Reportiiiiiiiiiii

7/30/2019 Reportiiiiiiiiiii

1/21

AIR UNIVERSITY

Report

May 6

2013Tax to GDP

Ratio Pakistan

Submitted to:

Mr.Arshad

Submitted by:

Bilal Hussain

Bilal Hanif

Hussain Ali Zaidi


2/21

Abstract

Wearenowquiteusedtohearingtherhetoricbythegovernmentandbureaucracyonhow

PakistanhasoneoftheworldslowesttaxtoGDPratiossincelong(bytheiraccountithasstoodbetween9.50and10.40percentinrecentyears),whichalsohappenstobeextremely

lowwhencomparedtoitsneighboringcountriesandsimilareconomies.SoGovernmentis

unable to allocate reasonable funds for development projects. Although Pakistan has

adoptedbestpracticesoftheWorldthroughIncomeTaxOrdinance2001andformulationof

InlandRevenueServicesafterharmonizingInlandFederaltaxes.Howeveritissufferingfrom

structuralweaknesses includingnarrowtaxbase, lowcompliance,widespreadexemptions,

lowcoverageandweakauditandenforcement whichareresponsibleforsuch low tax to

GDPratio.Thispaperaimsatanalyzing theroadto improving the low taxtoGDPratio in

Pakistan.AsafirststepweanalyzethehistoryoflowtaxtoGDPratioandinthesecondstep

wecompareour taxsystem withcountrieshavingalmostsimilarcircumstances like India,

Srilanka, and Bangladesh and also compare with one of the developed state, Sweden. In

thirdstep,weanalyticallystudydifferentreasons for low taxtoGDPratio.Results of the

wholeanalysisindicatethetoughchoicesanddifficultdecisionforthegovernmentintrying

toimprovethecurrentlylowtaxtoGDPratioinPakistan.Rootcauseofalmostallreasons,is

lackofpoliticalwill.Wethusrecommendcarrotandstickapproachtoenforcetheexisting

taxlawsandpoliciesbesidesaddressingmajorflawsinthesysteminordertowidenthetax

base.


3/21

SectionI:Introduction

Tax includes any penalty, fee or other chargeor any sum oramount leviable or

Payable. In ordinarysense, taxesare theleviesby the Government in exchange for the

servicesprovided to thegeneralpublicand arethe lifelineofanycountrybecauseof the

fact thatmajor chunk of the revenue to run acountry comes from them. Taxes whether

direct or indirect are linked with the economy of the country and that is generally

representedwiththetermGrossDomesticProduct(thetotalmarketvalueofallfinalgoods

andservicesproducedinacountryinagivenyear).

Tax-to-GDP ratio can bedefined as totalgovernment taxcollection divided by the

countrysGDP.The Countrieswith the best tax-to-GDPratios are Denmark50 percent ,

Sweden49.7percent,Zimbabwe49.3percent,Belgium46.8percent,France46.1percent,

Cuba44.8percent,Finland43.6percent,Norway43.6percent,Lesotho43.9percent,and

Italy 42.6 percent. If we analyze Tax-to-GDP ratio in Pakistan it is worse even than itsneighboring South Asian countries. For example Indias tax to GDP ratio is 17.7 percent,

Maldives20.5percentandSriLankas15.3percent.NowifwewanttocomparePakistans

taxtoGDPwithanycountryoftheregionwecanfindonlyBangladeshwith8.5%,Bhutan

10.7percentandNepalagain10.7percent.So,indeedPakistanstaxtoGDPratioisoneof

thelowestintheregion2.

Pakistan barely managed 8.9 percent Tax-to-GDP ratio in fiscal year 2009-10.

Unfortunately the country is being run on the financial oxygen being provided by

international donors agencies. Government borrowing from State Bank of Pakistan hasreachedastronomicalfigures.Theburdenofcirculardebthasshotupto63percentfrom58

percent of GDP. This financial inflexibility has ultimately squeezed public sector

developmentprogramswiththeresultthatgovernmentspendingoneducationandhealth

sectorisequaltonothing.

ItisunfortunatethattheGovernmenthasfailedtopersuadethefeudalclasstogive

taxesbutontheotherhandthepoorsalariedindividualsarethevictimofwithholdingtax

regime. Besides this inequality there are many loopholes in the prevailing tax system by

whichrichclassmanagetoevadetaxesbutpoor is forcedtobearthebruntoftaxes.Tax

exemptions/subsidiesarealsobyandlargegiventotheclassthathastheabilitytopaythe

taxes. Besidesinequalitythebiggestproblemremainssocialaspeopledonotfeelitastheir

dutytopaytaxesyettheydemandservices.

Tax to GDP ratio can be enhanced only when all sectors of economy contribute

proportionatelytowardtaxrevenue,butifweanalyzedifferentsectors,theircontributionin

overalleconomydoesnotmatchwiththeircontributiontoTax-to-GDPratioinPakistan,for

example whole sale and retail sector, transport, construction, hotels, restaurants and

Commissionagents.AccordingtoFBRestimatesthecontributionofmostofthesectors like

banking,insuranceandtelecommunicationisalsobelowpotential.Livestockiscontributing

50percentofthevalueadditiontoagriculture,buthasvirtuallynoshareintaxes.Similarly,


4/21

remainsamysteryandsoisthecontributionoffoodprocessingindustries.

Federal Board of Revenue is responsible for the collection of revenue in Pakistan.

