The Future Path of Tax Reforms in Pakistan
December 27, 2013
1.
Introduction
Pakistan’s
taxation system has come under intense scrutiny in recent years. The country’s
low and declining revenue yield has been attributed to wide-ranging concessions
and exemptions, large-scale tax evasion, and a slack and corrupt tax
administration. This has led to the perception of a virtual breakdown of tax
compliance in the country.
Improving the
tax effort has now become the lynchpin of any future economic reform process.
Experience shows that this will require political determination in order to overcome
the resistance from powerful vested interests. In addition, tax collecting
agencies such as the Federal Board of Revenue (FBR), will need to undergo
fundamental improvements to successfully implement the required changes in tax
policy.
The objective
of this chapter is to describe Pakistan’s taxation system both at the federal
and provincial levels, followed by an in-depth diagnosis of the factors
contributing to the exceptionally low tax-to-GDP ratio. We also assess the
level of tax rates, the magnitude of tax expenditures (revenue losses due to
concessions and exemptions in the tax code), and the extent of tax evasion.
Based on this
diagnosis, we identify the key elements of a reform package in the areas of tax
policy and administration. This set of reforms will promote transparency of the
tax system, improve the progressivity of the tax burden, and remove distortions
in the allocation of resources in the economy. Importantly, the various
measures proposed will help in significantly raising the tax-to GDP ratio.
2.
The Taxation
System
2.1.
Allocation of
Fiscal Powers
The major taxes
that can be levied at the federal level are given in Part I of the Federal
Legislative List (FLL) in the Constitution of Pakistan. As shown in Table 7.1,
this includes customs duties (including export duties), excise duties, taxes on
income and corporations, sales tax, capital value tax, taxes on natural
resources, capacity taxes, and terminal taxes on goods and passengers carried
by different modes of transport. With the exception of capacity taxes, all
these taxes are currently levied.
Table 7.1: Fiscal powers of the
federal government as per the Constitution a
Item no. (FLL-1)
|
Included
|
Excluded b
|
43
|
Customs
duties, including export duties
|
-
|
44
c
|
Excise
duties, including duties on salt
|
Duties on alcoholic
liquors, opium, and other narcotics
|
47
|
Taxes
on income
|
Agricultural income
|
48
|
Taxes
on corporations
|
-
|
49
|
Taxes
on the sale and purchase of goods imported, exported, produced, manufactured,
or consumed
|
Sales tax on services
|
50
|
Taxes
on the capital value of assets
|
Taxes on property
|
51
|
Taxes
on mineral oil, natural gas, and minerals used to generate nuclear energy
|
-
|
52
|
Taxes
and duties on the production capacity of any plant, machinery, undertaking,
establishment or installation
|
-
|
53
|
Terminal
taxes on goods and passengers carried by rail, sea, or air; taxes on their
fares and freights
|
-
|
Note: a = following the 18th
Amendment, b = fall in the domain of fiscal powers of provincial governments, c
= items no. 45 and 46 have been excluded (no. 45 included duties with respect
to succession to property, no. 46 included estate duty with respect to
property).
Source: Constitution of Pakistan (as updated up to the 20th
Amendment).
The provincial
governments have been given fiscal powers based on the exclusion of some parts
of the federal tax bases. Agricultural income tax and property-related taxes
have been declared provincial subjects. Following the 18th
Amendment, the sales tax on services has been brought exclusively within the
provincial domain. Further, all residual taxation powers are vested with
subnational governments. This justifies the provincial governments’ imposition
of taxes such as stamp duty, motor vehicle tax, and entertainment tax.
Additionally, Article 163 of the Constitution enables these governments to levy
a tax on persons engaged in professions, trades, and callings.
2.2.
Federal Taxes
The salient
features of each federal tax are described below.
Income tax. This is levied under the
provisions of the Income Tax Ordinance 2001. The legislation indicates the
types of income liable to taxation, tax rates, types of tax exemptions,
credits, deductions, and allowances.
Revenues from income tax accrue in the form of voluntary payments (along
with the filing of returns), collection on demand (following assessment), and
deductions at source (in the form of withholding and presumptive taxes). A
universal self-assessment scheme is in operation with returns being subject to
a stratified random audit. Currently, deductions at source are the major source
of revenue with a share of 57 percent, followed by voluntary payments, which
contribute 32 percent to revenues.
There are two types of withholding/presumptive taxes. The first includes
taxes collected at the point of accrual of different types of income, such as
salaries, export proceeds, dividends, and interest income. The second,
presumptive taxes, are collected on income proxies such as electricity and
telephone bills, the sale of automobiles, and air travel. The major deductions
at source are on income from services and payments for contracts, imports, and
salaries with shares of 25, 20, and 14 percent, respectively.
Sales tax. This is levied under the Sales
Tax Act 1990 and covers only goods. It has the features of a value-added tax
(VAT) with provisions for the tax invoicing of inputs and zero-rating of
exports. The act describes the registration process, filing of returns,
offences, and penalties. It contains seven schedules, of which the sixth
schedule gives the list of exemptions.
Customs duties.
The Customs Act 1969 enables the collection of customs duties. Duties on
imports are specified in the First Schedule at the 8-digit level of the
Harmonized System. Pakistan’s duty structure is cascaded by the level of value
added, with the lowest tariffs on primary raw materials and the highest on
finished goods. There are some tariff peaks on luxury items such as automobiles
and there is a list of banned items such as liquor.
