Higher revenue generation: an uphill task

THE NEWS 23th May 2011

By Sardar Irshad Shaheen

Collection of taxes has been the most vital source to generate revenue in almost every society of human history, and a taxation system is the lifeblood for socio-economic development of a modern state. A developed tax system helps establish a fair society through equitable distribution of economic benefits. Such a system must be business friendly to attract and encourage investment at all levels of business activities. But if a tax system remains regressive and inelastic, it discourages properly documented investment with its social implications compelling the country to rely heavily on other revenue generation sources, including foreign assistance with wholly unfamiliar and irrelevant recipes.

High tax rates and an overall complicated tax system in Pakistan are the main causes of black economy and tax evasion, non documentation and corruption. The informal sector is thriving due to unchecked illegal activities such as smuggling, black marketing, and drug trafficking that are taking place in major parts of the country to the advantage of pressure groups who are helped by powerful mafias and vested interests. They are further promoted and protected by politico- bureaucratic amalgam through erosion of institutional stability and hollow cosmetic measures.

Unfortunately, this state of affairs is not only allowed to continue but it is being strengthened by defeating professionalism to accommodate manipulating groups and incompetent individuals.

It is a proven fact that all taxes in any shape are unwelcome, but income tax is the most unpleasant of all taxes, and it remains so in whatever from it is introduced anywhere in the world. A chief reason for its unacceptability is that it does not provide any direct return or benefit to the taxpayer. That explains why Zakat even at a very low flat rate of 2.5 per cent was refused at a very early stage of Islamic history (during the period of first Caliph).

A country’s tax system can be successful only if it has:

(1) Clarity of law and communicable simplicity of procedure.

(2) Stability in institution building and continuity of policies for promoting tax culture, in accordance with the stage of development of a society.

(3) Specialised and professional top management equipped with practical experience in tax field.

(4) Enforcement of law in letter and spirit.

(5) Provision of incentives to the taxpayers with some direct social and material advantages.

Simplicity of tax law and procedure will not succeed unless the number and rate of taxes are reduced to a reasonable level. A few years back more than hundred different taxes were in operation in our country out of which the most frequently charged 77 taxes included; 20 federal taxes, 19 provisional taxes, 14 local taxes and 24 other levies and surcharges. The businessmen were entirely at the mercy of various government departments. The tax rates were also unreasonably high since it was an easy way to increase revenues by increasing the number or rate of taxes.



Simplifying tax laws through experimentation:

Legal provisions under the Income Tax Act 1922 were considered quite complex particularly due to new requirements faced by taxpayers in the emerging business environment. This act was replaced by Income Tax Ordinance, 1979, in which legal provisions and procedures were re-arranged in a much simplified manner. It was welcomed by all the stakeholders. There was no strong demand to replace this law by a new one. The only demand of the taxpayers then was that Universal Self Assessment Scheme be given legal cover instead of changing it every year through circulars.

Nevertheless to the amazement of every stakeholder, a new law was drafted not by local experts, but by a foreign expert- completely oblivious to the local conditions ñ purely on the pattern of a developed economy. This law became operative as the Income Tax Ordinance, 2001. Even senior field officers were not taken into confidence and the entire exercise was done under the compulsion of IMF and World Bank. In the name of reforms every detail was prepared by IMF through a ìconfidentialî paper in which the designation, nomenclature, the design of offices and number of officers and employees were proposed by foreigners. The dominant role allowed to the World Bank and IMF made many field officers believe for quite some time that funds for reforms supplied by these institutions were grants and not loans. Not only was the road map prepared by IMF followed literally, but the loan money had been squandered recklessly. After the promulgation of Income Tax Ordinance 2001, more than four hundred amendments had to be made in it during the first month alone. Over two thousand amendments have so far been made in Income Tax Ordinance, 2001 as it was not in tune with the domestic requirements. It was an unnecessary exercise of mere experimentation which greatly eroded the institutional fabric of the tax organisation and added a great deal of confusion.