However many questions have been raised by both national and international forum

regarding its transparencyand integrity issues.According to2010reportsofTransparency

International,FBRhasbeenrankedat8th positioninthelistofthemostcorruptinstitutions

in the country. Besides corruption, Board is being criticized for its failure to maximize

revenuepotentialbecauseofitsinefficientadministrationandstaff.

Pakistan gravely lacks in tax culture, rather it comes as an alien concept. The real

dilemmaofcountryisthatrichaswellaspoorbotharenotwillingtopaythetaxesonthe

groundofoverallinsecurityandlackofbasicnecessities.Governmentisoftheviewthatin

absence of revenue,demandsof the publiccannotbe fulfilled thoroughly. In this dismal

scenario the only available option to the Government is to improve its internal revenue

collection mechanism because how long the donors agencies will help us with their tax

payersmoneywhenwearenottryingtoimproveourownrevenuesystem.


5/21

SectionII:

HistoricalanalysisofthelowTax-to-GDPratio

As per historical records taxationsystem was introduced in Sub- continent through

IncomeTaxActof1922andCentralBoardofRevenuewascreatedonApril01,1924through

enactmentoftheCBRAct,1924.WhenPakistancameintobeing,itcontinuedwiththepre-

partition taxation system. Afterwards, taxation Research Committee was formed in 1958

consistingofGovernmentofficersandrepresentativesoftradebodies,whichafterthorough

deliberationsrecommendedsomechangesinIncomeTaxActof1922. IncomeTax1922Act

gradually became complicated due to numerous amendments with the passage of time,

which led the Government of Pakistan to introduce a new Income Tax Ordinance on 28th

June1979.Lateron,FederalGovernmentformedaNationalCommissiononTaxReformsin

1985 which was comprised of members of both houses of the Parliament, Government

officialsandrenownedbusinessmenofthecountry.Themainobjectiveofthatcommission

wastoproposeimprovementintheworkingofIncometaxlawsofcountry.After22yearsof

theenactmentof the 1979 Income taxordinance, theGovernmentofPakistan introduced

Income Tax ordinance 2001 0n 13th

September 2001. The basic purpose of the new

ordinancewastoharmonizethePakistanitaxationsystemwithInternationalbestpractices.

Sales Tax, which was administeredby the provincial governments before partition,

howeverwasmadeafederalsubjectin1948.GoodsandServicesActwasintroducedin1951

tocollectGSTinthecountry.AfterwardsGovernmentofPakistanreplacedtheGSTAct1951

withGSTAct1990withapurposetocollectthislevyinVATmode.

Pakistan is one of those countries which have the lowest tax to GDP ratio in the

world(asshowninthetable).Pakistanstaxationsystemsuffersfromstructuralweaknesses

like narrow tax base, low compliance, widespread exemptions, low coverage, and lack of

auditetcwhicharedirectlyresponsibleforabysmally lowtax-toGDPratio.Aggregatetax-

to-GDPratio

hasshownadecliningtrend,withafallofoveronepercentoftheGDPduringtheperiod.

RevenuecollectionbyFBRdoesnotshowanyproportionaterelationshipwithtax-to-GDPratio as is shown in the following table;with 268.0million collections in 1995-96,Tax-to

h h h l ll ll ld l


6/21

TaxtoGDPRato:Measuresfor mprovementi i

Graph : FBR Tax Revenue Collection

( %age ofGDP)

10

9.8

9.6

9.4

9.2

98.8

8.6

8.4

8.2

9.29.1

9.4

9.89.8

8.8

9.3

03-04 04-05 05-06 06-07 07-08 08-09 09-10

Source: www.fbr.gov.pk

At independence Pakistan had a low level of tax collection as a proportional of

national income.The increaseofcollection from9% in1960-61 to12.5%by1970-71was

closelyrelatedtochangingstructureofeconomy,permittinghighercollectionsfromexcise

andparticularlyfromcustomduties.Collectionshave,however,stabilizedataround12%-

13%ofGDPoverthe lasttwodecades.Strikingfeaturesduringthe1980shavebeenthe

decliningcontributionsof income taxes (downfrom21%of taxcollections in 1981-82to

14% in1985-86)andofdomestictaxation(excisedeclinedfrom31%oftaxcollectionsto

23%inthesameperiod).Thefactthattaxcollectionshaveneverthelessremainedconstant

as a proportion of GDP is largely because of greater reliance on custom duties, the

contributionofthistax instrument increasingfrom38%oftaxcollectionsto42%overthe

sameperiod.

Duringearly1990stherehasbeentradeliberalizationinPakistanandtheemphasis

in development strategy shifted from import substitution to export promotion.

Consequently,importtariffshavebeengraduallyscaleddownfrominitiallyveryhighlevels

toamaximumtariffof25percent. Theimplicationofthetariffreformswasamajordecline

inthetax-to-GDPratioofimportdutiesfromalmost5percenttojustover1percentofthe

GDPduringthepreviousyears.Thiswasboundtoexertastrongdownwardpressureonthe

overalltax-to-GDPratiounlesscomplementaryreforms introducedtoraisethetax-to-GDP

ratioofothertaxes.

