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1- CHINESE INVESTMENT IN PAKISTAN
2-
GWADAR: ATTRACTING INTERNATIONAL INVESTORS
3-
OIL PRICES ON THE DECLINE
4-
REDUCING FISCAL DEFICIT

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REDUCING FISCAL DEFICIT

.The urgency for reducing fiscal deficit was ill-conceived for historic reasons

May 26 - June 01, 2003

 

 

The striking feature of the government since October 11, 1999 has been its zeal for containing fiscal deficit. Initially, this zeal received active public support because it promised to unmask tax evaders who had robbed the state. However, that burst of support soon gave way to despondency since the scramble for reducing fiscal deficit disappointed the citizens.

More importantly the scramble for fiscal deficit reduction has damaged taxpayers’ (particularly investors’) confidence in the system — a fact recently admitted by a person no less than the Federal Finance Minister. The way the government went about collecting taxes was a mistake when viewed in the backdrop of the tax payment habits nurtured over the years. The drive created a negative sentiment for investment in which post 9/11 inflow of enormous cheap liquidity could not be converted into real investment. Right now Pakistan’s bewildered bankers don’t know what to do with the money that keeps coming into Pakistan. In a self-damaging effort to make some use of it they are lending it out well below their intermediation cost. What will this scenario lead to will become clear when banks declare their half-year operating results in July 2003. So far the indications are that by that time they will have hurt themselves grievously.

The urgency for reducing fiscal deficit was ill-conceived for historic reasons because from the outset Pakistan was not endowed with a large progressive entrepreneurial class. The scenario become worse as black sheep propped up by successive corrupt governments joined its ranks in large numbers in the 1980s and 1990s. As a consequence Pakistan has ended up with serious structural flaws that have rendered business and industry chronically inefficient for facing up to an era in which the opposite was required. Given this backdrop, Pakistan’s industry cannot become efficient enough to face up to competition, pay dozens of federal and provincial taxes (many of them illogically levied) and yet earn a profit that is a fair reward for risk-taking. Not surprisingly therefore, CBR’s tax recovery projections have always been over ambitious — a fact pointed out more than once by none other than the IMF and just blaming taxpayers for the continuing fiscal deficit is easy though wholly unfair. Paying taxes that keep rising every year without a logical explanation and the continuous increase in indirect tax imposed threaten the survival of various enterprises.

Relying on tax evasion entrepreneurs did not adopt pragmatic managerial practices to improve productivity of inputs to enhance their competitive edge and profitability. On the contrary to keep their enterprises "profitable" tax simply disappeared from the cost structure of business enterprises. Coming in this backdrop the drive to tax business activity practically at every stage shook entrepreneurs’ belief in tax evasion as the source of profit. They are now groping in the dark for an anchor to hold on to. They didn’t try modern business management methods and therefore can’t readily accept them as the means to raising profitability. It is not the time to punish them for believing in a fallible god but to gradually and skillfully strengthen their belief in the right things — equity, social responsibility, and fair play. They need time to adjust.

 

 

INITIATING A REFORM PROCESS

To begin with, the reform process must take note of the fact that past governments placed excessive reliance on imposition of indirect taxes, which is evidenced by the fact that more than two thirds of tax revenue continues to be realized through indirect taxes. This has been a major factor responsible for rising inflation and increased misery among the low-income groups because these taxes were simply passed on to them by business and industry through the price mechanism. In fact, these taxes were unscrupulously used by business concerns to disguise unjustified price increases. Higher inflation led to demands for higher wages. Increased indirect taxes took away the benefits of increased wages. This vicious circle went on fuelling inflation. Indirect taxes tend to be regressive. It is time that excessive reliance on indirect taxes is done away with. All existing indirect taxes must be reviewed to determine their impact on low-income groups. Those which try to restrict essential consumption must be withdrawn to reduce pressure for wage increases so that inflation is gradually reduced. If this is not done there will be no end to rise in inflation which will undermine whatever competitive strength is left in our beleaguered industry.

