‘Pakistan is run by arthis’

An interview with Shabbar Zaidi, Senior Partner & Chairman A.F. Ferguson & Co.

Another mini-budget amid fears and hopes of tax reforms is around the corner. So is the expected fresh round of NFC Award negotiations. In light of this, BR Research had a quick chat with the noted tax expert, Shabbar Zaidi to take his views on what the government ought to do if it really wants to reform taxation in Pakistan. He also sheds light on the need for Provincial Finance Commission (PFC) Awards, and why the next National Finance Commission (NFC) should open the can of worms and completely reassess the revenue-expenditure reassignments across the three tiers of government. Below are edited excerpts from that conversation.

BR Research: You have been very critical of the National Finance Commission (NFC) Award. Let’s begin with that.

Shabbar Zaidi: The NFC is technically irrelevant. The NFC cannot and should not be isolated from the PFC. Unless and until this country has an equitable PFC, the NFC will begin a bigger problem because it is only giving more money to the provincial chief ministers, but they have no performance to show for.
The NFC is not complete without the PFC; the PFC has to ensure that the money flows to the third tier of government. Accordingly, there will be lesser room for corruption because the size of the pie for each sub-national government will be lower; plus, there will be higher chances of accountability as citizens can compare the amount of money received by their district government, and the public goods it delivered to the people from those funds.

It is unfortunate that neither the politicians nor the media has emphasised the importance of having PFC awards, and how the failure to have proper PFC awards has diluted the earning capacity of second and third tiers of the government. The large size of federal transfers to provincial transfers means that provincial governments have no real incentive to increase their own tax revenues.

BRR: But there is a counter argument that provinces don’t have the big tax bases.

SZ: The provinces have enough in their domain. There is agriculture income tax, urban property tax, other property tax, GST on services, water and other utility charges and so forth. They have not created buoyancy.

The road in Nazimabad (a famous Karachi neighbourhood) for example, should be made from property tax collected from the district it is in. Federal taxes are not for making roads in my neighbourhood. As per law, urban immovable property tax is for the cost maintaining of the roads and other facilities in the area you live in. Yet those taxes are not collected whereas local government’s rights to collect those taxes have been taken away. In the US, property tax roughly equals about 5-6 percent of your income, but then their county government provides you the services as well.

BRR: Provinces have managed to increase the GST on services ever since they took back that collection from the FBR. In the case of Sindh Revenue Board (SRB) for instance, the share of tax collected from top four services (including telecom, banking) had nearly halved between FY13 and FY16. Doesn’t that show improved tax collection.

SZ: The growth in revenue of these provincial revenue bodies stems from new taxes on previously untaxed services, and not really from improved efficiency or increase in their tax bases.

BRR: Provincial tax revenue authorities don’t publish dataset relating to tax base, so we really can’t say. But would you agree that countrywide potential collection under agriculture income tax is between Rs100-Rs200 at the most, according to various studies.

SZ: That may be so in the case of tax potential of farming income or income earned from farm produce. But tax potential of the income earned by the trader of that farm produce, the middleman or the ‘arthis’, is no less than Rs1000 billion. Why isn’t this aspect researched by Pakistani economists?

BRR: But that isn’t provincial domain. That should be collected by the FBR.

SZ: It should be. It’s the biggest black hole in Pakistan’s economy. The trading and wholesaling business of farm produce is a money-making machine and their contribution to tax is zero. All of the farm produce - wheat, rice, cotton, sugar, milk, meat, fruits and vegetables - in all of these cases the farmer earns 10-20 percent and the rest is earned by the middleman. If the PTI really means business, then it must go after the ‘arthis’.

But can they? ‘Arthis’ are the ones who really run Pakistan. They finance crop production by farmers and they also finance mill for their farm purchases. These people are no more than a few hundred in number across Pakistan – the influential ones who are big enough to provide financial support to political leaders during elections. For instance, against hundreds of sugar mills in the country, there are only 14 ‘arthis’ or dealers who finance the mills’ purchases and buy all of their produce. There are also big ‘arthis’ in textile law business – they finance the fashion designer, the factory owner, the distribution operations and so forth; it’s essentially their business, and they earn enormous untaxed or undertaxed profits.

Not only is it that this income from trading of farm produce is hidden under the garb of farm produce income, it is the reason why Pakistan has such a huge cash economy. While some of these are financially included but fiscally excluded, most of these are both financially and fiscally excluded. And that’s why financial inclusion is not taking off in Pakistan.

BRR: Is VAT mode taxation the only option for Pakistan?