Exemptions and concessions are granted under different
statutory rules and orders (SROs); some of the major SROs include the
following:
No.
|
Description
|
565(I)/2006
|
Exemption
from customs duty on the import of raw materials, subcomponents, components, subassembly,
and assembly for the manufacture of specified goods (mostly automobiles)
|
575(1)2006
|
Exemption
from customs duty on machinery and equipment
|
567(1)/2006
|
Exemption
from customs duty on the import of specified goods (nonsurvey-based)
|
In addition,
there are SROs covering free trade and regional trade agreements.
Excise duties.
Federal excise duty is levied under the Federal Excise Act 2005. Some goods,
such as cigarettes, are subject to supervised clearance under this act. The
First Schedule lists excisable goods and the rates of duty, which are either
specific or ad valorem. Following the broad-basing of the sales tax, the
coverage of excise duties has been substantially curtailed.
2.3.
Provincial Taxes
The key features
of the major provincial taxes are described below.
Sales tax on services. This was introduced simultaneously by the four provinces with the
enactment of the Sales Tax Ordinance 2000. The tax has been integrated with the
federal GST (VAT), as though it were leviable under Sections 3, 3A, or 3AA of
the Federal Sales Tax Act 2000; all the provisions related to payment,
registration, audit, enforcement, and penalties are the same. Initially, its
coverage was extended at the standard rate of 16 percent to hotels, clubs, and
caterers; advertisements on television and radio; courier services;
telecommunication services; stockbrokers; and miscellaneous services provided
at ports. The responsibility for collecting this tax was assigned to the FBR’s
Inland Revenue Service, and revenues distributed among the provinces on the
basis of population shares.
In 2011, the
Sindh government introduced its own variant of the tax. It proposed creating
its own capacity to collect the tax by establishing the Sindh Revenue Board.
The tax no longer retains the features of a VAT and has effectively been
transformed into a single-stage sales tax. Recently, the government of Punjab
established the Punjab Revenue Authority.
Stamp duty.
This was promulgated over a century ago, not as a fiscal statute but as a
mechanism for authenticating a large number of instruments through the use of
adhesive stamps. These stamps are classified as either judicial or nonjudicial.
For example, the stamp duty on the value of a property sold is 2 percent.
Land revenue.
This was originally promulgated under the Land Revenue Act 1887, and is
essentially a land tax payable by owners of agricultural land. It is collected
through the elaborate tax machinery of the provincial boards of revenue, which
also maintain and update land records. Prior to 1947, land revenue was one of
the main sources of revenue for the provincial governments.
Motor vehicles tax. This is levied under the Motor Vehicles Taxation Act 1958. Different
lump-sum tax rates are specified for different types of vehicles, to be paid
either once or annually. Persons with motor vehicles are obliged to make a
declaration, pay the tax, and receive a license. The tax is collected by the
provincial excise and taxation departments, and is intended to cover the costs of
road operation and maintenance within the provinces. As such, the tax rises
exponentially for larger vehicles. Motor vehicles tax rates vary among the
provinces.
Urban immovable property tax. Introduced in 1958, the government levies this tax in
urban areas that have been declared ”rating areas”. The tax is charged on the
assessed rental value (ARV) of buildings and lands in a rating area at the rate
of 20 percent. It is collected by the provincial excise and taxation
departments on the basis of a formula for assessing the rental value contained
in the valuation tables. Revenues from this tax are shared with local
governments to the extent of 85 percent, after deducting 5 percent as the cost
of collection. Properties that are owner-occupied and have an ARV of less than
PRs 1,080 or are located on an area smaller than 5 marlas (125 square yards) are exempt.
The five taxes
above account for more than 90 percent of the provincial governments’ tax
revenues. The overall composition of tax revenues is given in Table 7.2.
Federal taxes account for the bulk of revenues, with a share approaching 95
percent in 2011/12. The largest federal tax is the sales tax, which generates
39 percent of total tax revenues, followed by income tax at 35 percent. Customs
duties and excise duties contribute 10 percent and 6 percent, respectively.
The share of
provincial taxes is very small at only 5 percent, which is low in relation to
countries like India where the share of state taxes is over 35 percent. The
sales tax on services has emerged as the largest provincial tax, followed by
stamp duties.
Table 7.2: Share of revenues from
different taxes (PRs billion)
Tax
|
2007/08
|
Share (%)
|
2011/12
|
Share (%)
|
Federal
|
1,045.4
|
96.30
|
1,969.6
|
94.86
|
Direct
taxes
|
387.9
|
35.72
|
731.9
|
35.26
|
Indirect
taxes
|
622.5
|
57.33
|
1,153.7
|
55.58
|
Excise
duty
|
86.5
|
7.97
|
126.2
|
6.08
|
Sales
tax
|
385.5
|
35.50
|
809.3
|
38.98
|
Customs
duty
|
150.5
|
13.86
|
218.2
|
10.52
|
Surcharge/levy
|
35.2
|
3.24
|
83.4
|
4.02
|
Petroleum
levy
|
14.5
|
1.33
|
60.4
|
2.91
|
Gas
development surcharge
|
20.7
|
1.91
|
23.0
|
1.11
|
Provincial
|
40.2
|
3.70
|
106.7
|
5.14
|
Stamp
duty
|
11.3
|
1.04
|
16.5
|
0.79
|
Motor
vehicle tax
|
7.8
|
0.72
|
11.1
|
0.53
|
Property
tax
|
4.1
|
0.38
|
7.8
|
0.38
|
Others
a
|
17.0
|
1.57
|
71.3
|
3.43
|
Total
|
1,085.8
|
100.0
|
2,075.7
|
100.0
|
Note: a = including land revenue,
agricultural income tax, electricity duty, etc., and from 2011/12 onward, sales
tax on services.
