At present, the Federal Board of Revenue (FBR) is under immense pressure to raise tax-to-GDP ratio essential for creating fiscal space. To take up all types of tax-related matters including determination of various taxes and duties and finalizing tax ratios, a tax reform commission is in the offing. Given limited fiscal space, narrow tax base and poor tax compliance, presenting various tax policy options before the commission is seriously warranted.
It is worth mentioning that Pakistan is lesser successful in tax collection than other developing countries. In 2011, the tax-GDP ratio in the country was 9.2 per cent as against 14.8 per cent in developing Asia-Pacific countries, 17.1 per cent in Latin America and the Caribbean regions, and 16.3 per cent in Sub-Saharan Africa.
There could be various tax policy options before the tax reform commission for strengthening tax revenues. A large number of micro- and small-sized businesses are operating in the informal sector not only causing loss of tax revenue but also hampering competitiveness and productivity. To bring these businesses in the tax net, sales tax registration for every business with industrial utility connection or commercial connection may be made compulsory regardless of the annual threshold. For taxation purpose, a special tax regime may be introduced for micro and small businesses. Under such a tax regime, these businesses may be subjected to a single income tax levy and lower sales tax rate and may not allow credit of input tax against output tax. To facilitate micro and small businesses, these may be asked to pay tax on quarterly basis in instalments. Partial exemption from payment of tax during first two to three years of activity may be offered to businesses created under special tax regime as an incentive.
In Pakistan, although the average corporate tax rate is higher as compared to other regions, no significant increase in tax collection has been witnessed. The average corporate tax rate from 2006 until 2014 was 34.89 per cent in Pakistan as against 28.3 per cent in the Asia-Pacific region, 29.8 per cent in Africa and 32.2 per cent in Latin America. It implies significant enforcement gap. To bridge this gap, granting a level of institutional autonomy to FBR to protect tax administration from corruption, political interference and pressure from various vested interests can be a better option.
In Pakistan, the corporate tax rate was reduced from 35 per cent to 34 per cent for 2014 in a tax competition with other economies of the region and in order to attract foreign direct investment (FDI). However, there is an immediate need to examine the impact of lower corporate tax rate on total revenue and investment as a string of studies found insignificant relationship between lower corporate tax rate and foreign direct investment. Therefore, enhancing corporate tax rate may be an area of interest before the commission.
With respect to individual income tax rates, a flat tax rate, like in Kazakhstan, Russia and Georgia, could be another option to simplify the tax system in order to curb tax evasion and tax avoidance and also to reduce the tax administration cost. However, the option of flat rate taxation needs to be considered carefully as such rates are highly regressive and have the potential of widening income inequality.
Another tax policy choice could be the reintroduction of tax on wealth that stood rescinded from 2001-2002. A number of countries that previously abolished the wealth tax are deliberating to reintroduce it so that the increasing income and wealth inequalities may be mitigated and the national debt eliminated. In addition, tax on wealth is considered an instrument to decrease inequality and to strengthen democracy.
Establishing dual income tax system that taxes income on labour and capital gains separately with lower tax rate on capital to encourage savings and investments could be another tax policy option. Taxing capital gain at lower rate is also likely to allow some room to address tax competition aimed at attracting investment.
With regard to tax exemptions and concessions, it is emphasized that these are costly in terms of revenue losses as compared to the benefits of increased foreign direct investment and are thus counterproductive. The estimated revenue losses due to exemptions and waivers of income tax, sales tax and customs duty went up from PKR 164.5 billion or 10.7 of total tax revenues in 2010-11 to PKR 208.2 billion or 9.9per cent of total tax revenues in 2011-12. Therefore, reducing and rationalizing tax expenditures could be a viable option for strengthening tax revenues and minimizing distortions.
To harmonize taxes and avoid tax competition, promoting regional cooperation would be useful in dealing with tax havens. For this purpose, the member states of the South Asian Association of Regional Cooperation (Saarc) can consider a certain level of harmonization of the taxation of profits of multinational companies. Furthermore, the transfer pricing issues necessitate more harmonizing of corporate tax rates in the region. Better information reporting and additional enforcement are the measures required to combat tax haven and transfer of funds out of country without taxation.
To sum up, reducing tax expenditures, increasing tax collection efficiency, extending sales tax base, taxing capital gains effectively, taxing imports of services, taxing foreign operations, improving tax administration and harmonizing income tax rates are the potential measures that could help in strengthening tax revenues and reducing distortions.
Pakistan has significant potential for enhancing tax revenues, improving the quality of tax administration, rationalizing tax rates and reducing the level of tax expenditures.
The author is a graduate in Taxation Policy & Management
from Keio University, Japan.