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Implications of General Sales Tax

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A general increase in the retail prices for the end users.

By Muhammad Mahmud
Jan 31 - Feb 06, 2000

Lecturer, Institute of Business Administration, Karachi

The General Sales Tax (GST) has been used as an effective instrument for widening the tax base in many countries but its implications are far reaching for the economies where a large number of people are below poverty line. World lending organizations like IMF and World Bank are putting great pressure on Pakistan government to impose GST across the board while the business community of Pakistan has never been ready to accept it. The business community successfully forced the previous government of Nawaz Sharif to take back the decision to enforce GST in 1999-2000 budget by agreeing on development tax at rate of 0.75 per cent of annual turnover up to Rs. 5 million.

General sales tax in one form or another is in vogue in industrialized countries around the world in the post world war era. Underdeveloped countries are also adopting it on the advice of World Bank and IMF. Though GST is prevalent in countries with high investment and saving rates, still country like Bangladesh being an under developed country and having common history with Pakistan for 24 years, has implemented it for last couple of years. Why is the business community in Pakistan against it? and why is Pakistan government keen to implement it? Questions like these are addressed here while evaluating implication of GST.

The term "general sales tax" includes a wide range of levies—retail sales tax, manufacturers' excises, gross sales tax, and value-added tax — with or without certain exemption on items like food. Each type of sales tax has its particular effect on the national economy.

Effect of sales tax on prices: Imposition of a sales tax at retail level affects the price immediately. Subsequently, other factors come into play and tend to modify the initial impact.

Initial impact: The imposition of a retail sales tax tends to produce a proportional increase in the prices for three reasons. Firstly, when the tax is collected through tokens or assessed by a schedule, the market inertia tend to preserve the pre-existing prices, with tax calculated as an independent superimposed charge. Secondly, when the regulations do not provide superimposition of tax on prices, imperfect competition among retailing facilities has the effect of addition of tax to the prices. Thirdly where sharp competition exists in the retail field, imposition of a retail sales tax is likely to be an external factor producing undefined action among competitors.

Long-term price effects: GST causes reduction—varying according to flexibility of demand for various commodities and services—in consumption measured in physical unit.

Decline of retail sales due to tax-induced price increases results in deduced orders placed the wholesalers and manufacturers. During the period of readjustment, manufacturer's profits are generally reduced, resulting in greatest loss to the lines with largest decline in demand. A new equilibrium of production and demand is ultimately established by shutting down of marginal high-cost firms. These changes influence the initial impact on prices, ultimately replacing them with new ones.

Effect on manufacturer: Unless special provision is made for the exemption of equipment and supplies purchased by the manufacturers, GST adds to the cost of these items. This tax element is a minor, unevenly distributed business cost factor. As such, its effect is split between profits and price increases according to the particular situation of the firm affected.

Effect on business structure: During the period of market readjustment to GST, all concerns involved in the production and distribution of the taxed commodities and services experience some contraction in demand for their output due to increase in equipment cost or reduced wholesale prices before tax. This would mean a reduction of profits or going into loss where profit had been marginal. It would also mean acceleration to insolvency and failure of marginal enterprises.

Effect on consumption expenditure and saving: A sales tax influences the consumption expenditure and saving in two ways due to increase in the prices of goods and services. First it diminished purchasing power available for consumption or saving. Secondly it penalizes consumption spending, while remaining neutral to saving.

Reduction of purchasing power: Where income prior to a tax-induced price increase is devoted entirely to consumption expenditure there is no choice but to reduce purchases (net of tax). This situation is most common among the lower income groups who are living completely up to their incomes.

Saving by individuals in the lower and lower-middle income classes may include budgeted savings like insurance premium, amortizing mortgage payments and installment payments for hire-purchase items. Such savings embody a high degree of rigidity. A tax-induced price would have little effect on such saving, leaving consumption spending the only area for pruning.

Penalization of spending: Price increases resulting from the levy of GST penalize spending. The reduction of purchasing power presumably exceeds the reduction in inclination to spend for people in lower income group who were previously spending up to the limit of their income. But for individuals in higher income ranges with an ample margin of saving, this reduction of propensity to spend may make a difference in their spending. If the tax rate is high, and the penalization of their spending is substantial enough, it may even decrease their customary standard of living. In such case the influence of sales tax on the saving of higher income classes is reduced, and its influence on their spending increased.

