In search of a new tax model

[sparklingway]

In search of a new tax model?​

Pakistan is in search of a new tax model that can generate sufficient resources for the government but at the same time does not hamper economic growth. Taxation is a potent instrument to shape and influence the socio-economic polices of a country, but in Pakistan it has not been given due attention. The first and foremost objective of tax policy is to raise resources for administration and development. Taxes also serve as main instrument for transferring resources from private to public use.

By designing a rational tax policy, funds can be raised from those who are holding assets idly or squandering them on luxury consumption. The most important objective of taxation is, however, to provide economic justice. 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 redistribution of wealth, such questions as treatment of weaker sections of society, e.g. women and children in a society. Tax policy is a democratic method to influence the distribution of income and wealth.

Pakistan is suffering on two counts: lack of capacity to collect the real potential of taxes and wastage of whatever is collected. The actual tax potential of Pakistan — by a very conservative estimation — is not less than Rs4 trillion. However, Federal Board of Revenue (FBR) is projecting that at best it would collect Rs1700bn or even less in the coming fiscal year. The target for the current financial year is Rs1380bn. Even if FBR manages to collect this figure, our fiscal deficit will be around Rs800bn — this is a pathetic state of affairs.

This is an open admission of inefficiency on the part of FBR and lack of political will by the ruling party to tax the rich and mighty as well as keeping the promise to live within resources by reducing wasteful expenses.

We all know that real issue is that of monstrous size of parallel economy. We cannot improve tax-to-GDP ratio (presently below 10 percent) unless tax evaders are brought into tax net. The second issue is over-sized State apparatus — doing nothing for public welfare but busy wasting whatever taxes are collected. The army of ministers, state ministers, advisers, consultants, and high-ranking government servants are not willing to cut down their privileges. The government can save at least Rs500bn every year by monetizing all the perquisites and benefits available in kind to these privileged classes.

It is an admitted fact that in Pakistan tax burden on the rich is decreasing and its incidence on the poor is increasing. The revenues of trillions of rupees were sacrificed by the governments — civil and military alike — through unprecedented exemptions and concessions to the rich and the mighty. The progressive taxes, e.g. wealth tax, estate duty, gift tax and capital gain tax, etc, were abolished and were replaced with indirect, regressive taxes that have disastrous impact on the poor. We have failed to tap the real tax potential at federal and provincial levels.

Taxation of agricultural income is the sole prerogative of provincial governments under the 1973 Constitution of Pakistan. All the four provinces have enacted laws to this effect, but total collection never exceeded Rs2bn against the actual potential of Rs200bn (share of agriculture in GDP is about 22 percent). The provincial governments can generate enormous funds — not less than Rs600bn — by levying tax on gain of immovable property. It was in vogue till 1979 when General Ziaul Haq asked all the provinces to abolish it as mighty generals started to earn huge profits on selling their plots allotted by the State.

Exemption is meant for the rich and the mighty who engage in speculative transactions. In the process, small investors are deprived of the entire investment. Due to manoeuvrings of big players, the exchequer also lost billion of rupees. Despite tax incentives, the market crashed many a times and billion of rupees of small investors were engulfed by big fish — those who started as small brokers are now owners of many banks and investment companies.

Tax losses for not taxing speculative transactions in real estate and capital markets are to the extent of Rs800bn per year. Multi National Companies (MNCs), through abusive transfer pricing mechanism, deprive Pakistan every year of tax loss of over Rs200bn.

The Wealth Tax Act of 1963 was abolished through the Finance Act 2003 on the specific demand of ex-Premier-cum-Finance Minister Shaukat Aziz before taking charge as Finance Minister of Pakistan. He was fully aware of the fact that by virtue of his status as resident in Pakistan, his world assets would attract provisions of the Wealth Tax Act, culminating into substantial tax liability on annual basis. The repeal of this progressive law, especially suitable in Pakistan where enormous assets are created without showing income, was shown to be justified despite tremendous revenue losses, and the resultant misery inflicted on the majority of the people of Pakistan.

In 2002, before its abolition, wealth tax was the only progressive tax left in Pakistan with tremendous potential for growth. This became obvious immediately after its repeal when billions of rupees (estimated at US$60bn) started pouring in from all over the world remitted by all and sundry without any fear of being investigated, courtesy the amnesty given under section 111(4) of the Income Tax Ordinance, 2001. Influx of enormous wealth was directed to the stock exchanges and real estate market where the sharks continued to engulf small investors; or it was used to artificially enhance the prices of property.

With no wealth tax to pay, both these avenues helped to increase individual wealth but dreadfully stripped the entire nation of its right to live in peace and economic prosperity. From 2003 to date, according to a conservative estimate, we have lost Rs200 to 350bs worth of wealth tax that could have been imposed on unaccounted/untaxed wealth amassed by those already enjoying the privileges of a luxurious life.

Section 111(4) of the Income Tax Ordinance, 2001 protects tax evaders as they can whiten untaxed income through an extremely simple and easily available procedure by going to a money exchanger and getting fictitious foreign remittance in his account after paying a nominal premium of 1 to 2 percent of the entire proceeds. The loss caused due to this provision alone for the last five years is nearly Rs275bn. In the last two years alone, revenue loss on account of taxing income from property at reduced rate is estimated at Rs90bn.

The above are just a few areas showing quantum of tax losses. If these are recouped and everybody is taxed according to its ability under Article 3 of the Constitution, we can easily collect Rs4000bn in fiscal year 2010-2011 without introducing Value Added Tax (VAT), rather we can reduce the rate of existing General Sales Tax (GST).

The writers, tax lawyers and authors of many books, are visiting professors at the Lahore University of Management Sciences (LUMS)

 

[Gin ka Pakistan]

Agriculture Tax, income tax plus PST and GST on all services and purchase , That is standard for all over the world.