Bridging tax gap - I

Tax gap of a country is measured by the amount of tax that remains uncollected due to non-compliance with tax laws A study, 'Pakistan Tax Gaps: Estimates by Tax Calculation and Methodology', jointly undertaken by the Federal Board of Revenue (FBR) and the Andrew Young School of Policy Studies at Georgia State University, provides details of tax gaps by type of tax and describes the methodologies and data used for such estimates. This study released in December 2008 under the authorship of Rubina Ather Ahmad (FBR) and Mark Rider (Andrew School) says that views expressed "are of the authors and not of the Government of Pakistan". It is strange that FBR disowned the report commissioned by it. Till today no reason is given for this act of FBR. The same thing happened with 2016 Report of Tax Reforms Commission (TRC) that was marked "confidential" and not disclosed to the public due to "reservations" of the top notches of FBR. The Federal Finance Minister, Asad Umar, and State Minister for Revenue, Hammad Azhar, should look into this matter and order the release of TRC's Report that is fundamental right of citizens under Article 19A of the Constitution of Pakistan.
According to the study ['Pakistan Tax Gaps: Estimates by Tax Calculation and Methodology'], Pakistan's federal tax gap in 2004-05 was Rs 409.5 billion or approximately 69% of actual tax receipts of Rs 590.4 billion. Terming this as "conservative estimate", the study claims direct tax gap at Rs 262.8 billion (around 143% of actual collection of Rs 183.1 billion) and indirect tax gap at Rs 146.7 billion (36% of actual tax collection of Rs 407 billion). Tax gap measured for fiscal year 2004-2005 has increased manifold in 2018. According to a very conservative estimate, it is not less that 70% of actual tax potential.
Tackling twin menaces of underground economy and tax evasion has always been a failure in Pakistan. "Our successive governments, instead of dealing with these issues, have been pardoning and appeasing tax evaders through various immunities and amnesties. The result is obvious: there is an ever-growing informal economy. The underground economy is driven by many aspects of poor fiscal policy, and as highlighted by Dr Arthur B. Laffer:
"........it isn't just high tax rates that indicate whether illicit trade activity will be a problem, but rather high tax rates coupled with other factors such as affordability, level of corruption, effectiveness of enforcement, and cultural and societal reasons"-[Handbook of Tobacco Taxation: Theory and Practice, The Laffer Centre at the Pacific Research Institute, 2014].
In Towards Flat, Low-rate, Broad and Predictable Taxes (PRIME Institute, Islamabad, 2016), it is suggested that instead of announcing periodic tax amnesties, the government should ask all citizens to take benefit of flat rate of 10 percent and file returns for the past years to incorporate undeclared and untaxed assets without any penalty or additional tax. Those who fail to do so by June 30, 2019 should be dealt strictly under the law. This can generate lot of revenue for the government for the current fiscal year and would give people a sigh of relief that after paying taxes for past years they would not be harassed in future. From Tax Year 2019-20 onwards, the State should show zero tolerance towards tax evasion.
The collection of taxes at federal level is much below the actual potential and the way it is reported/collected creates doubts and suspicion. In 2014-15, as in the past, FBR failed to meet the third revised target. The original target of Rs. 2810 billion was first reduced to Rs 2691 billion and then to Rs 2605 billion. The claim by Finance Minister that FBR exceeded the target for fiscal year 2015-16 has also been contested by many. In a report [Non-tax revenue: Rs 195 billion included in taxes to claim lofty collection, Business Recorder, July 3, 2016], it was alleged that Rs 195 billion collection on account of non-tax revenue "is shown as 'other taxes' to claim higher tax collection". It is further alleged that "Rs. 30 billion on account of Natural Gas Development Surcharge (GDS) is accounted for as 'other taxes' whereas it was placed under non-tax revenue till 2013-14".
