Public finances are needed for rendering public services; ranging from security, justice and other basic amenities like health, education, etc. One of the striking features of the countries that made extraordinary development in almost every field of life is that they had the capacity to raise much higher tax revenues as a percentage of GDP. Of course, some other factors such as endowments, geography and culture also play an important role in the development.
Unlike developed countries, the developing countries like Pakistan have limited capacity to raise public finances; hence, there is inadequate supply of public services, an optimal supply of which is crucial for development. For example, maintaining law and order situation is a prerequisite for boosting economic activity as it affects foreign direct investment as well as domestic investment, the key drivers of long-term economic growth. However, the central question is how the developing countries like Pakistan could strengthen revenue mobilization that is much needed for financing development activities in the country?
Remembering, development process requires not only increasing the level of taxation but also making drastic changes in the patterns of taxation with greater focus on broadening the tax base, which demands fewer exemptions and containing informal economic activities.
In view of globalization, the tax policy changes with heavy reliance on taxes on income and the value added, along with the diminishing dependence on trade and excise taxes from the last two decades or so are rightly directed. These tax policy changes are reflected from the reduced share of customs and excise duties and increased share of income tax and value added tax (sales tax) in federal tax receipts over the years.
Contribution of customs duty and excise duty in federal tax receipts was around 46% and 21% in 1990-91, which has declined to around 12% and 6%, respectively, in 2012-13. On the other hand, share of income tax and value added tax (sales tax) has increased from about 17% and 15% respectively in 1990-91 to 37% and 43% in 2012-13.
At present, some major challenges confronting the tax system in Pakistan are:
1. Narrow Tax Base
The base of taxes on income and value added is not broad enough to allow mobilization of sufficient tax revenues largely because of substantial informal economy and widespread exemptions. And this does not allow for evolution of better working tax system as well. Needless to say that a well-designed tax system could minimize the efficiency losses imposed by taxes and even raise the growth rates. A narrow GST base, for example, is perceptible from the fact that more than 78% domestic GST revenue is being collected from 14 commodities and more than 74% GST revenue on imports is being collected from only 10 commodities.
2. Inadequate Tax Policy
There are considerable revenue losses due to inadequacy of the tax policy. The Federal Board of Revenue (FBR) has been suffering a massive revenue loss to the tune of Rs. 361 billion per annum (equivalent to 1.6% of the GDP) due to exemptions and concessions to various sectors. The losses on account of tax holidays (lifetime) to Independent Power Producers (IPPs) were Rs. 63 billion, under-recovery of capital gains on securities and property at Rs. 70 billion, accelerated depreciation allowance at Rs. 64 billion, tax deduction on provisioning by banks at Rs. 24 billion, exemption of business income of trusts and foundations at Rs. 12 billion, concessionary rates Rs. 34 billion, tax deduction on WWF and WPPF payments Rs. 11 billion, low rates of AIT Rs. 40 billion and other revenue losses Rs. 43 billion. Such tax exemptions and concessions accorded to certain sectors of economy or taxpayers are against the principle of equity and fairness and tend to reduce tax compliance levels. Furthermore, these tax exemptions and concessions shift excessive tax burden on the rest of the taxpayers and it is empirically proved that high tax burden reduces tax compliance.
3. Weak Tax Enforcement
According to the figures from latest tax directory of the FBR, top 1% of companies accounted for 79% of the corporate income tax while top 1% of individuals contributed 29% to the personal income tax. Furthermore, revenue losses are colossal when combined with tax evasion and huge informal economy due to weak and imperfect enforcement. The FBR reports an estimated corporate evasion rate of 45% (FBR, 2012-2013) and a study by the World Bank (2009) estimates the evasion rate as high as 218% of actual corporate income tax payments. It is not out of place to mention that out of a total population of more than 180 million, only about 0.8 million file income tax returns and out of these filers, only 60% are taxpayers. Administrative penalties (additional tax, additional charges, etc.) are supportive elements for smooth functioning of the self-assessment system. On the one hand, administrative penalties are not effectively enforced while, on the other, such penalties are waived off by the government through statutory regulatory orders (SROs), which may be considered as an element of weak tax policy. It is because if taxpayer knows that he has not to pay additional tax or penalties for tax default, he is more likely to evade and avoid due payment of taxes. However, if fines are too high, the tax system is perceived as unfair and unjust, it will also reduce taxpayers’ compliance.
4. Lack of Transparency
In 2012, Transparency International (TI) ranked Pakistan 33rd most corrupt country as compared with 42nd in 2011. Similarly, in the Rule of Law Index of 2012, Pakistan was declared the 7th most corrupt country out of 97. This suggests that corruption level in Pakistan has increased substantially in the recent years. Even according to National Accountability Bureau (NAB), the daily corruption in Pakistan is nearly Rs. 7 billion. Likewise, according to FBR, a hefty amount of Rs. 15,000 billion was made legal by just paying a meagre amount in taxes of Rs. 150 billion under the Tax Amnesty Scheme. In the National Corruption Perception Survey 2011, the taxation department was found to be the 3rd most corrupt department among the ten selected for the purpose — it was 8th in 2010. And out of different taxes, income tax is the most corrupt field. The areas where corruption has been pointed out include: audit, issuance of tax emption certificates and issuance of refunds, etc.
Good governance has positive impact on taxpayers’ compliance because it develops a trust in taxpayers on the governance system to deliver optimum level of public services utilizing tax money. In case the governance system is corrupt or it has connived with the taxpayers, the taxpayers’ compliance level will be low, and vice versa.
5. Weak Intelligence and Investigation System
A strong system of intelligence and investigation plays an important role in smooth working of the self-assessment and to promote voluntary tax compliance. In Pakistan, the intelligence and investigation department was created in 2011 to carry out investigation and prosecution process into tax fraud cases pertaining to individual income tax, corporate tax, sales tax (value added-tax) and federal excise duty. The department lacks requisite human, physical and financial resources to carry out its functions efficiently. The number of investigators with requisite capabilities and skills is not sufficient to carry out exhaustive work of tax investigation and prosecution. The department lacks the desired level of legal backing as well. In case the prosecution process is lethargic, the very objective of creating deterrence against tax fraud through the investigation may not be achieved. A number of sales tax fraud cases involving huge revenues have been identified by the department in the recent past. The tax fraudsters have committed sales tax frauds by creating and registering fake firms and using fake invoices for refunds. Furthermore, millions of citizens, who had enormous wealth but had not been paying taxes have been identified.
6. Inadequate Taxpayers’ Service
In Pakistan, literacy rate is less than 60%, another important reason behind non-compliance of tax laws. It is said that the taxpayers promptly comply tax rules if it is easier and costless for them. In Pakistan, the taxpayers have to spend considerable time in making tax compliance. In a recent study by the World Bank (Paying Taxes, 2013), Pakistan was ranked 162 out of 185 world economies with regard to tax dealing. Pakistani taxpayers, on an average, spend 560 hours on dealing tax matters against the world average of 267 hours. On the other hand, the taxpayers’ understanding of the tax system, tax laws and tax administration largely influences tax compliance behaviour. It is also empirically found that high tax-compliance cost discourages tax compliance. Likewise, tax education, tax morale, tax information, etc. do also have an impact on tax compliance. The FBR is struggling to provide necessary services to taxpayers through taxpayers’ facilitation centres but these are not enough to ensure optimum taxpayer compliance of tax matters.