Collecting more taxes

It was the renowned American Supreme Court judge Oliver Wendell Holmes who wrote more than a century back that ‘taxes are the price we pay for a civilized society’.

If that is so then the message hasn’t reached many people in Pakistan – particularly the rich and powerful who seem to believe that the payment of taxes is a mug’s game, and rationalize tax evasion by citing governmental corruption or lamenting the poor quality of governmental social services as reasons for flouting the law. An all-pervasive presence of tax scofflaws is a major reason why the tax-to-GDP ratio in Pakistan has bounced around the 10 percent mark seemingly forever.

A veritable slew of tax experts from international and national organizations and think-tanks have made recommendations to reform the existing tax system but it appears that sound theoretical prescriptions almost always fail to be implemented because changing the status quo means butting heads against very powerful vested interests. So agricultural income tax gets a pass as does wealth tax. Mention land value tax, which is deemed by economists since the time of its most famous proponent, Henry George, to be the least distortionary form of tax and the most equitable, and its detractors become apoplectic. They raise a welter of objections such as the difficulty of assigning a fair valuation to land or that those owning land may well be rich on paper but are mostly strapped for cash and thus unable to pay. It is, therefore, not a matter of coincidence that many of the world’s major land reforms and land expropriations have come after revolutions and/or wars have occurred in the country where land redistribution has been undertaken.

On grounds of political acceptability, it is desirable that tax policy changes suggested be incremental rather than radical. One such measure to increase sales tax collections without raising tax rates is a lottery-type arrangement in which gifts and prizes are given to those customers who send in computer-coded sales tax receipts from retailers on purchases with the randomly drawn winning receipt numbers getting gifts like cars and home appliances. So, the greater the number of receipts sent in by consumers, the greater their chances of winning a prize. [The Federal Board of Revenue (FBR) has started such a scheme recently, targeting hotels and restaurants but the results of implementation are still awaited.]

Lottery schemes provide an incentive to consumers to ask shops for receipts. Some retailers even in high-end shopping malls refuse to hand out receipts even when asked (as a consumer I have personally experienced this) so the scheme needs to be made mandatory and tax cheats refusing to comply penalized for not doing so. Consumer boycotts will also drive home to errant retailers the importance of following the tax laws.

The lottery plan for expanding the tax net has been tried elsewhere. Thus, the Economist recently reported that in 2017 nine of the ten countries in the European Union that had much lower value-added tax (VAT) collections than anticipated had, or were about to, adopt a lottery scheme. The periodical goes on to note that the state of Sao Paulo in Brazil is such a strong believer in the efficacy of this type of scheme that it not only awards prizes on draws of lottery receipts but also gives citizens who present their tax identification numbers when making a purchase a chance to get a rebate of 30 percent of the sales tax paid on the purchase.

Another policy measure that merits attention in the context of enhancement of tax collection draws on research from behavioural economics. This is the concept of ‘nudging’ which is predicated on the belief that human behaviour can be influenced if the appropriate ‘choice architecture’ or, to put it another way, if a suitably designed choice framework is delineated when a decision must be made by a person or group.

A simple example of a nudge would be keeping healthy food options like vegetable salads at a cafeteria clearly visible at eye level while giving the unhealthier fat or sugar-laden items less display space so that customers are cued to choose the healthier foods. Note that the manner of presenting the food items has changed but not the types of food on the menu itself.

Nudging has had some success in the realm of tax collection – going by the UK experience. Using the insights derived from behavioral economics research that people are influenced by social norms, the UK tax authorities were able to increase the rate of tax compliance by reminding tax delinquents that others in the community who owed the same amount of taxes had already paid their dues. Other similar messages subtly reinforced the notion that by not paying taxes or delaying payment of the taxes owed the delinquents were betraying the social trust.

Nudging aimed to increase tax revenues has also been used successfully in developing countries. In a blog note posted on the World Bank’s website, the authors (Calvo-Gonzalez, Cruz, and Hernandez) cite research by World Bank’s economists on nudging to increase tax compliance in Guatemala where the average tax-to-GDP ratio between 2011 and 2015 was 12 percent – less than half the average for all Latin American countries in those years.

Starting in 2015, the Guatemalan tax authorities started sending out physical letters, emails and text messages to non-payers using nudging techniques that had proven to be successful in the UK. The messages relied on invoking social norms and national pride; however the messages that got by far the highest response was one that underscored social norms and another that included a warning that tax evaders could be subject to a tax audit and face the full force of the law. According to the World Bank’s bloggers, the result from this nudging experiment has been highly positive. More Guatemalans filed their tax returns and income tax collection has increased (although the authors do not say by how much in absolute or percentage terms since the campaign was first launched).

Tax collection is also dependent on the extent of documentation of the economy. A cash transaction offers the benefit of anonymity and privacy to all involved in the transactions. But it also facilitates tax evasion or, even worse, allows criminal elements to flourish since cash transactions cannot be monitored by the authorities.

The State Bank of Pakistan’s recent announcement of its plans for a cashless economy is a welcome development to further document the economy. A useful start in this endeavour could be withdrawing the Rs5000 note from circulation by a certain date that allows sufficient time for any person or entity holding such notes to convert them into smaller denominations. The aim is to make it more inconvenient for people to purchase ‘big ticket’ items by using cash in order to avoid scrutiny by the tax authorities.

Incidentally, the term ‘filthy lucre’ used to describe money is highly apt since money in the form of notes and coins is literally filthy. Research has shown that the worn currency notes and coins we carry around with us to use as a medium of exchange are a vector for disease-causing pathogens. This is unsurprising since many currency notes and coins are handled in an unhygienic environment such as with unwashed hands after use of a toilet or counted with the help of saliva or kept on contaminated surfaces. A cashless economy would likely be a blessing for public health authorities as well.

The writer is a group director at the Jang Group.

Email: iqbal.hussain@janggroup. com.pk