ARTICLE (May 14 2010): Over the period, our tax system has become rotten, oppressive, unjust and target-oriented. There is a dire need to discuss the philosophical framework and principles that should be the main concern of our tax policy.
Our revenue potential for 2010-11 is not less than Rs 4 trillion provided the rich and mighty are taxed, tax avoidance and evasion is countered, tax net is broadened, equitable and rational policies are devised with the consultation of stakeholders, tax machinery is completely overhauled and all exemptions and concessions available to the privileged sections of society are withdrawn.
Less than four weeks are left for announcement of the national budget for fiscal year 2010-11, the government has yet not prepared - or at least revealed for public debate - any National Tax Policy. Under a democratic dispensation, it is the duty of the elected parliament to make laws and approve policies put forth by the government (Federal Cabinet) for collection of taxes while FBR should merely implement them in letter and spirit.
During the last many years, before the announcement of annual federal budget, plethora of proposals are solicited by the government from trade and professional bodies, tax bars and industry's representatives. This practice, serving the vested interest, should be stopped.
Unfortunately, it's a fact that during the last decade, the FBR introduced an avalanche of mindless changes in the tax codes having no meaningful impact on much-needed industrial expansion and economic growth of the country. The existing process of initiation of budget proposal and making of revenue policies is firmly against the democratic norms. In a true democratic set-up, tax proposals are debated through parliamentary processes, and implemented after thorough public debate, whereas in Pakistan it has always been a bureaucratic prerogative, authority vests in the 'official kingdom' sitting in the Ministry of Finance and the FBR.
This is the root cause of failure of our fiscal and revenue policies. Would Abdul Hafeez Shaikh change this scenario and rely more on "people who know" rather than "all-knowing baboos in the government"? We have our serious doubts as Hafeez has less than a month to draft the Budget for presentation to the nation.
If we want to make Pakistan a self-reliant egalitarian state, we must prepare a pro-people, pro-growth National Tax Policy after taking input of all the stakeholders, expert opinion of a committee of experts in the field and FBR's point of view. Taxes should be for the benefit of the people, not the rich and mighty echelons of society. Since all the governments - civil and military alike - do not want to pay taxes themselves, our present tax policy is ill-directed, illogical, regressive and unfair tax.
In reality, these measures and policies have caused a dampening effect on the industrial and business growth while expanding the gulf between haves and have-nots. The sole stress on meeting revenue targets, without evaluating its impact on the economy is a self-defeating exercise. Had the successive governments concentrated on economic growth and industrial expansion, there would have been consequential substantial rise in taxes today.
It is impossible to enhance revenues without achieving sustainable economic growth. Over-taxing an already sick economy, as has been done in Pakistan, destroys growth and expansion leading to unemployment and social unrest. It is well-recognised that private sector regards the problem of dealing with government revenue agencies, in particular the FBR, a major constraint to its business operations and growth prospects - see "Punjab Economic Report Towards a Medium-Term Development Strategy", jointly compiled by the Punjab Government, the World Bank, Department of International Development, UK and Asian Development Bank.
Successive governments' onerous tax and regulatory policies have pushed millions below the poverty line. We will have to move quickly and decisively to reverse this trend by restoring Pakistan's undeniable geo-strategic and business competitive position in the region. There is an urgent need to take necessary and tough decisions to make Pakistan a respectable place to live, work and invest. Suggestions are being made regarding some key areas where paradigm shifts are needed in structural and operation level to ensure not only more tax revenue for the State but also social equity, redistribution of wealth and fairness so that honest taxpayers are not disillusioned.
Provisions for countering tax evasion: A curious paradox of our situation is that while money for worthwhile industrial and business growth and public benefits is scare, there is colossal unaccounted cash supply circulating in the economy in search of further undercover gains. What is more tragic is that this social evil inherent in our tax system is doubly compounded as it necessitates greater and greater tax burdens on those who are law-abiding.
The most crucial problem faced by us in fiscal reform programme is that of devising astute and stringent measures to curb tax evasion so that success can be achieved in distributing the burden of taxes fairly between different persons in the same or similar occupations.
Honest taxpayers have to be safeguarded as day by day they are getting disillusioned by the fact that tax evaders are not paying anything with the connivance of their friends and mentors in tax machinery. This unholy alliance between tax evaders and corrupt tax officials has to be eliminated as a first and foremost step if we want to initiate any meaningful change in tax system.
Available in the form of section 111(4) of the Income Tax Ordinance, 2001, is an unprecedented tax amnesty scheme favouring tax evaders, smugglers, corrupt, extortionists, drug barons and criminals. Such offensive schemes demoralise honest taxpayers [making them appear ludicrous for duly paying their taxes]. An extortionist can decriminalise his ill-gotten money through this scheme but a victim (businessman, perhaps), who paid it due to shameless failure or connivance of law enforcement apparatus cannot even claim it as an expense in his tax return! This situation needs to be corrected.
