Need for Making Tax System Equitable
Income tax is the major levy in almost all the developed countries, which, therefore, have direct tax collection as the largest share in their overall national tax collection. In these countries, income inequalities are minimal and the living standards of the people are high, yet almost similar. A stranger hardly finds poor people in these countries. In view of economic and social development contributed by the high tax-to-GDP ratio in such countries, it is not surprising to conclude that tax revenue is crucial for national development. Nonetheless, economic and social development depends on the type of taxes and the enforcement policy adopted for collection of tax revenue.
In the developing countries like Pakistan, there is an overwhelming reliance of the tax authorities on indirect tax revenue. To balance the budgets, the tax authorities in Pakistan collect over 60 percent of tax revenues through indirect taxes; including sales tax, federal excise duty and customs duty or trade taxes. Even major portion of the direct tax revenue is being collected through withholding taxes. Many withholding tax provisions are presumptive in nature, which directly assume the form of indirect taxes. The importers and manufacturers, whose transactions are subject to presumptive withholding taxes, tend to include the element of taxes in the price of their products. The adjustable withholding taxes are being claimed as refunds by understating or underreporting the taxable income.
Here arises a crucial question: who pays taxes voluntarily and who are forced to pay taxes to achieve tax target that was nearly PKR 4 trillion for the fiscal year 2017-18.
Dr Ikramul Haq and Huzaima Bukhari have reported in their article titled “The Great Tax Robbery” published in Friday Times on 21 October 2016 that at least 60 million people are forced to pay taxes in the form of advance tax. For example, millions of mobile phone users are paying advance tax on prepaid cards. Nonetheless, there are around 1.6 million tax return filers. The low number of the filers of tax returns vis-à-vis taxpaying people is despite the fact that the tax authorities have adopted differential tax rates policy for filers and non-filers. Even then, the number of non-filers as a percentage of the registered income tax payers remained high, at around 70 percent, in 2015-16, of the total 4.2 million persons registered and having valid National Tax Numbers during 2015-16 (actual tax return filers were 1.216 million and 2.98 million were non-filers). Therefore, the compliance level in tax year 2016 was only 29 percent. Furthermore, 30 percent of the tax return filers did not pay any tax in tax year 2016, as they declared income below the taxable threshold of Rs 400,000. The number of corporate income tax filers was 25,551 out of more than 60,000 companies registered. The number of active corporate tax filers is only 0.8 percent of the number of commercial and industrial electricity users, which represent an illustrative pool of potential entities liable for taxation.
It means there is a serious problem with the current tax regime. The people who are paying advance taxes could not be able to file tax returns and if their income is as low as taxable income threshold, why such people are not claiming refunds by filing tax returns?
There are serious challenges in this regard.
First, these people find it difficult to get evidence of tax collection in the form of withholding certificates from the withholding agents due to inadequate access to information and poor knowledge. Second, it is not possible for them to file tax returns either electronically or manually. Third, fee charged by their counsels is significantly higher. The people are reluctant to hire counsels because the high fee outpaces the refund amount, leaving behind little or no incentive for filing the tax returns. Fourth, if they succeed in filing tax returns and claim their refunds, the tax authorities do not always easily process the claims and within stipulated time limit prescribed in the tax statute.
Analysis of tax returns filed indicates that majority of tax returns were filed without payment of any tax. A large number of returns were filed by salaried persons for claiming refunds of the tax deducted in excess. A small number of taxpayers paid taxes with the tax returns. It means significant amount of direct tax collection comes from withholding taxes. It is wrong to conclude that only 1 percent of the population pays taxes. It can be said that only 1 percent of the population file tax returns.
Taxing transactions through withholding taxes, rather than income, results in socioeconomic problems. It is challenging for the tax authorities to tax the income of ultra-rich and easy-to-tax consumption or any other proxy tax base through withholding taxes. With the removal of wealth tax in the early 2000s, the people have accumulated huge fortunes without paying any tax. Therefore, such a tax policy and enforcement measures to meet tax targets only widen the income gap between the high-income people and low-income people, resulting in significant income inequality in the country. Low-income people find it difficult to meet both ends meet with meager amount of income which is subject to various indirect taxes also; it will not be surprising to conclude that they might be indulged in illicit activities to make money for survival. A society with significant income inequality suffers a number of social and economic ills.
In conclusion, it is suggested that the tax authorities must revisit the withholding tax regime and enforcement strategies so as to make the tax system more equitable and pro-economic growth. Reliance must be on direct tax collection by enhancing number of direct taxes and taking stringent actions against tax evaders. As the tax revenue is important for socioeconomic development, its overwhelming portion must come through direct taxation in order to make the tax system more equitable and growth-friendly. The tax authorities need to bridge the tax gap by bringing actual tax collection close to the tax potential of Rs 8 trillion.