There is a lack of judicious balance between direct and indirect taxes in Pakistan
By Huzaima Bukhari and Dr Ikramul Haq
The financial managers and tax collectors have persistently failed to overcome fiscal deficit and remove fiscal imbalances, as their policies are based on collecting taxes at source and without bringing the mighty sections of society within the tax ambit. They are interested in number game and are bent upon collecting taxes where the are not due: there is a direct link between growing poverty in Pakistan and distortion in tax base since 1991, when major tax burden was shifted on consumers by introducing presumptive taxes in the income tax law.
The lack of judicious balance between direct and indirect taxes, levy of regressive taxes in the garb of income tax, petroleum development surcharge, etc, have pushed an overwhelming majority of Pakistanis below the poverty line. The sole stress on indirect taxation (even under the garb of income taxation through presumptive tax regime on number of transactions) without evaluating its impact on the economy and the life of poor masses is a serious cause for concern.
According to official figures, the contribution of income tax (though major portion of it is now composed of indirect levies or expenditure taxes) as a percentage of the gross domestic product (GDP) is continuously declining -- it was merely 2.8 per cent in 2006-07, 2.9 per cent in 2005-06, 3.0 per cent in 2004-05, 3.01 per cent in 2003-2004 and 3.15 in 2002-2003 (CBR Year Books 2003-04 to 2005-06 and Economic Survey 2006-07).
According to a budgetary document titled Explanatory Memorandum on Federal Receipts 2007-2008, of the collection of direct taxes of Rs 329.7 billion (as per the latest figures released by the Federal Board of Revenue -- FBR) in the fiscal year 2006-2007, the share of various taxes is as follows: Income Tax (312.0 billion), Workers' Welfare Fund (1.50 billion), Workers' Participation Fund (6.50 billion), Foreign Travel Tax (2.619 billion) and Capital Value Tax (5.0 billion). It is strange to note that Foreign Travel Tax has been shown as a direct tax.
In reality, only income tax of Rs 220.0 billion (not 312.0 million, as officially claimed) was the total share of direct taxes in the total tax collection of Rs 841.4 billion. Taxes collected at source on goods and services, contracts, supplies, rent, etc, which being full and final discharge are in substance indirect levies, if subtracted from income tax collection, the actual figure comes to Rs 220 billion. Thus the share of income tax as a percentage of the total revenue is not more than 26 per cent, whereas the same is claimed to be 31.7 per cent at page 68 of Economic Survey of Pakistan 2006-2007. This exposes the so-called authenticity and reliability of official figures.
The reliance on indirect taxes, which constitute about 70 per cent of the total tax collection, proves beyond any doubt that the tax system is directly contributing to rising poverty, as people who possess enormous income and wealth are not been subjected to income taxation in Pakistan (wealth tax was abolished as a condition for joining of a person as our finance minister!). Thus the very purpose of redistribution of wealth as the main object of taxation is being defeated. It is pertinent to mention that in 2006 Sweden collected taxes at 50 per cent of the GDP, a rate almost twice as high as that of the United States and Japan. In most countries of Europe, tax revenue, on an average, makes 40 per cent of the GDP. In comparison, Pakistan collected taxes at only 9.5 per cent of the GDP in 2006-07.
Out of total collection of Rs 841.4 billion by the FBR in 2006-07, regressive taxes were to the tune of Rs 620 billion (after making adjustment of indirect taxes collected under the head of income tax!). This has distorted the economy, raised the cost of doing business, widened the gulf between the rich and the poor, and made the national industry non-competitive. The revenue deficit, despite this collection of Rs 841.4 billion, is monstrously high at Rs 200.5 billion and the fiscal deficit at Rs 373.5 billion.