SZ: The administrative split between federal and provincial governments for GST on goods and services has to come to an end. One single tax collection agency needs to collect both and distribute it as per whatever formula is agreed upon. Whether you want to create a new tax agency and reform FBR, which I think should be done at the very least even if it were only a change of name that aspect can be looked at. FBR has lost its reputation beyond repair; at the least there should be a change of name to signify a change of direction and a new vision.

BRR: Are you still wary of those optimistic notions that FBR can work on Nadra records and NAB tax evaders?

SZ: People don’t realise that asset records are with the provincial governments. Whether that asset is land, shop, office, industry, and car – all of these records are with the provincial governments. Income tax on the other hand is with the federal government. What can FBR achieve unless provincial and federal governments don’t share asset datasets?

Unless asset and income records are linked, it’s all a futile exercise. The FBR’s audit function is also limited by the information that the tax filer has provided. Their audit exercise is futile; it’s a waste of time. They can only audit based on the information that I have submitted to them; they have no way of knowing what I have not submitted to them. For example, FBR doesn’t know how many plots a person has. It can only raise questions over whether or not such and such expense can and should be allowed. This is why under declaration is as big an issue as non-declaration.

BRR: But when BR Research met Tax Reform Commission’s chairman six months ago, he said that Pakistan Revenue Automation Ltd. has seen substantial improvement thanks to a professional CEO, whereas Nadra had also now started sharing data with the FBR; and that the FBR now knows the ownership status of luxury cars and real estate properties.

SZ: The recording of all these assets are no easy task. It has to be a long-drawn affair; there are no quick fixes to it. Bank accounts will also have to be linked, for which laws and regulations will have to be changed to ensure that banks give requisite data to tax authorities. Why are banks allowed to open accounts above a certain threshold without the account holder being a filer? Doing so requires a long strategy and a strong political will, because effective tax reforms in effect means destroying the current economic edifice and creating a new one.

The prime minister must take the bitter pill and take tough decisions now. It will shake up the system and create more troubles in the short and medium term. But that is the only way out. And better do it now than to go back to square-one five years later.

BRR: Talking of records, are FBR datasets linked to SECP, Association of Persons and partnership firms’ datasets?

SZ: No! There is no data reporting mechanism. That’s too much to ask from the existing federal and provincial tax machinery; the state doesn’t even know the number of shops and hotels in Saddar area. Pakistan’s financial system, fiscal system and cash economy are working in diagonally opposite direction.
The last survey of property in Karachi was done in 1974. In Lahore it was done somewhere in the 80s. How can tax departments – federal and provincial – collect urban property taxes and link asset records to income records without a survey?

Successive governments don’t conduct property surveys and roll out property taxes because it hurts their vote bank. Even if the government lowers the tax rates to ensure that tax paid on any property remains the same after proper market valuation, people don’t support it because it will reveal the records of their assets created from undeclared income.

If the PTI is serious about tax reforms it will have to get down to this granular level to fix the system. They should learn from Manila where they used Google satellite imagery to fast track their property survey.

BRR: What has been your assessment of the recently ended tax amnesty scheme?

SZ: I think its timing was problematic; it should have continued for longer time with more media coverage given to it so more and more people could get into the system. At the same time, it should have come with a stick – in terms of whatever little datasets that FBR has. The total tax amount collected under the amnesty scheme is equivalent to about $500 million – which is 5 percent of the amount of asset declared. The collection could have been better if the scheme was well thought through.

BRR: Finance Minister Asad Umar is expected to kick start the NFC meetings soon. Do you think there is realization in the government to open the can of worms you earlier spoke of?

SZ: Going for full blown fiscal devolution and reassessing revenue and expenditure reassignments across federal, provincial and district governments means that you are diluting the powers of provincial political leaders. Who will listen to party leaders in Karachi and Lahore when district governments have the power to collect taxes and spend it there too?

At the most, there may be some tweaking here and there to avoid opening the can of worms. However, let me assure you that failure to take the bull by the horns and addressing the issues relating to revenue and expenditure reassignments together with fiscal and financial restructuring means that Pakistan’s economic survival will be at serious risk. You cannot treat cancer with aspirin.

At the very least, Prime Minister Imran Khan should spell out these problems to the nation and tell people that a country with such a flawed system cannot develop. They are excessively focused on financial corruption; corruption is not the issue. Flawed structure is. The government has already wasted six months harping about corruption, and if they don’t reform the system, its structure, and then they too will be back to square one by the end of their tenure.