The income tax had been the principal source of revenue for the federal government and now it stands next to the sales tax. Its contribution to tax revenue stands at 31% in 2005 and its share in the GDP has increased to around 9%. Despite these reassuring statistics, there is widespread disaffection with the tax policy of the government.
There is a consensus among a broad spectrum of the stakeholders that the present taxation system breeds mistrust and there is a feel that without a fundamental redesign of the tax policy, the government may find difficulty to meet its ever increasing demands for revenue generation.
There are several factors that have resulted in this state of affairs. Some of them are rooted in the income tax legislation, others are an outcome of the constitutional structure of the country and some others are the result of a complex web of lobbying and political compromises.
The exemptions allowed to various types of incomes in the second schedule of the Income Tax Ordinance 2001 (Ordinance) are examples of political compromises with implications for tax administration which are not within the ambit of the tax authorities.
Similarly, exemption allowed to agricultural incomes from federal income taxes is the most glaring example which has its basis in the constitution of the country, that in turn limits the taxpayer's base and increases the burden of tax on the non-agriculture and non-corporate sector.
The Section 41 of the Ordinance, in line with constitutional provision, exempts agricultural income derived by a person from tax under the Ordinance. Although the tax to GDP ratio has increased to 9% in 2005 still it is the lowest in the region.
The reason being that the sector creating the great distortion is the agriculture sector by not paying tax proportionately to its share in GDP. It has been felt that agriculture, having 21.5% of GDP, has the lowest contribution of only 1.2% in taxes, which is the main reason for the lowest tax to GDP ratio.
This lowest contribution of agricultural sector highlights the need to bring this untapped income into tax net for broadening the tax base.
The late Z.A. Bhutto had introduced for the first time the tax on agricultural income. But the late General Ziaul Haq after take-over of the government, among others, repealed this reform without making any formal announcement and won his side all the feudal that have powerful patrons and they continue to be the best in democracy.
It is now argued that agricultural income is a provincial subject and it is being taxed by them. The agricultural-related taxes were introduced in Sindh in 1994. Since then agricultural tax is declining in the last four years. Its collection was .Rs 201 million in 2003-04 compared to Rs 444.77 million in 2000-01.
Although the fact is that the rural elite gets 33% subsidy on electricity bill of their tubewells, agricultural loans disbursed during July-March 2004-05 amounted to Rs73.8 bn against Rs47.9 bn during the corresponding period last year, in addition the loans given by commercial banks surpassed Zarai Taraqiati Bank for the third consecutive year at concessional rate of interest, allowed free of duty import of tractors, supply of fertilisers at the cheaper rate, despite all these incentives allowed to them at a substantial cost to the tax years, but hardly they pay farm tax on their income.
The second category as a result of political lobbying and constitutional anomalies is the exclusion of the immovable property from the ambit of capital gain. Section 37 of the Ordinance excludes any immovable property from the definition of capital asset, in line with item 50 of the Federal Legislative List Part-I, Fourth Schedule of the Constitution.
Thus the imposition of tax on the capital gains arising from transfer/sale of immovable property is beyond the taxing power of the Federation. Addressing a seminar, the CBR Chairman said to the business community that black economy has no future in the country whereas gain on sale-purchase of immovable property/open plots is exempted from tax constitutionally which fuels black economy and raises the prices of the properties beyond the reach of the genuine buyers. It also encourages the speculative business in the stock market.
The Economic Survey Report 2004-05 indicated that as compared to the last few years, in the year 2004-05 the cost of exemptions in taxes had registered a massive growth. By 25.5% to Rs 24.85 billion from Rs 19.80 billion in the year 2003-04 as sector wise break-up is given the in table below:
It will be observed from the above table that revenue loss due to exemptions available under customs increased by 181.4% during the year 2004-05 compared to such losses under other statutes. The total number of exemptions available to taxpayers under the Second Schedule Part I to the Ordinance stands around 100.
And the total cost of these exemptions under income tax head stood at Rs 4.60 bn during 2004-05. It may be noted that this exemption amount did not include total exempted income under the agricultural sector nor capital gain.
Further break-up of the said 100 exemptions shows that around 20 % of them are related to the salaries, allowances and perquisites derived by the members of the Armed Forces of Pakistan and about 10% of them relates to the legislatures, the government officers and judiciary.
Further analysis of revenue collection and exemptions allowed in 2004-05 shows that revenue collection from customs was third in rank at Rs 113.9 bn equal to 19% of total collection made in 2004-05 whereas the loss of revenue occurred to the national kitty owing to duty exemptions was at the top of it at Rs 12.78 bn. Further collection from GST was at the top than other sources of revenue at Rs 239.53 bn equal to 41% of the total revenue generated in 2004-05.
Further break-up of it shows that 40% revenue from GST was from domestic consumers and 60% was attributed to import. Revenue from direct taxes contributed Rs 182.7bn in 2004-05, which was 44% of total indirect tax revenue collected.
