Pakistan's tax system: Appallingly inadequate!

There have been constant claims during the past two years that the Ishaq Dar-led Finance Ministry has reformed the tax system though its work is not yet complete - evident from the rise in tax as a percentage of Gross Domestic Product (GDP). The ever rising number of Dar's critics argue that this claim is seriously flawed not only because there is routine data manipulation through overstating revenues figures of an outgoing year due to advanced tax collections and freezing refunds, a practice common enough during the tenure of his predecessors, but also through engaging in accounting jugglery including through taking non tax revenue items and placing them under other taxes.
These are serious charges against the Finance Minister and it is relevant to evaluate whether they are at all credible. The following table notes the budgeted revenue projections, revised estimates as well as the projections for the budget year leading to four obvious areas of concern.
First, in 2012-13 budget documents, the last year in the tenure of the PPP-led coalition government tax to GDP ratio for the completed year (2011-12) was budgeted at 10.2 percent with revised estimate of 10.3 percent while the projected ratio for the budget year was 11.1 percent. However, Dar's budget documents of 2013-14 reveal a budgeted projection for 2012-13 not at 11.1 percent but 10.9 percent - a downgrade which is inexplicable as the actual projection would have shown a wider gap between what was budgeted and what was realised by the PPP-led coalition government including the three months of the caretakers. He however did not manipulate the budgeted FBR tax to GDP ratio for 2012-13 though actual data reflected achievement of rate of 8.8 percent only and this in spite of the fact that Dar raised taxes effective the day of the budget rather than from 1 July - the start of the new financial year).
Secondly in 2014-15 Dar's budget documents showed that the government over achieved its revenue targets during its first year in power - 9.5 percent was budgeted (which Dar raised to 10.9 percent) and revised it downward to 10.6 percent while projecting 11.5 percent for the year and claiming at the end of the year that the budgeted target was achieved. There is no doubt that 11.5 percent tax to GDP ratio is an improvement on the PPP years. However to achieve this target Dar, as the nation has come to expect of him, juggled data from non-tax revenue to other taxes. The three items that were included as non tax revenue till 2013-14 budget documents and itemised under other taxes in the year just past include: (i) petroleum levy targeted to generate 135 billion rupees in the current year as opposed to 126 billion rupees as per the revised estimates of last year, (ii) gas development surcharge budgeted to generate 30 billion rupees in the current year with the same amount realised last year, and (iii) 145 billion rupees generated from gas infrastructure development cess in the current year as opposed to the same amount budgeted and realised in the year just past. Or in other words a total of 310 billion rupees was taken away from non tax revenue and placed under other taxes. This shift showed a tax to GDP ratio higher than what is in fact the case and perhaps duped the International Monetary Fund (IMF) team as well as our other creditors that taxation reforms are well under way; or perhaps, sadly, the focus of the Fund has simply shifted to overall revenue irrespective of its source.
One would have assumed that with three of the non tax revenue components included in tax revenue total non tax revenue would have declined considerably. Non-tax revenue declined from the revised estimates for the year past of 1042 billion rupees to 894.5 billion rupees in the current year's budget. This decline of around 147 billion rupees is less than half of the 310 billion rupees of non tax revenue that is parked under other taxes. Dividend income has been shown as 88 billion rupees for the current year as opposed to the 83 billion rupees in the revised estimates of last year. And given the sale of shares of profitable state owned enterprises, a policy decision in violation of the PML-N manifesto that committed to the sale of only loss making units, the amount of dividends should have declined. Not so as the bulk of dividends are from the oil and gas sector, so maintain government sources with a degree of validity. The remaining shortfall in non tax revenue as per the budget documents would be met through PTA 3 G license generating 65 billion rupees (inexplicable as the license for this has already been issued with no new planned auction given the state of the economy) and around 10 billion rupees from miscellaneous receipts sourced mainly to higher collections from petroleum levy on LPG.
The Dar-led Finance Ministry has been focused on reducing the budget deficit, with unreasonable targets set by the IMF under the 6.64 billion dollar Extended Fund Facility, a commitment that has choked the country's growth rate. Dar typically tackled this through understating the deficit and raising reliance on withholding taxes. At present more than 70 percent of all direct tax collections are from withholding taxes which are: (i) not collected by the FBR but by withholding agents and are considered to be levied due to ease of collection rather than an attempt to bring the untaxed sectors into the tax net. In this context for the Chairman FBR as well as relevant staff vociferously defend withholding taxes and show them as direct taxes which is an unethical attempt to claim an improvement in performance where this is clearly not the case; in addition some withholding taxes are passed onto the consumers indicating their indirect tax credentials; (ii) federal government in violation of the ninth National Finance Commission award has not withdrawn excise duties on services sector that are now the domain of provinces, and (iii) the process of refunds on withholding taxes allowed to filers is very complicated and requires hiring tax consultants/accountants which may well raise the cost of the refunds to a level where they are not financially feasible. This, skeptics argue, may well be the intent of the government namely for filers as well as non-filers not to claim refunds on withholding taxes as the process is costly and cumbersome. Critics point out that even refunds to exporters are much delayed - a fact that is seriously compromising the country's exports and our macroeconomic indicators - so individual refund claims are unlikely to be on FBR's priority. Economists claim that withholding taxes on traders may be the last straw on the camel's back as traders are paying heavy taxes under the withholding regime (including 200 billion rupees annually on imports) while increasing the burden on consumers as many of withholding taxes are passed onto the consumers.
What perhaps is the single most serious charge levelled against the Dar-led Ministry is that there has been little indication of any decline in expenditure. In short austerity remains elusive as it did during the tenure of the Zardari-led government. To conclude, there is an urgent need to revisit the tax system with the objective of making it fair and equitable. Heavier reliance on withholding taxes or taking non tax revenue items and placing them under other taxes is a dishonest practice and in no way indicates that the tax system is being reformed. The ruling party would do well to make an independent assessment of the tax system as it completes its half term or else it would have to pay a heavy political price in the next general elections.

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Budget document year 2012-13 2013-14 2014-15 2015-16

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Tax to GDP for previous year (budgeted) 10.2 10.9 10.9 11.5

Tax to GDP revised 10.3 9.9 10.6 11.5

Projection for budget year 11.1 10.6 11.5 12

FBR tax to revenue for previous year (budgeted 9.3 10.1 9.5 9.7

FBR tax to GDP revised 9.5 8.8 9 9.5

FBR projected revenue 10.1 9.5 9.7 10.1

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