Regressive taxation and rising poverty

The shrinking share of direct taxes in overall collection of taxes at the federal level should be the immediate cause of concern for the government, parliamentarians as well as policymakers sitting in the Ministry of Finance and the Federal Board of Revenue (FBR).
It is now well-established that there is a direct link between growing poverty in Pakistan and distortion in tax base since 1991, when a major shift was made by introducing presumptive taxes (indirect taxes in the garb of income tax). The lack of judicious balance between direct and indirect taxes has pushed an overwhelming majority of Pakistanis towards the poverty line.
According to a press report, in the first half of the current fiscal year 2008-09, the share of indirect taxes rose to 62 percent and that of direct taxes dipped to 38 percent confirming that the "taxation system in Pakistan, contrary to the rest of the world, is highly regressive". The report did not take into account, the portion of the so-called income tax collection which is in fact indirect in nature.
If this was counted for, the share of indirect tax is not less that 78 percent in the total collection of FBR. A report recently submitted to the Economic Co-ordination Committee, admits that owing to heavy taxation of consumer items, the share of indirect taxes has registered a growth of 26.8 percent. General sales tax registered a growth of 28.3 percent, customs duty collection witnessed surge of 18 percent and federal excise duty went up to 33.9 percent.
The central goal of Tax Administration Reforms Project (TARP), funded by World Bank and Department for International Development (DFID), was to improve the direct taxation collection and minimise the indirect taxes to make the taxation system just and fair. However, at the fag end of the completion of TARP, the result is just the opposite.
This is how we implement our programmes and then blame IMF, the World Bank and other donors for our own wrongdoings. The Chairman FBR, before the Senate Standing Committee on Finance, conceded that "increase in direct taxes is one of the major challenges before the Board". Due to wrong policies of the successive governments - civil and military alike - the poor have been burdened with more and more taxes.
What makes the situation more painful is the fact that taxes collected are wasted by the rulers on their personal comforts and luxuries and the masses get nothing back out of what they pay to the State. The State has miserably failed to discharge its basic obligation of protecting life and property of its people, what to talk of extending social services free of cost.
Taxes collected are largely being used to provide for debt serving, defence, for the security and foreign tours of the rulers - besides regressive taxation the government resorts to borrowing money from wherever available to run the day to day affairs.
In recent years, the record inflation in the country has reduced the purchasing power of the consumers and the government, instead of giving any relief to the poor has been resorting to heavy indirect taxes to add further to their to these miseries - development surcharge on POL products is the most brutal example. The worsening plight of the poor is largely due to wasteful expenses on the part of the rulers and their hand-picked bureaucracy - which is not answerable to courts or masses.
The FBR data shows that general sales tax at import stage from POL products this year was Rs 43.028 billion as compared with Rs 40.222 billion last year, edible oil Rs 8.792 billion as compared with Rs 6.618 billion, and tea and coffee contributed Rs 1.817 billion as compared with Rs 1.117 billion.
As regards domestic sales tax, POL products contributed Rs 55.667 billion this year as compared with Rs 18.5 billion, telecom services Rs 23.398 billion as compared with Rs 21.809 billion, natural gas Rs 10.065 billion as compared with Rs 8.087 billion last year, cigarettes Rs 4.010 billion this year as compared with Rs 3.96 billion last year, cement sector Rs 1.810 billion this year as compared with Rs 1.734 billion last year.
Customs duty collection in July-December from POL products this year was Rs 12.590 billion as compared with Rs 7.293 billion last year. Federal excise duty collection in July-December period on cigarettes this year was Rs 15.460 billion against Rs 11.224 billion last year, cement Rs 8.616 billion as compared with Rs 6.828 billion last year, beverages Rs 5.5 billion as compared with Rs 3.3 billion last year.
Withholding taxes, major part of which is indirect tax due to presumptive taxation under the Income Tax Ordinance, 2001, during July-December period at imports was Rs 15.047 billion against Rs 12.641 billion last year, telephone bills Rs 10.356 billion against Rs 8.680 billion last year, deduction from salary Rs 12.042 billion against Rs 9.030 billion last year, bank interest Rs 5.868 billion against Rs 4.802 billion last year, dividends Rs 4.196 billion against Rs 3.105 billion last year, electricity bills Rs 5.597 billion against Rs 3.009 billion last year, deduction from cash withdrawal from banks at Rs 5.186 billion against Rs 2.790 billion last year.
The contribution of direct taxes as percentage of GDP was merely 3% in 2007-08. The pathetic state of affairs in respect of tax-to-GDP ratio in Pakistan for the last five years from 2003-04 to 2007-08 is highlighted in Table A. It is shocking to note that out of total "income tax collection" for the fiscal year 2007-08, presumptive taxes are to the tune of nearly 32%. In other words the total collection of income tax as reduced by these taxes is not more than Rs 250 billion.