After the operation of Income Tax Ordinance 2001, repeated concessions were allowed to taxpayers some of which were not even demanded by them. Our system of income tax today is one of the most concession-orientated systems in the world. But compliance of tax laws has shown no improvement.

In comparison, India redrafted the Income Tax Act 1922 in 1961 and income tax laws have been enacted under Income Tax Act 1961 with effect from 13-09-1961. In this act amendments have been made through 109 finance acts so far. These amendments have been smoothly made by adding additional sections and sub sections without drafting new laws again and again. For instance in Chapter-VI A dealing with some deductions, section 80A has 67 additional sections (besides sub sections) from section 80A to 80 VVA, and section 115 has 75 additional sections from 115A to 115WL. Indian income tax rules revised in 1962 are still operative. We replaced the Income Tax Act 1922 with Income Tax Ordinance 1979, which was repealed and replaced by Income Tax Ordinance 2001 drafted by a foreign expert based on the model of an advanced country.

The Indian tax system had the closest affinity with our business and social environment since both countries inherited the Income Tax Act, 1922. But instead of sharing common experience with Indian tax laws, we preferred aping a model of a distant advanced country having little relevance to our ground realities.

Erosion of FBR as an institution:

An imported finance minister (later prime minister) had managed to thrust upon the FBR five members from the private sector who had little working expertise in a taxation department. Huge amounts were spent on them as perks with hardly any positive achievements. All this was done in the name of reforms and introduction of fresh (but alien) experience in this specialised organisation. These members could hardly match the career tax officers having over 30 years of practical field experience. The officers and workforce remained disillusioned and no positive long lasting result could be achieved. Major attention was focused on withholding tax which has been imposed on nearly every consumable item or receipt, and income tax got converted into an indirect tax which is suicidal for the very spirit of direct tax system. Even the formulation of the budget has been artificial as major chunk of revenue came from sales tax, customs duties and withholding tax on constantly increasing imports. So when these sources fell, the budget target also fell significantly. As if this was not enough, the federal government appointed a generalist as chairman FBR last year (who was junior to 38 officers of FBR). This was done at the most crucial time, when collection of revenue was most needed during the end of last financial year and the government could ill afford such an adventure. When the career members protested at this appointment, they were sidelined. This year too, just four months before the end of the financial year, the previous head of FBR has been replaced by a new generalist officer. The appointment of a generalist as head of a technical and professional organisation reflects total disregard of national interests, particularly at this critical time.

Such an attitude appears to be a deliberate attempt to erode national institutions which is a classic example of bad governance. The undeniable fact is that FBR has been failing in raising its tax-to-GDP ratio due to: (a) excessive experimentation and resultant erosion of intuitions; and (b) little importance given to career offices and tax experts in policy making and top postings.

Current state of affairs:

(1) The budget target of the FBR was fixed at Rs1,630 billion which was revised and re-fixed at Rs1,588 billion. With two months left, FBRís total collection up to April 2011 was Rs1,147 billion, leaving Rs441 billion balance to be collected. Collection of such a huge amount does not appear to be possible. The policy makers not only banked heavily on foreign borrowings but had no definite plan for the economy despite energy crisis, slash in PSDP (twice) and substantial interest payments on foreign debt amounting to Rs1,300 billion, which consumed a large proportion of the national resources together with expenditure on war on terror.

The quality of economic analysis and research of our financial experts can be found in Economic Survey 2009-10. The information and figures spread over various pages lack any descriptive scrutiny leading to no direction. As a whole the survey appears to have been prepared with no thought or effort. If such is the government's priority then one should not be surprised if the revenue system today is in such a mess.

(2) As pointed out earlier, our income tax system today is heavily concession oriented, but despite that the tax base has not expanded adequately and the tax-to-GDP ratio is still plummeting.