During the early to mid 1990's,an elaborate withholding /presumptive tax regime

wasputinplace.Beyondthetypicaldeductionsatsourceofwage/salaryincome,unearned

capital income was brought into the tax net. Deductions at source were introduced on

income frombank deposits, securities, national saving schemes, dividends, house rentals,

etc.Inaddition,withholdingtaxesintheformofadvancetaxeswereintroducedonproxies

of income likeelectricity, telephoneand gasbills,cashwithdrawals frombanks,carsales,

etc.
http://www.fbr.gov.pk/http://www.fbr.gov.pk/http://www.fbr.gov.pk/http://www.fbr.gov.pk/http://www.fbr.gov.pk/http://www.fbr.gov.pk/http://www.fbr.gov.pk/http://www.fbr.gov.pk/http://www.fbr.gov.pk/http://www.fbr.gov.pk/


7/21

Theother areaof reform was in the sales tax.The Sales TaxAct of1990 contains

elementsofavalueadded tax.The taxbasewasbroadened initially tocovermoregoods

like petroleum products, electricity and gas. Subsequently, a number of large and rapidly

growingservices liketelecommunicationswerebrought intothe taxnet.Thestandard tax

ratehasalsobeenenhancedfrom12.5to15percentandthento17percent.Consequently

over the last two decades, the sales tax-to-GDP ratio has increased by two percentage

points. Overall, it is clear from the above description that the loss of revenue from the

reductionsin importtariffshasonlybeenpartlycompensatedforbyreforms indirectand

Indirecttaxes.

IntroductionofthesereformsintheIMFstandbyfacilityof2000-01,alsoinvolvedeffortsat

extending the general sales tax to retailers (above the threshold level of Rs 5 million).

Effective broadening of base was also rendered difficult by the absence of adequate

documentationintheeconomy.InanothereffortunderthePovertyReductionandGrowth

facility(PRGF)for2001-02to2003-04,thetax-to-GDPratiowastoberaisedfrom10.5%in

2000-01 to 14.3% by 2003-04. The actual ratio in 2003-04, in fact, remained somewhat

lowerthan10.3%.

Implementationof reformswas highlydependentonpoliticalwillandgovernance

capacity, for example, in early years of the last decade of the last millennium, the

government achieved notable success in extending the network of withholding and

presumptive taxes within the income tax system because a number of favorable factors

cameinconcert.Theseincludedtheprojectionoftheparticularreformasanintegralpartof

thegovernment'svisionofchange,buildingofastronganddiversifiedcoalitionofsupport,

strongleadershipfromthetop.

From2001-02 to2007-08,more fiscalspacewascreatedby largeraid inflowsand

debtrescheduling, thereappears tohavebeenavisibleslackeningof thefiscaleffortand

resortingtothe'supply-sideeconomics'ofstimulatinggrowthbytaxcuts.Thefirststepwas

the abolition of the wealth tax. This was followed by sharp reductions in tax rates. The

corporateincometaxratewasbroughtdownforprivatelimitedcompaniesfrom40percent

to35percentandforbanksfrom58percentto35percent.

Themaximumpersonalincometaxrateforsalariedearnerswasreducedfrom35to

20 percent and for the self-employed to 25 percent. Some withholding tax rates, forexample,onimporterswerealsoscaleddown.


8/21

SectionIII:

ComparativeanalysisofPakistanwithdifferentcountries

Most developing countries are increasingly focusing on domestic resource

mobilization toward economic development. In thiscontext, taxperformance is of crucial

importance, especially for adeveloping country,since it is theprimesourcefordomestic

resource mobilization. Many developing countries often face difficulty in augmenting taxrevenue to the desired level and considerable attention is being devoted to formulating

fiscalpolicybestsuitedforincreasingrevenue.

In this section we will analyze the tax performance of neighboring countries like

India, Bangladesh, and Sri Lanka, since ground realities in all three countries are almost

alike.MoreinterestinglyIndia,BangladeshandPakistanhavecomealongwaysinceBritish

left them.Of thethreenations Indiahasseenby farmostdramaticgrowth.Pakistanand

Indiaareclusteredtogetheratnumbers138and139respectivelyintheUNDPs174-country

rankingofhumandevelopment,whichtakesintoaccountsuchcomponentsofwell-beingas

lifeexpectancy,educationandgenderequality. Inbothcountriestaxrevenuesarebelow15% of GDP and come largely from Indirect taxes like sales tax and customs, which

discouragesimports.IndiahadafarslowergrowthratethanPakistansfromabout1947to

the1980,hasnotonlyimproveditsperformancefundamentallyoverthelasttwentyyears,

buthas alsogrownconsistentlyforthepasttwodecadesleavingPakistanfarbehind.Even

Bangladesh,onceconsideredasabasketcasebysomePakistanieconomistsandplanners,

has recently had several years of stablegrowth despite political uncertainty. With almost

similarcircumstances,India,SrilankaandBangladeshhaveachievedreasonabletaxtoGDP

ratiowhichincaseofPakistanisnon-existent.Soacomparativeanalysisofthesecountries

willbehelpfulincomingupwithanalysiswhichcontributetobroadeningofourtax-to-GDP

ratio.

3.1PakistanViz-a-VizIndia

The Indian economy is the 12th largest in USD exchange rate terms and second

fastest growing economy in the world. In terms of purchasing power parity, the Indian

economyranksthefourthlargestintheworld.IndiasGDPhastouchedUS$1.25trillion.The

crossingofIndianGDPoveratrilliondollarmarkin2007putsIndiaintheelitegroupof12

countrieswithtrilliondollareconomy1.TheCentralBoardofDirectTaxes(CBDT)isapartof

the Department of Revenue in the Ministry of Finance, Government of India. The CBDTprovides essential inputs for policy and planning of Direct taxes in India and is also

responsibleforadministrationof thedirecttax lawsthrough IncomeTaxDepartment.The

CBDTisastatutoryauthorityfunctioningundertheCentralBoardofRevenueAct,1963.