BUSINESSES MUST BEHAVE MORE MATURELY

The business community must share the blame for the increased burden of indirect taxes. It has demonstrated a lack of credibility in paying taxes levied on any other basis. The debate on the advisability of the General Sales Tax has brought to the fore bottlenecks that exist in the way of collecting such taxes. It is unfortunate that even after a lapse of 55 years the business community wants to be exempted from even the basic record keeping which could permit collection of taxes on verifiable bases. This is a wholly inexcusable lapse. Businessmen must gear-up for meeting the basic record keeping requirements. It is in their interest. Unless they can do so the taxation system will remain inequitable because it will not permit taxation on a realistic basis.

TAXATION REFORM PROCESS — SOME SUGGESTIONS:-

The process of tax reform must be two-fold. Firstly, we must reconsider the number of taxes currently being levied. Without doubt, there are too many and being collected by as many agencies. It has created avoidable headaches for the taxpayers and enormous opportunities for tax collectors to extort illegal gratification. Secondly, to be perceived by taxpayers as justified, taxes must be related to provision of visible benefits and services.

RATIONALIZING THE TAX STRUCTURE:

The aim of reforms should be to encourage people to pay taxes rather than evade them. As such, the spirit of reforms should be to simplify and rationalize the tax structure keeping in view only one objective i.e. justifying the incidence of tax. We must move away from the tradition of the Federation levying majority of the taxes. Except for Income Taxes and Customs Duties all other taxes should be levied and collected by provincial governments. This is necessary to meet the increasing demand for devolution of power and to permit the provinces to play their rightful role in the Federation even though, so far, their record of collecting taxes has not been encouraging. By refusing to pay special grants the Federation can force the provinces to play a more responsible role in collecting taxes.

The tax structure should consist of the following categories. All taxes be merged into the following categories:

• Income Tax
• Sales Tax
• Excise Duty
• Custom Duty
• Property Tax
• Gift Tax
• Capital Gains Tax
• Composite Municipal Tax

The multiplicity of taxes and levying of the so-called surcharges which make little sense to the taxpayers should be abolished forthwith. An example of how unrealistic taxation can be is the surcharge in the form of excise duty imposed on bank borrowing. Excise duties on cheques has discouraged documentation and served to inflate the black economy. Federal levies such as Employees’ Old Age Benefit Insurance, Workers’ Welfare Fund, and provincial levies such as Social Security, and Education Cess are examples of how confusing and unnecessarily complex the taxation system is. It would have been a lot better if a composite tax for these employee benefits were to be levied and collected by one agency. Revenues collected under a single head could be allocated to any of the above purposes, which is a prerogative that, in any case, remains with the government. It does not need to be injected into the revenue collection system.

RELATING TAXES TO SERVICES RENDERED:

Taxes levied on individuals, households, small businesses, agriculturists, and the corporate sector, must be so rationalized that:

• taxes can realistically be related to services and benefits provided by the state
• in terms of rates, taxes should not stifle incentive to increase/expand the level of productive effort
• taxes should serve as an incentive for reducing consumption and promoting saving and investment
• taxes are few in number and payable to fewer agencies thereby keeping the administrative cost of collection at a low level
• taxes are payable with minimum inconvenience in terms of paperwork and official formalities
• taxes are levied on bases which cannot be manipulated and therefore leave no leeway for collusion between tax payer and the levying/collection agency
• taxes in broadly the same category should be levied and collected by the same authority

RATIONALIZING TARIFF RATES AS AN INCENTIVE FOR PROMOTING ECONOMIC ACTIVITY:

It has been established by experts in the field of macro economics that as long as the overall impact of taxes on business income remains at levels below or equal to 50% of taxable incomes they serve as an incentive for increasing economic activity since out of every additional Rupee of net income less than half is payable in taxes. Such tax rates tend to generate maximum revenue in absolute terms because of increased economic activity and less incentive for tax evasion. It was earlier proposed to reduce corporate income tax to 50% over a period of four years. This was a commendable move. What needs to be examined is whether the incidence of all taxes being levied on businesses constitutes 50% of their income or more. An honest assessment will indicate that while income tax levels may have been reduced the combined incidence of all applicable federal, provincial and local taxes continues to be far in excess of 50%.