Taxpayers must be provided a guarantee of stability in tax rates and procedure of the system. Legal guarantee of Universal Self Assessment has been provided through statutory provisions in the Income Tax Ordinance 2001. Every return of income filed by a taxpayer is to be accepted irrespective of declared figure of income or loss. The rates of income tax were also to be reduced with some variation and the minimum rate should be half per cent and maximum twenty per cent for every taxpayer including the corporate sector. This would have reduced evasion, malpractices and corruption, resulting in expansion of the tax base. But the government fixed the rate at 35 per cent on corporate sector whereas on salary income, the maximum rate was reduced to 20 per cent. The FBR has again failed to appreciate the role of continuity and credibility of tax laws. Having failed to broaden the tax base, tax rates have been increased on all classes of income with complicated methods.

(3) The government on the advice of non-technical consultants and advisors has constantly been introducing whitening schemes, despite the fact that foreign remittances through banking channels were a constant source of whitening the untaxed money. The latest adventure by the government was that only two per cent tax was to be paid through a whitening scheme for whitening any amount of assets or black money, but the response was a paltry payment of Rs3.2 billion income tax for whitening assets, just 1.23 per cent of the total size of economy. This sorry state of affairs in the presence of every concession allowed by the government is most unfortunate and speaks loudly of the apathy of the policy makers. This also shows that the government would not want FBR to be an independent stable institution run by experts and experienced tax officers. Obviously the first priority of the government must be that highly experienced career officers of tax service be posted to top management levels of FBR and there should be no room for any mediocrity.

(4) Back in 1998 the number of taxpayers stood at 961,090. These taxpayers included salaried persons (411,000) and business class (534,000). After eleven years the position as on 30-06-2009 and 30-06-2010 was as shown in Table-1.

The figures in table 1 clearly reflect the dismal performance of the policy makers. The documented sector (or corporate sector) is very small which mainly bears the brunt of tax collection. Top one hundred taxpayers paid Rs174 billion in 2010 besides deduction at source and advance tax (mostly paid by petroleum, banking and manufacturing sectors). Other than the active registered companies and salaried class, the number of business taxpayers is quite low. Their share in the income tax collection is less than 10 per cent of the gross collection whereas the share of a salaried person is 7 per cent. After deducting the collection of tax paid by corporate sector at Rs176 billion plus gross withholding tax (with CVT collection), the balance amount left is Rs15 billion only which is around 3 per cent of total tax collection. It is argued that the business community pays withholding tax on almost each item, but the same is true of the whole population including the large majority of poor people. The common man pays withholding tax on mobile phones and other items (including CVT), which was almost 54 per cent of the gross income tax collection in 2009. It may also be added that corporate sector, government corporations, banks and some multinational companies including oil companies, have been paying bulk of the tax revenue. Almost the same number of companies (one hundred) paid over 80 per cent of indirect taxes. Obviously the number of regular business taxpayers who filed returns of income could not increase.

(5) Overall collection of FBR as on 30-06-09 and 30-06-10 shows an unpromising situatio. (see Table-2)

The figures in table 2 indicate that the amount of withholding income tax, sales tax on imports and federal excise on imports and customs duties works out to be 51 per cent and 63 per cent in both years, respectively. Major source of even domestic sales tax and federal excise duty comprises of:-

(a) Consumption of sugar and products of edible and medicine, etc.

(b) Utility bills and excise duty on bank transaction.

(c) Purchases by government and semi-government organisations, corporations and various contracts. Add to it the withholding tax on almost every item and it would be clear that the burden of 70 per cent of all taxes is being borne by the common man through indirect imposition of taxes.

It is a matter of grave concern that the situation is deteriorating. The tax-to-GDP rate has plunged to 8.8 per cent. The number of income tax business returns received during the last two years was quite unsatisfactory.