Out of total collection of Rs 1040 billion by FBR in FY.2007-08, regressive taxes are to the tune of Rs 750 billion (after making adjustment of indirect taxes collected under the name of income tax!). In the face of this undeniable fact, the FBR in its advertisements in various newspapers has been claiming that "taxpayers are partners in progress".
One wonders what kind of progress the FBR is talking about. The real potential of tax collection for FY 2007-08 was not less than Rs 2.5 trillion. The FBR failed to reach even the Rs 1.5 trillion mark by granting generous exemptions and concessions to the wealthy segments of society (exemption under one head alone ie capital gains on stock markets was Rs 112.45 billion according to government's own admission at page 262 of Economic Survey 2006-07].
The FBR only extorts money from the wreaker sections of society through exorbitant taxes [a poor man buying branded salt is paying 16% sales tax!]. It is now adding insult to injury by calling these victims of "fiscal highhandedness" as "partners in progress". The collection of direct taxes as percentage of total revenue is only 24.6% and not 39.6% as claimed by the FBR. The real direct tax-to-GDP ratio for 2007-08 was dismally low at 2.4% and not 3.0% as claimed by the FBR.
It proves beyond any doubt that the tax system is directly contributing to growing poverty as people who possess enormous income and wealth are not being subjected to income tax in Pakistan and poor people are subjected to heavy taxation eg 16% sales tax. Thus the very purpose of redistribution of wealth as the main object of taxation is being defeated.
It is pertinent to mention that in 2008, the government of Sweden collected taxes at 50% of GDP, almost twice as high as the total tax revenue of America and Japan, with both collecting around 25% of GDP. In the European Union, tax revenue, on average, reaches 40% of GDP. We have a dismally low tax-to-GDP ratio and according to FBR will have to wait for 20 years more to come up to the level of many developing countries [see Table B]. This is indeed a sorry state of affairs.
The higher ratio for the industrialised countries is primarily due to the higher level of revenue from social security, payroll taxes, corporate taxes and taxes on domestic on consumption while the taxes from international trade and non-tax revenue are lower. In contrast, in the developing countries the major portion of revenue comes from the indirect taxes, particularly the taxes on international trade and domestic consumption, while the direct taxes have a lower share.
Pakistan GDP-tax -ratio is even below than Sri Lanka and Thailand, which proves beyond any doubt the failure of fiscal managers and tax collectors. The burden of indirect taxes is always passed on the end consumers. These kinds of taxes take a very small portion of a rich man's enormous income and a very large slice of poor man's meagre earning.
The rulers - controlling the State and its resources - are not ready to pay income tax on their collossal incomes from agriculture, which they earn as absentee landlords. They are not willing to cut non-development expenditure at least by 50%. They are not inclined to live like a common man and surrender all the perks and privileges they are enjoying at the cost of taxpayers' money.
On the contrary, they are burdening the masses with more and more indirect taxes. The existing ill-directed, illogical, regressive and unfair tax system is widening the existing divide between the rich and the poor. The sole stress on indirect taxation [even under the garb of income taxation through presumptive tax regime on goods and services] without evaluating its impact on the economy and the life of poor masses is a lamentable policy.
In the name of higher growth in tax collection, the economic and social fabric of society is being destroyed. This policy of Musharraf is religiously being followed by Zardari et al - the only difference is that Shaukat Aziz is replaced with Shaukat Tareen.

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Table A: Tax-to-GDP

                Ratio-2003-04 to 2007-08

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Year             Tax/GDP Ratio (%)

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             Direct    Indirect    Total

              Taxes      Taxes     Taxes

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2003-04        3.0        6.2        9.2

2004-05        2.4        6.5        8.9

2005-06        2.5        6.9        9.4

2006-07        3.3        6.4        9.7

2007-08        3.0        6.5        9.5

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Source: FBR YEAR BOOKS

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Table B: Tax-to-GDP ratio of

 selected countries

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Country                        %

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Belgium                     43.3

Netherlands                 42.9

Germany                     26.6

United Kingdom              34.2

United States               25.1

Malaysia                    19.2

Thailand                    16.1

Sri Lanka                   16.0

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