High cost of tax exemptions

The culture of tax exemptions has always been a major problem of Pakistan's fiscal regime. According to certain credible sources quoted by a well known newspaper of the country (The News), the losses to the exchequer because of the failure to expand taxation to agriculture and services sector and to eliminate non-standard exemptions amount to at least Rs 300 billion per annum.
Tax authorities are aware of the high contribution of services and agriculture sectors in total GDP, but concede the fact that they are reluctant to move in the desired direction due to certain difficulties which are almost beyond their control. The cost of tax exemptions which witnessed a steep hike in the outgoing fiscal year has gone up further during the current fiscal year. The cost of exemptions in the shape of income tax was Rs 121.9 billion, followed by custom duties Rs 50.5 billion, sales tax Rs 12 billion, and federal excise duty Rs 0.5 billion during 2006-07.
The revenue loss on account of capital gains was estimated at Rs 112.4 billion. Tax managers were reported to have recognised this policy weakness during a recent meeting with the IMF mission but underscored the need to proceed gradually in this area, taking into account "political considerations".
Such a heavy leakage of revenues, in our view, should be simply unacceptable in the situation currently being faced by the country. Pakistan's tax revenue-to-GDP ratio at around 11 percent is relatively very low compared to other regional states, which limits the availability of resources for infrastructure development, poverty alleviation etc. The position this year is particularly difficult and the trend suggests that the initially envisaged target of tax revenues of Rs 1,025 billion is hard to achieve.
On the other hand, there have been heavy expenditure overruns due to strong growth in development expenditures, and higher than envisaged interest payments and energy subsidies. The cash fiscal deficit has already reached 1.6 percent of the annual GDP in the first quarter of 2007-08 as compared to 0.5 percent in the corresponding period of last year. It is estimated that in the absence of adjustments in fuel prices and electricity tariffs, subsidies could exceed the amount budgeted for the current fiscal year by more than 1.5 percentage points of GDP.
Obviously, while the prevailing situation calls for renewed and concerted efforts to plug all the loopholes in the tax system, the reports of increasing revenue loss due to tax exemptions are too grave to ignore. The loss of revenues will be many times more if the impact of tax evasion and the losses suffered due to the large existence of informal sector/underground economy are also added.
In all likelihood, the country could meet all its genuine current and development expenditures if only the relevant authorities could muster the courage and do the dirty work to stop the menace of high incidence of tax theft by legal or illegal means. The task is, of course, difficult but not impossible. After all, some other countries in similar situations have been able to overcome this problem. The FBR has so far failed to make the needed breakthrough despite repeated claims of making progress on the reform agenda.
Tax exemptions and evasion do not hurt only budgetary outcomes but also have serious implications in certain other areas of public policy. If tax exemption is granted to a certain sector even for genuine reasons, other sectors and vested groups would also clamour for similar treatment and most of the time it becomes difficult for the government to resist such pressures. Also, tax exemptions/evasion are generally inequitable by their very nature because the governments often try to compensate for this loss by increasing the tax rates on less vocal sections of society which are generally poor or by adjusting upwards the rates of indirect taxes, the incidence of which falls mostly on ordinary people of the country.
Also, the rich and the influential could park a bulk of their incomes in exempted sectors and deprive the government exchequer of lawful taxes due from them. Overall, we feel that the news item highlighting the actual loss due to tax exemptions needs to be taken seriously with a view to stopping this haemorrhage on the budget and improve the fiscal regime of the country. In no way, political and other considerations should be allowed to hamper the effort in this direction.