The growth of revenue in India is not quite impressive, rising from a meager of

6.7%ofGDPin1950-51to10.2%inlate1990sandpeakof12.9%in2008-09.Importantpoint

tonoteisthattax-to-GDPratiohasstartedincreasingconstantlyfrom2004andhasreached

at12.9%in2009.whiletax-to-GDPratioinPakistanhasstarteddecliningfrompeak13.2%in

thelastdecadeofmillenniumandhasconstantlydeclinedsince2000to2009reachingat

8.9in2009.ByinternationalstandardstheaverageleveloftaxationinIndiaisbelowtheaverage of high income developed countries and much lowers than the industrial


9/21

ofthestates.

In India, likemanydevelopingcountriesbulkofrevenue isbeingcollectedfromdomestic indirect taxes mainly from excise and sales tax. Constitutional arrangements

assignexclusive power tostates to levy sales tax while thecentralgovernmenthas to

relyonexcises,asconsequenceexcisebecomemajorcentraltax instrumentwithmore

extensivetaxcoveragethanothercountriesincludingPakistan.Takentogethersalestax

&exciseaccount for more than half of the total taxrevenue in India. India has seen a

rising dependence on foreign trade taxes in short. It is indeed administrative

difficulties withdirecttaxesthatleadtothemajorroleforindirecttaxesandcorporate

taxation in developing countries including Pakistan. Aside from the increased

governmentalefforts,theincreaseinnonagriculturesectorhascontributedtoriseintaxcollection as this sector is easier to tax. Secondly growing share of imports facilitated

overalltaxratioas importsprovideasignificantbaseforimportsdutiesaswellasexcise

andsalestax.

3.2Pakistanviz-a-vizSrilanka

Sri Lanka since early 80s, has been facing a deteriorated law and order situation

whenethnicconflictgainedmomentumthereandSriLankaseconomyshowedalowGDP

growth.TherevenuetoGDPratioofSriLankadeclinedfrom18.5%in1991to14.8%in2007and furtherdownto14.3% in2008and12.80% in2009butsoon itovercamethis

impedimentby focusingon its mainstrongholdof economy like its Teaexports,Tourism

sectorandontheotherhandgovernmenttriedtoimprovetherevenuecollection.Butthe

taxtoGDPratioisstillhighat14.3%ascomparetothatofPakistan


10/21

ThereexistshighrevenuecollectioninSriLanka,despitefacingdeterioratinglawand

order situation, and it has been successful in improving revenue collection, by offering

incentivetothetaxpayers, leviesrelaxationintimelimitforpaymentoftax,andthereare

somerelativelyhightaxrates,whichalsocontributedtotherevenuecollection. SriLanka

hasadopted twopronged strategy, takingpro taxpayerandprorevenuemeasuresat the

same time. Sri Lanka s taxation laws are quite similar to that of Pakistans though, like

taxationthresholdforincomeissame aswellasexemptionculture.

3.3Pakistanviz-a-vizBangladesh

Bangladesh, as an emerging developing country, is committed to augmenting

revenueandachievingfiscaldisciplinewithaviewto increasingself-reliance.Theexternal

environmentinfluencingthetaxperformanceofBangladeshhaschangedremarkablyasthe

country became increasingly integrated with the global economy during the 1990s and

onward.


11/21

Totaltaxes inBangladesharedivided intodirectand indirect taxes.Direct taxes in

Bangladeshconsistoftaxesonincome(incometax,corporationtax,agriculturalincometax)

andtaxesonproperty(wealthtax,gifttax,estateduty,capitalgainstax,urbanpropertytax,

house rent, land revenue, registration and non-judicial stamp). Like other developing

countries,directtaxescontributelittletooveralltaxrevenueinBangladesh.Around75%of

the total tax revenue in Bangladesh is comprised of indirect taxes. The direct taxes in

generalaccountedforlessthana25%ofthetotaltaxrevenueofthecountry.Traditionally,

the tax structure of Bangladesh is such that it has to rely on indirect tax for revenue

generation,which isdiscriminatory innature.Bangladeshhasonly2.7millionNTN-holders

outofapopulationofmorethan150million.

National Board of Revenue (NBR) is the central authority for tax administration in

Bangladesh and collects almost 75.37 percent of total revenue for the country, non tax

revenue 20.88%, revenue beyond NBR 3.76%. (NBR Annual Report, 2007).Tax revenue

constitutesaround80percentoftotalinternalresourcesinthecountry.TheNBRunderthe

Internal Resources Division of the Ministry of Finance is the apex tax authority of

Bangladeshandcollectsabout95percentofthecountrystotaltaxrevenue.Thenon-NBR

portionoftaxmainlyincludesnarcoticsduty,landrevenue,non-judicialstamp,registration

feeandmotorvehiclestax.