The facilitation of whitening untaxed/undeclared money should be restricted only to genuine industrial investment for bringing back such capital into disclosed/formal sector by paying some percentage as tax (kaffara will be a better word) and not meant for criminals, corrupt and unscrupulous elements in society.
Positive change in tax policy: There is a national consensus that existing tax policy needs to be reformulated to provide an equitable, pragmatic, investment-oriented and business-friendly tax system, integrating good tax administration with simplified tax laws that are easily understood and hassle-free in implementation. Recent efforts of the government to reform the tax system through World Bank loan/grant, recruitment of new members on market wages and reliance on reports of the so-called foreign experts have not yielded any positive results or acceptability from the taxpayers. Reform remains a closed door, bureaucratic exercise lacking any meaningful dialogue with the taxpayers, public pressure groups and tax experts who matter in the subject.
In the absence of a well-designed tax policy, the agenda of tax reform will always be lopsided. Members of parliament need to debate the restructuring process of the FBR to make required legislative and administrative changes. The FBR's power to issue SROs (Statutory Regulatory Orders) against Article 162 of the Constitution should be withdrawn immediately. After the announcement of budget 2010-11, the elected representatives of the people through debate and consensus in the Parliament need to assess the proposals on the touchstone of pro-growth policy. Such a budget then should be approved to secure support of all effected stakeholders before actual implementation in the Finance Bill 2010.
Equity principle The existing tax system itself is a worst expression of colonial heritage. It is highly unjust. It protects the establishment and exploitative elements that have monopoly over economic resources. There is no political will to tax the privileged classes. The common poor are paying an exorbitant sales tax of 16% (in fact 35% on finished imported goods after mandatory value addition and income tax at source) on essential commodities. Soon it would be replaced with 15% Value Added Tax (VAT) from July 1, 2010 as a commitment to IMF and World Bank. This regressive tax will hit the poor badly, but the mighty sections of society such as absentee landlords, big industrialists, generals and bureaucrats will keep on enjoying luxurious life without being made to pay wealth tax/income tax on their colossal assets/incomes.
It is tragic that in a country where billions of rupees are being made on daily basis through rent-seeking, speculative transactions in real estate and shares, tax-to-GDP ratio is pathetically low at 8.8%. The reason is unwillingness of the Government to crack down on undocumented economy and tax benami (name-lending) transactions - such actions will expose rampant corruption of the ruling classes.
The mighty sections of society are engaged in these transactions in posh localities, administered by defence forces and the FBR is powerless to take the date of transactions from them. It exposes the uselessness of the system to tap the real tax potential of the country. We need a public campaign to dismantle this unholy alliance that taxes the poor and benefits the rich.
Pakistan's indirect tax system is regressive and biased against the poor putting greater burden on the lower income households than the upper class ones, according to a report, "Social Development in Pakistan; Annual Review 2009", issued by the Social Policy and Development Centre (SPDC) in February 2010. It states that the poorest 10% of households contribute 16% of their income to the three indirect taxes - General Sales Tax (GST), Federal Excise Duty (FED) and Customs Duty. However, the report reveals that the burden of tax progressively declines as income rises and the richest 10% of households contribute only about 10% of their incomes towards indirect taxes.
The report states that Pakistan's tax regime consists of four main revenue sources; GST, FED, Customs Duty and Income Tax. Its structure is dominated heavily by indirect taxes, which combines over two-thirds (68%) of combined federal and provincial tax receipts. If surcharges on petroleum products etc are included, it observes, the indirect taxes rise to over three-fourth (76%). In terms of the share of federal taxes, indirect taxes account for 78%, the report says. According to the report, the average share of direct taxes for high income countries is 46% while in the low income countries it is 28%. Iran and India post direct tax shares of 40% and 32% respectively as compared to 22% by Pakistan.
GST claims 9.3% of the income of the poorest 10% of households, but only 5.9% of the income of the richest 10%. In other words, the burden of GST on the lowest deciles is 58% higher than the highest deciles. Thus FED is the most regressive tax, with the burden on the lowest deciles being 100% higher than on the highest deciles. Customs duties are the least regressive with the burden on the lowest deciles being 28% higher as compared to that of the highest deciles. The policymakers have exempted selected food items like wheat and rice from GST. However, this does not imply zero-rating of GST on account of the fact that the inputs that go into the production of these items are subject to tax. That is why the nominal tax rate of these items is zero, the effective tax rate amounts to about 7%.
The report by SPDC should be an eye-opener for the policymakers. In the report the impact of presumptive taxes on goods and services imposed under the garb of income tax law has not been taken into account. Had it been done, the ratio of direct taxes would have shown a further declining trend. The incidence of such taxes, which are imposed under income tax (sic), is borne directly by the consumers and the worst hit are the poor people.
