The level of taxes has increased considerably in the developed and developing countries since the and of the last century. Such significant increase in taxation raises questions on its effects on economic growth rate. Every government gears its policies for accelerating economic growth and reducing unemployment and inflation. It is empirically established that the structure and level of taxation can influence choices for investment and consumption and, therefore, can affect economic growth. In fact, the structure of taxation is probably more important than its level. It gives rise to a question: what will be the efficient structure of taxation?
A number of studies conducted in the past indicate that the capital income must not be taxed in order to accelerate economic growth. The taxation of capital income will discourage investment level — one of the indicators of economic growth. But, in a recent study by the International Monetary Fund, it is found that taxing the super-wealthy does not stunt the economic growth of a country. Instead redistribution will spur gross domestic product (GDP). It is argued that inequality is harmful to economic growth and that taxing wealthy people will reduce inequality and will boost growth and length of the growth cycle.
The taxation of consumption and labour are other policy options for appropriate tax structure. A tax structure is considered neutral and efficient if it leaves production undistorted. In accordance with production efficiency theorem, taxes on consumption, wages and profits are preferred over taxes on intermediate inputs, turnover and trade.
The IMF study has found that the corporate income taxes have the most negative effect on economic growth; followed by taxes on labour income and then on consumption. The taxes on property are found to be least harmful for economic growth due to less negative effects on consumption and investment decisions of the consumers and investors.
Such studies are important for developing countries like Pakistan to design efficient tax structure for raising tax revenue that is much needed for improving the public service delivery at operational level.
The tax structure in Pakistan has considerably changed over the years. At policy level, efforts are being made to focus on growth-friendly taxes such as sales tax, income tax and property tax. The contribution of these taxes in the total federal tax receipts is more than 80pc. The federal excise duty (FED) and customs duty are less important in terms of revenue generation, with 6pc and 13pc share in federal tax revenue.
Recently, it is realized at tax policy level that property sector in the country is a major destination of all types of black money. Under-declaring or mis-declaring the value of property in order to avoid taxes has become the norm. In certain cases, the declared value of property transaction is as low as 20pc of fair market price. Such a practice has weakened the efforts of documenting the economy and promoting economic growth. The housing society developers have amassed enormous wealth by adopting unethical practices of avoiding and evading due taxes. The money in the property sector is considered as idle and counterproductive for economic growth. It is being suggested to induce money out of property and channelize it toward productive economic sectors that would spur economic growth and result in reduction of unemployment and underemployment.
Accordingly, in the federal budget for 2016-17, necessary changes have been made in the Income Tax Ordinance, 2001. The city-wise valuation tables have already been released by the Federal Board of Revenue (FBR) for assessment of the value of property for levying income tax. This initiative to document the fair market value of property transactions is a move in the right direction and requires a must implementation to broaden the tax base. This will not only generate additional tax revenue for balancing the budget but will also document the economy by discouraging black money in the real estate.
Another tax policy shift from the last two decades is more reliance of the government on general sales tax (GST) for raising tax revenue. In the recent past, this tax has emerged as the most powerful levy for collection of tax revenue in the world. The GST/VAT is considered relatively less harmful for economic activity. Its design and enforcement is important in order to make this tax neutral and growth-friendly.
The present sales tax regime is replete with concessions and exemptions not only on imported goods but also on local supply. Under SRO 1125(I)/2011 and effective from 1 July 2016, sales tax rate at zero percent is imposed on the import and supply of goods and the purchase of energy (electricity, gas, furnace oil and coal) by persons who are doing business in the five export-oriented sectors including textile, carpets, leather, sports and surgical products. Import and local supply of many goods is exempted under the 6th Schedule to the Sales Tax Act, 1990. Similarly, reduced rate of sales tax is imposed on supply and import of many other goods. Such concessionary schemes have caused loss of Rs 207 billion tax revenue in 2015-16. Additionally, these schemes tend to make sales tax system non-neutral for economic activity.
There is also a need to revisit the presumptive income tax regime. It is empirically proved that the presumptive tax regime helps to enhance tax revenue collection significantly but it is not economically efficient. Therefore, this regime may be gradually shifted toward normal withholding tax regime with the improvement in tax culture.