Taxing traders: right goal, wrong strategy

The outcome of the much hyped campaign to bring traders in the tax net has been disappointing. The goal was right, but the strategy was wrong. It has ended up as yet one more example of the dozens of failed efforts to raise taxes over the last quarter century. Because of the wrong sequencing of reforms, successive finance ministers have failed to broaden and deepen the tax net. Reforms must first focus on the following two critical drivers of taxpayer behaviour.

The foremost hurdle to increasing taxes is the poor organisational culture and practices within the Federal Board of Revenue (FBR). The majority of taxpayers have a horror stories to tell on their experiences with the FBR. This results in those not in the net making every effort to stay out of the tax net. No initiative to broaden the tax base and increase tax revenue will succeed, without transforming the FBR into a ‘customer -driven, fair and competent provider of tax services”. In all those countries where tax collections have increased significantly, a critical success factor has been organizational transformation and culture change in the tax agency.

Global experience suggests that transforming public agencies, especially those that have a monopoly on their services – such as policing, taxation, justice – are the most difficult to reform. The organisational culture of these agencies is usually arrogant, intimidating and corrupted. Despite these challenges, Pakistan has no choice but to embark on the difficult journey of transforming the FBR. For the next couple of years, the entire focus of the government should be on transformation of the FBR, and all other initiatives to deepen or broaden the tax base should be put on the back burner.

A phased approach is needed for this organisational transformation. Priority should be given to a few small but critical steps which could lead to the taxpayer experiencing an FBR that is courteous, professional, fair and harassment-free – thereby closing the trust deficit between FBR and taxpayers. Through administrative actions and legislation, the finance minister should introduce simple changes over the next 8-10 months.

In order to minimise unethical and unprofessional practices all communication between the FBR and taxpayers should be by email, so that they are easily traceable. This action will stop the widespread unethical practice of backdating paper mail notices, notices shown as served in files but not in reality, and frivolous notices to harass taxpayers. ‘Offline’ requests by FBR staff to companies to pay taxes ahead of time so the FBR can meet targets should be made a punishable offence. Approval of FBR management should be required before freezing the accounts of taxpayers, to ensure that due process is followed and the taxpayer is not being harassed. All meetings between taxpayers and the FBR should be with a team of FBR staff, so that individual staff cannot indulge in unprofessional practices. Tax forms need to be simplified, especially the excessively intrusive income tax forms which create opportunities for harassment.

At present, the taxpayer is generally perceived as a tax cheat by the entire tax machinery. Also the ambitious tax targets and an unprofessional culture result in the taxpayer facing an intimidating biased environment within the FBR. Unjustified assessments and tax demands by frontline officials are seldom overturned by senior officers. The only option for honest taxpayers to seek redress of unfair assessments is either through the hopelessly inefficient court system or through bribes.

To address this issue, an Independent Panel of Experts (POE) comprising tax experts from leading chartered accounting firms should be established. The Ministry of Finance, and not the FBR, should engage the POE so they are not beholden to the FBR. The POE forum would provide the taxpayer an independent and expert second opinion on unreasonable decisions of tax officials resulting from incorrect interpretation of the law or perverse influence of tax targets. The POE would be an advisory body and its recommendations could be used by the FBR management to overturn unsound decisions by junior officials and resolve disputes before they end up in litigation.

The steps mentioned above would benefit both individual and corporate taxpayers. To further reduce trust deficit between the FBR and the corporate sector, the following additional actions are suggested. First, the POE should also be tasked to review, within six months, and recommend to the FBR management withdrawal of all frivolous and unjustified tax-related cases in court – resulting from flawed and deliberate misinterpretation of laws by overzealous tax officials. The large numbers of unjustified cases by the FBR are a major source of trust deficit. The FBR management itself is unlikely to withdraw such cases for fear of being perceived as indulging in wrongdoing. Second, all refunds held back by the FBR on flimsy grounds should be repaid. Third, large taxpayers should be provided with ‘premier services’, by staffing the Large Taxpayer Units with the best and brightest of FBR officers who are committed to improving the interface between taxpayers and the FBR.

The steps recommended above could change the operating culture of the FBR and improve the ‘touch points’ between taxpayers and the FBR. They would also help check the behaviour of unethical and low competence staff, and embolden the hundreds of high performing staff who are trapped in a bad system. Also, within the next two years, the FBR should (i) re-engineer all business processes to make them more transparent and predictable; and (ii) rewrite all tax aws and codes to make them less discretionary and less ambiguous.

Once the above actions take roots, a platform would be established for the government to embark on an ambitious medium-term reform that would focus on re-sizing the FBR into an ‘officer only’ agency comprising high integrity and high capability current (and new) staff who are paid competitive salaries.It would aso focus on removing all exemptions, and establishing low uniform tax rates for all economic activities while also launching an aggressive programme to expand the tax net.

The second critical driver of taxpayer behaviour is effectiveness of government expenditures. Because of decades of poor performance of the three organs of state – legislature, executive and judicial – the widely held belief among taxpayers is that their taxes are being wasted. On a daily basis they experience poor education and health services, broken down policing and access to justice, polluted drinking water, garbage on streets, contaminated food, incompetent and dishonest civil servants and legislators, etc. Therefore taxpayers, especially the honest ones, vehemently oppose paying more taxes to a bloated and dysfunctional state.

Regaining the taxpayers’ trust so they experience good ‘value-for-money’ for their taxes will take years of concerted effort by federal and provincial governments to improve service delivery, reduce waste and make public agencies customer driven. Although this a difficult and long-term proposition, the present government must make a determined beginning by getting consensus of the Council of Common Interest on a reform programme.

In conclusion, broadening of the tax base and an increase in taxes will remain elusive unless policymakers get the reform sequencing right. They need to first transform the tax agencies and enhance perceived value-for-money of the tax that is collected.

The writer is a former operations adviser at the World Bank.

Email: fffhasan@gmail.com