Importance of tax revenue in the fiscal system of a country cannot be negated because it is a leading source of revenue for balancing the budgets. Tax revenue constitutes major component of revenue receipts in all around the world with the exception of a few natural-resource-rich countries where non-tax revenue is a major source of revenue. It is also not out of place to mention that public service delivery at operational and tactical level is adequate in countries where tax collection as a percentage of GDP is considerably higher.
In Pakistan, like many developing countries where tax collection falls short of targets, public services such as education, health, security and justice are not adequate. As a result, literacy rate is extremely low (below 60pc), law and order situation is poor and justice is dispensed belatedly.
Another disadvantage of limited tax collection is large and sustained budget deficits (the budget deficit reaches as high as 8.5pc), which are accumulated in huge debts. At present, national debt is more than 64pc of GDP. Ideally the debt burden as a percentage of GDP in developing countries must not exceed 60pc from sustainability point of view.
Limited tax collection is due to flawed tax policy as well as weak enforcement. For the last many years, the tax to GDP ratio has been hovering around 10pc, which is considerably smaller even than the world’s average tax-GDP ratio of 14.8pc. It is beyond any doubt that the current tax collection is much lower than the potential. The gap is due to widespread tax evasion on account of direct and indirect taxes. People hardly feel shame in evading taxes. Federal Board of Revenue (FBR) reported an estimate of the corporate evasion rate equal to 45 pc. A study by the World Bank (2009) estimated the evasion rate as high as 218pc of actual corporate income tax payments.
Ideally tax policy should be based on principles of good taxation such as simplicity, vertical and horizontal equity, neutrality, efficiency, etc. It must not create distortions in the economic system by taxing some individuals or sectors of economy while leaving others untaxed; it must ensure uniform distribution of tax burden. In other words, choices of consumers and investors must not be adversely affected by tax policy.
In Pakistan, tax policy provides tax exemptions to some individuals and sectors of economy and shifts the burden of tax, in the form of high taxes, on others. Frequent changes in the tax policy through statutory regulatory orders (SROs) create uncertainty and make the tax system complex. Furthermore, tax exemptions and frequent changes have the potential of promoting tax evasion. Table below provides for various tax exemptions and average loss of income tax revenue (only direct tax levy at federal level) during the period 2009-10 to 2013-14 due to flawed tax policy.
Another important reason for collection of tax revenue less than potential is weaker enforcement of laws. One plausible reason for weak enforcement is inadequate human resources. With a population of exceeding 180 million, there were only 13,344 tax officials against the sanctioned strength of 17,044. On the other hand, in Japan for a population of 128 million, tax administration consists of more than 53,000 officials. Though two zones broadening of tax base (BTB) and withholding taxes (WT) have been created in each of the eighteen Regional Tax Offices but no additional workforce has been recruited to be employed there. With same sanctioned strength, the officers and staff in these zones are under a lot of pressure to complete arduous tasks of BTB and WT.
The size of black or undocumented economy in the country is estimated to be around 60pc of GDP. Therefore, revenue potential is far greater than the actual collection.
There was no tax investigation system of direct taxes before 2011-12. However, Finance Bill 2011-12 introduced Intelligence & Investigation System for surveillance of all inland taxes including income tax, sales tax and federal excise duty (FED). But these offices lack sufficient resources in terms of manpower and logistics to carry out the task of prosecuting the tax fraudsters. Furthermore, limited capacity of tax auditors and other staff due to lack of training is another reason of weak intelligence.
Literacy rate is less than 60pc in the country which is another important reason behind non-compliance of tax laws. Additionally, cost of tax compliance is very high. Pakistan ranked 162 out of 185 world economies with regard to tax dealing (World Bank “Paying Taxes”, 2013). In Pakistan, the taxpayers spend 560 hours on dealing tax matters against the world average of 267 hours. Undoubtedly, taxpayers’ understanding of the tax system, tax laws and tax administration largely influences tax compliance behaviour. It is found that high tax-compliance cost discourages voluntary tax compliance and tax education, tax morale and tax information so also have an impact on tax compliance.
For increasing tax collection and reducing tax evasion, strengthening tax administration is required, which can be strengthened through following measures:
- A gradual increase of the tax administration staff
- Strengthening the careers of officials
- Restructuring staff remunerations
- Streamlining duties and functions of offices
- Providing relevant foreign and local training to tax administrators
- Reinforcement of internal controls and strict accountability to reduce corruption in the fiscal system
- Solidification of the intelligence and investigation system by putting right type of human resources and logistics.