Broadening of tax base

In the last couple of months, Pakistan taxation system has been under the microscope and has stirred much debate due to its loopholes and limited tax network. Repeatedly, the Federal Board of Revenue (FBR) has failed to generate sufficient funds to finance the federal expenses. Very conveniently this failure blame is put on the FBR’s inefficiency and corruption by seasoned policymakers and economists. 

Another much popular narrative is to tax the already heavily taxed sectors. Yet the question and the crux of the problem remain there: has the FBR been able to collect what is due from all the sectors? This problematic, unbalanced equation needs to be sorted out and requires an in-depth analysis. The issue will remain unsolved otherwise.

International financial institutions like World Bank and watchdogs such as Transparency International have also hinted at massive leakage of revenue. These institutions have often been pointing out the unjustified “exemptions”, different tariffs, use of ineffective technology and capacity issues. To hit the bull’s eye, forensic audit of existing tax system, unearthing the potential of tax-yields and its plugging will be imperative before broadening the tax-net. Also important is to investigate that why there is no increase in revenue even after increase in tax rates.

New taxes remain on increase in the form of sales tax, custom duty and additional duty on almost whole of tariff, income tax, advance tax, additional property tax and withholding tax topped with federal excise duty.

The FBR nevertheless remains in short of targets which are met through taking advance taxes and withholding refunds worth billions of rupees. Secondly, the broadening of tax base failed to take off despite withholding taxes on cash withdrawal. In such trajectory, what is that arrests perennially the growth of the revenue. Is the tax-gap working as a termite and barring the revenue growth? To gauge that, the gap between theoretical tax liability and what is being actually collected is calculated.

The sales tax and custom duties (indirect tax) and tax on income (direct tax) are federal taxes. It implies that taxes on goods properly collected have positive bearings on the collection of income tax and vice versa. Consumption method is yet another method. Checking the quantity of the finished goods consumed and cross-checking with the quantum of goods upon which tax is collected and if a difference is found it is an indicator of tax slippage.

Quite a gap was identified in different sectors, found Rubina Athar, an FBR officer, in her study done in collaboration with World Bank. Consequently, recommended measures adopted to stop indicated leakage; no worthwhile answer is available in the FBR published data as well as in the World Bank reports for different years.

One of the simple ways to check the collection and the due taxes of sale tax in VAT mode are not difficult. In VAT mode, net taxes is paid after taking the credit for the tax already paid used in the manufacturing of the finished goods. Further, tax credit (input-tax) is either paid on imports or domestic purchases. Consequently tax, which works out on total supplies, should be roughly equal to taxes paid on import and taxes paid on local supplies.

In an international conference on VAT held in Islamabad 2009, I had presented them same issue too and graphically indicated that there is 80 percent gap between the target and actual collection. Sales tax contributes roughly more than 40 percent of the total collection. It means plugging 80 percent of the gap would have multiplying impact, as it would have boasted income tax collection almost by same proportion.

This did not happen, as it required meticulous exercise on cleansed data. But unfortunately the FBR always compensates operational weaknesses with easy to implement policy measure such as increasing tariff as has been done quite recently on heavily burdening with additional duty on auto-mobile sectors besides others. In this context, one could not help lamenting the remarks of finance minister on the slump of oil prices when he treated it as loss of revenue. Any prudent revenue czar would have exploited it to jump start stagnant industry by not enhancing sales tax on diesel which is raw material for industry as well for transport sector.

Another proxy measure taken by the FBR is levying 3 percent value additional tax on commercial importers as full and final tax liability. It does not hurt the importers for the simple reason that goods are imported on under invoiced value but are supplied in the local market on the actual value. One of the prominent chemical importers confided that there is roughly 40 percent margin on such commercial imports. It is expedient for the FBR to collect extra tax instead of taxing commercial imports under normal regime and collecting sales tax on actual value once make domestic supplies are made. One may not lose the sight that commercial import feeds informal economy, as there is no check on their local supplies.

Instead of fixing the nuts and bolt, the FBR experiments with new format of “declaration” forgetting the inconvenience it causes to taxpayers as well tax functionaries. Since 2013, it has played with “optics” without accepting the challenge of fixing operational weaknesses. The FBR is boasting of revenue growth, which is quite artificial, otherwise tax-to-GDP ratio would have improved.

Operational capacity needs to be built to collect due taxes instead of embarking on further broadening of the tax net. Consequently it must strengthen with the support of easy to operate technology. This could only be done when a team of fiscal professionals who have published research paper to their credit, progressive entrepreneurs and officials from tax machinery with established credentials of integrity, competence and tax friendly profile run the FBR. It should enjoy autonomy, with stated mission to transform from “auto-mode to dynamic-mode”. 

Freedom from political pressures, a clear digitalised system and above all the will to upgrade and cleanse the system is what the FBR needs. The writer is a fiscal analyst and can be reached on shafqatanand@gmail.com /Twitter on @Chafqat.