Source: Fiscal operation, Pakistan, Ministry of Finance.
3.
Tax Administration
The FBR is the
federal government’s tax collecting agency. It comprises three types of
members—line, functional, and support—under the chairperson. Line members are
department heads who are directly responsible for tax collection, i.e.,
Customs, Inland Revenue (South), and Inland Revenue (North). The latter two
departments are responsible for collecting income tax, sales tax, and federal
excise duty.
Five
functional members are responsible for inland revenue policy, taxpayer audits,
legal issues, facilitation, and taxpayer education and enforcement, respectively.
The support functions fall under members for administration, human resource
management, strategic planning and statistics, and accounting and training.
Withholding tax agents include employers, government departments/ministries,
banks, telecommunication companies, electricity and gas distribution companies,
airlines, and provincial taxation departments.
The provincial
tax administrations comprise multiple agencies (Figure 7.1). The excise and
taxation departments are responsible for collecting taxes from urban
jurisdictions, such as property tax and motor vehicles tax. The provincial
boards of revenue operate largely in rural areas and collect land revenue,
agricultural income tax, and stamp duties. Following the 18th
Amendment, the government of Sindh has established the Sindh Revenue Board
primarily to levy and collect the sales tax on services. The government of
Punjab has followed suit with the Punjab Revenue Authority.
At the federal
level, the FBR’s costs of collection are estimated to be 0.6 percent of the
revenues that accrue to it, with 0.5 percent in the case of the Inland Revenue
Service and 2 percent for the Customs Department. The provincial costs of
collection are equivalent to 3 percent of own-revenues, which is low by
international standards.
Figure
7.1: Structure of tax administration in Pakistan
Note: SRB = Sindh Revenue Board, PRA = Punjab Revenue
Authority.
4.
Tax-to-GDP Ratio
The overall
tax-to-GDP ratio, inclusive of federal and provincial taxes, surcharges, and
levies, was 10 percent in 2011/12 (Table 7.3). During the last decade, the
tax-to-GDP ratio has shown a declining tendency, falling from a peak of 11.5
percent in 2002/03. During this period, FBR revenues declined by about 0.5
percent of GDP. The major part of the overall fall was due to surcharges/levy
on gas and petroleum, oil, and lubricant (POL) products, respectively.
A positive
development has been the rise in the direct taxes-to-GDP ratio from 3.0 to 3.6
percent, which has contributed to a more balanced and progressive tax system.
Indirect taxes have fallen significantly from 6.9 to 6.1 percent of GDP,
between 2000/01 and 2011/12.
Table
7.3: Tax-to-GDP ratio of Pakistan, 2000/01–2011/12
(percentage of GDP)
(percentage of GDP)
Year
|
Direct
taxes
|
Indirect
taxes
|
Surcharge/levy
|
Total taxes
|
FBR’s
revenue
|
Share of
direct taxes
|
2000/01
|
2.99
|
6.89
|
0.73
|
10.61
|
9.42
|
28.18
|
2001/02
|
3.20
|
6.41
|
1.23
|
10.83
|
9.11
|
29.54
|
2002/03
|
3.17
|
6.94
|
1.41
|
11.53
|
9.57
|
27.49
|
2003/04
|
2.92
|
6.84
|
1.09
|
10.84
|
9.25
|
26.94
|
2004/05
|
2.72
|
7.01
|
0.41
|
10.14
|
9.05
|
26.82
|
2005/06
|
2.82
|
7.06
|
0.67
|
10.54
|
9.36
|
26.75
|
2006/07
|
3.85
|
6.41
|
0.74
|
11.00
|
9.76
|
35.00
|
2007/08
|
3.79
|
6.47
|
0.34
|
10.60
|
9.83
|
35.75
|
2008/09
|
3.46
|
6.00
|
0.99
|
10.44
|
9.08
|
33.14
|
2009/10
|
3.66
|
5.83
|
0.90
|
10.39
|
9.05
|
35.23
|
2010/11
|
3.31
|
5.64
|
0.63
|
9.58
|
8.60
|
34.55
|
2011/12
|
3.58
|
6.06
|
0.40
|
10.04
|
9.12
|
35.65
|
Source: Pakistan, Ministry of
Finance.
Table 7.3 also
shows the structure of tax revenues. Pakistan appears to rely heavily on
indirect taxes, especially on taxes on goods and services. This also suggests
that the major focus of tax reforms in the country will have to be on further
enhancing the share of direct taxes.
Table 7.4
shows that Pakistan has the lowest tax-to-GDP ratio among 13 selected
developing countries. The centrally collected tax-to-GDP ratio of India and
Pakistan is more or less, the same, but the contribution of subnational taxes
is substantially larger in India. The average tax-to-GDP ratio of the 13
countries is 14 percent compared to less than 10 percent for Pakistan. This is
the first (crude) estimate of the “tax gap” in Pakistan.
