Reducing Income Inequality Through Taxation

The word ‘democracy’ a Greek word in origin’ is composed of Demo or the people and ‘Cracy’ rule, or rule of people, it started in city states of Greece. A lame tradition of Democracy was practiced in Rome where it got mixed up with Emperorship and had a zigzag course. Otherwise in Europe, worst authoritarian rule remained entrenched till the French Revolution or the 18th century where the theory of Divine Rights of Kings was propounded. It developed after the French Revolution or after the 18th century primarily in England and also in France but naturally under the hallow of different cultural backgrounds ‘Democracy’ as is now practiced evolved in England and the British Parliament is called the mother of all parliaments.

A possible explanation for the rising inequality in the country could be the flawed and ineffective taxation policy and the imperfect enforcement thereto. Our tax-to-GDP ratio ‘at below 10pc’ is the lowest among other economies of our size. On average, the tax-to-GDP ratio has been marginally above 9pc for the period 2003-04 to 2012-13. Though tax collection in absolute numbers has increased over the years, yet in terms of percentage to GDP, it has been stagnant and has even declined in the recent past.

The low and declining tax-to-GDP ratio suggests that a massive tax avoidance and evasion has become a usual matter for the corporate and non-corporate taxpayers either with or without the connivance of tax functionaries. This phenomenon also manifests the weak tax enforcement.

As the rich and influential people in Pakistan evade paying the due tax, so the policymakers are left with no option but to rely on indirect taxation in order to secure revenue that is essential to balance the budget. At present, more than 60pc of the total tax revenues is being generated through indirect taxes including sales tax (44pc) and customs and excise duty (16pc). Even within the ambit of direct taxation, income tax is the main source of revenue with 98pc contribution. Ironically, around 60pc income tax revenue is being raised through withholding tax regime, which is overwhelmingly presumptive in nature and has the tendency to assume indirect form of taxation.

Furthermore, a wide range of tax deductions, credits and exemptions have benefitted only those who already have hefty incomes. Secondly, there are no recurrent taxes such as inheritance tax, wealth tax, gift tax, etc. Even though the agriculture is the backbone of our economy, there is no tax on agricultural income of the owners of large landholdings.

In the presence of a taxation policy that is heavily reliant and dependent on indirect taxes it is not possible to reduce income inequality; rather the situation has become exacerbating and perturbing. It is because the indirect taxes are directly included in the final prices of commodities which the consumers purchase and hence pay for that tax. This gives rise to a soaring inflation. With double digit inflation during the last decade, the $1 a day yardstick for defining poverty has lost its significance and the Finance Minister, Mr Ishaq Dar, has declared a new benchmark of $2 a day.

In this context, it is important to mention that there are two measures of equity: (i) Horizontal equity that requires that the taxpayers with equal level of income pay the same amount of tax and thus bear equal tax burden; (ii) vertical equity that requires the taxpayers with different levels of income to pay different amounts of tax and thus bear unequal tax burden.

The government should introduce a series of reforms to ensure that the top earners do contribute their fair share of tax to the national exchequer. For this, formulation and implementation of effective taxation policy, which is fundamental to achieve redistribution of income and to reduce the income inequality, is more than indispensable now.

Abolishing or scaling or rationalizing back a wide range of tax deduction, credits and exemptions, which are benefiting only the big businesses, should be reconsidered at the earliest. There is a dire need for restricted and careful use of SROs, because so far these haven’t been beneficial to the economy, rather have contributed to the complication of the tax system which has been a source of huge losses to the national kitty.

Shifting the tax mix towards a greater reliance on recurrent taxes on immoveable property could also be a viable option.

It is also important to review other forms of wealth tax such as inheritance tax, gift tax, etc.

At the same time, international cooperation should be sought to minimize tax evasion on cross-border transactions as high-income individuals and companies structure their finances to take account of favourable tax provisions in different countries.

Broadening the income tax base to fill up lacunas and reduce tax evasion opportunities is much needed. This is the only way to optimize revenue and reduce inequality.

Last but not least, ensuring tax compliance by tax enforcement measures such as penalties, additional taxes, etc., is of pivotal importance to securing revenue and to allow the self-assessment system to perpetuate in the society.

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