They have to pay GST on supplies of iodized salt, which is sold under brand names. In the Sub-continent when the British rulers imposed salt tax, there was mass movement of disobedience that forced them to withdraw the levy. Our rulers are even worse than the British imperialists as unashamedly they have imposed exorbitant GST of 16% on salt. What makes the situation more painful is the fact that nobody has ever raised a voice against this cruel tax. It shows national apathy. Now VAT is going to hit many items of daily needs of the poor.
Determination of a tax base capable of measuring an individual's ability-to-pay is a major problem of our tax system. This rule is incorporated in the form of progressive rate schedule for personal income tax, estate duty, and property tax world-wide.
In Pakistan we have moved from this policy to unequal sacrifice rule where the mighty civil and military bureaucrats (now they are part of the landed aristocracy by getting State lands as awards and rewards), rich industrialists and greedy businessmen are paying meagre personal taxes while the poor are compelled to pay GST of 16% [it is as low as 2% to 4% in countries like Japan and Singapore, boasting affluent societies] and bear ever-rising costs of public utilities and POL products. This is in direct violation of constitutional guarantee given in Article 3, but the apex Court is busy somewhere else rather than taking suo moto action on it. The government must immediately remove these dichotomies and distortions. Taxes should be for the welfare and benefit of public at large and to make the State invincible, not for the luxuries of the rulers and State functionaries.
Benefit principle According to this principle, an equitable tax system is one, under which tax payments are based on the amount of benefits received from government services. In other words, the cost of government services should be apportioned among individuals according to the relative benefits they enjoy. Clearly, implementation of the benefit principle presupposes determination of the incidence of public expenditure before deciding distribution of tax burden. Thus it encompasses issues of both tax and expenditure policies.
Our successive governments have failed to convince the people that payment of taxes is their collective responsibility. All the civil and military governments alike were engaged in wasteful expenditure, never bothered to live within their means and failed to even protect the life and property of the people, not to talk of providing them basic needs of health, education and civic amenities. Are they justified to ask people to make sacrifices when the life style of the rulers is shahana (imperialistic)?
Tax policy should be used as a tool of distributive justice. The Government should launch programmes, financed mainly through taxes, to solve the twin problems of unemployment and poverty. These welfare-oriented schemes may also include subsidised/free medical and educational facilities, low-cost housing, and drinking water facilities in rural areas, land improvement schemes, and employment guarantee programmes. Once people see the tangible benefits of the taxes paid, there will be better response to tax compliance. Taxes cannot be collected through harsh measures and irrational policies. The rulers and tax bureaucrats have to demonstrate by their actions a clear inspirational model for the taxpayers to believe them and to pay taxes honestly and diligently.
Assignment of tax.
Assignment of tax means transfer of taxation power form a higher level to a lower level government. Taxation power includes the following: right to levy tax, collect tax, and appropriate proceeds from the tax. Thus, there can be three interpretations of assignment of a tax.
Firstly, higher-level government may levy and collect a tax but handover the entire proceeds to lower level governments. Secondly, the higher-level government may levy a tax but allow the lower level governments to collect it and fully retain the proceeds therefrom. Finally, the higher-level government may transfer a tax to lower level governments, a situation which defines assignment of a tax in its strictest sense.
Our tragedy is that on the one hand we have too many taxes in the country (federal, provincial and local, although share of the last two is negligible in the nation's revenue) and on the other the benefits of revenue collection are not reaching the poor masses. The few rich are the real beneficiaries of every luxury that is available. Fiscal gap is increasing every year bringing more miseries for the common people of Pakistan. We have utterly failed to reform our tax system, despite getting a huge loan from the World Bank, which was unnecessary as 5% allocation for this purpose could have been made from taxes collected by FBR every year.
The Pakistani nation has become one of the most heavily and cruelly taxed nations of the world. They are liable to over 50 local and provincial taxes and levies. These exclude federal taxes and levies. What makes the situation more painful is the fact that the system of taxation is unfair, complex and costly, which punishes the honest and detracts savings and investment.
In democratic dispensations, taxation is considered as a potent instrument to shape and influence the socio-economic polices of a country. It is, therefore, imperative for us to formulate a nationally acceptable tax policy keeping in view our own peculiar conditions and not by taking dictation from the donor agencies, who only suggest what suits their vested interest.
Our tax policy must take into account:
-- Present stage (still not in the take-off position) of our economic development.
-- Objectives of economic policy.
-- Priorities of economic policy that are continually dependent upon the changing economic, social, and political milieu.
