The new paradigm Under the afore-stated situation of lawlessness, a fresh approach and a renewed policy are urgently needed measures to replace the entire taxation system for fiscal consolidation and stabilization. The equation is simple. Federal government needs at least Rs 5 trillion of revenues, for which determination of a fair tax base is imperative. The current complex system, only favours a few thousand officers and their staff along with people having money power and who can blatantly flout the law. It is possible to suggest a simple flat rate tax that is neither burdensome nor difficult to implement but it would deprive the bureaucracy and some vested-interests who would be most likely to oppose it. Nonetheless there is no option but to dismantle the existing, out-dated and anti-growth tax system if we have to overcome the twin but inter-related malaises of fiscal deficit and debt burden.
Arthur B. Laffer and Stephen Moore in their book "Return to prosperity," have expanded upon a theory that meets our existing conditions. While elaborating upon the practicality of flat rate of tax, they write: "Excessive taxation is detrimental to labour and capital, poor and rich, men and women, old and young. Excessive taxation is an equal opportunity tormentor. Businesses locate their plant facilities in order to make higher after tax returns for their owners. In the short run, higher taxes on labour or capital lower after tax earnings. During depressed times, businesses are often desperate to reduce costs because of a shortfall in revenues. Increased taxes in one location can be the final straw leading to businesses' relocating to more tax-friendly locations or making the ultimate decision to close down operations. In the longer run, immobile factors (such as low wage workers and commercial and residential real estate) are left to suffer the tax burden."
Referring to the significance of mode of taxation, the writers draw justification from a noted nineteenth century American economist Henry George who wrote in his book, "Progress and poverty" (1879): "The mode of taxation is, in fact, quite as important as the amount. As a small burden badly placed may distress a horse that could carry with ease a much larger one properly adjusted, so a people may be impoverished and their power of producing wealth destroyed by taxation, which, if levied in any other way, could be borne with ease."
There has to be a source of motivation for taxpayers to comply voluntarily and to some extent eagerly in contributing towards the national exchequer. Whenever the governments resort to high-handedness in collecting taxes, the people term it as broad daylight robbery, instrumental in encouraging tax evasion. As propounded by the eminent authors of "Return to prosperity" on pg. 174:
"The theory of incentives provides the basis for the concept of a flat-rate tax, which is so called because a tax applies equally to all sources of income and does not change as a result of taxpayer's volume of income. Any exemptions, deductions, differential rates, or progressivity would, as a matter of linguistics, preclude the name flat tax. They also represent a deviation from the principles of efficient taxation. Such exemptions to the even application of a single narrow tax base, lead to a higher tax rate, make for greater complexity, and increase tax avoidance."
They further say that: "In the realm of economics taxes are negative incentives and government spending entails positive incentives, subject to all the subtleties and intricacies of the general theory of incentives. People attempt to avoid taxed activities-the higher the tax, the greater their attempt to avoid."
The tax system that will work smoothly for Pakistan, keeping in view our peculiar socio-economic circumstances and mind-set of masses, must be a flat rate with no compliance hassles. All taxes should be merged into one single tax with complete assurance to the masses that they would be free from any kind of harassment; and money collected could be spent towards their welfare. The agenda of fair taxation cannot succeed if wastage of public funds and its abuse by the rulers continue unabated. The quid pro quo for paying taxes is as important as the system to collect tax. Where the public is blamed for not paying their due share, public authorities are equally, if not more, responsible for indulging in corrupt means taking cover of complicated procedures that eventually lead to poor collection of revenue. As mentioned by the writers:
"A flat rate eliminates much of the inefficiency in a convoluted tax system by broadening the tax base and sharply reducing marginal tax rates. Many of the distortions that exist with the current tax system are minimised. A flat tax rate reduces the collection cost per dollar of tax revenue and eliminates much of the bureaucracy necessary to monitor and enforce numerous taxes. Its adoption leads to a surge in growth and creates a more competitive economy."
The tax base with respect to direct tax vis-à-vis fair distribution of incidence can be achieved in the following two ways:
1. 15% tax on net worth tax of exceeding Rs 1.5 million on the closing date (previously known as 'valuation date' under the repealed Wealth Tax Act, 1963); or
2. 10% flat rate tax on net income.
A person could be given a choice to adopt either of the above mentioned bases to pay revenue to the state voluntarily and he should be aware of the fact that competent and effective tax machinery exists having tax intelligence system that can easily detect tax avoidance. Without this deterrence even the new system which is a great deal simpler, will be unworkable. Nowhere in the world is proper collection of taxes possible without a strong enforcement apparatus. However, the apparatus should be friendly and firm - friendly, to the extent of educating and guiding the people for fulfilment of their tax obligations, and firm to the extent of punishing wilful defaulters.
As far as sales tax is concerned, it has been emphasised time and again by us in these columns that Pakistan needs harmonised sales tax (HST) which should be single-stage and single-digit. This envisages collection through a National Tax Authority which should replace all existing authorities at both federal and provincial levels.
The National Tax Authority (NTA)National and provincial assemblies should pass a law agreeing on establishment of NTA responsible for collecting all taxes imposed by the federal and provincial governments. This would facilitate people to deal with a single revenue authority rather than multiple agencies at national, provincial and local levels. The mode and working of NTA can be discussed and finalised under Council of Common Interest [Article 153] and its control can be placed under National Economic Council [Article 156].