This trend shows that revenue target surpassed the original target of Rs580 bn for 2004-05 was attributable to the import activities increased and it did not reflect impressive performance of the tax authorities.
Moreover the significance of sales tax has grown over the years, presently contributing 58.7% of indirect taxes or 40.5% of tax revenue. Thereby the common man is burdened with the tax more and more which negates the claim of the government that poverty reduction goal is achieved.
However, the import activities increased during the year but revenue on this score did not match its increase; The share of customs duty collection to total indirect taxes has been reduced to 28% because the import tariff under the donor's pressure has been reduced considerably. The revenue collection from the customs has resultantly decreased.
The government's present policy to reduce the import tariff to the minimum has rendered the imported goods cheaper than locally manufactured goods available in the markets. The markets are flooded with Chinese goods in particular and others European countries in general.
Consequently local industries are facing closure and unemployment is increasing. The governments under pressure of the donors who have subjected it to brutal plunder under neo-liberal reforms.
The history is the lesson that under the pressure of the donors IMF and WB who forced Zambia to adopt economic reforms under the cover of sweeping trade liberalisation, dismantling public sectors and massive privatisation, it was forced to lower tariff on textile imports, especially used clothes, which caused a surge in import of cheap second hand clothing from industrialised countries. Resultantly, the textile sector of the country not only collapsed but vanished and around 30,000 people lost their jobs.
A similar situation is being created in our country under the beautiful slogan of economic reforms and trade liberalisation by the IMF and WB, supported by US and their allied countries. Our import bill has surpassed the export earning 32%, local industries are adversely affected and revenue collection from customs has also decreased.
These factors are warning bells for the government to review its policy on import tariff. It may be understood that increase in aid from the donors gives greater lever to them to impose more conditions on our economy.
In the circumstances that the Chairman of CBR has made appeal to the business community to join hands to achieve the ambitious target of Rs 690 bn set for the year 2005-06.
In order to expand the tax base, overhauling of the exemptions provided in the Second Schedule is necessary to determine whether the objective set by providing these incentives, the growth of investment or the welfare of the general public is achieved. For instance the income of the Mutual Funds, Modarabas or capital gain income from the sale of shares etc is exempted under different clauses of the Schedule from tax chargeable under the Ordinance which needs to be reviewed in the present scenario of growth achieved in these sectors, since these exemptions were allowed to them at a time when these sectors needed incentives in the year 1981 onward.
But presently these Funds have matured enough that they have surplus funds, which are utilised for investment in acquiring banks and industrial projects by their operators. These factors are pointers that they no more need exemptions from tax but they may be made to contribute to the national exchequer. It will facilitate the CBR to expand the tax base.
It would be interesting to mention the glaring example that recently inserted clause (106A) in the Finance Act 2005, has exempted from income tax the corporate entities of WAPDA which were granted exemption from income tax for the assessment years 1998-99 to 2000-01as per ECC decision on January13, 1998. That is after the exemption period has expired about four years ago, it has now been exempted with retrospective effect for unlimited period.
The agony is that the powers conferred to the Federal Government u/s 53 of the Ordinance are being misused through its applicability retrospectively.
The CBR has double standard policy in respect of levying or exempting any income from tax.
It also discriminates among the sectors. For instance it is squeezing the manufacturing sector, which contributes 61% taxes, while its share in GDP is only 15.9% whereas it has left the agriculture sector having 21.5% of GDP but its yield in taxes is only 1.2%.
The increase in the income tax collection during the last few years is mostly due to withdrawal of around 90 income tax exemptions from the Second Schedule of the Ordinance as part of IMFs conditionalities under the Poverty Reduction and Growth Facility programmed rather than expanding the income tax base. However, it is possible that the scope of the tax base may expand if the exemptions in the Second Schedule are curtailed further.
In order to enhance the growth rate there is need to expand the tax base but the government also should take into account seriously the losses occurring in the public sector and subsidised government corporations/authorities on account of irregularities and mismanagement of the funds. WAPDA has sustained a loss of Rs 10.39 bn.
Moreover, the Accountant-General has pointed out that National Highway Authority sustained a loss of Rs 74 bn on account of irregularities in 2002-03. The waste of taxpayer's money in such a manner is a source of discouragement for them to pay taxes.
The situation needs a study on vital tax policy issues for broadening the incidence of tax to all sectors of the economy and giving relief to those sectors which, appeared to be over-taxed. While the government claims that the economy has attained high growth it continues to face several challenges and the social indicators present a different picture; poverty continues to affect millions of households. The economic governance has to be improved so that the benefits of growth reach the masses.
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2004-05 2003-04
(Rupees in Bln)
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Customs 12.38 4.40
Sales tax 7.85 9.25
Income tax 4.60 6.15
Central Excise Duty 0.02 -
Total Rs 24.85 19.80
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