Table
7.4: Comparison of tax-to-GDP ratio and taxation structure
in selected countries
Percentage
share of taxes on
|
|||||
Country
|
Year
|
Tax-to-GDP
ratio (%) a
|
Profits,
income
|
Goods and
services
|
International
trade
|
Bangladesh
|
2011
|
10.0
|
26.7
|
36.9
|
36.6
|
Brazil
|
2010
|
15.3
|
43.4
|
52.9
|
3.7
|
China
|
2009
|
10.5
|
28.2
|
67.5
|
4.2
|
India
|
2010
|
9.7
|
56.5
|
28.1
|
15.4
|
Indonesia
|
2010
|
10.9
|
53.7
|
43.4
|
2.9
|
Malaysia
|
2010
|
13.8
|
77.7
|
19.5
|
2.8
|
Pakistan
|
2011
|
9.3
|
34.6
|
52.7
|
12.7
|
Philippines
|
2011
|
12.3
|
47.6
|
30.3
|
22.1
|
South Africa
|
2010
|
26.0
|
56.5
|
39.5
|
4.0
|
Sri Lanka
|
2011
|
12.4
|
21.8
|
56.4
|
21.8
|
Thailand
|
2011
|
17.6
|
46.4
|
48.2
|
5.4
|
Turkey
|
2010
|
20.6
|
31.4
|
67.0
|
1.6
|
Egypt
|
2010
|
14.1
|
48.5
|
42.3
|
9.2
|
Average
(13 countries)
|
2009–11
|
14.0
|
43.6
|
45.0
|
11.4
|
Note: a = federal/central taxes
only.
Source: World development indicators, World Bank.
Next, we
examine the factors that have contributed to Pakistan’s low tax-to-GDP ratio by
isolating the “base” and ”rate” effects on the change in the tax-to-GDP ratio.
The “base” effect arises when the relevant tax base rises faster/slower than
GDP, while the “rate effect” comes into play when the effective tax rate on the
tax base rises/falls. The methodology used to identify the two effects is given
in the Appendix.
The analysis
spans the period 2007/08 to 2010/11 (see Table 7.5). The main reason for the
significant fall in the FBR’s tax-to-GDP ratio (by over 1.2 percent of GDP) is
the large negative base effect. The two primary tax bases in the economy,
large-scale manufacturing and imports, grew little during these years. The
former has largely remained static while imports showed a growth rate of only 1
percent in dollar terms.
Table
7.5: Base and rate effects on the change in taxa-to-GDP
ratio, 2007/08 to 2010/11
(%)
Tax
|
Base effect
|
Rate effect
|
Change in tax-to-GDP ratio
|
Direct taxes
|
-0.03
|
-0.50
|
-0.48
|
General sales tax
|
-0.56
|
0.30
|
-0.26
|
Customs duties
|
-0.28
|
-0.15
|
-0.43
|
Excise duties
|
-0.12
|
0.06
|
-0.06
|
Total
|
-0.99
|
-0.24
|
-1.23
|
Note: a = only federal taxes.
Source: Authors’ calculations.
The Social
Policy and Development Centre (2008), however, concludes the opposite where the
base and rate effects are concerned. Between 1999/2000 and 2006/07, the
tax-to-GDP ratio rose by 0.7 percent with a large positive base effect of 3.0
percent of GDP; this was largely neutralized by a sizeable negative rate effect
of 2.3 percent of GDP. The large-scale manufacturing sector grew by over 11
percent and imports expanded rapidly at the rate of 15.7 percent per annum. In
fact, the economy should have witnessed major ”fiscal drag”[1] during
this period of fast growth, but the revenue gains were largely frittered away
by the policy to reduce tax rates.
5.
Tax Rates
Tax rates were
brought down sharply by the military government. The maximum income tax rate on
individuals and associations of persons (AOPs) was scaled down from 35 to 25
percent in the Finance Bill of 2006/07. Tax rates were reduced substantially
for small companies (from 45 to 25 percent) and for banking companies (from 50
to 35 percent), in a staggered manner.
The maximum
import tariff was brought down from 45 to 25 percent by 2002/03, along with a
cascading down of the overall tariff structure as part of the process of trade
liberalization. This simultaneously affected revenues from sales tax at the
import stage and from the presumptive income tax on imports. The rate of excise
duty on cigarettes was also reduced. Overall, it appears that the Musharraf
government essentially followed a supply-side strategy of bringing down tax
rates in order to boost the economy. The tax bases did expand but not enough to
enable a major jump in revenues.
The subsequent
democratically elected government had to reverse this policy somewhat in the
face of a declining tax-to-GDP ratio. A minimum income tax was introduced,
while the maximum tariff on imports was raised once again to 35 percent and
brought down to 30 percent in the Finance Bill of 2012/13. The standard sales
tax rate was raised from 15 to 17 percent, and only recently reduced to 16
percent. An across-the-board special excise duty of 2 percent was introduced on
imports and domestic manufacturing, but withdrawn in 2012/13 in the lead-up to
the elections.
Following
these changes in the tax policy, how do Pakistan’s tax rates now fare in
international comparisons? Table 7.6 shows that the corporate tax rate on large
companies is relatively high at 35 percent as opposed to the average of 27
percent in the 13 selected countries. However, the maximum individual income
tax rate appears to be relatively low at 25 percent, while the standard sales
tax rate is on the higher side. These conclusions suggest the future direction
of changes in tax rates.