As regards to sales tax, the situation is worse. The number of enrolled sales taxpayers is merely 102,167 and only 90,204 returns are now regularly being filed. During the financial year ending on 30.06.2010, only one hundred corporate taxpayers paid 81 per cent sales tax (Rs240 billion) out of a total collection of Rs295 billion domestic sales tax. A major amount of domestic federal excise duty was also paid by only twenty four corporate taxpayers (mostly petroleum companies).

Solution:

The past experience of over three decades leads us to the conclusion that frequent experimentation and outside interference has caused erosion of the FBR as a stable tax collecting institution, with severe repercussions for the taxpayers and officials alike. The Central Board of Revenue was re-designated as Federal Board of Revenue through an act of parliament with effect from November 1, 2007 as a semi autonomous body after years of deliberations and efforts. The newly established organisationís performance was affected by mindless experimentation and appointment of non professional individuals at the helm of affairs. The FBR appears to lack direction and functions without proper coordination among various tiers of its departments. There is great deal of confusion and dissatisfaction all around.

If the government is really serious in tackling the issue of tax revenue collection, it must consider the FBR as an essential state institution. The right people for the right job must be a permanent feature with well defined career- oriented expertise in the organisational hierarchy. In areas like reforms and restructuring, the task must be left to experienced and senior officers of FBR only, who can reexamine every aspect of structural anomaly according to the actual requirements and ground realities. It must be emphasised that the FBR needs to be strengthened as an organisation based on professional competence.

The following measures, therefore, need to be adopted for immediate and long-term stability and efficiency of the taxation system, which would also help to expand the tax base and increase revenue:

A - (1) FBR is traditionally plagued with political pressure and bureaucratic (vested interest) influence. The first step should be to select chairman of FBR on merit. For this purpose, the post of chairman should be advertised for selection through Public Service Commission for a fixed tenure of four years based on academic qualification and professional experience. Such a step would go a long way in stability and efficiency of the FBR with no apprehension of political interference.

(2) Job classification with career planning must be clearly defined with strict application at all levels for postings and transfers. Job performance of various sections of FBR needs to be revamped for better coordination and only those officers should be posted in FBR who have sufficient field experience turn by turn for a fixed period.

(3) A full fledged research and development wing needs to be established to guide the FBR in the tax policy matters and suggest practical ways for effective coordination between FBR and field formations in the light of ever emerging new situations.

(4) Systems of appraisement of customs duty and Pakistan Customs Computerised Systems (PACCs) and system of sales tax processing and Sales Tax Automated Refund Repository System (STARR) should not be closed, but upgraded for application in all the dry ports and sea ports to make them transparent and less time consuming. Only fully trained and honest officers should be empowered to appraise and assess tax liabilities in accordance with best practices principle.

(5) Smuggling is perhaps the most lucrative and organised business in Pakistan and smuggled goods are sold openly everywhere particularly due to misuse of Afghan Transit Trade (ATT). Many departments including Federal Investigation Agency, commerce ministry, and foreign office deal in anti-smuggling cases. Other agencies like Coast Guards, Frontier Constabulary, Levies and even the police department have been given anti-smuggling powers. It not only creates overlapping and delay in taking proper action, but it also becomes a source of organised corruption which explains why smuggled goods are available not only in big cities but also in small towns. These agencies mostly run after tracing smuggled goods for corrupt practices and they do not focus on their own duties. A single agency fully trained and equipped must be empowered in dealing with anti-smuggling in an effective and transparent manner.

(6) All exemptions from sales and income tax should be withdrawn. The chief commissioner should be empowered to allow exemption in genuine cases for a specified period.

(7) At present only one hundred taxpayers of the corporate sector pay 90 per cent of sales tax on imported and domestic items. To make it acceptable within the business community, sales tax or RGST should be considerably reduced to 5 per cent starting from a fixed rate of 1 per cent or Rs100 on specified monthly sales (gradually increasing up to 5 per cent which should be adjustable). Sales tax at the rate of 1 per cent should also be imposed on defence purchases as well as on all medicines which should be non-adjustable. International tenders should also be taxed 1 per cent non-adjustable sales tax.