Notwithstanding the various fiscal reforms of the recent past, Bangladesh fiscal

systemcontinuestosufferfromanumberofmajorweaknesses:

NarrowlyBasedTaxStructure

LowLevelofRevenueMobilisationandLowRevenueProductivityandHighAdministrativeCosts

RegressiveNatureofTaxation

HighTaxIncidenceandtaxevasion

CumbersomeLegal Procedures


12/21

SectionIV:

CausesoflowtaxtoGDPratio

Afterthoroughunderstandingandanalyzingthetaxpoliciesofthreedevelopingand

oneofthedevelopednations,throughwhichthesecountriessucceededinachievingenviable

taxtoGDPratioandanalyzingthehistoricalrecordsoffiscalbackgroundofPakistan,wewill

nowanalyzetheshareofvariousfactorsinlowtaxtoGDPratioinPakistan:

4.1DemographyofPakistan

Demographictrendsofacountryplay importantrole intaxtoGDPratio.Morethe

peopleareprofessionalsand inemploymentzone,higher is taxtoGDPratiobecause this

segmentofsocietyisinvolvedineconomicactivityandbecomesinstrumentalinincreasing

the revenue collection. However demographic trends in Pakistan are not favorable for

revenuecollection. PresentlypopulationofPakistanisabout187million1

outofwhichmaleandfemalepopulationisabout48%and51%respectively.36.7%ofthepopulation(male

33,037,943 / female 31,092,572) is 14 years old or below of it. 59.1% of the population

(male53,658,173/female49,500,786) lies betweenrangeof 15and64years. 4.2% of the

population (male 3,495,350/female 3,793,734) is above 65 years. Pakistans urban

population has increased by sevenfold and total population has increased by fourth fold

duringlasttwodecades.Itsbirthrateisabout1.6%.

If we improve demographic trends in Sweden its population is 9.1million out of

which15.4%

of

the

population

(males

722,558/female

680,933)

is

14

years

old

or

below

of

it. 64.8%of the population (male 2,982,268/female2,910,135) lies between 15-64 years.

19.7%ofthepopulation(male80,068/female992,665)is65yearsoraboveofit.Whereas

SriLankapopulationisabout21.9millionandAgestructureis:

0-14 years: 24.9% (male 2,705,953/female 2,599,717)

15-14 years: 67.2% (male 6,993,668/female 7,313,440)

65yearsandover:7.9%(male720,219/female950,916)

Accordingto2009, HumanDevelopmentReportoftheUnitedNationsDevelopment

Programme(UNDP),60.3%ofPakistanisliveonlessthan$2aday2.Inthissituationwhena

bigchunkofteenagepopulationandhalfoftheadultpopulationi.e.womenareplayingno

roleintheeconomicactivity,revenuegenerationpossibilitiesareless.Consequentlytaxto

GDPratioisnecessarilyalsolow.Similarlypeoplehavemeagerbuyingcapacityresultingin

lowcollectionofSalesTax

4.2 Literacy

Without education and in the absence of technically and professionally skilled

population economic as well as social development can hardly be achieved Consequently


13/21

yearsageandabove) literacyrateofPakistanaspernationalcensus1998was45%which

increasedto54%accordingtothefindingsof thePakistanSocialandLivingMeasurement

(PSLM)survey2007-08.

Theprojectedliteracyratefortheyear2009-10wasaround60%3.About55%males

and45%femalepopulationoutofthis60%literatepeoplewasprojected4.

Merely a literate person cannot contribute in its lot national exchequer, insteadpeoplewithtechnicaleducationandprofessionalbackgroundplaydueroleinincreasingthe

revenuecollection.TheLiteracyrateofdifferentcountriesisgivenbelow:

Bangladesh .53.5%

Pakistan .54.2%

SriLanka .90.8%

Sweden .99%

Malaysia .91.9%Nepal .56.5%

India ....66%

Japan .99%

China .93.3%

Singapore .94.4%

One should keep in mind that a major chunk of population of the above mentioned

contrariescomprisesofliterateaswellasskilledpeopleandprofessionalswhoareplaying

importantroleineconomicactivities.AsfarasPakistanisconcerned,about60%ofthetotal

literatepopulationcanonlyreadandwriteandareparticularlynotdoingmuchinrevenue

generationforthecountry.Thus low literacyrate isalsoan importantfactor in lowtaxto

GDPratiointhecountry.

4.3 SocioEconomicFactorsandlowTaxtoGDPratioin Pakistan

Socio economic problems facing Pakistan are glaring. Law and order situation, terrorism,

poverty and unemployment aresomeof thesocialproblems which are taking toll on the

revenuecollectionofPakistan. It issobecauseeconomicactivityhasdeclinedandforeign

investorsarereluctantininvestinginPakistan.Besides,thiseconomicsituationinPakistanisnot satisfactory. Energy crises has destroyed the industrial base of Pakistan. Most of

industriesarebearinglossesandarecontributingnothinginGovernmentexchequer.

4.4 NarrowTaxBase:

There is no figure of speech to explain it more appropriately that greatest threat

posed to revenue collection in our country is our narrow tax base which has a direct

correlation with low tax-to GDP ratio. Measurement of narrow tax base is important

because themobilizationof tax revenuehasadirectnexuswiththenumberof taxpayersparticipatingactivelyinthesystemsetuptolevyandcollecttaxes.InthecaseofIncomeTax

h b f f l d h l l f h


14/21

SincemanyyearsPakistans(Income)TaxBasehasbeenmoreorlessstableat1%or

less of the total population. In the United States, 72 million Returns of Income are filed

annuallywiththeI.R.Swhich,givenapopulationof300million,translatesintoataxbaseof

justover24%.InMalaysia,thetaxbaseisabout20%.InIndia,taxbaseistouching4%andin

Turkeyitis5%.

