The integration of domestic taxes cannot be achieved in the absence of a unified CBR workforce.

Aug 21 - Aug 27, 2006

Pakistan still has a very low tax-to-GDP ratio of only 9.5 percent despite the fact that the country is marked for having the highest income tax, corporate tax and VAT rates, which clearly proves the inefficiency in the system, besides the low coverage. A uniform 15 percent sales tax is applicable in Pakistan, yet sales tax collection stands for only 3.7 percent of GDP.

Efficiency ratio (total VAT as percentage of GDP divided by VAT standard rate) stands one of the lowest in the world mainly for the reason that service sector was almost out of its domain and there was no universal applicability resulting in the absence of a chain of transactions. Low income tax yield was justified as of exemption for years of agricultural income from the tax net and the constitutional inability of taxing it.

Agricultural income tax was, however, introduced a few years back but the revenue yield is not even 0.1 percent of GDP, whereas agriculture contributes 26 percent of GDP. That advocates more administrative, financial and functional autonomy for the CBR, which is necessary for smooth implementation of reforms. CBR continues to be a division of the Federal Government and not upgraded as a Revenue Authority and has now entered the most crucial phase of reforms that calls for sufficient autonomy to carry out day to day operations and the modernization of tax machinery.

The integration of domestic taxes cannot be achieved in the absence of a unified CBR workforce. If officers of the organisation belong to two or three different service groups of the government, having separate systems of recruitment, posting, promotion and work procedures, the integration of processes and systems would be next to impossible. The government, through an administrative order, had allowed some additional powers to the CBR Chairman so that he could take some initiatives, but still, had to follow government's recruitment, promotion, disciplinary and financial rules.

It is abundantly clear that the CBR in its present shape has been unable to raise the tax to GDP ratio to levels prevailing in other countries at similar stages of development. One of the main reasons for such poor performance has been the stranglehold of the government on its staffing and working and unnecessary interference in its routine procedures and policies.

Many times in the past, a case has been made with all the justifications to separate the organisation of the CBR and upgrade and rename it as Revenue Authority, but the decision was delayed on one pretext or the other. Understandably, powerful figures in the government do not want to lose control of an organisation through which they can bestow benefits or punish certain individuals or groups. But the times have changed. Pakistan's development effort requires much higher level of domestic resources, which is only possible by enhancing the administrative and technical capability of the CBR by isolating it from the government's main bureaucratic set-up.

In an age of specialisation, it is hard for the generalists to keep pace with the rapid changes in some fields. Nobody is suggesting autarchy for the CBR but only autonomy in its day-to-day working and reasonable degree of independence to implement government policies as well as to recruit and deal with its workforce on its own.

The example of State Bank is before us. After granting it autonomy, it has functioned more efficiently, earned more respect and at the same time fully co-operated with the government to achieve the set economic objectives. If the CBR is made more responsible by granting a reasonable measure of autonomy, it would also be better placed to discharge the functions assigned to it more efficiently. On the other hand, the government may face serious financial and technical constraints to achieve its long-term economic objectives, including increasing the current $104 billion GDP to $700 billion by 2030, says a draft of "Approach Paper on Strategic Directions to Achieve Vision 2030, a copy of which was obtained by PAGE.

It stresses that the current low tax-to-GDP ratio will have to be improved substantially to overcome the constraints for improving financial, scientific, technical and human resources to increase the present per capita income of $780 to $3,000 in the next 25 years.

The approach paper enlists five major challenges which need to be addressed to achieve Vision 2030 goals: better education, easy access to justice, affordable and good health care, improved governance and management of the institutions.

The paper, prepared by the Planning Commission, recognizes risks and limitations in attempting to define the way of life in 2030 and appreciates nature, diversity and enormity of the challenges. "The process requires consistent inputs from all stakeholders, including various tiers of the government, civil society as well as a broad range of experts."

We have a large informal and undocumented sector of the economy, particularly relating to commercial sector. A sizeable portion of public funds is siphoned of through corruption, fraud and embezzlement. These funds then find their way into such activities and transactions inside or outside the country which are not being taxed due to 'lack of information' and an effective mechanism of tracing these 'incomes' and expenditures.

The tax base also gets narrowed down due to the wide range of exemptions and tax rebates provided in the income tax, sales tax and custom laws. Corruption also eats away a significant amount of would-be tax but corruption is a culture (in certain situations a necessity) in our society. People take pride in making money, as a lot of them think that it was destined for them. As regards tax corruption, there are three parties to it: Taxpayers (as they do not, inter alia, trust the system and pay a lot of 'taxes' for their own security and survival), tax representatives (even most reputable individuals and firms look the other way when tax is being avoided and evaded particularly by their multinational clients) and tax officials (a lowly paid and demoralised species). What we need is a sound policy, skill, automation, effective monitoring/deterrence and adequate quid pro quo. Then the tax base squarely depends on the amount of the real incomes of the individuals.