Table
7.6: Comparison of tax ratesa in selected
countries (%)
Country
|
Corporate tax rate (large companies)
|
Individual income tax
(maximum
rate)
|
VAT/GST
rate
|
Bangladesh
|
45
|
25
|
15
|
Brazil
|
34
|
27.5
|
17–25
|
China
|
25
|
45
|
17
|
India
|
13
|
33
|
5.5–14.5
|
Indonesia
|
25
|
30
|
10
|
Malaysia
|
25
|
26
|
-
|
Pakistan
|
35
|
25
|
16
|
Philippines
|
30
|
32
|
7–12
|
South Africa
|
28
|
40
|
14
|
Sri Lanka
|
35
|
35
|
12
|
Thailand
|
20
|
37
|
7
|
Turkey
|
20
|
35
|
18
|
Egypt
|
20
|
20
|
10–25
|
Average
|
27
|
32
|
12–16
|
Note: a = federal/central taxes only.
Source:
http://en.wikipedia.org/wiki/List_of_countries_by_tax_rates
6.
Tax Exemptions and
Concessions
Along with the
reduction in statutory tax rates, the Musharraf government granted wide-ranging
exemptions and concessions that contributed further to the reduction in the
“effective” tax rates. These included the following measures:
-
Abolition of the
wealth tax
-
Exemption granted
on capital gains from shares
-
Zero-rating of the domestic sales of major export sectors, such as
textiles
-
Exemption from
sales tax granted to agricultural inputs, such as fertilizer and pesticides
-
Exemption from
sales tax granted to plant and machinery
-
Promulgation of a
large number of SROs for exemption from or concession in import duties.
Presumably,
these measures were taken to gain the support of powerful interest groups.
According to
Bari (2012), the one exemption that was granted to capital gains from shares
led to a huge cumulative revenue loss of over PRs 1,000 billion between 2003/04
and 2006/07, at a time when the stock market was booming and the share price
index had jumped up by 280 percent. This massive tax break led to the emergence
of a new class of big capitalists in the country, who had invested heavily in
the stock exchange.
This brings us
to a very basic question: How far has Pakistan’s tax-to-GDP ratio been eroded
by exemptions and concessions? This requires estimating tax expenditures,
defined by Atshuler and Dietz (2008) as “revenue losses attributed to tax laws
which provide for a special exclusion, exemption, deduction, tax credit,
preferential rate of tax or a deferral of tax liability.” The word “special” refers
to tax breaks that are not commonly observed in tax systems internationally.
The Pakistan economic survey for 2011/12
gives an official estimate of PRs 186 billion as the value of tax expenditures
incurred under federal taxes, which is equivalent to 0.9 percent of GDP
(Pakistan, Ministry of Finance, 2012). The largest share is that of customs
duties (49 percent) followed by income tax (38 percent). This compares with an
estimate of 5.1 percent of GDP as India’s total tax expenditure, with the
largest share (54 percent) accounted for by customs duties. The corresponding
estimates by Mortaza and Begum (2006) for Bangladesh are 2.5 percent of GDP,
with 90 percent accounted for by indirect taxes. As such, tax expenditures
appear to be lower in Pakistan.
In the
following subsections, we provide, for the first time, a comprehensive
estimation of tax expenditures in Pakistan, inclusive of both federal and
provincial taxes. Presented in Table 7.7, these estimates are almost three
times the official estimates, at PRs 550 billion in 2010/11, which is
equivalent to 3 percent of GDP. A detailed description of the tax expenditures
is given below.
Table
7.7: Major tax expenditures in Pakistan
Tax/head
|
Tax expenditure
(PRs billion)
|
Percentage share
|
Federal
|
466
|
83
|
Direct taxes
|
164
|
30
|
Exemptions
|
46
|
|
Deductions/allowances
|
88
|
|
Concessionary tax
rates
|
30
|
|
General sales tax on
goods
|
91
|
16
|
Exemptions
|
70
|
|
Zero rating
|
21
|
|
General sales tax on
services
|
64
|
12
|
Exemptions
|
64
|
|
Custom duties
|
136
|
25
|
Exemptions
|
44
|
|
SROs
|
80
|
|
FTAs
|
12
|
|
Excise duty
|
11
|
-
|
Exemption of luxury
goods
|
11
|
|
Provincial
|
95
|
17
|
Agricultural income tax
|
50
|
|
Urban immoveable
property tax
|
30
|
|
Capital gains tax
|
15
|
|
Total
|
561
|
100
|
As percentage of
revenues
|
34
|
|
As percentage of GDP
|
3
|
Source: Authors’ calculations.
6.1.
Federal Taxes
The main federal
taxes levied are described below.
-
Income tax. The
major tax expenditures in 2010/11 included an accelerated depreciation
allowance at 50 percent[2]
in the first year (PRs 55 billion),[3]
a capital gains exemption on shares (PRs 22 billion), a 30-year tax holiday[4]
for independent power producers (PRs 12 billion), tax deductions on loan
provisioning by commercial banks (PRs 9 billion), an exemption on profit from
Behbood savings certificates (PRs 9 billion), tax deductions on charitable
contributions (PRs 2 billion), a concessionary presumptive income tax on the
export of goods (PRs 16 billion), the exemption of export income from services
(PRs 1 billion), and others[5]
(PRs 28 billion).
-
Sales tax on goods.
This includes exemptions on goods (PRs 64 billion) including agricultural
inputs, machinery, processed foods, pharmaceuticals, etc.; and the zero-rating
of domestic sales of export-oriented sectors such as textiles and leather (PRs
21 billion) (Social Policy and Development Centre, 2010).
