Taxation Issues

ECONOMIC REFORMERS
Low Tax Generation And Pakistan’s Economy
Group Members
Haider Waseem Anwar
Eamaan Azhar Arain
Warda Zahid
Adiya Farooq
Muneeb Abbas

introduction
Pakistan is currently facing critical tax revenue generation issues. The low tax to GDP ratio has been a major problem that affects the overall economy of Pakistan. The current tax to GDP ratio is under 10 % according to the latest FBR report (Where developing countries have a tax to GDP ratio of around 20 %, and developed countries having around 35- 40 %).
The low value of tax generation prevents economic growth and development by affecting the real GDP, external and internal debt and even other forms of revenue generation. The real question still remains what causes the tax generation volume to have such a low value, and what could be, or is being done to solve this problem.
Reasons for the low tax to GDP ratio
One of the reasons of low tax revenue is the low tax base. Observing the history of Pakistani economy we can see how the tax generation is low not due to the slow growth in tax base, but due to the decrease in the existing tax bases. Over the time we have seen various examples of such policies that reduce the tax base. Some examples can be observed during the period of 2000- 2008; the high influx of cash and delay in debt repayment motivated the government to cut back on many forms of tax. Corporate financial tax on people was reduced by 15 % and on banks by 23 %. The income tax on salary of government employees was reduced by 15 % and on self-employed people by 10 %. There was also exemption on sales tax in agriculture and industrial sector, while the import tariffs were also reduced. The abolishment of wealth tax also helped aggravate the problem of low tax base, as much of the rich people with high percentage of contribution towards tax revenue had no obligation to give tax on their accumulated wealth. The capital gain tax on shares was exempted which further reduced the revenue from tax (Pasha). Through misusage of political power, such abolishment of taxes on, a few industries and business operations, in the name to promote certain field has created many problems for Pakistan’s economy. The low tax base was not increased with the same pace it was increased, and this has created an overall low tax base in Pakistan with the passage of time.
Another issue is the flawed system and half-heartedness of implementation of tax law. The low amount of tax payers of around 2 Million is registered as tax payer (Pasha). The highly unregistered amount of tax payers can be seen as a flaw in the administration of tax collection. Only around 18,000 corporate entities have been filed for being taxed. The tax gap (The difference between the amount decided to be collected as tax, and the amount that actually is collected) is also around 79 %; according to a report of 2009 by World Bank, the evaded tax was around 786 Billion compared to a 1.1 collection of tax revenue (Sindhu). This means that from the low amounted of people counted to be recorded for taxation; the number is further reduced by the lack of efficiency in administration.
Corruption also plays an important role to make the tragic situation of low tax revenue generation, egregious. The TIP (Transparency International Pakistan) indicated a embezzlement of around 300 Billion Rupees in the Federal Government department in 2010. The Agp( Auditor National Pakistan) also concluded a corruption case of around 116 Billion Rs. in the account of FBR. Corruption being like plague, has made the job of honestly collecting the tax generation revenue in Pakistan more difficult.
Furthermore, an investigation by the FBR has revealed that some of the leading celebrities of the entertainment industry have been paying very little or no taxes at all as compared to their earnings. Actors such as Faisal Qureshi, Humayun Saeed, Nauman Ejaz, singer Hadiqa Kiyani and writer Umera Ahmed are reported for hiding their incomes, under-declaring their assets and overstating their expenditures. For example under this report one of the celebrities, the actress Atiqa Odho, has claimed to have paid Rs536, 000 tax in 2011 and Rs480,000 in 2010 which does not match to her earnings (Dawn Newspaper). Pakistan’s income tax department has served notice to 21 International Cricketers for tax evasion which amounts to almost 100 million in the past two years. These cricketers didn’t file their tax returns and used workarounds such as fitting themselves in the category of lesser tax liabilities. They paid taxes at a rate of 6 or 7 percent (minimum slab) violating the income tax ordinance (sports.ndtv). It’s the weakness of FBR that people so easily escape the punishments prescribed by the law for not paying the correct amount of taxes. http://sports.ndtv.com/cricket/news/item/198796-notice-to-21-pakistani-cricketers-for-evading-tax Low tax effects on borrowings, real GDP and inflation, other forms of revenue
Due to low tax generation, Pakistan is having stunted economic growth, increased budget deficit, high inflation and is depending more on borrowings, both domestic and foreign.. (http://www.dgtrdt.gov.pk/Research/37th_synndicate_%20rports/5.pdf ). http://www.tradingeconomics.com/pakistan/tax-revenue-percent-of-gdp-wb-data.html
A report (http://www.pakistantoday.com.pk/2012/06/01/news/profit/head-over-heels-in-debt/?printType=article ) published in June 2012 stated that the public debt position was worsening. Amongst the factors that caused the decline in position was a narrow tax base. This public debt position has resulted in a large fiscal deficit. The public debt has increased from 12.3 % / Rs 1.315 trillion to Rs 12.024 trillion during just the July to march period of the current fiscal year. This will lead to great implications on the economy. A greater amount of allocation would be directed towards debt servicing in the future according to the economic survey of 2011-2012.
The rising domestic debt and the sustained poor performance of the government is increasing the cost of borrowing as well. http://dailymailnews.com/0512/28/Editorial_Column/index.php)