The provinces should also feel responsible for better and efficient tax collection. Presently they are isolated and rely on distribution from the divisible pool whereas the Federal Board of Revenue annually collects less than the assigned revenue target. The responsibility to collect revenues should be joint and several giving a participative sense to all federating units.
The NTA should consist of officers and staff should represent federation of Pakistan as in taxes both the centre and provinces have equal stakes. If the size of the pie grows every federating unit will get more and the Centre will also have more money at its disposal. For NTA, an all Pakistan Tax Service should be established. Recruitment for All Pakistan Tax Service must be independent of the present Central Superior Services structure. Competent people having knowledge in accounting, law, IT and administration should be selected through special board comprising members from the existing Federal and Provincial Public Service Commissions.
Determination of direct tax/income-based method According to available data, total number of persons having taxable income of more than Rs 400,000 is between 12 to 15 million and tax base is around Rs 50 trillion (after taking into account informal economy). Flat rate taxation of just 10% with strong enforcement system will yield Rs 5 trillion under income tax alone.
Determination of direct tax/wealth-based taxation According to Credit Suisse, total wealth in Pakistan amounted to $495 billion in 2015. This was $170 billion in 2000 showing that total wealth in Pakistan has increased at an annualised rate of 7.4% during the last 15 years-it confirms how untaxed wealth has been growing and what real size of undocumented economy is. Study of Credit Suisse says that the share of middle-class adults in Pakistan's total adult population of 111 million is 5.7% (6,327,000 adults). To qualify to be a middle-class Pakistani adult, the person must have wealth of at least $14,413. This means that each adult belonging to this class should possess a minimum wealth of Rs 1,527,000 as per present dollar-rupee parity. If state offers 15% optional tax on net wealth to the rich in lieu of income tax, the total collection will be nearly Rs 5 trillion.
The incidence of this levy will not be on the less-advantageous segments of society. There would be fewer people-ultra rich and the affluent-to deal with as well as no income computation and no hassles to engage expensive accountants and consultants. Since cost of compliance would be negligible, the affluent would hopefully pay this tax willingly instead of going for complex income taxation.
Pakistan has the 18th largest "middle class" in the world Pakistan's middle class consists of over 6.27 million people, according to Credit Suisse, a global financial services company. In its Global Wealth Report 2015 released on October 13, Credit Suisse said Pakistan has the 18th largest middle class worldwide. The study has revealed that 14% of world adults constituted the middle class in 2015 and held 32% of world wealth. The share of middle-class adults in Pakistan's total adult population of 111 million was 5.7% in 2015 as opposed to India's 3% and Australia's 66% in 2015. Middle-class Pakistani adults constituted 0.9% of the worldwide middle-class population. The highest concentration of middle-class population in 2015 was in China (108.7 million), followed by the United States (91.8 million) and Japan (62 million). Read: Disproportionately: Taxation system not anti-poor but anti-middle class
Defining 'middle class' Economists use a variety of methods, such as income and standard of living, to define what constitutes the middle class. Credit Suisse uses the measure of 'personal wealth' - or a 'wealth band' instead of an 'income range' - to determine the size and wealth of the middle class around the world.
Taking the United States as the benchmark country, Credit Suisse considers an adult to be part of the middle class if they have wealth between $50,000 and $500,000 valued at mid-2015 prices.
Credit Suisse came up with the minimum and maximum figures for the US middle-class wealth band based on its median earnings and the amount of capital a person close to retirement age needs to purchase an annuity paying the median wage for the remainder of their life. To be a member of the middle class in 2015, according to Credit Suisse, a Pakistani adult must have wealth of at least $14,413. http://tribune.com.pk/story/973649/pakistan-has-18th-largest-middle-class-in-the-world-report/Determination of the indirect tax base
All existing indirect taxes should be replaced both at the federal and provincial levels with Harmonised Sales Tax (HST). There are multiple tax collection authorities now, rendering the life of the ordinary citizen miserable since he is unable to comprehend complex laws without having to pay heavily to professionals.
If the present indirect taxation is replaced with HST as in a comparable federation like Canada, it would not only improve revenue collection but would also help to alleviate the sufferings of taxpayers who have suddenly been bombarded by multiple tax authorities.
In the Pakistani milieu if a single-stage 5% HST is levied, it would yield at least Rs 3 trillion both at federal and provincial levels. A comprehensive study, courtesy Tax Reform Commission (TRC), is already with FBR. In this study, prepared by a sub-committee of TRC, even the matter with respect to cascading of prices has been addressed and dealt with satisfactorily.
All taxable would happily pay 5% tax HST as there would be no:
-- input/output tax adjustments;
-- withholding at the time of receiving payments;
-- issues of unpaid refunds; and
-- long and tedious audit procedures.
Conclusions 1. If we want optimum collection of taxes fairly and without hampering growth, it is imperative to abolish present tax laws and enact new ones.
2. Collection of taxes through a single national agency as suggested above.
3. Establishment of a Tax Intelligence System sending quarterly information to potential taxpayers about their economic activities so that they can be informed in advance as to how their incomes and expenditure should finally look like in their tax declarations.
4. Prudent spending of public money through a transparent process enjoying the confidence of the people.
(Concluded) (The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences)
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