-
Sales tax on services. This includes exemptions on services (PRs 70
billion) (Ghaus-Pasha, 2011), including those listed in the First Schedule but
not in the Second Schedule of the Sales Tax on Services Act.
-
Customs duty. This
includes zero duties on POL products, fertilizer, and cotton (PRs 44 billion);
exemptions in SROs, especially SRO 567(I)/2006, 565(1)/2006, and 575(1)/2006
(PRs 80 billion); and preferential rates of duty in trade agreements,
especially with China (PRs 12 billion).
-
Excise duty. This
refers to exemptions on luxury goods such as air-conditioners, freezers, large
automobiles, televisions, perfumes, and cosmetics (PRs 11 billion).
6.2.
Provincial Taxes
The main
provincial taxes levied include:
-
Agricultural
income tax. Low presumptive rates of taxation (Institute of Public Policy
[IPP], 2010) (PRs 50 billion).
-
Urban immoveable
property tax. Low presumptive rates of gross annual rental values, preferential
treatment of owner-occupied properties, and lack of extension of rating areas
(PRs 30 billion).
-
Capital gains tax.
Exemption on properties (PRs 15 billion).
6.3.
Analysis of Tax
Expenditures
Some important conclusions emerge from this analysis of tax
expenditures:
1.
Tax exemptions and
concessions in direct taxes (income, capital gains, and property taxes) account
for a tax expenditure of almost PRs 260 billion, equivalent to 46 percent of
the total. There is, therefore, empirical evidence to support the perception
that tax breaks in Pakistan disproportionately benefit the rich and powerful,
including the feudal class, the textile lobby, trading community, property
owners, and investors in shares.
2.
The structure of
customs duties has been perverted by the large number of SROs and exemptions
granted to industries such as automobiles, fertilizers, and textiles. The duty
structure needs to be rationalized by adhering to the principle of standard
statutory rates to enable proper cascading by the level of value added.
3.
In the case of the
sales tax, the strategy must consist primarily of broadening the tax base,
especially by bringing those services into the tax net that have grown rapidly
and are consumed chiefly by the upper-income groups.
7.
Incidence of Taxes
It is useful to
derive explicitly the implications of features of the tax system in terms of
who bears the burden of taxes in Pakistan. Wahid and Wallace (2010) have
derived these for the year 2007/08 as part of a study commissioned by the FBR.
The pattern of incidence is given in Table 7.8, according to which the burden
appears to be mildly progressive, despite the numerous tax expenditures on the
richer segments of society.
Table 7.8: Incidence of taxes in Pakistan, 2007/08
Taxes paid as percentage of income
|
|||
Decile
|
Direct taxes
|
Indirect taxes
|
Total taxes
|
1
|
2.01
|
6.42
|
8.43
|
2
|
2.20
|
6.17
|
8.37
|
3
|
2.18
|
6.08
|
8.26
|
4
|
2.30
|
6.20
|
8.50
|
5
|
2.35
|
6.59
|
8.94
|
6
|
2.38
|
6.73
|
9.11
|
7
|
2.50
|
6.26
|
8.76
|
8
|
2.91
|
6.82
|
9.73
|
9
|
3.35
|
6.28
|
9.63
|
10
|
6.38
|
6.74
|
13.12
|
Source: Wahid and Wallace (2010).
However, there is reason to believe that the tax burden has
become less progressive since 2007/08. First, the incidence of indirect taxes
on the lower income deciles has increased because of the change in the
contribution of different commodities to revenues. In particular, the share of
revenues collected from POL products has risen from 19 percent in 2007/08 to
over 32 percent by 2011/12. The bulk of revenues accrue from HSD oil, which is
used primarily for public transportation.
Second, the incidence of withholding
taxes, especially on imports, contracts, electricity, and telephones, is likely
to be more regressive than allowed for in the methodology used by Wahid and
Wallace (2010). In fact, Kemal (2008) demonstrates that the overall incidence
of taxes was regressive in 1999/2000. More recently, Qadir (2011) has
calculated the burden of indirect taxes by quintile in 2008/09. The results
indicate that the incidence is substantially more regressive than indicated by
the FBR study.
8.
Tax
Evasion
Tax evasion is commonly perceived as being rampant in
Pakistan. The two statistics frequently cited to highlight this are, first,
that only one in 100 persons in the country pays income tax, and second, that
more than 60 percent of parliamentarians do not file their tax returns.
However, it needs to be recognized that Pakistan has an elaborate withholding
tax regime that has played a major role in curbing evasion. It is estimated
that, as a result of these deductions, the actual number of taxpayers is
substantially larger than perceived. This is because:
-
payments
are made on over 100 million mobile/line phones on bills/prepaid cards,
-
almost
17.7 million bank accounts contribute to income tax via the fixed tax (at 10
percent) on interest income, and
-
over
306,800 industrial units and over 2.9 million commercial enterprises pay income
tax in the form of withholding tax on electricity bills.
The income tax net is thus wider than perceived due to the
presence of a large number of deductions at source. The problem is that the
payments are usually small and the element of progressivity has not been built
into the withholding/presumptive tax regime.