 

 

ENCOURAGEMENT FOR SMALL & MEDIUM SIZED INDUSTRIES

Self-sufficiency has been achieved by the Newly Industrialized Countries (NlCs) of Asia and Latin America not by providing incentives only to large corporations and multi-nationals but by encouraging even more the small and medium-size enterprises because they form the major part of the economic base. Sustained economic progress is not possible unless prosperity reaches the lower income groups not as charity but as support and incentive for increasing economic activity to make every household self-supporting. Efficient and enterprising smaller units grow into bigger businesses. The more of them we have the better it would be. It is therefore imperative that taxation of small-scale units should be kept at levels which serve:

• as an incentive to expand operations, and also
• permits generation of reasonable profits to bolster investor confidence and,
• permits profit retention so that businesses can grow through internally generated sources or fresh equity.

Taxation system must ensure that it serves as an incentive for setting up of domestic industries by allowing input cost advantage so that these units are able to:

• import both plant, machinery, and raw materials at landed costs (including all other taxes) which permit competitive advantage, and
• are able to produce quality goods at prices that can compete with imported substitutes.

RATIONALIZING IMPORT TARIFFS

We are under WTO pressure to reduce import tariffs. We must pursue the policy of rationalization of import tariffs keeping our long-term objective in view which is to curtail import of consumables. Instead, we should encourage import of industrial capital goods. By freezing duties on imported consumables and reducing duties on import of capital goods we will be complying with IMF conditionalities without jeopardizing our national economic objectives. We cannot dream of self- sufficiency while continuing to ignore the fact that economic prosperity cannot spread unless businesses grow in number, their productivity is raised, import substitution is achieved at an increasing rate and employment opportunities are created. Non-rationalization of tariffs has encouraged smuggling which continues unabated because there is growing demand for goods which are either not produced locally or can be produced locally but only at high cost leaving great incentive to smuggle them. There is obviously no solution to the problem in the short-term except strengthening the role of preventive agencies.

Import duties on items being manufactured locally should not be lowered too much and too quickly if domestic industries are to be supported in progressively producing on more competitive prices by achieving economies of scale. The sooner we strengthen the competitive edge of our domestic industries to produce intentional quality at competitive prices the better. Meantime, we can review import duties on items that are imported because of domestic non-availability and lower them to levels where it will be more attractive to import them legally rather than smuggle them. Surely, it is better to earn more revenue by lowering tariffs rather than earn little despite high rates.

CLEARING THE COB WEBS IN THE COLLECTION MACHINERY:

This is an area that calls for a complete overhaul because this is a major factor responsible for low revenue collection. What seems to be fundamentally wrong with the tax collection mechanism is:

• the method of tax assessment
• the extent of discretionary powers provided to assessing functionaries
• cumbersome and time-consuming methods for paying taxes

We have not re-defined our priorities and revised our books of statutes after independence. We continue to be guided by the British colonial laws and practices. Civil servants following in the footsteps of colonial rulers can no longer manage Pakistan. That was the style of the 1930s. Taxing businesses justly requires knowing them inside out. To do so, tax assessment methods should be devised in consultation with independent experts who could advise on accurate methods of income and expense assessment thereby eliminating much of the leeway currently being exploited by both taxpayers and assessing authorities to the detriment of the state. Tax liability by the taxpayer can be made simpler and tax assessment bases clearly defined.

What we require are professionally devised industry-wise frameworks for self-assessment of tax. These should be prepared in consultation with tax accounting experts and representative bodies of taxpayers. The formats should be:

• comprehensive and
• wholly self-explanatory so that each item of income, expense, and investment, is clearly identifiable by the taxpayers, and there is little room for confusion in filling out tax returns.

By simplifying terminology and item identification process and establishing verifiable bases for accurately arriving at various income and expense figures the chances of arbitrary assessment or concealment of facts can be eliminated to a large extent. It will reduce cases of appeals against assessments and provide for faster revenue collection. The future tax return should consist of:

• the Return, and
• a comprehensive guide on filing the return.