OutofPakistans1.7milliontaxpayers,around1.6milliontaxpayerspayaboutRs.21,000eachas incometaxeveryyear.Allofthesepeoplefall intothe lowesttaxbracket

wheretheirannualincometaxislessthanRs.500,000.Evenmoreinterestingisthefactthat

thisparticulartaxbrackethasnotgainedmanynewentrantsoverthepastthreeyears;to

beexact,statisticsshowthat1.663milliontaxpayerspaidlessthanRs.500,000asincome

taxin2008.Thisnumberwentdownto1.478millionin2009andthenbackto1.662million

inthetaxyear2010.Clearly,overthepastthreeyearsnotmanynewtaxpayershavebeen

identifiedbytheFBR.Lessthan20,000peopleinPakistanearnedenoughtopaybetween

Rs.1millionandRs.5million(10lakhsto50lakhs)astheirannualincometaxin2010,while

21,077taxpayershavepaidannualincometaxintherangeofRs.0.5milliontoRs.1million

(fiveto10 lakhs)andearnedthestateexchequera littleoverRs.13.5billion.Thismeans

thateachofthese21,077peoplepaidanannualincometaxofaroundRs.650,000.Andthis

was the income tax bracket with the second highest number of taxpayers. Only 7,680

taxpayersearnedenoughtopayincometaxintherangeofRs1milliontoRs1.5million(10

to15lakhs).WithatotalcollectionofoverRs8billion,eachofthesetaxpayerscontributed

a mere Rs1.52 million to the government exchequer in the year. Around 3,000 taxpayers

paidincometaxbetweenRs1.5millionandRs2million(15to20lakhs)ayearwhile2,414

taxpayerspaidtaxintherangeofRs2milliontoRs2.5million(20t025lakhs).

4.5FaultyTaxpolicy:

Tax policy is the government's approach to taxation, both from the practical and

normativesideof thequestion.Countrieswithhigh taxtoGDPratios followapolicywith

focus onprogressive taxes (taxationat rates which rise with income) so for as itcorrects

income inequality and precludes enduring differences in society. But in Pakistan whole

emphasis is on Indirect taxes. Even direct taxes are being collected in shape of indirect

taxes.

In Pakistan progressive taxes like wealth tax and capital value tax on transfer of

expensive immovable property, has the potential of not less than 400 billion. But

unfortunatelyWealthtaxwasabolishedin2003onextremepressureofcertain influential

elements.Thedilemma inthiscountry isthat therichandmighty in thiscountry,arenot

readytopaywealthtax/incometaxontheircolossalwealthand income. Inthissituation,

government isconstrained topounceuponthepoorwithregressivetaxessales taxand

presumptivetaxesundertheincometaxcode.Whenthesetaxeswereimposedin1990and

1991,fiscaldeficitinthecountrywasjustRs80billion.After20years,thedeficithassoared

tooverRs900billion,provingbeyondanydoubtthat,farfromassistingfiscalmanagement,

irrational taxes has pushed thenation to totaleconomiccollapse. Irrational taxmeasures


15/21

Overtheperiodoftime,theincidenceofregressivetaxesshamelesslyleviedonthe

poor has been increasing, making the powerful sections society richer and richer.

Progressivetaxes,likewealthtax,estateduty,capitalgainonimmovablepropertyandgift

tax were abolished to benefit the rich. This has distorted the entire tax system, created

income inequalities, widened the rich-poor divide and retarded economic growth. On

average,developingcountriesobtaintheirbulkofrevenuefrom:

Domestictaxesfromgoods&services.

i) Foreigntradetaxesmainlyimports.

ii) Incometaxes(mainlyoncorporations)respectively.

Incontrastthreebigsourcesofrevenueinindustrialstatesare:

i) Incometaxes(morethan40%oftaxrevenuemainlyonindividuals)

ii) Domestictaxesongoodsandservices

iii) Socialsecuritycontributions(morethan10%ofGDP)respectively.

4.6 UndocumentedEconomyofPakistan:

Theundocumentedeconomy isundeclaredincomeearnedthroughsomeeconomic

activityoveraperiodoftime.Alargesizeoftheundocumentedeconomyincludescasesof

non-declarationof incomedueto ignorance,fearfromharshattitudeoftaxcollector,and

low literacy rate. It is estimated that we have an undocumented economy that is three

times the sizeof regulareconomy. Evenwith various tax amnestiesand opportunities to

whiten money through different products, we have not been successful to bring enough

peopleintothetaxnet. 2.75millionPakistanis,or1.6percentofthecountrysestimated

160 million people, are registered taxpayers. Only approximately, two million people file

their returns and the compliance ratio has always been low. The share of taxpayers to

populationislowwhencomparedwithalargedevelopinganddevelopedcountries.

TheundocumentedeconomyhasbeenthemajorcauseoflowtaxtoGDPratio.FBR

hastrieditsbesttogetthismajorchunkoftheinformaleconomyintoregistrationbuteven

then the informalsectorhasbeensuccessful inescaping thedocumentation, forexample

whenVATmodewas introducedtocollecttaxateachstageofsupplychainsothatevery

personinvolvedintransactionshouldberegistered,theystartedpracticeoffakeandflying

invoices. Through the use of fake and flying invoices they get the benefit of VAT mode

taxationbuttherealpurposeofgettingtheeconomydocumentedisnotbeingfulfilled.

Agriculture income is exempt from income tax since 1947. If income tax is imposed on

agriculturalincomeanytimeinfuture,howtheagriculturalistswouldprovetheirSourceof

Fundsforthewealththeyhaveearnedsofarcreated.Ifconfrontedwiththesamequestion,

Will they be asked to summarize their 63-year-old record to establish their entire wealth?

