Despite reform initiatives mounted by FBR, the ratio of direct taxes to GDP in Pakistan has remained stagnant at 3 percent over the last many years, which is the lowest ratio among the countries of this region, says a Recorder Report, quoting the FBR Quarterly Review. As compared to Pakistan, direct taxes in the region have assumed greater importance by becoming a major source of revenue generation for regional governments.
For instance, in India the proportion of direct taxes to total tax collection increased from 30.2 percent in 1995-96 to 45.1 percent in 2005-06, going up further to 48.8 percent in 2006-07, while the ratio of direct tax-to-GDP was only 2.8 percent in 1995-96, which improved to 5.6 percent in 2006-07, and is budgeted at 5.7 percent for 2007-08. The system there has not only been simplified; it also provides more incentives for compliance.
In emerging economies like Singapore, Malaysia and Indonesia, the direct tax-to-GDP ratio ranges between 6 and 7 percent. In contrast to this, the position of direct taxes in Pakistan has remained at around 3 percent for the last many years. Pakistan's tax regime largely resembles the one practised in Latin American countries, where indirect taxes, particularly the sales tax, account for a relatively higher share within the overall tax revenue.
The indirect tax-to-GDP ratio stands at around 4 percent and less than 2 percent if the withholding taxes are excluded. The FBR Quarterly Review has highlighted major reform initiatives undertaken by the Indian tax authorities, which have helped improve the overall direct tax collection. The tax authorities in India have introduced the Permanent Account Number (PAN) for all taxpayers which has to be quoted on tax returns in all financial transactions. This has helped the tax authorities to keep track of taxable income.
The revenue target set by Pakistan for the current fiscal is expected to reach one trillion rupees. The broadening of tax base will ensure fair distribution of the tax burden among various sectors of the economy. The overall services sector, including wholesale and retail trade, as well as agriculture are potential candidates for increasing collection. The tax base has remained narrow due to a wide range of exemptions and concessions as well as large-scale tax evasion. Secondly, the tax rates have been pitched at high levels, which has created a vicious circle of widespread evasion.
The revenue loss to the national exchequer due to tax exemptions declined by 51.2 percent to Rs 89.52 billion in 2007-08 against Rs 183.69 billion over the previous year. While comparisons with other countries can throw up useful lessons for us, there is a need to understand the composition of tax-GDP ratio in Pakistan before undertaking any similar exercise. The tax-to-GDP ratio declined in 2005 due to the re-basing of GDP by the Finance Ministry. Enhancing the tax-to-GDP ratio is essentially a policy issue that calls for determination of the parameters of composition of GDP and identification gaps.
The major causes of a low tax-to-GDP ratio in Pakistan include a narrow tax base, poor compliance by taxpayers, too many exemptions (the most notable being agriculture), the presence of a huge underground economy, and a serious mismatch between sectoral contributions in the tax-to-GDP ratio. There is a need for FBR to further broaden the tax base by effectively plugging all loopholes in the tax collection system. A thorough revamp of the entire tax machinery is also called for to remove the flaws that have kept our tax-to-GDP ratio one of the lowest in the region. Secondly, the camouflage of indirect taxation should be removed to make the system more transparent.