The problem of revenue is bad tax policy, not cheating

Revenue generation is important but not top priority as in last 3 decades. Much effort and money has been spent in collecting taxes and spreading the story that “we are a nation of tax cheats!”

Such self-loathing is sad!

What came out of the Andrew School TARP study was a tax gap of roughly 30% of potential. Since then we have exaggerated this figure without ever confronting it with serious analysis or doing a study of our own.

For example, in a country where less than 2% of the population has a bank account according to the State Bank and the number of credit cards are only 1.3 million (less than 1% of the population, why is there an expectation that the number of filers and people paying should be by some estimates as high as 20 million? Look at survey data, and that too confirms that the rich are not very large in number. As can be expected in a poor country like Pakistan the rich cannot be 20–25% of the population.

Everyone talks of broadening the tax base as if there are millions of people who are avoiding taxes. This is not saying there is no tax avoidance. There is in all countries. And yes, we also see the avoiders since they are the most prominent, well known and the most powerful people in the country. The issue is why is the whole country being labelled as tax cheaters and that too by our own government.

Yet the potential revenue may largely be missed because of the government exempts favorites from paying full taxes. The biggest exemption still remains agricultural income tax which is outside the income tax regime based on artificial Produce Index Units (PIUs). We also know of about Rs400–600 billion that are lost from exemptions to favourites given out in the famous statutory regulatory orders (SROs). Put the two together we are close to the potential tax that everyone cites.

So, let us stop the narrative of “a country of tax cheats.” Officials who continue to repeat this mantra should do some serious research to substantiate their case or stop this self-serving, convenient accusation.

Rather than beat up on the whole country and continue to dream up draconian measures for more revenue, it would be wiser for Federal Board of Revenue (FBR) and the finance ministry to invest in some thought and research to build a better policy. Sadly, both the FBR and finance ministry websites are absent ,any such work or discussion.

There are those outside the government — Ikramul Haq and Huzaima Bukhari — who have done some good work. By now, they should have presented their work in talks at the FBR and finance ministry. But the arrogance of the colonial government prevents them from listening to natives. They remain beholden to foreign consultants regardless of quality of their work.

As Haq and Bukhari and others have noted, the problem is more that we have a mindless and grabbing tax policy that does not conform to any principles of taxation. Here is how.

1.     Tax policy is distortionary and has negative impact on the economy.
2.     SROs are affecting industrial organization in Pakistan and preventing business entry and development of markets.
3.     Withholding income taxes on goods and services are in reality transaction taxes which are both regressive and distortionary. In most countries, withholding tax only applies to incomes. Here withholding taxes are applied as income tax on many services such as utility bills, school fees, mobile telephone payments. And in most cases, this is done with no intention to refund the money.
4.     The withholding regime that FBR now relies on for revenue needs serious review and thought. There are now over 60 withholding taxes and about 70% of revenue comes from withholding taxes. Banks, utilities and many other enterprises have become revenue collection agencies, increasing their costs and weakening the collection chain.

So, if business establishments are collecting taxes for the FBR, what then is the FBR doing?

Withholding income tax as practiced in Pakistan operates like a regressive transaction tax affecting the poor the worst. The system is set up such that this income tax is withheld from the poor with no chance of getting a refund.

Withdrawal of SROs and the withholding regime in an orderly manner but relatively soon will give the economy more breathing room

2.     We must develop a vision of what a good tax policy is and figure out path to go there. For me it is a few simple taxes
3.     Income taxes that are low, progressive, all-inclusive, and clear. For the middle class it must be graduated to 15%, and for very high incomes (say over Rs300 million annually), it could go from 20–40%
4. No exceptions (for agriculture, this will require a constitutional amendment).
5.     Corporate tax at about 20%
6.     A simple capital gains on short-term speculative investments of less than one year. The rate must be set as equivalent to the ordinary income tax. The capital gains tax on long term investments should be a flat 5%
7.     Inheritance tax should be 40% above Rs10 billion, and nothing below that limit.
8.     Sales tax should be collected in value-added tax (VAT) mode, starting at 8%. (This requires a constitutional amendment). Collection must be unified. The split of revenues is a political decision and should be maintained.
9.     Property tax should be set as a local but low flat rate and the government should pay it as well to allow different jurisdictions to benefit. For example, the federal government must pay Lahore for the staff college and the Civil Service Academy or else relocate.
10.     Simplify tariffs to 3 lines that we had developed in early 2000s
11. At least 5% on all goods
12. 10% tariffs on intermediates

                                        iii. 15% tariffs on finished goods

3.     All exemptions should be removed in a three-year period and all powers to place exemptions withdrawn. All tax changes should go through the budget.
4.     We need a constitution amendment quickly to make fix the revenue system to achieve the following:
5.     To bring agricultural income into the income tax system.
6.     To ensure that services and goods are unified for sales tax collection at the federal level. This will allow the collection system to be unified for collection. Of course, the federal government will share the revenue with provinces in accordance with the law and constitution.
7.     As an aside, this constitutional amendment could also be used to introduce and strengthen much needed local governments as well as putting in place more provinces for better governance and a balanced policy.
8.     Lastly can the FBR and finance ministry both develop some research capacity, so they can study these issues and develop a learning attitude rather than rely on donor consultants?
9.     The proposals roaming around on wealth tax and minimum asset tax are wrong and need to be reviewed carefully in the light of the following.
10.     It taxes the saver twice and rewards the profligate. It will lower the savings rate.
11.     It will fall disproportionately on the old as they are mainly wealth holders.
12.     It will fall disproportionately on the middle class who are forced to hold wealth on their name. Business owners have a several ownership levels that will allow them to get a break.
13.     Valuation of some assets is very disputable and difficult to assess.
14.     Most people will be holding wealth in the form of real assets or real assets, which will be full of disputes and hardship.
15.     Most wealth holders will have locked wealth in real estate which has appreciated in value. Will they have the liquidity to meet the tax obligation? In that case are we going to make them vulnerable to sharks and dispossess the saving middle class
16.     It will give an added impetus to capital flight.
17.     It will further lower our saving rate.

This then is a minimum agenda for tax policy reform. It will have the advantage of simplification as well predictability.

Alongside this we must have tax administration reform. There the solution will be to get good human capital in the FBR with appropriate technology. Let an independent serivce well-versed in technology and modern autditing techniques run the place.

Letting the elite district management group (DMG) of the civil service of Pakistan (CSP) officers run the FBR has been a disaster and should be immediately discontinued. Let a responsible and accountable tech savvy group emerge to collect revenue.