This is the standard practice in all developed countries. To postpone it on frivolous or perhaps self-serving grounds is to strengthen the case for continued mismanagement of the taxation system. Chambers of Commerce should accept their responsibility for developing jointly with Tax Advisors and Tax Authorities the record-keeping formats to be used by small businesses and draft a simple guide in all provincial languages on how to maintain books of account as per tax regulations.

 

 

IMPROVING THE TAX RECOVERY SYSTEM

By trying to generate revenues from a limited population of taxpayers Pakistan has become one of the highly taxed and logically therefore highly corrupt economies of the world. With so many business units being taxed (at least on paper) and at such high rates, the government’s revenues ought to be enormous. The question is: where does the revenue go leaving massive fiscal deficits to be funded by Public Sector Borrowing year after year. There are three explanations of this phenomenon:

• taxes are not collected fully or
• taxes are collected but proceeds are spent for causes not disclosed to the public
• both the above malpractices are in vogue.

FACILITATING TAX COLLECTION

Tax collection should not be perceived as an exercise in issuing bureaucratic orders without any regard to the taxpayers’ convenience. The government must realize that life is no longer as simple as it used to be fifty years ago. Life’s routines are now very demanding and complex and people need to plan things in advance to be able to apportion time and resources for them and they need to be helped in paying taxes on time. It is not a favour but an obligation of the state towards its citizens. By putting up a friendly face and lending a helping hand the state can achieve much more. Governments in developing countries including even those that had a colonial history have realized this fact. Some of the ways in which taxpayers can be facilitated in paying taxes are as follows:

Tax collection accounts: It defies common sense as to why tax payments can be deposited only with State Bank of Pakistan or National Bank of Pakistan. Why can’t other banks be allowed to collect taxes which could be transferred to respective government accounts on a weekly basis? It has not occurred to taxation authorities that allowing scheduled banks to collect taxes would speed up tax collection. All that the government would be required to do will be to carry out random spot checks of their collection accounts maintained with the scheduled banks to verify whether funds were transferred promptly or not.

Tax returns availability: As for the efficiency of the tax collection system one only has to recall the scenes that take place in front of Income Tax offices every year when taxpayers have to literally beg for tax return forms for filing their returns. The state of affairs is no better at other tax collection offices. We are all familiar with the difficulties with which ‘challan’ forms are made available to taxpayers for paying taxes. You have to buy them and that too from touts sitting outside the premises of these offices.

Tax Return Formats and booklets: We have yet to institute the practice of publishing booklets containing:

• formats of the various tax returns to be filed by citizens, and
• guidance on filling them out as well as
• the manner of paying taxes, and
• lists of offices where these payments may be made.

Such booklets should be mailed to all existing taxpayers at least six weeks before the closing date for filing tax returns. These booklets should be issued separately by federal, provincial and local governments and should include lists of tax offices and banks where payments can be made.

 

 

GOVERNMENT STATIONERY OFFICES: Government’s stationary offices (in the private sector by all means) should be set up in every sizable locality where all types of government stationary meant for use by citizens is on sale at prices fixed by the government. This includes items such as application forms for passports, driving licenses, vehicle registration, company registrations, stamp papers, etc.

TAX ADVISORY OFFICES: These offices should be set up to help taxpayers file their returns where Tax Advisors appointed by the government should be available to provide free advice to the taxpayers.

INSTALLMENT PAYMENTS: Taxpayers should be given the option of paying taxes either in lump sum or in monthly installments. Those wishing to pay taxes in installments should be advised to write to the concerned taxation office requesting for installment payment booklet.

COMPOSITE TAX DEMANDS: Taxation authorities responsible for collection of several taxes should always send a composite tax demand which will cut down the number of payments to just one.

ACCOUNTABILITY OF TAX AUTHORITIES: Provincial and local government offices should be required by law to send along with the tax demand a summary of the manner in which last year’s tax revenue was spent and a summary of the plans for utilizing tax revenues of the tax-year.