Tax on agricultural income is in the news again. Reportedly, the IMF has demanded imposition of uniform tax on agricultural income by October 2024 as a condition of the upcoming Extended Fund Facility. Instead of demanding government Pakistan to bring agriculture income under federal tax domain – which would require a constitutional amendment – the Fund has demanded that agricultural income tax rates be revised through amendments to the provincial finance acts.

It seems that the Fund has finally had enough of Pakistan’s extractive ruling elite granting blanket tax exemptions to their voting blocks, while extracting ever more revenue out of corporate sector and salaried class individuals. The Fund finally also seems to appreciate that the existing scheme of taxing same classes at ever increasing rates has reached its limit and will no longer pay dividends. After all, the law of diminishing returns – or the Laffer’s Curve in tax theory – had to set in at some point.

But will the Fund’s demand yield any substantive results?

The common refrain in Pakistan is that majority of the agricultural or farmland is owned by subsistence or small hold farmers, and thus taxing agricultural income may not yield significant revenue, while risking the ire of politically consequential vote bank. It is also true that agriculture’s tax potential is probably significantly lower than its contribution to national GDP of 24 percent, while questionsare also raised whether this share is accurately measured or is significantly off the mark. But more on that some other time.

If agriculture’s contribution to national income were used as a proxy, the sector should contribute nearly one fourth or Rs 1.3 trillion of total income tax target for the current fiscal year. In reality, total revenue collected under agricultural income tax by provincial governments is estimate under ten billion rupees. Surely, the distance between target and reality indicates that there must be more to the story.

First, income tax slabs for individuals are generally progressive in nature. This means that higher the income, higher the tax rate imposed. Therefore, to assume that agriculture is equally profitable as industrial, or services sector is inherently flawed. By definition, agriculture sits at the bottom of value-addition ladder, thus the returns on investment must also be lowest.

However, this is not to say that the negligible value of revenue collected from agriculture is reasonable or justified. Given total agricultural farmland of 35 million acres and minimum monthly rental yield of sixty thousand rupees, the sector could still generate at least Rs300 billion per annum if taxed at uniform tax rate as non-agricultural income. This comes out at just Rs750 per acre per month.

Yet, this is not where the meat lies, quite literally. According to Economic Survey of Pakistan 2023-24, the livestock segment contributes 61 percent of agricultural gross value added, which requires minimal land. Of this, dairy segment alone accounts for 27 percent of the 61 percent. Yet, unlike land holdings, there is really no way of accounting of liters of milk sold in dehs and mouzas every year across the country, or profits earned. Yet, just by the virtue of its size alone, the dairy economy alone should contribute as much tax revenue as the crops segment.

The bitter truth is that anyone remotely connected to Pakistan’s rural heartlands understands that without first sizing and accounting for the farm economy, there is really no way to estimate the tax potential of Pakistan’s agricultural sector. In absence of this documentation, any presumptive taxes imposed shall be inherently flawed and attract public outcry, especially at a time when frequency of extreme weather events has increased volatility of farm income and profitability significantly?

Does that mean nothing can be done? Of course, not. It is often lamented that the industrial sector contributes majority of the direct/income taxes in the country, rendering it uncompetitive. But the fact is no one pays taxes or seeks documentation of income willingly. The most common reason why firms report official income is to seek access to banking credit lines or business from reputed buyers. Either way, the objective for reporting profitability is often means to business growth. Once any business begins to report profitability (and growth) year after year, banks show willingness to offer credit. The more growth follows, the easier and larger access to credit becomes.

The key to documenting any sector thus is through enabling access to credit and bank loans. Only once a business/industry has access to banking credit lines, are they forced to show both profitability and income growth from one year to another. This in turn forces businesses to maintain accounts. Only once they begin to maintain books regularly, can the taxman demand tax which is reflective of true income (or whatever is closest to it).

Bring tax rates on agricultural income in line with those on non-agricultural income. But do not expect any miracles. But open the valves of credit, and both growth and taxeswould follow.