FBR identifies factors responsible for high tax gap

RECORDER REPORT

ISLAMABAD: The Federal Board of Revenue (FBR) has identified factors like exemptions and narrow tax base as major reasons for high tax gap in Pakistan.

It is learnt here on Friday that the tax gap analysis revealed that there are a several factors contributing to the high tax gap in Pakistan. The structural problems, such as narrow tax base due to exemptions, but tax evasion and distrust of public institutions, and administrative weaknesses all also take a toll on tax collection. Recent reviews of tax returns reveal that even compliant taxpayers do not provide essential information in the returns. Due to these discrepancies in returns, a number of opportunities for underreporting income or claiming lower rates and liabilities are generated. As better quality data becomes available, a more refined analysis will be possible to highlight specific issues in individual sectors.

International experience shows that tax reform can deliver large increases in tax effort. The countries with income levels comparable to Pakistan generate higher tax-to-GDP ratios. The simple tax-to-GDP ratio in Bangladesh, India, Nepal and Sri Lanka are systematically higher than Pakistan's despite these countries have similar tax policies and administrations. Countries like Egypt, India, Thailand, Turkey and South Africa experienced, report said.

The rapid growth and rising tax ratios during the time period when Pakistan saw the tax ratio only rise with economic growth. In Asian and Pacific countries overall, central government tax collections increased from 13.8 percent in 2000 to 16.5 percent by middle of the decade, it remained almost constant in Pakistan and then declined with the global economic crisis.

Sources said that the gap analysis in the report corroborates the worries that tax revenue in Pakistan is raised in an inefficient way, favouring certain sectors and economic activities over others. Such incidence of taxation can deter people from investing the most productive sectors and earning more from the resource available and ultimately adversely affect economic growth. Some sectors are much more heavily taxed compared to their contribution to GDP than other sectors. It is already known that about one fifth of GDP comes from agriculture, yet this sector yields no more than 1 percent in FBR revenues. Services make up almost half of economic value added, but generate only one quarter of central taxes due to the low tax receipts from wholesale, retail, and transport.  Given the shortfall in agriculture and services, industry carries the brunt of the tax burden - its tax share is three-times as high as its GDP share.

Within the industrial sector the variations in tax gap estimates demonstrate the unequal incidence of taxation. In addition, there are question marks to what extent the tax system, through the way it treats different income classes of people differently, is sufficiently equitable. While some progress has been made, Pakistan's tax code remains complicated and most taxpayers have little knowledge of their obligations, sources referred to the report.

Sources said that Pakistan can take measures to increase the tax to GDP ratio by around 3.5 percentage points over the medium-term. In order to ensure a healthy long-run economic development, Pakistan needs to embrace substantial changes in tax policy aimed at increasing the buoyancy of the tax system, broadening the tax base. The measures like reduction in distortions and phasing out exemptions will contribute to closing the tax gap. Such tax reforms are also required to deal with the risks stemming from sustained large budget deficits, sources added.