Fixing the Pakistani Tax System

The existential threat to Pakistan starts with the letter ‘T’. It’s ‘Taxes’. More precisely, it’s the lack of a fair and equitable taxation system, and the unwillingness and inability of successive governments to fix it.

It will be useful to review the recently presented federal budget for 2013-14 from the perspective of fairness of ‘burden sharing’. While the budget does make a welcome – albeit somewhat modest – attempt to widen the tax base, it falls short of the standards of equity and fairness by placing an unduly large burden on existing and honest taxpayers.

Take the case of the higher tax incidence on salaried persons – a group of around 900,000. While this group of captive taxpayers will be coughing up substantially more tax revenue, the group of professional service providers (doctors, lawyers, architects, consultants, tax practitioners, interior designers etc.), agriculturists, retailers and wholesalers, transporters and many, many others will continue to escape lightly.

Similar is the case of the income support levy – a rehashed version of the wealth tax, but imposed on “moveable” rather than “immoveable” assets. The handful of honest taxpayers disclosing their assets truthfully will face a larger tax burden, while habitual tax dodgers who grossly understate their incomes and overstate their expenses each year, and who also conceal the increase in their assets by dispersion of ownership, will walk away by paying a pittance.

How will the Federal Board of Revenue (FBR) rectify this imbalance and inequity, when it has not been able to lay its hands on tax dodgers – many in powerful places – for decades?

This underscores the importance of reforming the FBR first, and then initiating measures that empower it further to monitor and scrutinise – a point which we will return to later.

On the issue of burden-sharing and demonstrating political will and resolve to see many of the taxation measures through, the government’s buckling under pressure to government servants on the issue of salaries is not a good start or sign.

The budgetary burden of civil servants’ salaries (federal only) has increased 3.5 times in the last four years – from Rs184 billion in 2009-10, to Rs640bn in 2013-14 – making this segment amongst the most favoured and pampered in terms of government spending.

Returning to the issue of reforming the tax system, it is clear that Pakistan has to work along three axes: improving tax policy, restructuring tax administration, and changing the tax culture. A non-exclusive list of measures that can help, follows.

Tax policy

The adoption of a resolution by parliament or a policy statement by cabinet reiterating commitment to the principle of all incomes to be taxed, irrespective of source;

• Elimination of major exemptions in income tax and sales tax regimes. The latter alone is estimated to cost the exchequer around Rs80-100bn annually.
• Unwinding the Presumptive Tax Regime, in place for categories such as exporters, commercial importers, professional services etc., and moving to a regime of determination of tax liability after filing of returns;
• Closing loopholes such as Section 111(4) of the Income Tax Ordinance that provide for permanent ‘whitening’ schemes;
• Simplification of the tax code should be considered. Ambiguous treatment and multiplicity of taxes should be eliminated in the medium term.
• Introduction of an “adjustor” in the next NFC Award whereby a province can be penalised for shortfall in revenue collection against a calculated “tax potential”. This will be necessary to correct the skewed disincentive at the moment against own-resource mobilisation by the provinces in the presence of a generous transfer from the federal divisible pool;

Improving taxpayer confidence

To improve accountability and transparency, and to enhance taxpayers’ confidence, the annual tax declarations of members of parliament, starting with the cabinet, to be made public and pre-selected for audit and scrutiny by an autonomous FBR;

• As part of wider FBR reform, establishing an ‘arms length’ relationship with taxpayers through use of third-party developed automation solutions.
• Issuance of a charter of taxpayer rights, leading eventually to a bill approved by parliament. This charter (a draft of which has already been prepared by a sub-committee advising the federal tax ombudsman) will detail the rights and obligations of taxpayers, the government and the FBR;

Tax administration

Providing constitutional tenure for chairman and members FBR to protect their working from political interference (such as for the State Bank governor). In addition the FBR should be converted into a fully autonomous organisation with separate pay scales from government (as laid out in the FBR Act of 2007).

• Elimination of FBR’s discretionary power to issue Statutory Regulatory Orders. This authority should vest with parliament, and an SRO should only be issued after a public hearing by the National Assembly’s Standing Committee on Finance and Revenue. No SRO to be issued that pertains to any member of the standing committees and/or the cabinet.
• Identification of potential taxpayers via use of “third party” databases. To a large extent, this work has been done. the FBR has identified over 3.2 million potential taxpayers by “querying” the Nadra database for tell-tale signs of an affluent lifestyle, and matching them with the tax register.

In terms of sequencing, while many of the measures can be implemented simultaneously, the major area of focus should remain reform of the FBR. If implemented honestly, the measures listed above can lift Pakistan’s tax collection within three years closer to 13pc of GDP.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Originally published in the Daily Dawn.