With increases in domestic borrowings, the interest rate rises. Consequently, private investment is crowded out and aggregate supply decreases which contributes to an increase in inflation. As foreign borrowing increases, non-interest current account deficit goes up. Moreover, there is a rise of capital losses on external debt due to the depreciation of exchange rate. Both of these factors contribute to inflation. The budget deficit also effects inflation expectations of the population. The increased public spending that gave rise to the deficit in the first place raises the anticipations of growing price levels; this fuels inflation even more. Although some inflation is beneficial for growth of the economy, high inflation over a certain threshold affects the output growth in a negative way. http://issuu.com/businessrecorder/docs/fr_2012?mode=window&pageNumber=1 Even though the real gdp has been increasing from 2010 to 2012, it still is less than it was in the past decade. Having a look at the data provided by IMF report, the trend for the real GDP from 1980-2011 shows a declining and a volatile GDP. The tax to GDP ratio is not improving and this has an effect of stunting economic growth. This has further worsened the debt position of Pakistan. With decreasing foreign direct investment, Pakistan is becoming less attractive for the world market. This together with the low revenue generation is increasing the debt burden. http://www.imf.org/external/pubs/ft/scr/2012/cr1235.pdf

http://www.efic.gov.au/country/countryprofiles/Documents/EFIC-country-profile-Pakistan-January-2012.pdf?utm_source=seo&utm_medium=country-pakistan&utm_campaign=seo-efic-country-pakistan-pdf-lk-120626
Due to our lower tax base and generation, foreign countries are unwilling to grant aid to Pakistan. Therefore, it becomes harder for the government to raise other forms of revenue. To quote what Hilary Clinton said: “Pakistan cannot have a tax-to-GDP rate of nine per cent when land owners and all the other elites do not pay anything or pay so little it’s laughable. And then when there’s a problem everybody expects the US and others to come in and help.”
Solutions
As we have already established in the previous section, Pakistan’s low Tax to GDP ratio has been recognized by many economists and other intellectuals both inside and outside the country as the leading cause of different economic problems. Some believe that such tax reforms are now close to impossible given the current condition of Pakistan but if proper steps are taken, this falls very much in the realms of possible. In this report we’ll try to give a few possible solutions to the massive tax problem of Pakistan. We’ll try to analyze this problem on different levels to have a better understanding of why a country with a population of almost 17 million has a tax to GDP ratio around 10.2 %. The first thing that comes to mind is why Pakistani’s are hesitant to pay taxes? Or why Pakistani’s don’t pay taxes at all? There’s a general mistrust in these people and they don’t believe that the funds collected will be spent on the public at large. They will be used to fulfill the personal needs/wants of politicians. Coming to our second problem, the people don’t believe that paying these taxes will in any way increase the quality of government services or public goods provided to them. This is a very serious problem and even if the government takes steps to efficiently allocate tax revenue, this low collection of taxes will prevail until people’s trust is restored and they are assured that these funds will be used in the best possible way keeping in mind the interest of the public. This goal can be achieved by making plausible promises about improvement and increase in public goods and services. They have to make the people believe that these taxes won’t simply reduce their disposable income but in effect increase it by the reduction of expenses on private goods and services by better provision of healthcare, education and other public services. Another step that should be taken is the transfer of some of the tax burden of middle and lower income class people by reducing indirect consumption taxes and shifting that burden to wealth taxes.
Another major reason for Pakistan’s low tax collection as already explained previously is corruption and fictitious tax assessments. This is another serious problem which heavily damages tax collection. As pointed out earlier many people are offered to pay a relatively small amount of bribe instead of their taxes. If this persists even the above mentioned solutions won’t properly solve the problem of tax collection. There should be a proper reformation of legal procedure and anyone found in corruption related to taxes should be heavily fined along with some jail time. A formation of an intelligence bureau especially during the initial period of these tax reforms should be formed which will keep a close eye on the taxation authorities and also pursue people to pay taxes. Proper steps should be taken by the authorities in an effort to account for all payments and income so that the tax base is broadened.
The narrow tax net in Pakistan also contributes to low tax collection. The inclusion of agriculture in the tax net has been considered for some time now and it was even backed by one of the main political parties of Pakistan, Nawaz Sharif led PML (N). Agriculture accounts for almost 25% of the GDP of Pakistan and gives jobs to almost 40% of the labor force. Landlords that earn millions through agriculture are not even taxed a single rupee and it’s a common practice that other people also try to label their income as agriculture where possible to evade tax. As this tax is not imposed on the sale as sales tax, this tax should not result in an ever inflating price of agricultural products as wrongly feared by some people and is one of the most important steps that have to be taken to address this massive tax collection problem in Pakistan.