Wecannotdeclaretheirpreviousexemptwealthasdubiousoneandhencedriveawaythe

entirewealthfromtheeconomicactivityorenlargethesizeoftheundocumentedeconomy.


16/21

4.7WeakAuditandEnforcement:

One of the major problems in Pakistan which also hinders the smooth audit and

examinationprocedure is the lackofdocumentationparticularly in thecaseof individuals

and also pertains to the firms and small corporations. It implies that an incomplete and

inaccuratedataisprovidedbythetaxpayerwithpoorrecordkeeping.

AlthoughdetailedworkingandprocedureshavebeenidentifiedintheNationalAuditManual

toreformtheauditsystemofFederalBoardofRevenue,butitrequiresimplementationin

itstruespirittoyieldthedesiredresults.Thisyearonly18,098corporateentitiesfiledtheir

incometaxreturnsasagainsttotalregisteredtaxpayers i.e.44,794companies,soadeficit

ofmorethan60%.Evenfilingofcorporatereturnsremainedshortby13.8%asmorethan

21,000 corporate entities filed tax returns during the same period last year, indicating a

weakenforcementoflaw.InAOPscase,thereareonly34,155AOPs

whichfiledtheirreturnthisyearasagainsttotalregistered135,292AOPtaxpayerswiththetaxdepartment,showingashortfallof74%infilingofreturns.

TheTaxGap(thedifferencebetweenthesumoftaxowedandamountoftaxpaid

voluntarily andon time)standsat79%ofactual taxreceipts inPakistan.A WorldBank

report in September 2009, pointed out that the total tax evaded in 2007-08 stood at

Rs.796billionagainstacollectionofjustRs1.1Trillion.

Only2.4millionpeople(outofapopulationof180million)filetheirtaxreturns.

This is because of tax evasions, avoidance which thrive because of weak audit and

enforcement.Onlyafractionoftaxesillegallyevadedorlegallyavoided,canberecovered

through initiation of legal proceedings against the tax evaders. This involves a

cumbersomelegalprocessandwearerarelyabletorecovertheexactunpaidamountof

taxes after delays of months and years because of weak enforcement, lacunas in laws,

socialandpoliticalpressuresandwidespreadcorruption. InPakistanallreturnsarefiled

under Universal Self- Assessment Scheme. Taxpayers are selected and the audit

proceedings are carried out. In Pakistan the primary objective of the audit has always

beentocreatedeterrence,improveand encourage compliance to the tax laws on

voluntarily

basis

i.e.

promoting

selfassessment

system.

Treating

audit

as

source

of

revenuehasbeenasecondaryobjective.


17/21

4.8 Corruption:

Corruptionisconsideredtobesttherootcauseofallsocialproblemsincludinglack

of good governance and low tax to GDP ratio in Pakistan and in Pakistan it is a well

established phenomenon. In the year 2010, Transparency International Pakistan (TIP)foundthecountrytohaveslippedfrom42ndmostcorruptstatein2009to34thin2010.It

identifiedcorruptioncasesworthRs.300billioninFederalGovernmentdepartmentsduring

theyear.Whilefocusingonpettycorruptiononly,NationalCorruptionPerceptionSurvey

2010indicatedthatcorruptionin2010hadincreasedfromRs.195billionin2009toRs.223

billion.Accordingto2010reporttaxationdepartmentisatno8intermofcorruption.And

out of different taxes, income tax is the mostcorrupt field. The areas where corruption

hasbeenpointedoutare:reducingfictitiousassessment,underassessment,reduction in

tax,gettingtaxcertificate,releasinggoods,andrefundofextrapaidtax.

4.9 Taxexemptions:

Section53ofthe IncomeTaxOrdinance2001,section13ofsalestaxact1990and

section 16 of Federal Excise Act 2005 etc. empowers theFederal Government toexempt

from tax any income or classes of income, or person. Tax exemptions are granted under

restrictivesetofconditionsbuttakemanyshapeswithfarreachingrevenueimplications.In

certaincasesthesearegrantedtopromoteinvestment,exportsandgrowth,inothercases

privileged personalities areentitled tosuch exemption, or they areallowed tovulnerable

groups to preserve equity in the tax system (essentially tax expenditure). Some of these

exemptions are time-bound, i.e. they lapse after the duedate unless renewed further or

theyhavenoexpirydateandtheirtermination(orcontinuation)dependsonthedesignof

taxpolicybeingpursued.

With the passage of time the list of exemptions had grown bigger to include tax

rebates,concessionsandnon-standardexemptions.Pakistan'seconomicinstabilitystemsin

large part from low government revenue resulting from the elites use of tax evasion,

loopholes etc. Less than three million of Pakistans 175 million citizens pay any income

taxes,andthecountrystax-to-GDPratioisonly9percent.Pakistanstaxevasionproblem is

caused by three things: poor legal frameworks and bureaucratic capabilities withregardto revenue collection; corruptioninthe form of apredatory class that privileges

certain sectors and vested interests with unjustified tax exemptions;and eliteswho

cutdeals with thestate toevadetaxation,made possible by an anemic agriculture

income tax (agriculture makes up 22percent of Pakistans GDP, but only 1percent of

its tax revenue).Research suggests that with a more extensive, transparent,

progressive,andequitabletaxstructure, government revenue could easily double, thus

closing the huge gap between defense and development expenditures.


18/21

4.10 Sectoraldiscrepancyintaxcollection:

A sectoral analysis to determine the real factors responsible for creating the gap

betweentaxtoGDPratioshowsthatservicessectoristhemajortaxnoncompliantsector.

