"Everything should be made as simple as possible, but not simpler". Our taxation system complexities are required to be simplified, but at the same time, the coverage has to be broad based. The FBR is aiming a tall (next to impossible) target of 34-40 percent growth in FY20 depending up on how much tax is collected till June 30, 2019.
The IMF conditions have compelled the government to undo long run tax exemptions which have arguably been misused for decades, and spurred a rent seeking culture. The FBR religiously used SROs to bypass parliament in case of imposition of taxes or more importantly exempting taxes for a few sectors, or in some cases for a few companies (or individuals). The system has deliberately been kept complex for a few to enjoy rent without being noticed, or even when things are highlighted, there are no studies to support what potential tax loss is or what economy has benefited out of these exemptions.
It is time to test the water. It is time to open up the economy by breaking the shackles of rent seekers. The immediate response would be inflation, dip in exports and fall in production, including agriculture. A lot of hue and cry from the lobbyist who have kept media, parliamentarians and other stakeholders happy one way or the other while enjoying at the cost of economy at large.
The economy may get more messy and the opposition along with these rent seekers would exert as much pressure as they can on the premise of inflation and job loss to undo the proposed changes. It is hard for any government to dare touch the untouchables - exporters and traders; current regime has no choice, but to end exemptions, correct the import/export under/over invoicing, and to have the right sales tax structure. Else, prematurely exit from the IMF.
The effectiveness of high tax rates dilutes with the exemptions through fifth, sixth and other schedule to sales tax, and via SROs. GST is at 17 percent on goods and services, and is expected to be increased to 18 percent in the upcoming budget. The effective or actual rate, on domestic sales basis, was around 4.5 percent collected from mere 55,000 entities in FY14 as rest is either exempted or evaded. In FY18, at 17 percent GST, the collection was 4.3 percent of GDP.
The real game of under reporting or evasion is done in imports. The tax collection is highly skewed with 43 percent FBR collection in FY18 was at imported stage. Within it, 55 percent of sales tax and 14 percent of direct tax was collected at imported stage.
Now, all a trader requires is to under invoice imports to get rid of majority of his tax liability. The custom officers and traders have incentive to collude and share the benefit of under invoicing. In FY18, total imports, as per PBS, were $ 60.8 billion while custom duty collection was Rs 608 billion - implying average duty of 9 percent. The duty is mostly at 20 percent.
Surely tax is evaded, and is cascaded. For example, if a trader imported goods of Rs 100 million and invoiced it at Rs 50 million, and sold them at Rs 125 million in domestic market. The actual value addition is Rs 25 million, but he has to show value addition of Rs 75 million. The gap of Rs 50 is somehow become part of black economy through fake input flying invoices of unregistered suppliers by paying 2 percent on it.
There are other ways to curb taxes at import stage too. For example in case of paper, the paper for rough copies of students are duty exempt, but a few import fine dutiable paper as rough, to avoid taxes and duties. Another example is that 20 ft import container is documented against goods which have low or no duty, but would have numerous other consumer goods - one can find in super market, loaded under the name of low duty goods.
There is massive under-invoicing and that cascades to GST and WHT collection and tax potential further diluted. The difference between exports recorded from China for Pakistan is about $6-8 billion higher than imports recorded from China in Pakistan, and majority of that is under invoiced. Similarly, many goods are being consumed in Pakistan but are imported for use in Afghanistan - like cigarettes and tea.
The problem is that loading of taxation is higher at imported stage and that has incentivized people to under-invoice and manage the supply chain through grey and cash economy. In case of exports, domestic sales are being recorded as exports to enjoy the zero rating on supposedly taxable goods. The other way to enjoy duty exemptions by showing domestic sales as exports by over-invoicing exports. For example, import copper at zero rate for exporting fans, but sell mainly in domestic market, and claim refunds by showing domestic sales as exports.
A similar problem is in the services business where GST is a provincial subject. The restaurants, beauty salons, etc., are probably under-invoicing the sales to lower the GST liability. That effectively lowers their income tax liability to federal government as well. For any business, the income is to be gauged on turnover and using the industry average of gross and operating margins to estimate the income before taxes. But since turnover is under invoiced, it cascades to all other taxes.
Then there is a problem of transfer pricing by big corporate - buying raw material/intermediate goods from parent company abroad at inflated prices to depress the gross margins and lower the income tax liability in Pakistan while the company abroad may be in a country where taxes are low or exempted.
The bottom line is that our taxation system is complex. The need is to make it simple. We should move towards single stage taxation in the value chain at either the point of import or at domestic production or sale. And at imports, there should be simple duty structure with no exemptions. If the country achieves this through tax reforms, tax collection can double at even half the rate. But, it is easier said than done.