(8) Federal excise duty should be merged with sales tax to reduce the number of taxes and hassle for the taxpayers. The sales tax system must not only be fully automated to minimise delays and corruption, however a strict system of audit should also be put in place to eliminate the misuse of the system.

(9) Claim of refund on account of input cost has been a major source of corruption and malpractice. This can be curbed by reducing sales tax rates and abolishing exemptions. Instead alternate incentives can be offered to exporters including exemption of income tax and other taxes/levies on exported goods.

B - (1) Tax revenue enhancing measures:

For expanding the tax base, some provisions of law need to be amended / added to ensure that:

(a) All property transactions involving plots of 2 kanals and above in the urban areas of big cities should be registered only after verification of national tax number (NTN) of seller and purchaser;

(b) Similar method should be adopted for sale and purchase of commercial property of any size in big cities;

(c) All types of vehicles with market value of one million rupees or above should be registered/transferred after verification of NTN from the tax officer;

(d) Every person traveling abroad, except students and foreign nationals should be required to obtain NTN from the income tax department. This should also include travel for Umrah, Hajj or Ziarat, medical treatment and personal visits;

(e) Expenditure on lavish functions, including marriage and social/political gatherings and conferences should be taxed either at a fixed rate or booked for assessment of income after verification of NTN of the person concerned;

(f) Services sector is highly under taxed, particularly the income of surgeons, physicians, advocates and professionals rendering consultancy services. Surgeons earn an average of Rs0.5 million to Rs20 million per month. A specialistís income ranges from Rs0.2 million to Rs1.5 million per month, whereas their annual declared income is generally even less than their monthly income. Fees of private professional colleges and schools are also very high. Their share in revenue is nominal but no meaningful audit has ever been conducted. A mechanism needs to be adopted to properly tap this very important under taxed source of revenue;

(g) For better compliance, tax returns should be prepared in Urdu together with pamphlets for proper guidance of taxpayers.



(2) Making the tax laws equitable:

(a) The most frequently raised objection by the business community in particular and public in general is that politicians are selected by the people to safeguard their rights and are supposed to make laws in the best interests of the populace. Nonetheless, our politicians violate the law themselves when it comes to paying tax. Statistics show that very few legislatures of the national, senate and provincial assemblies are on tax rolls; and those who have a NTN pay an insignificant amount compared to their lavish expenses. It should be made mandatory under the law for every person contesting in the election (at any level) to get a NTN and file their return of income and wealth statement. Any person found guilty of tax evasion must immediately be disqualified. Such a step will give substantial boost to payment of taxes as leaders of the people will become a role model for them, dispelling the public perception that they consider themselves above the law.

(b) Due to a powerful lobby of authoritative landowners, agricultural income is exempt from income tax as it is a provincial subject under the constitution. Tax exemption to such a large section of economy reflects a huge distortion and the tax laws appear as inequitable. Taxing the agriculture income will make the taxation system not only equitable but it will greatly help boost the low tax-to-GDP ratio. Three steps should be taken in this direction:

(i) Agriculture land up to 15 acres should be exempted from income tax.

(ii) Income tax rates should be reduced (even for other taxpayers) to make the tax acceptable and to reduce the tendency of evasion.

(iii) Agriculturists can be compensated by provision of cheap fertilisers, electricity and irrigation water

(c) At present the FBR has not devised a worthwhile effective procedure of audit both for income and sales tax. There is no practical deterrence against evasion of tax after introduction of Universal Self Assessment Scheme. There needs to be a transparent provision in law that each case shall be audited on its turn after every third or fourth year (unless caught earlier on account of some definite evasion).

