Another important factor that discourages compliance with tax laws is the extremely complicated and cumbersome nature of procedure involved in being registered with the revenue authorities. Even the corporate and educated class finds it difficult to comprehend, follow and observe the simultaneously applicable innumerable legal obligations, what to talk of the illiterate and ordinary man on the street. If a survey is conducted with respect to merely the advance tax provisions (almost 75 in number), it would reveal how a person is supposed to be aware of so many avenues where either tax is being withheld or he himself is paying income tax and the consequences of these taxes, the credit of which he may or may not be allowed to take while filing his return. In the first instance, a highly meticulous record of all such transactions that invoke taxes would have to be maintained and secondly, an even higher level of grasp over the law would be required to apply it.
Considering the present level of inflation and the high cost of living, the minimum threshold of income (Rs 400,000) where no income tax is to be paid nor a return needs to be filed, is within the reach of an overwhelming population, including people who are earning income from simple employment, trade and vocations. With the prevailing standards of literacy in the country, how can it be expected that the common man has any cognizance about tax laws let alone complying and then tackling the authorities who are perpetually ready to whip anyone-innocent or guilty. Had it been restricted to simple arithmetic, things could have improved but the cruel methods adopted to teach the nation lessons in paying taxes have only proved detrimental rather than motivating. People take pride in beating the authorities, no exemplary punishment has been meted out to confirmed evaders, no effort has been made at the grass root levels to educate the public about its obligations and instead of serving the nation, officials of the revenue department are poised to pounce upon the first stray taxpayer to squeeze him dry. Revenue officers are trained to look suspiciously at every registered taxpayer-their motto being "guilty until proven innocent." Even though law requires that officers should counsel and guide the taxpayer with respect to his duties and rights, he is conveniently forced to engage a tax consultant who, if professionally unethical, is capable of causing much more financial damage to his client than the amount of tax in question.
Black economy and tax losses
Tackling twin menaces of black money and tax evasion has always been a failure in Pakistan. Successive governments, instead of dealing with these issues have been pardoning and appeasing tax evaders through various laws and amnesty schemes. The result is obvious-there is an ever-growing informal economy. The present accumulated size of underground economy is estimated at Rs 30 trillion; almost equal the size of documented economy. If tax at flat rate of 10% is offered to all who have failed to pay in the past, in just one year FBR will collect Rs 3 trillion and then in future this figure would be much higher compared to what is collected at present. In fiscal year 2016-17, FBR collected Rs 3.36 trillion, suffering a shortfall of Rs 259 billion, leading to a substantial increase in fiscal deficit. Resultantly, the borrowing spree of the government continued unabated in 2016-17, and situation for the ongoing fiscal year in no different.
The new paradigm
Under the afore-stated situation of imbalances, a fresh approach and a renewed policy urgently needed to replace the entire taxation system for fiscal stabilization. The equation is simple. Federal government needs at least Rs 7 trillion of revenue (for meeting all development and non-development expenditures along with retirement of expensive loans), 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 tax rate 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, outdated 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 labor 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 labor 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 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 mindset 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 would 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 minimized. 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 by imposing 10% flat rate tax on net income of individuals and reducing corporate tax rate to 20%. This kind of simple taxation would induce voluntary compliance provided all the citizens are aware of the fact that competent and effective tax machinery exists having a 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 emphasized, time and again, by authors that Pakistan needs harmonized sales tax (HST) which should be 7% as in Singapore and Thailand. This envisages collection through a National Tax Authority which should replace all existing authorities at both federal and provincial levels.
The further details of simplified, flat rate taxation can be seen in authors' paper, Towards Flat, Low-rate, Broad and Predictable Taxes, available at http://primeinstitute.org/wp-content/uploads/2016/08/Towards-Flat-Low-rate-Broad-and-Predictable-Taxes.pdf
The National Tax Authority
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 the 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 representing the 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 a 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 10 to 12 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 the indirect tax base
All existing indirect taxes should be replaced both at the federal and provincial levels with Harmonized 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 7% 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.
Conclusions
1. If we want optimum collection of taxes fairly and without hampering growth, it is imperative to abolish the present tax laws and enact new ones.
2. Collection of taxes through a single national authority 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 member Adjunct Faculty of Lahore University of Management Sciences)
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