Additionally, there is too much emphasis on personal income
tax evasion. It is likely that more revenues could be generated by focusing on
corporate tax evasion. The numbers are striking: out of the 52,800 or so
companies registered with the Securities Exchange Commission of Pakistan, less
than a third file returns, and out of those who do, only a fifth actually declare
taxable profits. The State Bank of Pakistan (2008) estimates the additional
revenues that could be generated if tax evasion was curbed to be 2.5 percent of
GDP while Junaid (2011) calculates the share to be 3 percent of GDP.
9.
Tax Reforms
Based on the above
analysis, we now identify the package of reforms required in tax policy and
administration to achieve a major jump in the tax-to-GDP ratio. The primary
focus is on direct taxes, not only in order to increase the yield but also to
make the tax system more progressive.
9.1.
Tax Policy
The major steps
required are explained below.
9.1.1.
Direct Taxes
Effective agricultural income taxation. As per the Agricultural Income Tax Act enacted by the
provincial governments in 1947, the present structure comprises either a fixed
presumptive tax (with an exemption limit) per acre or a progressive rate
structure on actual agricultural income (with scope for substantial
deductions). The presumptive tax rates vary from only PRs 150 to PRs 250 per
acre, which is less than 1 percent of the net income per acre. These rates need
to be raised substantially. Simultaneously, the penalty for failing to file a
return should be raised from the present maximum amount of PRs 1,000 to 100
percent of the assessed tax, following the detection of nonfiling.
Development of personal income tax. This is considered a prerequisite for signaling
greater equity in the tax system, and could help raise taxpayer compliance
generally.
Taxation of assets. As indicated earlier, a wealth
tax was levied on individuals up to 2000. It was an indicator of equity in the
tax system and wealth returns also provided collateral evidence of income. This
tax should be reintroduced; alternatively, a minimum assets tax could be levied
at 1 percent of global net assets, as the minimum income tax payable.
Minimum tax on turnover. As mentioned above, a very small percentage of
companies actually pay corporate income tax. Although a minimum tax on turnover
was introduced in the Finance Bill of 2009/10, it was withdrawn in the Finance
Bill of 2012/13. There is a strong case for reintroducing this tax with the
usual carry-forward provisions in order to curb corporate tax evasion.
Withdrawal of tax expenditures. As is the case in India, transparency and the proper
accounting of tax expenditures should be introduced as part of the information
provided when the budget is presented to Parliament. This will enable public
debate on which exemptions and concessions are justified.
Direct taxes.
Initially, the following tax expenditures need to be effectively targeted:
-
capital gains
(short- and long-term) on shares and property
-
tax holidays
beyond five years
-
reduction in the
first-year depreciation allowance
-
tax deduction on
loan provisioning by banks (to be allowed only for priority sectors such as
small and medium enterprises, agriculture, and exports).
Rationalization of tax rates. The divergence in tax rates between individuals, and
small and large companies needs to be eliminated. The corporate tax rate on
large companies (especially those that are publicly quoted) could be brought
down gradually to 30 percent. Simultaneously, the maximum tax rate on
individuals and AOPs/small companies could be raised to 30 percent. This would
encourage the process of corporatization in the economy and imply a more
progressive personal income tax structure.
Moving from schedular to comprehensive income taxation. Currently, most forms of unearned income are taxed at
source as separate blocks of income at a fixed and final rate of 10 percent. As
highlighted earlier, this has reduced progressivity. These fixed taxes should
be converted into withholding taxes in the case of income from bank deposits,
savings schemes, dividends, and interest on securities and prize bonds, etc.
This will also enable persons whose total income is below the exemption limit
to claim refunds.
Fixed taxes are also levied on income proxies. In the case of
contractors, suppliers, service providers, and importers, we propose a scheme
whereby the current fixed rate is raised for taxpayers who want to make this
their final payment, and a lower rate for those who prefer to make a
withholding tax payment and include the income derived in their returns. This
could promote the process of documentation in the economy.
Development of property tax. This will involve extending rating areas, levying a
higher tax on commercial properties, and reassessing gross annual rental
values.
Incentives for filing returns. Numerous incentives could be offered to taxpayers
(AOPs and small companies) who have regularly filed their returns over a period
of two years with no under-declaration or short payment. These incentives could
include the following:
-
some preference in contracts for suppliers to government departments;
-
a guaranteed
refund within the stipulated time;
-
access to a bank
loan up to a certain limit;
-
provision for the
carry-forward of losses;
-
partial or full
exemption from withholding taxes, contributing thereby to an improved cash flow
position;
-
preferential
treatment in obtaining access to public services such as passport issuance and
electricity or gas supply; and
-
tax credit.
These
incentives could induce a significantly higher number of tax returns.
9.1.2.
Indirect Taxes
Proposals to
reform indirect taxes include the following:
Introduction of a broad-based
integrated VAT.
The passage of the VAT bill of 2010 should be reconsidered. Recent developments
such as the establishment of separate tax machinery to collect the sales tax on
services by the provincial governments of Sindh and Punjab have made the task
of integration more difficult, and have complicated the process of input-tax
invoicing services in manufacturing and manufactured goods in services. A
system for recording tax invoices issued across provincial boundaries and of
credits/refunds between governments needs to be introduced.
Broad basing
has considerable scope, especially in the area of services. For example, the
services tax in India is levied on 125 services and generates 1 percent of the
country’s GDP. In Pakistan, major services that are not covered by the sales
tax on services include credit cards, security, consultancy, accountancy,
legal, airport, and air travel agent services. Such services are consumed
mostly by corporate entities or upper-income groups. The standard rate could be
brought down to 12.5 percent once again, following the broad basing.
