Simplification of taxes for growth — I

The biggest challenge on tax mobilisation front faced by Federal Board of Revenue (FBR) is bridging monstrous tax gap through automation and introduction of tax intelligence system and not levying more taxes or enhancing the rates of the existing ones.

“If we were to construe Entry 52 of the Legislative List keeping in view the above meanings of the expression “in lieu of”, it becomes evident that the Legislature has the option instead of invoking Entry 47 for imposing taxes on income, it can impose the same under Entry 52 on the basis of capacity to earn in lieu of Entry 47, but it cannot adopt both the methods in respect of one particular tax. Since under sections 80-C and 80-CC the imposition of presumptive tax is in substitution of the normal method of levy and recovery of the income tax, the same is in consonance with Entry 52”—Supreme Court of Pakistan in the Messers Elahi Cotton Mills & others v Federation of Pakistan & others [ PLD 1997 Supreme Court 582].

Budget 2021 for fiscal year 2020-21 is in the making in the midst of very difficult times when we are faced with economic meltdown due to Covid-19 outbreak—the third wave is playing havoc with re-imposition of smart lockdowns in many areas of various cities. The protection of human lives and mitigating extreme financial hardships faced by weaker segments of society need to be given the top most priority. The traditional approach adopted for decades in Pakistan for balancing the books, levying more taxes, containing fiscal deficit and other number games will have to be reconsidered in totality under the prevalent exceptional circumstances. In this series, we will present concrete measures to simplify taxes for growth leading to better revenue collection without hampering the already troubled and how to revive it fast and then move towards growth.

Like all other nations in the coming days, we will have to strive harder to ensure survival and revival of businesses adversely affected by Covid-19 pandemic that employ millions having no other source of income. Overwhelming majority of businesses in the wake of lockdown necessitated due to Covid-19 epidemic is on the verge of closure. These were already suffering due to sluggish economic activities, high utility bills and markup rates. Big to small and medium enterprises have been demanding a comprehensive bailout, including tax reliefs. They are facing difficulties in securing loan facility announced by State Bank of Pakistan to pay salaries/wages. Those on rent are demanding remission/deferment/loan to pay the same. Their demand is of interest-free loan and/or grant to employees to avoid lay-offs as after opening of businesses, they argue, it will require many months to recoup losses and achieve break-even. Amid this bleak scenario, they claim that markup would be an additional burden. There is demand of massive tax reduction, deferment of old and forthcoming liabilities, tax amnesty, and zero taxation for employees earning up to Rs 100,000 per month, waiver of advance income tax and over 75 withholding tax provisions contained in the Income Tax Ordinance, 2001, Sales Tax Act, 1990 and all provincial laws relating to sales tax on services.

Unfortunately, nobody is talking about raising revenues by suggesting and taking some out-of-box measures. Somebody needs to tell the Prime Minister that the iniquitous prescription of erratic and oppressive taxes in the forthcoming federal budget will not solve our problems especially in the prevalent circumstances. The federal and provincial governments need to generate and spend more money on infrastructure improvement to create more employments and ensure higher growth, engaging private sector to take part in public projects. This would kick-start the economy. Simultaneously, the governments need to reduce wasteful expenditure, right-size the monstrous size of their machinery, monetize all the perquisites of bureaucracy and make taxes simple and low-rate. State lands, lying unproductive owned by the federation and provinces, should be leased out for industrial, business and commercial ventures. It will generate substantial funds, revenue (through public auction 5% as full and final tax can be collected amounting to billions) and facilitate rapid economic growth.

The World Bank in its report, Pakistan Revenue Mobilisation Project, has noted:

“Pakistan’s tax revenue potential would reach 26 percent of GDP, if tax compliance were to be raised to 75 percent, which is a realistic level of compliance for lower middle income countries (LMICs). This means that the country’s tax authorities are currently capturing only half of this revenue potential, i.e., the gap between actual and potential receipts is 50 percent. The size of the tax gap varies by tax instrument and by sector. The tax gap in the services sector is larger than in the manufacturing sector (67 percent vs. 46 percent respectively) and it is larger for the GST/GSTS than for income tax (65 percent vs. 57 percent respectively)”.

The World Bank, before mentioning tax gap, has not done proper research or study on oppressive taxation and fragmented structures at federal and provincial levels that are the main cause of our fiscal problems. In this series, the fundamental issues will be highlighted along with solutions—details can be seen in ‘Towards Flat, Low-rate, Broad and Predictable Taxes’ (PRIME Institute, Islamabad, 2016, now its revised and enlarged version is published in December 2020 is available free at: https://primeinstitute.org/towards-flat-low-rate-broad-and-predictable-taxes/).

Federal and provincial governments in Pakistan have shown a lukewarm attitude towards restructuring the country’s tax system to achieve efficiency, equity and to promote economic growth. Complex tax codes, complicated procedures, reliance on easily-collectable indirect taxes, weak enforcement, inefficiencies, incompetence and corruption are main factors for low tax collection.

Instead of broadening the tax base and simplifying laws, federal and provincial governments offer amnesties, immunities, tax-free perks and perquisites to powerful segments of society. As a result of this policy mindset, ordinary businesses and citizens suffer. In the above cited study we have presented the roadmap for radical revamping and restructuring of the entire tax system, suggesting broad, lower-rate taxes and collection through automation as highlighted in Automation of revenue collection—I, Business Recorder, February 1 & Automation of revenue collection—II, Business Recorder, February 7, 2019.

Tax reforms undertaken to date, have mainly been patchworks, and proven to be an exercise in futility. Tax reform commissions and consultative committees, constituted for reforming the system, have proven to be unsuccessful as they have been suggesting remedies for curing the incurable or otherwise curing symptoms rather than addressing real causes.

The reforms, including World Bank-funded six-year-long Tax Administration Reforms Project (TARP), miserably failed to motivate people towards voluntary tax compliance. The number of tax filers (excluding those filing income below taxable limit of paying negligible amount to become part of Active Taxpayers List to avoid higher incidence of withholding taxes) is still extremely low due to complex and cumbersome procedures, even filing of e-return is not possible by the well-educated class, what to speak of small and medium enterprises (SMEs) and individuals doing business at small level. The number of sales tax registered persons and those actually paying any substantial amount is even more pathetic (less than 50,000).

In 2020, the federal government obtained a loan of US$400 million for Pakistan Raises Revenue (PRR) Project. It may be mentioned here that the total cost of Pakistan Raises Revenue (PRR) Project is estimated at US $1.6 billion, of which the counterpart contribution is $1.2 billion and IDA financing is US$400 million. Following in the footsteps of the Federal Government, the Punjab Government decided to borrow US$304 million from the World Bank for tax reforms and it was approved by Planning Commission on September 16, 2020. Like earlier programmes, these are also bound to fail as stakeholders are not taken on board.

The only viable option for meaningful change is to replace the existing tax system with simple, low-rated tax on a broad-base, pragmatic and growth-inducive. With such a system in place, those who are not into the tax net or who avoid true disclosures would be encouraged to pay their taxes voluntarily, honestly and diligently. It will create incentives for better compliance and lead to accelerated economic growth. A paradigm shift is required to restructure the entire tax system to induce more investment, accelerate growth and ensure economic prosperity for the country benefitting all members of society. This should be coupled with transparent and quality spending of taxpayers’ money for welfare of society as a whole and incentivizing growth and economic well-being of every individual. All these areas will be explained in the forthcoming parts of this series.

(The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS))

Copyright Business Recorder, 2021