Ignoring prudence

LAHORE: National Tax Reforms Commission (NTRC) in its interim report in 1986, identified three basic maladies from which Pakistan was suffering at that time. Those were tax evasion, smuggling and corruption. Unfortunately these issues remain unresolved even after 37 years.

It has now become our national culture to recognise the impediments to growth and then to sit on them for decades without taking remedial measures. The value-added tax was imposed in 1987 probably on the basis of NTRC report, but we have not been able to implement it in its true spirit even after 36 years. Our inability to remove the maladies pointed out by NTRC has gradually made us a begging nation. Our tax to GDP ratio remains stubbornly below 10 percent which is half the tax to GDP ratio in other economies.

If the tax to GDP ratio doubles from the current level, our tax revenue would double from our current documented GDP. If the informal sector is brought into the tax net, we might fetch at least three times more tax revenue, which would be more than our annual fiscal requirements even if we double our development outlay.

The size of the informal economy in Pakistan denies the actual taxation potential of the country. The value-added tax (VAT) has facilitated most of the economies to enlarge their tax base.

In Pakistan we still believe in trial and error theory under which many unsuccessful measures are repeated to document the economy. In fact, an IMF official once told the government not to try to destroy the beauty of VAT through irrational tinkering.

Governments in Pakistan would continue to take undesirable measures to increase revenues as they lack the courage to take the corrective measures that would hurt vested interests. The role of special interest groups, particularly of the rent-seeking bureaucracy, is well known.

Informality suits both the informal entrepreneurs and the bureaucracy. No polite measures can break the nexus between these two vested interests.

Violation of rules by any of them has to be dealt with an iron fist. Now after the 18th amendment the federal tax collectors face constraints within the context of a weakened centre and resurgent provinces keen to score points in maximising access to resources.

The collusion between vested interests, including the tax administration have led to the difficulties that have also exacerbated the “trust deficit” between the federation and the provinces.

Against global norms current legal provisions prevent the GST from being the “pass-through” consumption tax that it was meant to be, and reinforced the “backward-shifting” such that the incidence of the tax fell back on the producers.

In the context of considerable “informality” and a narrow tax base, this had the effect of further penalising the formal sector enterprises that happened to fall into the GST net. In the presence of an equally strong parallel informal sector and high GST rate, it is impossible to prevent the formal sector from going for informality.

To make matters worse, the business community is also against transparent tax reforms because most of them under-report their income and production both to earn more profits and compete with the informal sectors that pay no taxes.

Tax reforms would generate information that could also be used to determine their actual income tax liability. Lack of credibility of the tax administration also poses serious constraints in proper documentation.

The same tax administration allows informal business activities to thrive right under their nose, while they tighten their noose against registered taxpayers.

Pakistan would be forced to accept the harshest conditions of multilateral institutions until the government musters the courage to reform the entire tax system transparently and do away with all exemptions.