Augmenting the tax-to-GDP ratio

Pakistan must augment its dismal tax-to-GDP ratio of 9 percent to meet the financial requirements for rehabilitation and reconstruction of the flood/militancy and earthquake-hit areas. The Federal Board of Revenue (FBR) wishes to increase the ratio to 15 percent by 2015, which is a must as a high tax-to-GDP ratio means sustained socio-economic development as more money is there for developing different sectors of the economy and for uplifting the living standards of the people.
World leaders generally and the US foreign secretary Ms Clinton especially, have been repeatedly urging that Pakistan should raise its own tax-to-GDP ratio and its rich should contribute to the efforts at first before asking the international community for money for reconstruction after the floods.
According to Hillary Clinton, the most important step Pakistan can take is to pass meaningful reforms to expand its tax base and that the rich and elite support the government and people of Pakistan. The ratio, unfortunately, has been on the decline for the weak and corrupt tax collection machinery, smuggling, frail commitment to raise new taxes and bring untapped areas under the tax net. According to an estimate, the government was losing around Rs 500 billion a year in taxes. Governments have always expressed their concerns on the issue but the remedy often resorted to has been defective.
Very few people in Pakistan pay taxes. Only 2.5 million of the total population of 170 million pays direct taxes, which include 1.8 million salaried taxpayers. It is shameful to say the least. According to a report jointly released by FBR, Georgia State University and the World Bank last year, that every man, woman and child in Pakistan is evading taxes worth Rs 4,800 annually and the existing tax gap stood at 67 percent of the actual tax receipts.
"The narrow tax base, tax evasion, distrust of taxpayers and administrative weaknesses have taken a toll on tax collection and some sectors are more heavily taxed than others. Agriculture contributes about one-fifth of GDP, and amounts to no more than one percent of the FBR revenue. Given the shortfall in agriculture and services, the industry carries the brunt of the tax burden, and its tax share is three-times as high as its GDP share," the report says.
Political and religious leadership leads from the front but the Pakistani leadership has not been creating good precedents for the people. According to a report in a national daily, Prime Minister Yousuf Raza Gilani and his 25 ministers and a top religious leader and his brother in sworn affidavits submitted to the election commission of Pakistan at the time of their elections, have admitted that they don't pay any income tax.
Extremely hesitant as the Pakistani leadership is to cut down on their bourgeoning current expenditure, the shortage of funds in wake of less taxes leaves little room with the government other than either to slash development budget or seek expensive foreign debts as has been witnessed in the post-flood situation in the country.
Rather than expanding the tax-base by bringing more people under the tax net, the existing tax-payers, mainly the salaried class, have been subjected to an increased tax ratio by successive regimes. This has resulted in an increased resort to theft in taxes and services by the people and entrepreneurs. Tax exemptions are making things further worse. The economic survey 2009-10 states that the mighty and influential sectors and individuals have managed to secure tax exemptions worth Rs 147 billion in major taxes.
The national economy has also received both internal and external shocks during the past thirty plus years. Prolonged load-shedding and the law and order situation have dealt a severe blows to the industrial sector in the country. Naturally when productivity is affected by these factors, how are the entrepreneurs expected to give huge taxes.
Direct taxes were Rs 520bn as against the initial target of Rs 544bn last year. This year it is Rs 633bn, which also seems impossible given the straight record of the tax collection machinery. A broadened but rational and balanced tax structure with minimal exemptions is needed direly, but it requires a strong political will to do so on part of the government which unfortunately is no there.
Shaukat Tarin, the former finance minister, had promised to bring agriculture, stock exchanges and real estate business in the tax-net for increased revenues, but he was resisted and instead shown the door by the powerful lobbies. Last year, the former finance minister Hina Rabbani had said that Pakistan had a three-year plan for shifting from indirect to direct taxes, expanding the tax base and taxing the untaxed sectors, but the ideas seems to have been abandoned to the detriment of the people and development.
To get the country out of its current economic turmoil, a strong political will, urge to excel and development as priority number one are required. Importance of clear vision, a sustained growth strategy and political will can't be overemphasised.
To ensure industrial growth and the full potential of the industries, the government should overcome the energy shortage and build as many big and small hydro-power generation units as possible. More economic activities and development would yield more taxes. For raising the tax ratio, smuggling to/from Afghanistan and Iran would have to be stopped or controlled. The informal economy is thought to be two times bigger than the formal economy of Rs 16,000 billion. Corruption will have to be brought down, if not eliminated altogether.