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
leviesretail 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 reductionvarying
according to flexibility of demand for various commodities and servicesin
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
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
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
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
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.
The government's stance on levy of GST at the retail level is as
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
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.
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
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.