Broadening the tax net-II: A solution to taxation woes?

The narrative highlighting the importance of enhancing the number of tax filers also fails to take into account the tax policy that was fashioned to address the particular nature of Pakistan’s economy and the capacity of the tax administration.

Leaving aside the share of total tax revenues from indirect taxes such as Sales Tax, Federal Excise Duty and import duty, at least 70 percent of the collection of income tax comes from taxes withheld on various economic transactions.

The net of adjustable withholding taxes was spread to cover all significant transactions at points where the persons out of the tax net have to interact with the formal economy and to collect withholding taxes on these transactions. These withholding taxes nudge the non-filers to enroll in the tax system to get credit of the tax collected from them by filing tax returns.

Broadening the tax net — I: A solution to taxation woes?

The nudge factor was also given a strong boost by progressively enhancing the rates of withholding taxes applicable on non-filers.

These higher rates for non-filers constituted an innovative feature to tailor tax policies to the ground realities and had these been properly studied by the academia and correctly projected by the government, the measure would have been a singular contribution of Pakistan’s tax policy for all developing countries with similar economic setups.

Instead, the subsequent government and FBR leadership without comprehending the significance of these measures, became easy prey of the false narratives, such as the absurd allegations that higher rates for non-filers amount to legitimizing non-filing and that the large number of withholding taxes is an adverse reflection on the performance of FBR, etc.

No one from FBR was able to present the actual picture and the rationale of these measures. On the contrary, from 2019 to 2022 a considerable number of withholding taxes were withdrawn with a promise to enhance revenues through enhancing the number of tax filers. Understandably, the “success” of this shift in tax policy has never been documented or made publicly available.

A few sane voices have also questioned the focus on registering new taxpayers by pointing out the number of potential taxpayers on the basis of statistics such as Pakistan having close to 80 million unemployed women,60 percent of the population subsisting below poverty line, more than 130 million Pakistanis being below the age of 30 and how much do the youth below the age of 30 years make in Pakistan? 77 million Pakistanis who are food insecure and whether we should expect to collect income tax from food insecure Pakistanis (‘The Tax Net’ by Dr. Farrukh Saleem, The News July 21st July, 2019).

The myth regarding effectiveness of campaigns to increase the number of tax filers has also been debunked by academicians who refuse to remain hostage to classical economic ideas. International Center for Tax & Development (ICTD), which is an independent research center focused on improving tax policy and administration in lower-income countries, has in July 2023 published a Policy Brief titled “Why Mass Tax Registration Campaigns do not work”, a collaborative work by eight experts.

The authors note that policy makers and donors have become increasingly interested in the use of mass registration campaigns as a tool to expand the tax nets in lower-income countries. They also examined the commonly held beliefs that there is a substantial revenue potential in registering new taxpayers, that expanding registration decreases informality and unfair competition between informal and formal businesses and enhances the fairness of the tax system.

Interestingly, they specifically mention the leveraging of third-party data, such as that from national identification authorities or utility providers which may sound greatly familiar to the followers of Pakistan’s aspirations in this regard.

However, according to the study, there are serious deficiencies in all these narratives. In practice, the revenue outcomes of mass tax registration exercises have been unsatisfactory at best.

According to the authors, there is evidence that mass tax registration campaigns can have awkward effects that have not yet been realized. They can have a negative equity impacts, as they end up unduly targeting lower income earners and smaller firms. The administrative costs of such campaigns are often high, both for taxpayers and revenue administrations.

Registering smaller taxpayers can be highly time- and resource- consuming, in most cases costing more than the potential revenues at stake. Mass registration campaigns often lead to tax registers that are stuffed with inactive taxpayers, those that either are not economically active or not compliant or both.

The study concludes that both government policies and donor programmes are still shaped by an unrealistic view of their potential outcomes and a rethinking of tax registration is therefore needed. They recommend that revenue authorities should do away with mass tax registration campaigns, but of course do not imply that revenue authorities should give up on registration altogether.

This should be done through a natural and evolutionary process, leading to voluntary registrations based on facilitated compliance and fair treatment of the taxpayers rather than by target setting and adopting coercion.

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.

Here, it needs to be clarified that it is not being advocated that those who are legally liable to file their returns should not be doing so. What is being disputed is the misplaced priorities.

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.

(Concluded)

Copyright Business Recorder, 2023