This is the first of a two-part series of articles focused on how the government achieved a revenue raise? The first part focuses on direct tax collections, particularly withholding tax, and the government's claim that it is justified in crediting revenue from this tax to direct taxes. Part-two would focus on the increase in indirect taxes and non tax revenue.
The Dar-led Finance Ministry has been citing the growth in direct tax revenue as a major achievement. The question is how has this increase in revenue been achieved? The following table shows the budgeted and revised revenue targets:
The PPP-led coalition government and the incumbent PML-N government have followed past precedence and relied more heavily on indirect taxes whose incidence, by definition, is greater on the poor than on the rich. However the difference between indirect and direct taxes has narrowed since the PML-N government took over power which should be supported as direct taxes are based on the ability to pay principle. However, the nearly 29 percent increase in direct tax collections (from the revised direct tax collections in 2012-13 to revised direct tax collections of 2014-15) is mainly attributable to a massive rise in withholding tax collections which registered a compound annual growth of 24.5 percent during the last three years with growth in Federal Board of Revenue (FBR) collections registering 8.9 percent. The budgeted rise in direct tax collections for the current year, if achieved, would give a percentage rise of over 40 percent when compared to the revised collections in 2012-13.
Pakistan inherited withholding tax on salary and interest income under the Income Tax Ordinance (ITO) 1922, repealed by the Income Tax Ordinance, 1979 while during the 1990s its coverage expanded on various transactions particularly presumptive transactions.
The Dar-led Finance Ministry insists that withholding taxes, which are withheld by withholding agents and supposedly monitored by the FBR, are defined as a direct tax throughout the world. This is technically correct. Withholding taxes are applied on income and in some countries on interest and dividends, as well as on royalties, rent or even real estate, all sources of income. In Pakistan, withholding tax deducted from salaries constitutes only 11.5 percent of the total collected under this head. The bulk of withholding tax revenue post-Dar is collected from consumer items/services - on imports, airline tickets, use of internet, cellular phones/landlines, local supply of goods, industrial and commercial electricity, cash withdrawal from banks etc. This compels one to conclude that the bulk of withholding tax revenue collected in this country is regressive in nature particularly when applied on transactions.
In an aside it may be relevant to note that the government's decision to impose 0.6 percent tax on all banking transactions on those traders who do not file their returns under the Voluntary Tax Compliance Scheme (widely regarded by all including the International Monetary Fund as yet another tax amnesty scheme though the government officials disagree) may well lead to fuelling the cash economy. This assertion is strengthened by the fact that earlier in the current year when the government reduced this levy to 0.3 percent pending the outcome of negotiations data suggested a rise in the cash economy. Thus the danger is that this levy may fuel rather than dampen the illegal economy.
Several countries levy withholding tax to combat evasion and/or to promote filing of returns, negative factors that are prevalent in Pakistan that, as per the Finance Ministry, provide adequate justification for the levy of withholding taxes. But the Sharif administration is levying withholding taxes on consumer items/utilities/fees ,etc, which in other countries would be under the head of sales tax/customs duties/excise duties. In Pakistan, these other taxes are over and above the withholding tax.
The Finance Ministry has separated the filers of income tax returns from the non- filers with the latter paying a higher rate than the former. The objective: to document the large parallel illegal economy by incentivizing tax filing. In principle, this is a valid argument however data and interviews with the payees have shown two disturbing trends: (i) refunds are piling up as the government remains focused on revenue generation as a condition of the ongoing International Monetary Fund programme; in the current year refunds increased by more than 20 percent in comparison to the year before. Haroon Akhtar Khan, the Special Assistant to the Prime Minister on Revenue, declared that the FBR has been instructed to clear all refunds by the end of next month - a commitment that few believe as the next IMF tranche release may require a revenue that can only be met by advance tax collections and lower refunds; and (ii) those who claimed refunds in the past year told Business Recorder that any request for refund is a long and arduous process and many filers simply write it off as a rise in cost of say procuring an airline ticket to save time and energy; others point out that whenever a request for a refund is made the relevant wing of the FBR initiates an audit inquiry designed to deter claimants request for refunds.
The withholding agents too have expressed their concerns about being given the responsibility for collections and maintain that they bear a substantial compliance cost including human resource cost, IT infrastructure cost, as well as other overheads.
Disturbingly during a recent meeting held in the FBR it was agreed that reliance on withholding tax as a component of direct taxes would be further increased to 75 percent. In other words, this heavy reliance is unlikely to be reversed given that once a tax has been implemented and therefore implicitly accepted by the payees it is unlikely that any future government would abandon it, however inequitable, unfair and anomalous it maybe.

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                          (Rs million)
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Year             Direct taxes         Indirect taxes
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2012-13     932,000    (779,100)   1,571,575  (1,345,475)
2013-14     975,700    (891,000)   1,622,375  (1,384,000)
2014-15   1,180,000  (1,109,000)   1,630,000  (1,496,000)
2015-16         1,347,872                1,755,834
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