IMF proposals largely disappointing

The International Monetary Fund (IMF) in a Selected Issues Paper uploaded on the website on the same day as the Article IV consultations and ninth review issued a comprehensive list of recommendations with the objective of unlocking Pakistan's revenue potential. The list includes, strengthening capital gains tax by integrating general sales tax collection system on goods and services under one collection agent, adopting a common rate schedule for all financial assets, eliminating exemptions from real estate transactions, reducing the tax exempt income threshold, widening tax brackets, adopting more progressive and lower tax rates, banning "benami" transactions and undertaking risk-based audits. This is not the first time such a comprehensive list has been suggested by economists, local or foreign, and reflects almost standard normal reform prescriptions that have been part and parcel of research/issues paper for years. The problem is in the implementation that remains hostage to political considerations and in the context of the recently uploaded Issues Paper disturbingly reflects the lack of information by the Fund staff of our constitution, our tax structure and the tax culture that is widely held responsible for bottlenecks in the implementation of reforms.
The IMF suggestion to integrate general sales tax on goods and services under one collection agent is easier said than done. The country's constitution stipulates that the federal government can levy sales tax on goods only. Services fall under the domain of the federating units for the purposes of sales tax. Furthermore, when there was a single agent namely the Federal Board of Revenue (FBR) for collection of goods on services under an arrangement between the federal and provincial governments the collection on services was a miniscule compared to what the provinces began to collect later. The capacity of the three provinces notably Sindh, Punjab and Khyber Pakhtunkhwa (KPK) to collect sales tax on services has been visibly strengthened by the recently established provincial revenue authorities. In view of stated experience one would be, therefore, profoundly naive to recommend that any of the three provinces led by three different political parties would accept any amendment to the constitution that would allow the Federal Board of Revenue (FBR) to collect sales tax on services on their behalf. The reason is simple: the revenue collected by the provincial authority is credited entirely to the provincial exchequer while collection by the FBR would imply that it would not only charge collection charges but also credit the amount to the federal consolidated fund which would then be divided between the provinces according to the National Finance Commission award.
What is even more disturbing about this recommendation is the fact that one collection agent necessitates cohesion and concerted efforts in tandem between the federal and provincial revenue collection entities. In the case of Pakistan there is no such cohesiveness and complaints by the provincial authorities are frequent that the FBR is encroaching on their turf. In addition, FBR has been accused of not playing its due role of an honest arbiter between the provinces on resolving issues of cross-border tax adjustments and issues relating to applicability of sales tax on goods and services.
The Issues Paper also suggests that "to improve taxpayer compliance and curb tax avoidance there is a need "to modernise and bolster the effectiveness of tax administrations at federal and provincial levels by reorganising along functional lines, integrating databases and information technology, and requiring a tax identity number in all financial and immovable property transactions. This would also help deal with the potential problem of using remittance transfers as a means of tax evasion." Again, with little if any co-ordination between the federal and provincial tax authorities, fuelled further by mistrust, and the alleged engagement by 'influentials' in money laundering this recommendation appears to be doomed to failure. The Fund's suggestion appears to reflect unawareness of the Finance Ministry's decision to allow national identity cards instead of only the NTNs to be used to file returns.
The Fund's proposal to support risk-based audit is essentially a good one; however, unlike in other countries where the audit entity identifies high risk areas of activity for audit, in Pakistan the audit officers' performance is a function of how many cases each officer audits and how many leakages he/she identifies - a situation that leads to frivolous cases. What is required are stiff penalties for tax evasion and fraud.
The Fund's recommendation to strengthen capital gains tax can be supported and many a local economist has been advising the Dar-led Finance Ministry to at least adhere to the agreement between former Finance Minister Hafeez Sheikh and the stock market players in terms of progressively increasing the rate of taxes. The actual revenue that can be generated from such a tax is estimated at 200 billion rupees - if levied at the same rate as in other regional countries particularly India - according to former Finance Minister Hafiz Pasha. Business Recorder also supports the elimination of exemptions from real estate transactions and widening tax brackets.
However, the Fund's suggestion to reduce the tax exempt income threshold and adopt more progressive and lower tax rates is inexplicable for two reasons. First, it fails to take account of the fact that those with income of less than Rs 400,000 do pay advance tax on cell phones/electricity, etc. Second, the income tax is mainly collected from the salaried people leaving the rich (be they rich farmers or be they rich non-filers) outside the tax net.
The suggestion to adopt more progressive and lower taxes in this country would apply mainly to income tax which unfortunately has been redefined as withholding tax. FBR's performance therefore remains poor reflected by the heavy reliance on withholding agents who are at present making 65 to 70 percent of all income tax collections - withholding tax that in many cases is being passed onto the end consumers and therefore is not strictly speaking a tax on income. Indirect tax collections stipulated by the Fund staff at 68 percent of all taxes collected is therefore clearly an erroneous claim.
The suggestion to ban Benami transactions is, no doubt, a reflection of the commitment by the Dar-led Finance Ministry to the IMF under the 6.64 billion dollar Extended Fund Facility to undertake the necessary legislation that would require amending the Trust Act by the end of the current month. However, it may be recalled that the father of the nation Quaid-e-Azam Muhammad Ali Jinnah, had argued against amending the Trust Act that provides the basis for Benami transactions in the Viceroy's legislative council prior to Independence on religious grounds. Article 227 (1) of the Constitution stipulates that "all existing laws shall be brought in conformity with the injunctions of Islam as laid down in the Holy Quran and Sunnah...and no new law shall be enacted which is repugnant to such injunctions." In other words, any amendment to the Trust Act is more than likely to be challenged in a court of law. The IMF's recommendation to set up a tax policy research and analysis institution outside the FBR is fully supported. Not only that it should be housed outside the FBR but preferably it should not be administratively under the Ministry of Finance for it to be truly effective.
To conclude, the Fund document is by and large disappointing and reflects a lack of knowledge about the actual conditions prevalent in Pakistan. The Selected Issues Paper in its section on estimating real exchange rate misalignment gives a range of between 5 to 20 percent - a range that is simply too wide to be considered worthy of the premier agency on monitoring macroeconomic data of all member countries.