New tax model

Unlike many other countries of the world, Pakistan's apex revenue authority, Federal Board of Revenue (FBR), has never bothered to launch well-designed Voluntary Tax Compliance Programmes backed by strict enforcement actions against defiant citizens. Resultantly, the number of persons filing income tax returns in Pakistan is pathetically low (below one million), though the number of persons subjected to withholding taxes is over 50 million. Since 2002, when the new Income Tax Ordinance 2001 was made effective, FBR has miserably failed to implement 'universal self-assessment scheme' by employing modern audit techniques backed by a deterrent in the form of effective Tax Intelligence Systems (TIS). Exploiting the self-assessment scheme, the non-reporting and under-reporting of incomes, evasion of sales tax and federal excise duty is rampant in Pakistan. The government, instead of launching a crack down on untaxed money, has always adopted the policy of appeasing tax cheats extending generous whitening schemes.
The failure of FBR is on two counts; firstly it has failed to collect taxes from where these are actually due thus paving the way for an enormous parallel economy and secondly it could not induce the people towards voluntary tax compliance. This has created a malevolent malady-social injustices where the rich are enjoying a luxurious life while millions are living below the poverty line.
The failure to collect assigned targets by FBR is perpetually widening the burgeoning fiscal deficit-it may cross Rs 2 trillion during the current fiscal year. This testifies to bankruptcy of political leadership and economic managers. Policy of giving a free hand to inefficient tax officials and appeasing tax evaders, money launderers and plunderers of national wealth is showing its impact in all spheres: political culture of swapping loyalties continues, nation is knee-deep in debt and utter despair-all sectors of economy are showing disturbing indicators. In this scenario, neither political leadership nor 'technocrats' running Finance Ministry have any definitive plans for revitalizing the tax system and curing the ailing economy.
Our real revenue potential is much higher than targets assigned to FBR, which it fails to achieve even after downward revisions. For tapping our actual potential, there is an urgent need to make FBR an autonomous body, bring undocumented economy in the tax net, bridge tax gaps and distribute the incidence of various taxes judiciously amongst all segments of society.
Our rulers and tax officials, corrupt and inefficient, go after small fry but promote and protect the rich and mighty, who corrupt the State institutions with money power. The promoters of untaxed and dirty money sitting in the Parliament declare extremely low incomes, not even enough to run their kitchen. Though they claim to be champions of rule of law and defenders of the rights of the people, their actions speak otherwise. They should be taken to task through an independent accountability commission and punished, if found guilty of living beyond the declared means.
The generally accepted principles of taxation are efficiency (explained by a reduction in distortions in the allocation of resources), equity (requiring the more able to bear burden of paying tax at higher rates) and effectiveness (insulating tax machinery from all outside influences). How can these principles be enforced in Pakistan when the elected members are tax cheat?
Pakistan needs an altogether new tax model, capable of generating sufficient resources for the government and helping the country in paying off its ever increasing debt burden. Taxation, a potent instrument to shape and influence the socio-economic policies of a country, has not received due attention in Pakistan. The foremost objective of a tax policy is raising resources for administration and development, transferring of resources from private to public use. A rational tax policy penalises those who hold assets idly or indulge in luxury consumption. In democracy, the most important objective of taxation is to provide economic justice, which relates to distribution of tax burden and benefits of public expenditure. Taxation of the rich for the benefit of the poor is at the core of social democracy. It encompasses, besides redistribution of wealth, such questions as treatment of weaker sections of society eg women and children, minorities, the disabled and unemployed. All these elements are missing in our polity and tax policy.
The starting point for re-hauling of tax system should be dismantling the existing bureaucratically-controlled structure. FBR should be run by an independent Board of Directors as is the case in many countries. Presently, FBR is run by the headquarters of the ruling political party. Complete insulation of it from political influences is a pre-requisite for a meaningful tax reform agenda. An independent National Revenue Authority should be established involving all the provinces run by All Pakistan Revenue Service (PRS) comprising experts and not bureaucrats having little or defective knowledge of modern tax administration tools.
The rich in Pakistan are either outside the tax net or do not pay personal taxes in accordance with their actual ability to pay. As a result, the poor are overburdened with indirect taxes and withholding income tax-17% to 32% sales tax on most of the items consumed by them and exorbitant withholdings at source though income is below threshold limit of Rs 400,000. Those who control 90% of resources contribute less than 2% in total tax revenue. Pakistan needs to tax every person having an annual income of Rs 500,000 or more at progressive rates irrespective of source of income. This measure alone would generate tax revenue of over Rs 6 trillion provided all exemptions and concessions are abolished.
For generating funds for the poor, the government, through heavy taxation, must discourage certain activities, for example, consumption of luxury goods and tobacco. Such measures act as a deterrent, avoiding a spillover of these items in the society, creating disturbance as a consequence. For providing public transport, education, health, housing and improving environment, special surcharges, congestion cess, and carbon tax should be imposed. Harmonised Sales Tax (HST) on all goods and services through a single national tax agency at the lower rate of 6% is the need of the hour to improve tax-to-GDP ratio significantly.
The existing tax justice system-hopelessly outdated, painfully ineffective and marred with inefficiency and inordinate delays-needs complete restructuring so that fiscal disputes between the State and taxpayers get settled within a year at the latest. No agenda of tax reform can succeed unless an effective justice system exists. The present 4-tier tax appellate system is expensive and time consuming. It should be replaced by a 2-tier system-first appeals should go to National Tax Court with intra-court provision and thereafter proceed to Supreme Court directly by way of leave to appeal. This would settle tax disputes expeditiously and restore taxpayers' faith in the tax system.
(The writers, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS).)