Rationalization of customs duties. The statutory tariff rates (by nature of the good in
terms of value added) must be adhered to with essentially three slabs of 5
percent, 15 percent, and 25 percent, respectively. Simultaneously, most SROs,
except those pertaining to trade agreements, should be withdrawn.
Additionally,
in order to eliminate the problem of under-invoicing, a system of minimum
import prices could be introduced for some commodities, with the provision that
these prices be periodically revised. This system was in operation in Pakistan
in the 1990s and does not violate World Trade Organization rules, if used
selectively.
9.2.
Tax Administration
FBR. Radical
changes are required to make the FBR more effective in implementing reforms in
tax policy and collecting more revenues. The following measures need to be
undertaken on a priority basis:
-
Converting the FBR
into an autonomous revenue authority
-
Strengthening the
Revenue Division of the federal Ministry of Finance to formulate tax policy
-
Requiring tax
officials to file asset declarations periodically
-
Strengthening the
tax ombudsman and vesting him/her with judicial powers
-
Strengthening the
FBR internally in the areas of audit and intelligence
-
Developing a data
warehouse linked particularly to withholding tax payments
-
Streamlining the
process of payment of refunds
-
Augmenting the
quality of human resources
-
Publishing an
annual tax directory of payments by taxpayers.
Provincial tax administration. The following proposals need to be considered:
-
Reducing the
multiplicity of taxes by abolishing taxes such as the cotton fee, entertainment
tax, and tax on property transfers that generate low yields
-
Avoiding
overlapping taxes, for example, on property by “piggy-backing” on federal taxes
-
Merging the Excise
and Taxation Department with the Revenue Board/Authority, following the process
of screening officials
-
Making intensive
efforts to streamline business processes and to introduce information and
communications technology, especially to enable taxpayers to e-file their
returns or make payments
-
Appointing a
provincial tax ombudsman, also vested with judicial powers
-
Augmenting the
quality of human resources
-
Publishing a tax
directory of payments of agricultural income tax and urban immoveable property
tax.
Clearly, this
agenda of reforms is an ambitious one, but it has become necessary in the
presence of a low and falling tax-to-GDP ratio and the incipient breakdown of
Pakistan’s tax culture. However, it will require strong political will and the
capacity building of the implementing institutions. If the proposed reforms are
put in place within the next two years, they could yield a conservative
estimate of almost PRs 500 billion—equivalent to an additional amount over 2
percent of GDP (see Table 7.9).
Table 7.9: Revenue yield from tax
reforms (with a tax base of 2012/13*)
Direct taxes
|
Revenue
yield*
(PRs billion)
|
Effective agricultural
income taxation
|
60
|
Taxation of assets
|
50
|
Minimum tax on turnover of
companies
|
22
|
Withdrawal of tax
expenditures
|
130
|
Total
|
262
|
Indirect taxes
|
|
Introduction of a
broad-based integrated VAT
|
140
|
Withdrawal of SROs in
customs duties
|
96
|
Total
|
236
|
Overall total
|
498
|
Percentage of GDP
|
500
|
Note: * = 20 percent above the
estimates given in Table 7.7.
Source: Authors’ estimates.
10.
Conclusion
Pakistan’s low and declining tax-to-GDP ratio has been attributed to
the major tax bases’ lack of buoyancy, low personal income tax rates,
wide-ranging exemptions/concessions, and widespread tax evasion, leading to
large revenue losses. There are also serious perceptions of inequity and
corruption in the tax system, which have gravely affected tax compliance such
that the tax culture in the country stands in danger of breaking down.
This chapter
has, accordingly, proposed a structural and radical reforms agenda both in the
areas of tax policy and administration. These reforms will go a long way in
making the tax structure more progressive, reducing tax evasion, and raising
the revenue yield in the next two years by over 2 percent of GDP.
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Appendix
The methodology
for decomposing the change in the FBR’s tax-to-GDP ratio into “base” and “rate”
effects respectively is described below.
We designate
the following:
T = actual tax
revenue
t = effective
tax rate
b = tax base
Y = GDP
That is, T =
tB
The tax bases
for different taxes are as follows:
Tax
|
Tax base
|
Direct taxes
|
Nonagricultural GDP
|
Sales tax
|
Imports + large-scale manufacturing
+ banking and insurance + telecommunications
|
Customs duties
|
Imports
|
Excise duties
|
Large-scale manufacturing
|
Subscripts 0 and 1 designate the base and terminal years, respectively.
The change in
the tax-to-GDP ratio is given by
That is,
(1)
Equation (1)
gives the expressions for the base and rate effects, respectively.
* The author is dean of social sciences at Beaconhouse
National University, Lahore.
** The author is director of the
Institute of Public Policy at Beaconhouse National University.
[1] ”Fiscal drag” occurs when fast economic growth leads to an increase in
the tax-to-GDP ratio.
[2] The normal depreciation rate is 8–10 percent.
[3] The magnitude of tax expenditures is given in
parentheses.
[4] The normal tax holiday period is five years.
[5] Including tax deductibility of payments to Workers’
Welfare Fund and Workers’ Participation Fund, tax credit for provident funds,
exemption on income from trusts, concessionary rates of sales tax, and lower
income tax rates for suppliers and teachers.
Labels: Pakistan, Pakistan Economy, Pakistan: Moving the Economy Forward, Publications
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