Per capita income is a misleading measure in this regard as our economy has a narrow base and wealth is accumulated in a few hands who are housed in the upper portion of the socio-economic pyramid. This is the main reason for the inelasticity in tax collection as it does not increase proportionately to the growth of GDP, which for the FY05 was 8.4 percent while the tax-to-GDP ratio showed negative growth and growth in the GDP did not lead to a growth in tax base; even if more taxes are collected it would not reflect the prosperity level of the (majority) people of the country and the expansion of tax base.

According to the State Bank of Pakistan, the tax ratio is around 40 percent for high income countries, 25% for middle income countries and about 18% in low income countries. While, according to 05/World Development Indicators, Pakistan and India are placed in the low income group; Sri Lanka, Thailand, Philippines to the lower middle income, Malaysia to the upper middle income and Korea to the high income group. Consequently, the issue of the broadening of the tax base cannot be restricted to the tax on only agriculture incomes or the services sector etc but is to be viewed in the larger perspective.

Just to make things more clear, a comparative chart prepared from various sources like IMF, World Bank, ADB and others are given below. It can easily be said that the broadening of the tax base has direct relationship with the structure and level of development of economy.

Fortunately, since FY 2002-03, Pakistan could achieve a certain level of macroeconomic stability and our growth for FY 2004-05 was the highest in the region after China but this must not lead to complacency, rather it should trigger the process to visualise things more comprehensively and to get rid of the historical baggage as well, so that a sustainable growth can be achieved.

In developed and some of the developing countries, particularly where states have federal or devolved structures, taxes are collected by local governments, state or provincial governments and union or federal governments for example, in India, South Korea, and USA. Tax collecting authorities are decentralised and all tiers of the government contribute to the total tax revenue. Ratios of OECD countries (Turkey and S. Korea included) are based on all taxes and at all levels, whereas in Pakistan we calculate ratio on the basis of taxes collected by the CBR.

In Pakistan, however, tax collecting powers are mainly vested in the centre that is the Federal Government. Local governments are still in the developing and unfolding stage. As regards our tax base, it includes incomes of individuals, AOP's and companies, levied @2% on the industrial establishments on their total (non-presumptive) income of Rs 100,000 and above, CVT on imported vehicles not previously used in Pakistan and on air tickets for foreign travel; consumption taxes (sales tax at the import stage and on domestic sales; central excise duty on selected commodities like cigarettes, beverages, cement, POL, insurance and Natural Gas etc) and custom duties on dutiable imports.

Although tax on agricultural income and on capital gain in immovable property cannot be levied by the federal government, provinces however collect land revenue, taxes on agricultural income and stamp duty etc.

There is no authorisation to levy sales tax on services - for it falls under the domain of provinces - hence not being levied and it is being said that both these sectors constitute 75% of GDP. Break up of actual net collection at Rs 591.1 billion for FY 2005 is as under:

Direct taxes which include income tax, WWF and CVT contributed 30.98% i.e 183.1 billion with the individual's share (61.1 billion) i.e 36%, others (10.6 billion) i.e 5.789% and the corporate sector (Rs 110.4 billion) i.e 62%. ii) Indirect taxes (69.024%) which consists of sales tax (at the import stage and on domestic sales) at Rs 408 billion with sales tax at Rs 240, central excise at Rs52.9 and customs at Rs 115.1 billion.

To broaden the tax base and increase the number of tax payers, we chose the bureaucratic way, the CBR, earlier, also assigned a special task, particularly to certain zones and generally to the whole hierarchy, to capture new tax payers to "broaden the tax base".

Previously, the same exercise was also done through the WAPDA, KESC and telephone billing records resulting in the marginal increase of NTN holders. The number of NTNs has though increased due to the mandatory requirement of the NTN to purchase the vehicle, but all these techniques so far have made no genuine contribution to the increase of taxpayers (return filers). On the other hand, some analysts are of the opinion that the number of tax payers is much more than what is being reported by the CBR (1.6 million, return filers 1.2 million) as, in their opinion, all those whose tax is withheld/deducted by electricity, phone, bank and other such authorities, irrespective of the quantum of tax, are tax payers.

The issues of the broadening of the tax base and tax-gap shall be viewed in the larger context and proper perspective. Regarding tax collection patterns, the main feature is the increasing reliance on goods and service tax and social security contributions. Corporate taxes, except for S. Korea, do not cross 10% of the total tax burden. The importance of sound fiscal policy and modern and effective administration cannot be downplayed to broaden the tax base and to achieve higher ratios.

It must, though, be understood that reform is an ongoing process, yet a progressive and state-of-the-art foundation must be laid down for the further continuation of the process. A close working partnership should be established with the OECD, ADB and South Asian countries. Reasonable remuneration for honourable living, specific industry and issue wise training (in and out of the country) and automation must form the core of the reform process.

Automation and documentation can be the main tools to achieve efficiency and transparency. Given the load of work and multitude of aspects of taxation, it is impossible to achieve better results by manual efforts or partial automation. This is also important that human resource available must be trained to cater to the needs of the reform process and various functions like audit (including accounting and tax), legal and communication technology and training must be based on strategic planning and well worked out modules.