Budget: rationalise taxation

On the eve of another ritual exercise of announcing federal budget, official date has yet to be finalised, expected on June 12, 2024, there is a need to re-evaluate tax policy and revamp tax machinery, as highlighted in our last week’s column [Budget & tax policy, Business Recorder, May 31, 2024]. Taxation in Pakistan is oppressive, lopsided and counterproductive—only 2% of corporatization of total business. By heavily taxing the corporate sector, successive governments have been encouraging undocumented sector.

It is worth mentioning that the Reforms and Resource Mobilization Commission (RRMC), constituted on December 1, 2022 by then fourth-time finance minister, Muhammad Ishaq Dar, now 4th Deputy Prime Minister and 39th Foreign Minister of the country, proposed many anti-corporate proposals like taxation of undistributed profits on which companies had already paid taxes! It was proposed even though earlier provision levying the same [section 5A of the Income Tax Ordinance, 2001, was declared ultra vires by the Sindh High Court and leave to appeal against its order was purportedly rejected by the Supreme Court which judgement is yet not made public on its website by the highest court of the country].

As per latest figure for January 2024, the number of registered companies in Pakistan was 212,108 with annual addition of about 25,000. In countries like Malaysia, Indonesia and Turkey, these are in millions. If Pakistan is to discourage undocumented economy, it needs rapid industrial expansion through corporatization. Taxation can play a key role in the process by reducing corporate tax rate to 20%. For non-corporate business entities rate should be flat 30%. Sales tax should also not be more than 10 percent as is the case in Japan, Vietnam, and Singapore etc.

Taxation should serve as a catalyst for industrial expansion and economic growth creating more jobs. In Pakistan, ill-directed, illogical, regressive and unfair tax regulations coupled with import restrictions are causing a dampening effect on the industrial and business growth. The sole stress on meeting revenue targets, without evaluating its impact on the economy, has crippled trade and industry. Had successive governments concentrated more on economic growth, there would have been substantial rise in taxes as a consequence. It is not possible to enhance revenues with stagflation—over-taxing ailing economy, as has been done in Pakistan, is bound to destroy the revenue system as well.

Fixing revenue targets in isolation and without making necessary efforts to improve productivity and economic growth is our real dilemma. In a country where there is no security of life or property, notwithstanding the availability of some tax benefits, investors would never come forward.

Federal Board of Revenue (FBR) creates uncertainty by introducing Statutory Regulator Orders (SROs), blocking undisputed refunds, making excessive tax demands and resorting to all kinds of negative tactics to meet its budgetary targets, e.g. taking advances of billions from large taxpayers like banks and oil companies—just to mention two! Such actions by the tax machinery are detrimental for businesses. Despite these repressive actions, FBR has failed to meet even revised targets in the past, what to speak of realizing the real tax potential that at 16% of GDP is Rs. 32 trillion, if we take into account the parallel economy (both legal and illicit). Income tax law makes no distinction in taxing legal or illegal incomes.

Economic managers must focus on increasing productivity, efficiency, growth and reducing cost of doing business—these alone can ensure more revenues for the State. Successive governments’ onerous tax and regulatory policies have pushed millions of people below the poverty line. Pakistan needs to move quickly and decisively to reverse this trend.

Revenue performance is nothing but the best and optimal use of resources. Since the composition of investment is an important determinant of an economy’s growth rate, public policy must discourage the flow of resources to low priority areas, diverting them instead to vital sectors. By imposing higher taxes on luxuries and other low priority items (such as open plots, expensive cars, jewellery etc.), the government can dissuade the consumption and production of such items, ensuring in the process release of resources for high priority sectors.

The primary function of a tax system is to raise revenue for the government for its public expenditure as well as for local authorities and similar public bodies. Therefore, the first goal in development strategy as regards taxation policy is to ensure that this function is discharged effectively. Performance of the Pakistani tax managers on this account is highly disappointing, with fiscal deficit remaining high during the last many decades and despite revenue targets fixed annually and subjected to downward revision many a times, yet remained unachieved. Tax-GDP ratio, at 11.4% in fiscal year 2022-23 was pathetically low.

The second equally important function of taxation is to reduce inequalities through a policy of redistribution of income and wealth. Higher rates of income taxes, capital transfer taxes and wealth taxes are some means adopted for achieving these ends. In Pakistan, there has been a gradual shift from equitable taxes to highly inequitable ones—from removing inequalities through progressive taxes to presumptive and minimum taxes as well as numerous withholding provisions (easily collectable taxes)—has destroyed the very philosophy of taxes. This deviation has effectively transferred the burden of taxes from the rich to the poor.

Economic justice relates largely to distribution of tax burden and benefits of public expenditure. It is a component of the broader concept of social justice, which encompasses, besides distributive justice, such questions as treatment of women and children, and racial and religious tolerance in a society. Tax policy is a democratic method to influence the distribution of income and wealth on desired lines.

The main ingredients of this policy can be (a) progressive direct taxation of income, wealth, and property transactions, (b) taxation of commodities (customs duty, excise levy, and sales tax) purchased largely by high-income groups, and (c) subsidies (negative taxation) on goods purchased by low-income groups. In Pakistan, moving from progressive taxation to regressive taxation has definitely proved disastrous as our society is already divided on economic, political, geographical and religious grounds.

Our income tax collection should be around Rs 10 trillion. If there are 20 million individuals having annual taxable income of Rs 1.5 million (a very conservative estimate), total income tax collection will not be less than Rs 7000 billion. If we add income tax from corporate bodies, other non-individual taxpayers and individuals (having income between Rs 600,000 to Rs 1,000,000), the gross figure is going to be a whopping Rs 10 trillion! FBR collected only Rs 3086 billion as income tax during fiscal year (FY) 2022-23. Another shocking fact is the dismal performance of FBR’s field officials in collecting income tax in FY 2022-23 through their own efforts (4.66 percent!). They managed out of total collection of Rs 3086 billion under the head income tax, just Rs 144.308 billion (out of current demand) and Rs 2.85 billion (out of arrears). This confirms the sorry state of affairs prevailing in FBR where officers are getting double salary, bonuses and honorariums!

Out of total income tax collection of Rs 3086 billion, FBR received Rs 1874.29 billion (60.74%) from withholding tax agents. In this area as well, massive corruption is prevailing with the connivance of tax officials—some withholding tax agents collect/deduct taxes but do not deposit in the government treasury, or the payer and the payee join hands to deprive the exchequer of billions of rupees with the connivance of corrupt tax officials. The real potential of withholding taxes, based on estimates of total GDP for FY 2022-23, was not less than Rs 5500 billion.

Similarly, due to rampant corruption in sales tax, federal excise and custom duties, the total collection in FY 2022-23 was much below the actual potential. In the last fiscal year [FY 2022-23], FBR collected Rs 2591 billion under the head sales tax, Rs 370 billion under federal excise duty and Rs. 932 billion under custom duties. Total indirect collection of Rs. 3893 billion was distressingly low. Sales tax collection alone should have been Rs 7000 billion and total indirect taxes at Rs 9000 billion.

Weak enforcement that includes incompetence and corruption is the real malady of our tax system. Tax codes are mindlessly amended each year through Finance Bill and in between, by way of SROs. The solution lies in complete re-engineering of the system [roadmap is given in ‘Towards flat, low-rate broad and predictable taxes’, revised and expanded edition 2020, PRIME, Islamabad], being deferred year after year in the name of short-term compulsions!

Copyright Business Recorder, 2024