In Pakistan, tax collection is significantly lower than the actual potential given the size of the country’s economy as tax-to-GDP ratio has been less than 10 percent for the last decade or so. Combining together the tax collection on account of income tax, sales tax, federal excise duty and customs duty, this ratio is far less as compared to similar economies in the world. Since the structure of taxes is heavily tilted towards indirect taxes, which are considered easier mode of tax collection, one of the lowest tax-to-GDP ratios in the world is a matter of grave concern for Pakistan’s tax policymakers and administrators.
Sales tax is a modern tax and is considered an efficient mode of tax collection. Over the years, contribution of VAT/GST in overall world tax collection has increased significantly but Pakistan like other developing countries is yet to exploit its true potential due to a number of factors.
Despite sales tax contributes around 45pc to overall tax revenue collected at federal level, its full potential has not achieved due to tax frauds / massive tax evasions. It is worth mentioning that sales tax collection increased from 1.5pc of GDP in 1991-92 to 4pc in 2002-03 but afterwards the ratio declined to 3.5pc in 2009-10. Average sales tax-to-GDP ratio was 2.9pc during the period from 1991-92 to 2011-12. The average sales tax efficiency ratio in these years was about 19pc whereas the ratio was 27pc in Sub-Saharan Africa, 35pc in Asia and the Pacific, 37pc in Americas, 38pc in European Union and 37pc in North Africa and the Middle East. Likewise, the C-efficiency or collection efficiency ratio increased from 17.3pc in 1991-92 to 31.1pc in 2002-03 but decreased to 25.3pc in 2011-12. The average C-efficiency ratio was about 25pc during the period 1991-92 to 2011-12 against 38pc in Sub-Saharan Africa, 58pc in Asia and the Pacific, 57pc in Americas, 64pc in EU and 57pc in North Africa and the Middle East.
Though collection of income tax in absolute terms has increased significantly over the years, as a percentage of GDP, there is no sizeable increase despite adoption of several measures such as minimum and presumptive withholding taxes that are not recommended by the economists/tax gurus being detrimental to economic growth. Presently, on average, the income tax-GDP ratio is hovering around 3.5pc, while those of excise and customs duties have declined over the years due to shift in taxation policy from trade or excise taxes to income tax and sales tax in VAT mode.
It is said that the best way to raise taxes is through additional economic growth. However, lacklustre economic growth during the last many years, mainly due to myriad social, economic and political problems, provides little space to FBR for additional tax collection. As economic growth is improving, an increase of 0.5pc has been witnessed in the tax-GDP ratio during FY2014-15.
There is a massive loss of revenues due to exemptions, allowances and deductions from income tax, sales tax and customs duty, which was Rs 887.5 billion or equal to 3.9pc of GDP during the previous five tax years (2008-09 to 2012-13). In 2014-15, loss of direct-tax revenue due to tax expenditures has been estimated at Rs. 84 billion. However, a massive loss of revenue, to the tune of Rs. 225 billion, incurred on account of sales tax. Overall revenue loss due to exemptions was estimated to be 16pc of total tax collection during 2014-15.
Generally, the tax incentives in the form of tax exemptions are provided to investors to boost economy and to create new jobs. Nevertheless, slow economic growth measures in terms of real GDP over the last five years or so signifies the ineffectiveness of various tax incentives in accelerating the pace of economic growth.
Imperfect enforcement is an important cause of tax revenue loss and a wide tax gap. Tax evasion, both by corporate and non-corporate taxpayers, is massive in Pakistan. There are more than one forms of tax evasion such as none or under-reporting of tax liability.
Weak enforcement could be due to inadequate staff, scarcity of physical and financial resources and/or poor working capacity of the staff. The taxpayers might exploit weaknesses in the enforcement mechanism to evade taxes.
In order to improve revenue performance, bridging the tax policy gap as well as the gap arising from weak enforcement is inevitable. The tax policy change encompassing minimal use of exemptions is needed to refine the existing taxes and to provide level playing field to all sectors of economy. At the same time, it is crucial to strengthen the current enforcement mechanism by enhancing administrative efficiency and capability as well as improving compliance through taxpayer services and tax education.
In addition, regular and effective examination of records could create deterrence effects against tax evasion and underreporting. At the same time, appropriate training of the connected staff could improve low level of recovery out of demand created as a result of examination of records.
It is said that there is no taxation without information. Therefore, effective use of relevant information could help bridge the tax gap besides encouraging documentation.
The PR activities through mass media could be helpful in disseminating and increasing tax knowledge and enhancing tax compliance. Listening to public opinions and requests could improve mutual understanding and trust between taxpayers and tax administrators. These activities require to be handled at each level of tax management. Various PR tools such as television, radio, newspapers, etc., should be extensively used for providing updated tax information.
Tax consultation is widely used as an instrument to enhance tax compliance. Its objective is to assist taxpayers in tax matters and encourage voluntary compliance of accurate tax return filing and tax payment.
Last but not least, it is imperative to impose stipulated penalties on taxpayers who violate provisions of law. Similarly, strengthening tax investigation system is also fundamental to creating deterrence against tax evasion and to bridging the tax gap.
The writer is a graduate in Taxation Policy & Management from Keio University Japan and has certification in International Economics and Law & Economics from Faculty of Economics Keio University, Japan.