6% of total national tax collection of Rs 4.75 trillion in fiscal year 2019-20 (11.4% of GDP).

No agenda for tax reforms by the International Monetary Fund (IMF) or World Bank or of simplification of tax system by many can improve tax compliance, unless there is efficiency, technical competence, integrity and ability of the tax machinery to relentlessly pursue and punish tax evaders without any political interference and ill-motives. The functional structure in IRS has failed to achieve these objectives. Nobody has ever emphasized on bettering the overall working conditions of FBR and improving training, professional skills of officers and staff. Does it really need enormous money to extend the respect and courtesy to taxpayers? Does this issue relate to market wages or foreign funding or advice?

The fundamental element of tax reforms is providing an efficient and competent administration, which is nowhere visible in Pakistan. Tax administrations, both at federal and provincial levels, lack the requisite level of digitization, professionalism and human skills. Any exercise relating to comprehensive tax reforms cannot be a time-bound affair and does not mean merely altering tax laws or suggesting cosmetic changes here and there. Reforms can be successful only if a comprehensive analysis is made of the whole system, that is, tax codes, tax administration, state of economy, taxpayers’ attitude, revenue needs of the country and many other allied aspects.

We desire tax reforms without first establishing an efficient, workable structure. One may give the example of Sweden’s tax agency, Skatteverket. It maintains data of each and every person, natural or juridical. Skatteverket is accountable to the government, but operates as an autonomous public authority. We need to establish ‘National Tax Authority’ — see details in ‘Need for National Tax Authority’, Business Recorder, October 20, 2017. This innovation alone can counter massive pilferages in collections that were estimated at Rs 3 trillion by IMF in its country report of 2016 (Unlocking Pakistan’s Revenue Potential) and presently the number may be even bigger, near about Rs 5 trillion.

Successive governments, military and civilian alike, have failed to tackle the twin menaces of hidden economy and fiscal deficit. The study, What is hidden, in the hidden economy of Pakistan? Size, causes, issues and implications, by Ahmed Gulzar, Novaira Junaid and Adnan Haider, shows that corruption and tax evasion are not only causing an expansion in the size of the informal economy but also hampering the growth rate, thereby adding more to economic uncertainty, income inequality and poverty. This study by PIDE needs updation and determination of actual size of hidden economy and its impact on growth.

The existing tax system is not taxing hidden economy and the rich, but collecting advance/adjustable income tax of 12.5% from 183 million mobile users. Resultantly, income and wealth distribution disparities are rapidly widening. Under the given scenario, efforts are needed both at federal and provincial levels to enhance the size of the pie by shifting to growth-oriented taxation (There’s need for new tax model, Business Recorder, February 26, 2021).

As to innovative tax reforms, The PTI government in the coming budget must provide a fair and just tax system for which comprehensive model is available in Towards Flat, Low-rate, Broad and Predictable Taxes’ (PRIME Institute, available free at: https://primeinstitute.org/towards-flat-low-rate-broad-and-predictable-taxes/). This model provides for revenue collection of Rs 8 trillion along with maximising economic growth. Our legislators must come forward and resolve to achieve a sensible balance between income, capital and consumption taxes. They must favour spending not on ill-designed social programmes to bank more votes than social returns, but on important investments in creating human capital (e.g. education, training and health), and necessary public infrastructure to increase productivity and growth.

(The writers, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE))

Copyright Business Recorder, 2021