TAXING THE TAXED

SHAMSUL GHANI (shams_ghani@hotmail.com)
Jan 18 - 24, 20
10

The changed global environment and Pakistan's policy irresponsiveness, particularly during the last three years, have made its economy bereft of sense and direction.

Till 2007, the country was working on an unmistakable theme of consumption-led growth. If it was madness, then at least there was a method in it. After condemning that theme, next government dumped it but never came up with any alternate workable model. If it has to be production-led growth, then what measures have been taken to achieve it?

Does one praise the prevailing unreasonable interest and corporate tax rates-both of which are highest in the region? Or is it the ever increasing cost of doing business that we can be proud of? The recessionary trends in the economy and a deteriorating tax to GDP ratio are sending very strong signals of impending economic chaos.

With the recent improvement in global and domestic economic trends, Pakistan's corporate sector has reported, during the first half of current fiscal, higher revenues but subdued margins. This amply highlights the core weakness in the country's tax systems. The shallow viewpoint that a high tax rate will generate higher tax revenues holds no more logic in the age of diversified business environment.

A high tax rate essentially gives a way to tax evasion and contracts business volumes. By expanding the tax net and reducing the tax rates, the government can not only increase tax revenues through high business volumes but can also provide momentum to the economic pace.

True that corporate sector has failed to play its due role in the economic developments of the country, but that is the administrative side of the issue falling within the ambit of regulatory bodies. A high corporate tax is not the answer to the inefficiencies of corporate sector. It simply raises the cost of doing business as companies tend to increase prices of their goods and services to maintain the desired level of their bottom lines. To raise the prices, they resort to cartelization which itself becomes a hurdle in the way of fair market competition.

Unjustifiably high tax rates are considered a vehicle to achieve high tax revenue targets that are set with short term objectives. This malady has its roots in Pakistan's defective political system under which individuals, and not organizations, are considered important. The individuals, with the specter of job-uncertainty looming large, never get time to do anything of substance that is based on long term objectives. Some straitjacketed tactics are used to achieve short term goals. An increased tax rate or continuation of an already high tax rate is one of such tactics.

Prevailing corporate tax rate of 35 percent in Pakistan, highest in the region, is very regressive in nature. The average corporate tax rate in the region is below 30 percent. OICCI had recommended last year a cut of 7 percent over a period of two to three years. The anomalous rate of 20 percent for smaller companies having a turnover of up to 200 million is also a countervailing factor as it restricts organizational expansion on one hand and encourages use of unfair corporate practices on the other.

The workers' funds tax rates also add to the corporate burden making their cost of doing business still higher. In the given situation, it is safe to assume that Pakistan can not compete with any of the regional economies in any of the economic areas, be it the rate of inflation, the benchmark interest rate, food and energy security, cost of doing business, size of capital formation etc.

Under the burden of an astronomical cost of doing business, textile and LSM sectors' slack poses a great challenge to economic growth.

TAX REVENUE COLLECTION DURING THE LAST 13 YEARS (MILLION RUPEES)

PERIOD DIRECT TAXES INDIRECT TAXES TOTAL TOTAL TAX COLLECTION
SALES EXCISE CUSTOMS
1996-97 85,060 55,668 55,265 86,094 197,027 282,087
1997-98 103,182 53,942 62,011 74,496 190,449 293,631
1998-99 110,207 72,105 60,905 65,292 198,302 308,509
1999-00 112,950 116,711 55,784 61,659 234,154 347,104
2000-01 124,585 153,565 49,080 65,047 267,692 392,277
2001-02 142,505 166,561 47,186 47,818 261,565 404,070
2002-03 151,898 195,139 44,754 68,836 308,729 460,627
2003-04 165,079 219,167 45,552 91,045 355,764 520,843
2004-05 183,372 238,537 53,104 115,374 407,015 590,387
2005-06 224,986 294,798 55,272 138,384 488,454 713,442
2006-07 333,737 309,396 71,804 132,299 513,499 847,236
2007-08 387,487 376,930 92,185 150,579 619,694 1,007,181
2008-09 440,271 452,294 116,055 148,382 716,731 1,157,002

A better tax system decrees higher collection on direct tax side, as indirect taxes are conveniently passed on to the end consumer thereby creating inflationary pressures on the economy. Corporate tax is one form of direct taxes. The ratio of direct taxes to the total tax revenue shot up from 31.5 percent in 2005-06 to 39.4 percent in 2006-07. The fact that this ratio has shown marginal shrinkage when it came down to 38.5 percent in 2007-08 and then to 38.1 percent in 2008-09 does not augur well in a situation when our total tax collection is on a rise on year-on-year basis.

In this scenario, it may sound illogical to recommend a cut in corporate tax rate, but the corollary is that such move, if properly supported by administrative and tax-base-broadening measures, will bring a definite overall improvement in tax to GDP ratio which is presently less than 10 percent against a standard 25-30 percent mark.

A major segment of services sector remains outside the tax net either through willful evasion or as a result of tax system's failure to identify it as a potential source of revenue. According to a recent Asian Development Bank report, an amount equivalent to 2.2 to 2.9 percent of GDP is estimated to be lost due to tax evasion which means that Pakistan's actual tax to GDP ratio should be around 13 percent.

Tax exemptions to the elite sections of society are also the highest in Pakistan which need to be scrapped or at least scaled down. Agriculture income tax could be another potential source to boost tax revenue. The large holders of agriculture land are the long standing beneficiaries of this sneaky exemption. Can we expect the government to make a landmark decision to tax this influential and hugely affluent sector of the economy? This will not only legitimize the stashed-away high profile income of feudal lords but will also pave ground for a cut in corporate tax.