The tax dilemma

How does Pakistan overcome its budget shortfall? The recommendations of the Tax Reform Committee (TRC), empowered to propose tax reform, became public on Friday. One of the key changes it proposes is to impose a flat rate of tax on petroleum products to replace the current mechanism of charging a certain percentage on the selling price. This would mean that the rupees of tax paid per litre of a petroleum product would remain constant over the year. However, the message does not appear to have registered with the Federal Board of Revenue which, a day earlier, allowed a new two percent regulatory duty on most petroleum products, in addition to increasing GST on petroleum products from 18 percent to 20 percent. The government claims that the measure would cover for the shortfall in expected tax revenue generation due to a decrease in the international price of petrol. The second significant measure proposed is to impose a flat rate of tax on shops based on shop size. The tax would be imposed on millions of small retailers who reportedly escape the tax net by under-declaring their turnover and profits. It has also recommended doing away with tax amnesty schemes, which have become controversial for encouraging tax avoidance.
Both proposals, on petrol and retailers, speak of confusion at the highest level of government over how it hopes to cover its budget shortfall. The current mechanism for getting tax on petroleum products and the one that has been proposed contradict each other. Moreover, the recommendation to impose a flat rate on shops based on size, not sale, admits a regulatory failure on the part of the FBR. The proposal does not make sense as a small shop in a high-end commercial area could be making hundreds of times more revenue that a similar sized shop in a small neighbourhood. The proposed petroleum products change makes more sense as the information that the decrease in petrol prices decreased tax collection by around Rs8-10 billion is worrying. The other side of it, however, is that decreased petrol prices actually reduce government spending, so the tax shortfall should be manageable. While the tax proposals show that the TRC is trying to come up with new ways of bringing more people into the tax net, the proposals admit that the government is incapable of coming up with a way to tax retailers, importers and exporters based on the volume of goods sold. With such paralysis, it is no wonder that raising GST on consumable items, including petrol, in an ad-hoc manner is the preferred way for the FBR to meet its targets.