One of the biggest impediments towards achieving higher sustainable economic growth in Pakistan is the poor taxation system and abysmally low tax collections. Due to failure of successive governments to carry out transformative reforms in our taxation system for decades, Pakistan has one of the lowest tax to GDP ratio, with the result the country has not been generating sufficient funds to provide for necessary expenditures such as defense, debt servicing, law & order, development of necessary infrastructure, while the biggest victims of this situation have been very poor allocations of health and education of our people. Over the years, successive governments have further compounded the problem by imposing the highest rates of taxation when compared to other emerging markets, both for direct and indirect taxes, besides excessive reliance on withholding and presumptive tax regimes, non-payment of refunds, resorting to arbitrary assessments by tax authorities in order to meet revenue targets to the satisfaction of donor agencies, especially to satisfy the IMF conditionalities. Furthermore, the devolution of service tax and formation of provincial tax authorities have further exacerbated the difficulties of tax payers with exorbitant increase in cost of doing business.
Besides being counterproductive to business and investment climate in the country, our cumbersome taxation system is one of the key reasons for one of the lowest ranking in the World Bank's index of "Ease of doing business", in which Pakistan stands at 138 in the latest ranking.
It is obvious that there is dire need for various reforms to improve taxation system, but it is not the intention of this paper to cover all such reforms. The focus of this article at present is to highlight the need for transforming our indirect tax system by implementing a "goods and services tax" to be collected under value added tax (VAT) mechanism as has been done in our neighbouring country India through a constitutional amendment. The basic premise for this taxation is the principle that if the taxation system is made simpler, and there is one uniform tax collected preferably by one organisation by entire supply chain, even a relatively low tax rate will result in higher tax collections, besides reducing difficulties of taxpayers and improving business climate.
Owing to complicated sales tax framework and various other reasons, we have one of the highest sales tax rates when compared to low income countries. Although basic rate of sales tax on goods is 17% (even this is very high when compared to other comparable countries where sales tax rates varies between 10% to 15%) but due to further tax of 2% on unregistered persons, disallowance of input tax on services and disallowance of legitimate input taxes by tax authorities, the effective rate goes up to around 23% to 25%. Besides this high sales tax on goods, the Provincial sales tax on services are also chargeable ranging from 13% to 16%, and there is serious disconnect between the Provinces amongst themselves and between the Provincial and Federal tax authorities, which cause huge problems for taxpayers.
These factors are hampering Pakistan's economic growth, as they seriously undermine the ability of our businesses to compete in the national and international market, which is apparent from declining exports and poor performance of our manufacturing sector.
Learning from Indian experience of building consensus on Goods and Services Tax
India has also faced similar problems for decades due to multiple indirect taxes at federal and states. Taxes are multi-layered there as the Central Government levies taxes like service tax, excise duty, etc while States levy taxes like sales tax on goods, entry tax, octroi, etc. According to an analysis, these several taxes add the cost of taxes between 25 to 40 percent to the cost of goods and services, which significantly increases the cost of goods and services. Due to existence of multiple tax laws and authorities, the cost of compliance for businesses and cost of collecting tax for the governments have also increased. Considering this background, Indian businesses and certain political parties have been trying to address these issues for decades for introduction of a unified "Goods and Services Tax".
After continuous efforts of several years by businesses and political leadership, Indian Parliament has passed 122ndconstitutional amendment on August 3, 2016; which is expected to be a very significant move towards simplification of sales tax system on the principle of 'one nation one tax'. After ratification of bill by remaining States, it will be presented before President for getting assent and thereafter, the Government will release GST law for passing by the parliament and respective State assemblies. The date of implementation is expected to be from 1 April 2017. Under the new regime, sales tax on goods and services including various other indirect taxes paid at Central and State level like excise duties, octroi, etc, will be replaced with the envisaged one goods and services tax. The basic model of such integrated tax would be as under:
-- Central GST (CGST) and State GST (SGST) would operate concurrently on supply of goods and services within the State.
-- Integrated GST (IGST) would apply on Inter-State transactions, which will be aggregate of GGST and SGST.
-- Imports would be subject to IGST on destination principle. SGST component of IGST would be apportioned by State where supplies get consumed.
-- The input tax credit would be available for CGST for discharging CGST liability on output at each stage. Similarly the SGST paid on inputs would be allowed for paying the SGST output. No cross utilisation of credit would be permitted.
-- Cross utilisation of credit of CGST between goods and services would be allowed. Similar facility of cross utilisation of SGST would be available. However, cross utilisation of credit between CGST and SGST would not be allowed, except in specified situations.
It is expected that this system will reduce multiplicities and bottlenecks in the tax system. GST will ensure that indirect tax rates and structures are common across the country, thereby increasing certainty and ease of doing business. A system of seamless tax credits throughout the value chain, and across boundaries of States, would ensure that there is minimal cascading of taxes. Reduction in transaction costs of doing business would eventually lead to an improved competitiveness for the trade and industry. The effective tax rate of indirect tax is also likely to come down that will directly benefit the common man. The tax system is likely to be simple to administer by the tax authorities and it will reduce their cost of collection of tax. Goods and services tax network (GSTN) -a common portal is likely to be set-up for GST implementation and compliance. This system will also help in broadening the tax base owing to housing and monitoring of all data at one place. The new system is likely to increase the competitiveness of Indian goods and services in the international market and give boost to Indian exports.
Global experience of uniform GST
World over in almost 150 countries there is GST or VAT, which means tax on goods and services. Under the GST scheme, no distinction is made between goods and services for levying of tax. In other words, goods and services attract the same rate of tax. The real challenge for implementation of a uniform system of GST arises in countries which have federal structures, only some of them have been able to implement a uniform GST successfully with great benefits for their economy and people. One such example is introduction of GST in Australia in 2000, which is collected by the Australian Tax Office. The revenue is then redistributed to the states and territories via the Commonwealth Grants Commission process. The GST was introduced in New Zealand in 1986, currently levied at 15%. As a consumption tax, the EU VAT taxes the consumption of goods and services in the EU VAT area.
Like India and some other countries following unified system of sales tax on goods and services, there is a dire need for our country to simplify and harmonise our indirect tax system on the same concept of 'one uniform tax' under VAT principle by replacing the multiple indirect taxes on goods and services imposed by different federal and provincial authorities. The implementation of this unified sales tax system will foster a common or seamless Pakistani market and contribute significantly to the growth of the economy. Simple, efficient and uniform GST will also overcome the issues and shortcomings of the existing indirect tax structure while at the same time the benefits of a comprehensive national GST can be best derived with common laws and rules applicable across all Federal and Provincial levels. Although, a uniform GST is no brainer considering the rationale discussed above and its benefits to the economy, it is never easy to implement major reforms especially in a federal structure. It took decades for Indian business and political leaders to achieve necessary consensus, but finally Indian leaders have achieved what was unthinkable few months ago. Obviously it will take time in Pakistan to build consensus for this very critical reform that affects federal and provincial relationships, which is also a sensitive matter. However, given the critical importance of this reform for Pakistan's taxation system and its economy, it is highlight recommended that leaders of our business community and leading professionals should initiate the process of dialogue with federal and provincial governments for achieving this essential reform. I believe that learning from Indian experience, and given sincere and persistent efforts by our businesses and professionals, we can achieve this goal in much shorter time what India has achieved after great difficulty and sustained efforts over a long period of time.