Researching tax

Over the last two months, a series of developments at the FBR have raised hopes that some progress may finally be had towards expanding the tax base in the country. Recent news flow is also heartening.

At the one end, the tax body is musing over a supra-national law to help it collaborate with Nadra and collect third party data to help run analytics for the purpose of finding tax evaders. And at the other end, it has initiated inquiries against major shopping malls and housing societies to plug revenue leakages. These are important steps in the right direction, one which require increased focus in collaboration with provincial tax authorities and the academia.

Thanks to the first of its kind tax expenditure report published by the FBR a few months ago, we now have some idea of the tax expenditure incurred by the state under each specific clause of income, sales, and customs tax laws. But estimates of tax expenditure do not shed light on tax evasion by specific clusters and sectors.

By definition, tax expenditure estimates are unadjusted amounts, which means that eliminating or repealing specific exemptions, credit etc would not necessarily yield rupee amounts estimated as tax expenditure. This is because actual tax receipts depend on a wide variety of factors including tax enforcement, taxpayer behaviour and compliance, and a host of macro and microeconomic factors.

As a measure of increasing documentation and to come up with estimates of tax evaded, the FBR should join hands with provincial tax authorities and the academia to first estimate the size of various markets, industries (including the mapping of manufacturing and shopping clusters), and then come up with estimates of tax losses to the state. Tag teaming with provincial authorities is important not only because service sector GDP is huge and GST on services is a provincial subject but also because mapping the service end of the economy would help track and trace the whole value chain.

Two other important extensions to FBR’s quite useful work on tax expenditure estimate warrants consideration.

The first is impact analyses of specific exemptions, credits and so forth. While the list of specific exemptions, credits, etc under umpteen clauses in income/sales/customs laws is rather long, a reading of FBR’s tax expenditure report suggests that only a handful of items account for the biggest share of expenditures under each of tax heads.

The impact of these big-ticket exemptions can and should be jointly studied by FBR and the academia, and to that end the tax body should seek research collaboration with the likes of Pakistan Institute of Development Economics. Afterall, as growing body of tax literature shows investors do not always consider tax incentives to be a decisive factor when considering investments in developing countries; who knows how many useless exemptions does Pakistan have.

The second involves exploratory research to assess the impact of substantial reduction in tax rates applied on a flat rate on growth in any given sector, and its overall impact on economy. This is an important area to understand because as such tax expenditure estimates are static, or in other words tax expenditure estimates do not account for changes in taxpayers’ behaviour. If benchmark tax rates are reduced substantially, tax compliance may rise, and a bigger area of economic activity may start coming into the documented segment. This exercise may well be done as a short-term socio-economic project.

Research on fiscal affairs is critical towards expanding the tax base and other facets of tax reforms. One hopes FBR’s ongoing reform strategy includes becoming a research-based learning organisation.