(d) Typically traditional bureaucratic method for raising revenues is to increase the rate of tax and number of taxes, which is counter-productive as such a method encourages tax theft and makes the tax base shrink. Not only the minimum rate should start from the lowest slab, but the maximum rate of income tax should not be more than 20 per cent, as no one would willingly pay tax more than that. Instead of promoting short-term interests, the FBR must bring the tax rates to a reasonably acceptable level so that measures adopted for increasing the number of taxpayers and revenue become fruitful. Lower tax rates can be a better tool of persuasion for taxing agriculture income. Moreover, another very important advantage of lower tax rates would be that it can help in introducing sales tax even at the retail level. The traders dislike documentation due to fear of paying income tax. If they can declare maximum receipts and incomes because of lower tax rates, the resistance to the imposition of sales tax would be minimised.



(3) Wealth tax:

(a) Wealth tax was abolished in 2000 under the pressure of powerful lobbyists, comprising mostly of civil and military bureaucracy, who did not want to pay wealth tax on their properties and plots. Tax on wealth is an important instrument of a fiscal policy which endeavours to establish an equitable economic system. Due to rising trend of investment in non-productive sector like properties, it would be advisable to impose wealth tax on all immovable properties at a fixed rate to be paid at the time of purchase/transfer. Wealth tax on each property measuring 2 kanals and above should also be charged annually. Other assets including costly vehicles can also be taxed accordingly.

(b) All the measures require the will of the government to enforce the law in letter and spirit. Successive governments have been bullied by apprehension of tradersí strikes, and they have wrongly considered them their decisive political constituency. A few hundred thousand traders can never change the fate of a government or political party if it remains more sensitive to the well being of the large population of 180 million people. Moreover, the ruling elite itself sometimes proves to be biggest hurdle in the enforcement of law. A tax collector sent his officials to monitor sales of one restaurant in Lahore, which incidentally belonged to the minister of state for finance. The collector was immediately made officer on special duty (OSD) and the whole campaign resulted in a fiasco. The political leaders in general and the party in power in particular consider themselves above the law. Such a mindset would never enable us to stand on our own feet.



C - Special incentives for taxpayers:

Our present system has not envisaged any provision of incentives to the taxpayers. To promote tax culture, the government must provide some special incentives to them. For instance, a certain limit of payment of tax (say Rs200,000) can be fixed for an individual taxpayer for one year, and if a taxpayer pays tax (of that amount or above), then he should be allowed some privileges for that year. For instance:

(i) Power to attest certain documents that year; (ii) Recommendation to issue specified number of armed licenses in that year; (iii) Recommendation to issue national identity cards and domicile certificates etc; (iv) Status of honourary magistrate and power to check and challan the traffic violators for one year by fixing a threshold of tax payment for this purpose. This will ensure additional advantage of effective control to regulate the otherwise quite unwieldy traffic throughout the country; (v) Priority in obtaining telephone, electricity, sui-gas connections; (vi) VIP treatment in hospitals and in courts of law; (vii) Some social security system should be introduced for regular taxpayers and incase of old age or disability, they should be paid some percentage of amount out of the tax already paid by them over the years; and (viii) Highest taxpayers should be offered honourary seats in legislation and government corporations. They should be guest of honour in certain local, provincial or national ceremonies/functions.

TABLE - 1



S. No. Total Number of Tax Payers Year ending Year ending

30-06-09 30-06-10



1 Number of companies 18973 19755

2 AOP Cases 28779 31135

3 Salaried Cases 145019 196101

4 Non corporate business 549252 638633

5 Number of return filers 765461 1444389

6 No. of persons shown in statements,

certificates of salaries, imports and exports, etc. 1766998 2313606



TABLE - 2



Taxes Year ending 30-06-09 Year ending 30-06-10



Sales Tax (total) 478284m 516348m

(1) Sale Tax on imports 203323m 247246m

(2) Sale Tax on domestic 274961m 269102m

Federal Excise (total) 113715m 124784m

(1) FED on imports 14617m 13557m

(2) FED on domestic 99098m 111227m

Customs (Net) 155905m 160273m

Income Tax (Net) 480487m 525977m

(Including withholding tax + CVT)