Despite this, the chairperson of the Central Board of Revenue (now FBR) claimed that the share of direct taxes sharply increased to 39 percent in 2006-07 against 30 percent in 2005-06. This is gross misrepresentation of data. If presumptive taxes on goods and services camouflaged as income tax are excluded from the collection of direct taxes, the share of indirect taxes touches 70 per cent. It is pertinent to mention that the average share of direct taxes for high-income countries is 46 per cent, while in the low-income countries it is 28 per cent. In 2006, Iran and India posted direct tax shares of 40 per cent and 29 per cent respectively, as compared with 31.7 per cent (in reality, 26 per cent) by Pakistan.
The present tax policies of the government are detrimental for economy, social justice, business and industry. Those who possess more economic power (income and wealth) should contribute more to the public exchequer. The ability-to-pay principle is regarded as the most equitable and just method of taxation. It is emphasised primarily for its re-distributive role. In Pakistan, the rulers have completely deviated from this principle, which is, in fact, their constitutional obligation. The existing tax system protects the establishment and exploitative elements that have monopoly over economic resources. There is apparently no political will to tax the privileged classes.
The common people are subjected to General Sales Tax (GST) of 15 per cent plus one per cent Federal Excise (tax incidence is 42 per cent on finished imported goods after applicable customs duty, sales tax, federal excise, mandatory value addition and income tax) on essential commodities (even salt sold under brand names is subjected to 15 per cent GST), but the mighty sections of society -- like big industrialists, feudal lords, generals and bureaucrats -- are paying no wealth tax / income tax on their colossal assets / incomes. It is tragic that in a country where billions of rupees are being made in speculative transactions in real estate and shares, tax-to-GDP ratio is pathetically low (just 9.5 per cent in 2006-07) and the government is least bothered to tax undocumented economy and benami (name-lender) transactions.
The mighty sections of society are engaged in these transactions and rulers of the day, being dependent on them, lack the will to tax them. Pakistan is quite capable of substantially reducing or even eliminating its fiscal deficit and improving tax-to-GDP ratio to 25 per cent within two-year time provided a comprehensive programme, well designed work plan, scientific approach and multi-dimensional strategy is adopted for tax reforms and resource mobilisation.
The FBR is directly responsible for present state of affairs, as its mafia-like operations have been helping people to avoid tax on income by paying bribes. Through the infamous system of Statutory Regulator Orders (SROs), the FBR's top officials provide 'legal' ways and means to the mighty sections of society to amass huge wealth, which is now threatening the state's very survival. It is worth mentioning that soon after the passing of Finance Act, 2007, the federal government reduced rate of collection of tax from purchasers of locally manufactured cars from five per cent to 2.5 per cent. This benefit to local the car manufacturer cartel and those who have the money to buy cars (but not paying any tax claiming that it is from exempt source -- agricultural income) was extended by using executive authority.
The sole stress on indirect taxation (especially under the garb of income taxation through presumptive tax regime on goods and services) without evaluating its impact on the economy and the life of poor masses is a serious cause for concern. The exorbitant rate of GST (on an imported article of public consumption, the effective rate of indirect tax before any further supply is 42 per cent and nowhere else in the world it is so high) is another problem. As a result, a large segment of the middle class is being pushed into lower middle class category, while the total number of people living below the poverty line is also increasing at an alarming pace.
The priority of our rulers is achieving revenue targets, fixed ambitiously every year in utter disregard of how various taxation measures will affect the economy and lives of the common people. Fixing revenue targets in isolation, and without making necessary efforts to improve productivity and economic growth, has forced Pakistan into a dilemma, where it can neither afford to give any meaningful tax relief package to the common people, trade and industry (due to the huge fiscal deficit) nor can it achieve a satisfactory level of economic growth (due to the retrogressive tax measures).
This is a vicious circle in which our policy makers find themselves trapped. They will have to find ways and means to come out of this tangle to make Pakistan a competitive haven, where investors find satisfactory conditions to live and invest. In a country where there is no security of life or property, notwithstanding the availability of a host of tax benefits and other incentives, the investors will never venture to risk their capital.