The Challenge of Low Tax Yield

The challenge of low tax yield

No state can survive or live with dignity in the comity of nations without raising sufficient revenues required for financing productive and non-productive expenditures. Pakistan’s public debt, by March 2015, was recorded at Rs16.936 billion or around 62pc of the GDP. The primary source of increase in public debt is the domestic borrowings to finance fiscal deficit. Thus the foremost reason for accumulation of public debt is the persistent large fiscal deficits. For example, the fiscal deficit was 8.2pc of GDP in 2012-13 and it reduced to 5.5pc of GDP in 2013-14. However, this reduction is largely due to contraction of expenditures.

On fiscal front, a daunting challenge is limited tax yield due to less efficient tax system and unplanned expenditures. An important reason behind unrelenting fiscal deficits and thereby accumulation of excessive public debt is considerably low tax yield as tax-GDP ratio was only 10pc in 2013-14 owing to widespread tax evasion. For example, the Post Clearance Audit (PCA) has detected evasion of duty and taxes at Rs 1,287 million during 2014-15, which was 333pc higher as compared to Rs297 million in 2013-14.

Tax evasion exists in many forms. PCA has detected tax evasion of Rs879 million as a result of misuse of exemptions and Statutory Regulatory Orders (SROs). It is not out of place to mention that the government has already lost tax revenue of Rs412 billion in 2014-15 as a result of tax expenditures (exemptions) including income tax revenue of Rs83.6 billion, sales tax Rs 225.4 billion and customs duty Rs103 billion respectively. Income tax revenue of Rs 51.5 billion was given up in favour of Independent Power Producers (IPPs). Similarly, tax expenditure of sales tax on account of SRO 1125/2011 alone stood at Rs55 billion.

Narrow tax base is a major tax policy challenge intimidating the fiscal sustainability. Less than one per cent tax return filers out of total population offer a better illustration of this challenge. A considerable portion of taxable population remains outside tax net knowingly and deliberately to evade duties and taxes resulted in high tax rates or higher tax burden on small taxpaying population. This situation has posed a serious threat to fiscal sustainability as ever-expanding public debt has alarming consequences for the economy.

To counter reduced tax base and to prevent further tax revenue leakages, overwhelming part the Income Tax Ordinance, 2001 comprises of such withholding provisions wherein tax deducted and collected is presumptive or final and no adjustment is allowed. Such a tax policy is empirically found counterproductive for the economy as these tax measures tend to modify the behaviour of consumers and investors but are greatly helpful in limiting tax evasion. For example, minimum tax scheme introduced under section 113 of the Income Tax Ordinance has resulted in reduction of tax evasion up to 60-70pc of corporate income.

Nonetheless, mode of tax collection has largely become indirect due to excessive reliance on presumptive taxes. About 60pc tax revenue is raised through indirect taxes such as sales tax, customs duty and federal excise duty. Additionally, 40-45pc income tax revenue is being collected through presumptive withholding tax provisions. Such a portion of tax revenue has the potential to be a part of prices of goods and services.

According to PCA, other reasons for loss of tax revenue are under-valuation and non application of valuation rulings (11.4 million), mis-declaration of description and tariff classification (395.5 million) and evasion of anti-dumping duty (1 million) respectively. Widespread tax evasion indicates lack of tax culture in the country.

Among the several determinants, lack of trust and confidence among the populace regarding fair and neutral taxation and useful spending of public funds has been contributing to lower tax compliance. People stop paying due taxes if the fiscal system fails to prevent wasteful revenue leakages. There is a positive correlation between the level of mistrust and the size of corruption within the fiscal system.

Tax compliance is also low due to pervasiveness of high rate of illiteracy in the country. To comply tax provisions and tax procedures for filing and paying of taxes require relevant knowledge. Therefore, to broaden the tax base, the field formations need to explore opportunities for conducting public education programmes on tax laws, tax procedures and accounting requirements, particularly for small enterprises. Working with industry and community groups for promoting benefits of filing tax returns such as lower tax rates, adjustments of tax withheld and refund claims is also important to improve tax compliance.

Above all, strengthening tax intelligence and investigation system as well as prosecution is essential to creating deterrence against tax evasion and tax frauds as people involved in malpractices such as issuance of fake and flying invoices consider it legitimate business activity though not. Similarly, such a strong system is required to stop other forms of tax frauds including suppression of supplies, concealing of assets, wrong tax declarations, misuse of exemptions and SROs, etc.

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