It is necessary for us to use the forthcoming budget as a tool for CHANGE and not as protector of status quo. In taxes, we need to bring some fundamental structural and operational changes. Mere amendments here and there will serve no useful purpose. New tax strategy should entail the following three components:
Resource mobilisation and GDP growth
The first and foremost objective must be to raise resources for public authorities for administration and development. Taxes are the main instrument for transferring resources from private to public use. By designing an appropriate tax structure, resources can be raised from those who are holding them idly or squandering them on luxury consumption.
According to Roy Gobin, "the revenue criterion is usually the dominant consideration, since governments in developing countries have become increasingly aware of the active role which budgetary measures can play not only in initiating and promoting growth but also in maintaining political power. Not only are higher revenue levels needed, but also tax yields should be increased at a faster rate than income, if infrastructural investments and social welfare expenditures are to be financed without generating unacceptable inflationary pressures and/or increasing reliance on foreign assistance."
The revenue performance is in fact the best and optimal use of resources. Since the composition of investment is an important determinant of growth rate of the economy, public policy must discourage the flow of resources to low priority areas so that they could be diverted to vital sectors of the economy. By imposing high tax rates on luxuries and other low priority items (such as motor cars, air conditioners etc), the government can discourage the consumption and production of such items, ensuring in the process release of resources for high priority sectors. Conversely, offering tax concessions or even subsidies can encourage production of necessities of life and employment-oriented industries.
Distributive justice Distributive justice or economic justice is an important function of tax policy. Economic justice relates largely to distribution of tax burden and benefits of public expenditure. It is a component of the broader concept of social justice, which encompasses, besides distributive justice, such questions as treatment of women and children, and racial and religious tolerance in a society. Tax policy is a democratic method to influence the distribution of income and wealth on desired lines.
The main ingredients of this policy can be (a) progressive direct taxation of income, wealth, and property transactions, (b) taxation of commodities (customs duty, excise levy, and sales tax) purchased largely by high-income groups, and (c) subsidies (negative taxation) on goods purchased by low-income groups. In Pakistan, we have moved from progressive taxation to regressive taxation. It is a dangerous step that is bound to result in civil unrest, as our society is already divided on economic, geographical and ethnic divisions.
The primary function of a tax system is to raise revenue for the government for its public expenditure as well as for local authorities and similar public bodies. Thus the first goal in development strategy as regards taxation policy is to ensure that this function is discharged effectively. The performance of the Pakistani tax managers is highly disappointing as fiscal deficit remained high during the last decade and the revenue targets fixed annually were much below the actual revenue potential of the country. Tax-GDP ratio remained dismally low.
The second equally important function is to reduce inequalities through a policy of redistribution of income and wealth. Higher rates of income taxes, capital transfer taxes and wealth taxes are some means adopted for achieving these ends. In Pakistan, there has been a gradual shift from equitable taxes to highly inequitable taxes. The shift from removing inequalities through taxes to presumptive and easily collectable taxes has destroyed the entire philosophy of taxes. This deviation has transferred the burden of taxes from the rich to the poor.
Stabilisation Initial developmental efforts are generally marked by inflationary tendencies in an economy. Inflation, if uncontrolled, may thwart all development plans and bring misery to the poor. A reasonable degree of price stability should be a primary concern of a government's economic policies. The overall level of economic activity in an economy depends upon aggregate demand, relative to capacity output. At times, the level of aggregate demand may be insufficient to secure full employment of labour and other factors of production. At other times, aggregate demand may exceed available output at full employment level. Government intervention in both the cases becomes essential to correct such disequilibria in the economy.
The evaluation of our existing tax system with reference to the foregoing objectives is a difficult task because various other policies (like public expenditure policy) may be geared to achieve the same objectives. The Advisory Council of FBR and many Task Forces on tax reform constituted from time to time never considered these questions but rather, confined themselves to superficial aspects of tax system merely suggesting a few changes here and there. To what extent the redistributive objective has been served and what was the relative role of tax policy in it is a difficult question to answer.
Moreover, the various objectives of tax policy may not always work harmoniously. Rather, they are often in conflict with each other if not mutually exclusive. Since the tax system of a country grows out of the interaction between political judgement and economic rationale, the process of compromises and trade offs is influenced by political expediency and economic logic, the former, in most cases, having the upper hand. In fact, political requirements and economic thinking change with time, giving new directions to tax policy. As Richard Bird has observed, "Tax reform is, therefore, a never-ending process, not something that can be brought about once and for all and then forgotten."
Though it is unlikely yet one hopes that in its third budget, the government will announce a new National Tax Policy based on the principles discussed above and instead of slogan-mongering will determine proper direction and devise steps for rapid industrial and economic growth that will automatically take care of revenue mobilisation without putting any undue burden on masses.
(The writers, tax lawyers, are members of visiting Faculty of Lahore University of Management Sciences)
Source: http://www.brecorder.com/index.php?id=1056465&currPageNo=1&query=&search=&term=&supDate=
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