Relative effect: When the receipts of GST are used to retire public or bank debts, no purchasing power is generated to replace the one absorbed by the tax. Under most other circumstance, however, expenditure of tax fund by the government would restore part or all of the purchasing power absorbed by the tax to the national economy, though not necessarily with same income-class distribution as the original absorbed purchasing power. This restoration of purchasing power would offset and modify the effects of the tax as noted above, of the raising and expending of the tax funds were considered as interdependent.

General sales tax exercises more effect on consumption expenditure than any other major revenue tax. Consumption expenditure, which determines the distribution of the sales tax burden among income classes, is more concentrated among the lower income classes. Since the distribution of burden among income classes is a major factor in the effect of any tax on saving and spending, this consideration alone places the GST as a spending obstacle. In addition, GST has the added effect of penalizing, and hence discouraging consumption expenditure.

Sales tax scenario in Pakistan

Sales Tax is chargeable on all locally produced and imported goods except cement, computer hardware/software, poultry feeds, pesticides, fertilizer, medicine and food stuff.

The present rate of tax at import and domestic is 12.58 of the value of:

Taxable supplies made in Pakistan by a registered person in the course of business or any taxable activity.

Goods imported into Pakistan.

Taxable supplies specified in the Third Schedule of Sales Tax Act shall be charged to tax at the rate of 12.5 per cent of the retail price which along with the amount of sales tax shall be printed or embossed by the manufacturer on each article, packet, container, package, cover or label as the case may be.

Where taxable supplies are made in Pakistan by a person other than a registered sales tax payer, will be charged at a further rate of 1 percent of the value.

Turnover tax: Turnover tax shall be charged at a rate of four percent by any manufacturer who is making taxable supplies provided that taxable turnover of that manufacturer does not exceed one million rupees in any period during the last twelve months.

Retail tax: Retail tax shall be charged at the rate of fifteen percent by the retailer who is making taxable supply.

Zero rating: The supply of the goods exported and goods on board vessels proceeding to destinations outside Pakistan shall be charged to tax at a rate of zero percent.

Tax credit not allowed: A registered person shall not be entitled to reclaim or deduct input tax paid on:

The goods used or to be used for any purpose other than for taxable supplies made or to be made by him.

Any other goods, which the Federal government may specify by notification in official gazette.

Economic implications

The government's stance on levy of GST at the retail level is as follows:

The direct tax collection was down due to continuous increase in tax rates and insufficient expansion in the taxable base resulted in fiscal deficit. Therefore a need for indirect source of revenue had to be found to cover the huge deficit.

The side of parallel/ undocumented economy is thought to be much greater than the size of the documented economy and the imposition of the sales tax at the retail level is a measure adopted to bring in the open the income of transactions undertaken via sales tax returns.

The saving rates in our economy are very low because of our consumption-oriented nature and a tax on retail level would serve to realize benefits from large retail level turnover.

The Central Board of Revenue (CBR) set up a special task force to charge GST across the board, including retailers. However the business community views GST from a completely different angle and has the following disputation:

• There is a difference between western societies and Pakistan as far as tax culture was concerned. Nowhere in the world, the GST is a federal levy; it is for the provinces to decide the fate of sales tax and its rates in line with the opportunities for business there.

• Consumer is highly price sensitive and the imposition of the sales tax would only serve to make goods more expensive to the end consumer. When faced with such a situation, the most likely event would be the fall in earnings from the trading business due to reduced demand.

• The cost of GST is being passed on to either the consumer or the producer.

• General sales tax would take a big bite out of the profits when business starts lowering prices to share the burden of GST with the consumers.

Conclusion

Levy of general sales tax will result in:

• A general increase in the retail prices for the end users.

• Decrease in the profits of manufacturers due to sharing of GST burden.

• Fall in general demand levels due to price hikes.

• Increase in revenues for the government aiding in decreasing the level of the fiscal deficit and lowering level of bank borrowing.

• The incentive for registration i.e. the lowering of GST by one percent will induce a lot of operators in the parallel economy to come into the open.

• The producers and the traders registering under the sales tax act would be immune from the opening of records for assessment under the income tax act.