Thenumberofsub-sectorswhosetaxcontributiondoesnotmatchwiththeircontribution

toGDP isfartoomany.These includewholesaleandretailsector,transport,construction,

hotels/restaurantsandcommissionagents.

AccordingtoFBRestimates,thecontributionofthemostofthesectorslikebanking,

insuranceandtelecommunicationisalsobelowpotential.Dr.AtherMaqsood(memberFBR)

said that livestock (poultry industry i.e. chicken/eggs, animals farming, milk and meat) is

contributing 50% of the value addition to agriculture,but has virtually no share in taxes.

Similarly,Taxcontributionofsprawlingorchardsandhorticultureisalmostmissing.


19/21

SectionV:

How to Enhance

I would like to point out that it is not a rocket science as to how to improve the tax-to-GDP

ratio. The simple solution is that our political and business leaders should first set examples by

paying their due share of tax to the government. The rest of the puzzle will be solved

automatically.

Tax to GDP ratio can be enhanced only when all sectors of economy contribute proportionately

toward tax revenue, but if we analyze different sectors, their contribution in overall economy

does not match with their contribution to Tax-to-GDP ratio in Pakistan, For example whole sale

and retail sector, transport, construction, hotels, restaurants and commission agents.

According to FBR estimates the contribution of most of the sectors like banking, insurance and

telecommunication is also below potential. Live stock is contributing 50 percent of the value

addition to agriculture, but has virtually no share in taxes.

Similarly, tax contribution of sprawling orchards and horticulture is almost missing. Within the

manufacturing sector, contribution of textile sector compared to its contribution to GDP

remains a mystery and so is the contribution of food processing industries.

Subsidies and exemptions must be minimized. People should be motivated to pay taxes.

Amnesty schemes could also benefit.

Tax collections should be increased by broadening the tax base rather than by raising marginal

rates of tax.

Areas of Focus:

~ Capital Gains Tax on Property

~ Urban Immovable Property Tax

~ Agricultural Income Tax

The target in the on-going IMF Program is to raise the tax-to-GDP ratio by 3 percentage points

by 2012-13.


20/21

SectionVI:

Conclusion

Apparentlythewordtaxcomprisesofonlythreelettersbutithasawiderspectruminterms

of applicability. Since the inception of Pakistan government is striving for the effectiveimplementationoftaxationsystemandcollectionofmajorbulkofrevenuefromit.Currently

morethan80%ofthesourceofgovernmentrevenue is throughtaxcollection leviedunder

thescopeofincometax,salestaxandfederalexcisetaxetc. Ourinabilitytocollectenough

direct taxes has forced successive governments to increase indirect taxation as well as the

pricesofbasicutilitiesandpetroleumproductstoincreaserevenuegeneration.

Increase in tax collection is hardly keeping pace with increased budgetary targetsandGDP.

Overthelasttenyears,indirecttaxationhasincreasedontheaverageby22.02percent(FBR

Yearbook '09-'10) due to near static income tax collection. WB has been pushing forward

some big measures in the form of tax readjustment policies like the VAT, however, thebiggest problem remains that people do not feel their duty to pay taxes yet they demand

services. ComparingtaxtoGDPratioofPakistanwithothercountriesoftheregionhaslifted

the curtain from the weaknesses prevailing in the taxation system of Pakistan. Since Only

Bangladeshhasaslightly lowertaxtoGDPratiothanPakistanwhiletheothercountries like

Srilankaand IndiahasbettertaxtoGDPratiothanPakistan.In Indiathetaxculture isquite

strong because there is less political interference in tax collection, no exemptions for

agricultural income and better enforcement which has led to the progress of revenue

collectionthroughdirecttaxation.While inSrilankathemainfactorwhich isresponsiblefor

theirbettertaxtoGDPratiostemsintheincentivestothecompliantandregulartaxpayers.In our research paper, we have also tried to learn about the taxation system of developed

countrieslikeSweden.InSwedenpersonalincometaxrateisprogressiveandthecorporatetax

is set comparatively low, which encourages people to do business and encourages self-

employmentratherthanbeingemployed. Itcanbeinferredthatthepoliciesadoptedbythe

developedcountriesaredifficultbutarenotimpossibleandcanbeimplementedinPakistan.

It merely needs awareness, strong political will and community participation with zeal and

commitment. Pakistan has a greater potential for improvement, we have many untapped

sectorswhichcancontributealotinPakistanstotalrevenuecollection. Oursmaybealow

tax effort country but does have a high buoyancy ratio, implying that the policymakers of

Pakistan should tap the potential to opt for greater revenue mobilization through internal

resources in order to meet the budgetary deficit by overcoming unlimited tax exemptions,

poor tax base, inequality of taxing, undocumented economy, repeated tax amnesty etc.

Therefore,it isimportanttoplacegreateremphasisonadministrativereinventionandpolicy

reforminordertoidentifyandremovetheloopholesintherevenuegenerationprocess.


21/21

In a nutshell with all prevailing loopholes and deficiencies we have a greaterpotential

foradvancementandbettermentoftaxationsystemofPakistan.Theneedofthehouristo

dealwiththemaincausesresponsibleforlowtaxtoGDPratioi.e.uncalledforexemptions,

sectoraldiscrepancy,lowtaxbaseandweakauditetc,withironhand.

Date post:	14-Apr-2018
Category:	Documents
Upload:	bilal-hussain
View:	214 times
Download:	0 times

Reportiiiiiiiiiii

Documents