Tax Collection Figures (2014-15 to 2017-18)For the fiscal year, 2017-18, revenue target was Rs 4013 billion that was later revised downward to Rs 3935 billion. FBR collected only Rs 3751 billion. It collected income tax of Rs 1441 billion against the target of Rs 1562 (deficit of Rs 121 billion). Sales tax collection at Rs 1488 billion against target of Rs 1541 billion witnessed shortage of Rs 53 billion. FBR also faced a shortfall of Rs 16 billion under the head Federal Excise Duty as it collected Rs 216 billion whereas the target was Rs 232 billion. Only collection under customs exceeded the target by Rs 6 billion against the assigned target of Rs 600 billion. The overall shortfall of Rs 184 billion vis-à-vis the revised target of Rs 3935 billion and that of Rs 262 billion from original target pushed the fiscal deficit to a record Rs 2.5 trillion as on June 30, 2018. The total revenue collection by FBR in 2016-17 was Rs 3368 billion. It missed the original target by a wide margin of Rs 250 billion. In 2015-16, FBR, despite imposing additional taxes of Rs 360 billion, allegedly blocking over Rs 220 billion refunds and taking Rs 30 billion as advance failed to meet the third-time revised target showing shortfall of Rs 222 billion vis-à-vis original target of Rs 2810 billion, which was first reduced to Rs 2691 billion and then to Rs 2605 billion. Income tax collection in fiscal year 2014-15 was Rs 1033.7 billion and projection for 2015-16 was Rs 1307 billion. The actual collection, reported by FBR, is Rs 1220 billion-showing a shortfall of Rs 87 billion. Collection of sales tax in 2014-15 was Rs 1088 billion and projection for 2015-16 was Rs 1230.3 billion. By raising sales tax on POL products from 17% to 30-50%, the government managed to collect Rs 1329 billion in 2015-16. Customs collection in 2014-15 was Rs 306 billion and projection for 2015-16 was Rs 348.5 billion. After levying regulatory duty on over 300 items, it was increased to Rs 404 billion in 2015-16. Federal Excise collection in 2014-15 was Rs 162 billion. Against a projection of Rs 200.9 billion, actual collection for 2015-16 was Rs 177 billion.
In another report [At long last: FBR achieves revenue target for last fiscal year, Pakistan Today, July 1, 2016], it is observed that "after withholding all the tax refunds during the last fiscal year and forcing companies to pay advance income tax, the Federal Board of Revenue (FBR) announced on Friday that it had achieved the tax revenue collection target of Rs 3.1 trillion set for Fiscal Year 2015-16." It further says that "FBR was holding more than Rs 250 billion in tax refunds during the last fiscal year. The tax refunds were kept to maintain the tax revenue target agreed with the IMF."
The meeting of target by FBR through "undesirable means" was also highlighted in yet another report [FBR nails down Rs 3.1tr tax target, Shahbaz Rana, The Express Tribune, July 2, 2016] as under:
"...that the overall collection of Rs3.1 trillion was a result of one of the largest clandestine operations, as the FBR took over Rs150 billion in advance taxes from oil and gas, telecommunications and banking companies. The government also blocked payment of over Rs250 billion genuine refunds of the taxpayers".
It is obvious that on the one hand FBR has been facing the challenge of bridging tax gap and on the other collection figures reported are not reliable. The way forward is suggested in a study, Towards Flat, Low-rate, Broad and Predictable Taxes (PRIME Institute, Islamabad, 2016). This study suggested comprehensive structural reforms to introduce a new tax system being low rate, fair, simple and predictable. The study gives a detailed roadmap for a tax model that can accelerate economic growth and yield substantial revenues for the government-much more than what is being presently collected through complex and oppressive tax system. Below is the working for tax potential on the basis of model suggested in Towards Flat, Low-rate, Broad and Predictable Taxes.
Income Tax
Income taxation at the moment is highly complex and fragmented. There is classical taxation under various heads of income, while many transactional taxes, presumptive and minimum taxes have been added to distort the entire concept of personal income taxation. The paper suggests simple and flat rate taxation of 10 percent for individuals and 20 percent for companies and other entities. The prevailing myth that only 1% of the population pays income tax is totally baseless-the distinction between 'filers' and 'payers' is ignored, even by those who claim to be experts! The reality is quite the opposite. In fact, 95 million Pakistanis are subjected to advance adjustable income tax of 12% as pre-paid mobile users. There are 68 withholding taxes-both adjustable and non-adjustable and those subjected to tax are in millions. It includes not only total population liable to income tax, but millions of those who have no taxable income. Since millions, having no taxable income, do not file income tax returns/statements, a wrong impression exists that our income tax base is narrow.
According to official and non-official figures, present tax base is around Rs 30 trillion (after taking into account informal economy). Flat rate taxation of just 10 percent with strong enforcement system suggested in the study will yield Rs 3 trillion under income tax from individuals and around Rs 2 trillion from corporate and other entities.
(To be continued)
(The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences)