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Ailing tax system and state of economy

Huzaima Bukhari and Dr Ikramul Haq

On November 25, 2008, the International Monetary Fund (IMF) approved the $7.6 billion 23-Month standby arrangement for Pakistan, which was later enhanced to 11.3 billion in July 2009. Pakistan was committed with IMF to introduce VAT from 1 July 2010, besides a number of other reforms. However, Finance Minister, Abdul Hafeez Shaikh, in his budget speech announced that the VAT would be introduced from October 1, 2010. Much to the annoyance of IMF, the promise was not honoured even in October 2010 and beyond. Resultantly, the tranche of US$ 1.7 billion was deferred with the condition that it would not be released unless Pakistan fulfilled its commitment of introducing VAT - government has camouflaged it by calling Reformed General Sales Tax (RGST) to avoid public criticism.

Even after re-appointment as Finance Minister, Mr. Abdul Hafeez Shaikh has yet not unveiled any strategy how RGST Bill, presently pending in National Assembly after being passed by Senate, would be made acceptable to all. He is on record to claim that huge money has been spent by vested interests to resist RGST as it would lead to 'documentation of economy' and 'better tax compliance'. While addressing IBA convocation in Karachi on December 4 2010, he said "One-third of the country's population is below the poverty line and the elite are still reluctant to pay taxes and are resisting reforms."

What is preventing Mr. Hafiz Shaikh to bring these 'vested interests' in the tax net? The worthy minister should be taking the higher-ups of Federal Board of Revenue (FBR) to task for their dismal performance. In fact, they are the ones who are responsible for the present pathetic state of affairs. Since 2002, the FBR has been receiving millions of dollars from the World Bank and other donors for Tax Administration Reforms Programme (TARP) - after expiry in 2009 this programme has been extended till end of 2011 despite utter failure - but our tax-to-GDP ratio remains one of the lowest in the world. If the FBR has failed to tax the elite, despite availability of stringent tax codes and sufficient manpower, the blame cannot be shifted to others using the oft-repeated phrase 'there is lack of political will to tax the rich". It is an established fact that despite resorting to all kinds of highhandedness, data manipulation, blocking genuine refunds, harsh tax policies and unjust withholding taxes, the FBR has failed to improve the tax-to-GDP ratio - it dropped to 8.87% in 2009-2010 from 12.5% in 2001-2002. The provinces have also failed to collect agricultural income tax and laws enacted to this effect remain dormant or unenforced. Over a period of time, the incidence of regressive taxes, shamelessly levied on the poor, has been increasing-making the powerful sections more and more rich. Progressive taxes like wealth tax, estate duty, capital gain on immovable property and gift tax were abolished to benefit the rich, thus distorting the entire tax system, creating income inequalities, widening the rich-poor divide and retarding economic growth.

When regressive taxes - sales tax and presumptive taxes, under the income tax code-were imposed in 1990 and 1991, our fiscal deficit was just Rs. 80 billion. After 20 years, our fiscal deficit has soared to over Rs. 900 billion, proving beyond any doubt that irrational taxes do not solve fiscal management; rather they can force a nation towards total economic collapse. Irrational tax measures have always played a decisive role in destroying civic society and paving the way for anarchy and chaos. This is exactly what the rulers are doing in Pakistan.

Table A: Direct & indirect taxes collection for FY 2009-2010

The commitment of enforcing VAT with IMF can still be made acceptable to all political parties by adopting a middle path. The right course would be to impose it at a reasonable rate - between 6% to 8% as is the case of Japan and Singapore, two developed economies of the world. It would not only fulfill contractual obligation with donors but bring more revenues and at the same time avoid an unbearable tax burden on the poor and middle class population. The claims of the Finance Minister and other spokespersons of the government that 15% tax on essential items would be bearable for the poor are simply incorrect. Due to regressive taxation, more and more people are being pushed below the poverty line, economy is in deep recession, people have no jobs and yet our economic wizards are justifying more taxes - this is certainly bad economic policy and cruel governance.

Table B: Comparison of net collection by FBR in FY: 09-10 and FY: 08-09

Fiscal policy in Pakistan has become a tool of oppression. Over the last 30 years, 2% of total population has accumulated 80% wealth without paying any personal taxes whereas total number of persons living below the poverty line is now 65 million. The country, due to inept leadership and corrupt government structures, is piling up huge debts - external debt till 2015 would increase to US$ 75 billion from the present figure of US$ 55.

The country's total foreign and domestic debt at the beginning of 2011 has touched the dangerous mark of almost Rs 11 trillion. The government is continuously borrowing heavily to meet its burgeoning budgetary deficit. According to the State Bank of Pakistan, domestic debt increased to Rs. 4.958 trillion by September 2010, from 4.018 trillion in September 2009. The external debt of the government increased to Rs. 3.864 trillion in September 2010 from Rs. 3.656 trillion in September 2009. By September 2010, foreign debt was $58.41 billion as against $55.62 billion in June 2010, showing an increase of $2.79 billion in three months.

By the end of 2010, our domestic debt went up to Rs. 5.50 trillion as a result of the government's insatiable borrowing quest. In September 2010, the domestic debt and liabilities were Rs. 5.191 trillion, which registered an increase of Rs. 306 billion in just three months. During 2009 to 2010, domestic debt showed an alarming growth of Rs. 1.05 trillion. In December  2009, domestic debt/liabilities stood at Rs 4.447 trillion rupees which increased to Rs 5.5 trillion by December 2010. Instead of accepting harsher and harsher conditions of foreign donors, our rulers should be making efforts to break the debt shackles by increasing revenues to the tune of Rs.4-5 trillion and reducing the expenditure of the monstrous government apparatus.

Our financial managers are caught in a dilemma. On the one hand there is a mounting pressure from the donors to reduce fiscal deficit through improved collections and on the other the ailing economy is not in a position to meet the ever-growing revenue targets. The collection figures released by FBR from July 2010 to January 2011 are showing negative growth in indirect taxes and marginal increase in direct taxes (even though this increase is also due to withholding huge refunds).

The revenue collection by imposing RGST, as admitted by the government, would be meagre, whereas progressive taxes like wealth tax and capital value tax on transfer of expensive immovable property - incidence of which would be on wealthy classes alone - could fetch not less than Rs. 400 billion. Wealth tax was criminally abolished in 2003. The rich and mighty in this country are increasing the tax burden on the poor and helpless masses, but are not themselves ready to pay wealth tax/income tax on their collossal wealth/incomes. It is high time that FBR publishes a complete directory of taxpayers and amounts paid by them during the last 20 years. Those who have failed to pay their taxes should be barred from taking part in any election or hold a government post. This would be a major change in election laws paving the way for reforms in democratic representation.

According to FBR, less than two million Pakistanis filed their returns up to December 31, 2010. According to Pakistan Telecommunication Authority (PTA), the country has now 100.2 million mobile users - all of whom pay 10% income tax on mobile use, irrespective of whether they earn taxable income or not, as well as 19.5% sales tax. How can FBR claim that our tax base is narrow? Many of these users, especially those paying Rs 25,000 and more annually to mobile companies, are either not filing income tax returns or even if they are filing are paying income tax much below their actual income. The issue of non-reporting and under-reporting of income has not effectively been tackled by the FBR till today. It is the duty of the FBR to issue notices for filing returns to all those spending Rs. 25,000 or more on mobile use alone. One wonders what prevents the FBR from doing so? Obviously the ruling elite does not seem to be behind this inefficiency!

Day and night we hear from official quarters about the narrow tax base in Pakistan and that people are not paying taxes. PPP stalwarts in TV talk shows and FBR through its spokesperson keep on levelling such baseless allegation completely oblivious to the fact that 100.2 million mobile users are taxpayers - though less than 1.5 million filed income tax returns. If our politicians, policy-makers and tax-wizards cannot distinguish between taxpayers and return filers, one doubts how they can reform the tax system, what to talk of enforcing invoice-based sales tax.

If the present policies continue as such we can never hope to improve either our tax culture or economy. The FBR high-ups and field officials suffer from an attitude problem besides being undoubtedly corrupt and inefficient. The honest ones in the FBR are even worse. They being sadists, are bent upon destroying everything around. They create such huge and obnoxious demands against existing taxpayers that it is no more possible for them to run their business. This attitude can be verified from various decisions of the Tax Tribunal where their arbitrary tax assessments are quashed, but the taxpayers pay a heavy price both in monetary terms and the mental torture/agony they suffer. It is strange that the FBR takes no action under the Efficiency & Disciplinary Rules against them even after their orders are held to be unlawful, excessive, arbitrary and unreasonable. If the higher courts pass strictures against the officials, no heed is intentionally paid to them and such officials are protected and at times even rewarded.

The zeal and enthusiasm of the tax machinery in harassing people is motivated by self-interest as they are more interested in meeting their individual targets, rather than those fixed for the State. Therefore, their conduct and working is always viewed with suspicion and distrust by the general public. There are a number of reasons for this reaction. Highhanded and corrupt tax officials have created a general atmosphere of distrust between the taxpayers and the State. Successive governments have failed to utilise the taxpayers' money in a transparent manner. The ruthless misutilisation of public money by the corrupt rulers has forced the people to openly defy the tax laws. The main reason for decrease in Foreign Direct Investment (FDI) is this prevailing situation in Pakistan. Foreign investors are reluctant to come to a place where tax officials demand their share for not participating in any productive process of the business.

Over the last many years, the need for tax reforms is stressed and reiterated by all quarters including the Government itself. However, each attempt in this direction during the last several years proved to be a complete failure - the case of Tax Administration Reforms Programme testifies to it. The main reason for this failure is that search for rationalisation and simplification of our tax laws is misdirected as we are living in an era of a complex and intricate global environment. Neither the official policymakers nor the professionals hired on behalf of IMF/World Bank possess the vision for this gigantic exercise, as they lack the understanding of the mundane realities of Pakistan - the stress for the introduction of the VAT in the absence of personal taxes is a classic example.

The most neglected area is quick dispensation of justice to taxpayers. Our tax appellate system is the worst in the entire world. The tax machinery is becoming ruthless with every passing day and almost every taxpayer has now become a victim of abuse of powers (arbitrary as well as unlimited!) at the hands of the tax officials. Those who do not pay taxes in connivance with tax collectors are satisfied and safe. For them not paying to the State is better than paying the tax collector for his self-aggrandisement. This is a pathetic state of affairs. The tax collectors want to achieve their unreasonable (sic) targets from a few corporate houses (by creating unjust demands), without bringing into the tax net those (presumably their "friends") who do not pay any tax. In these circumstances, the honest taxpayers get arbitrary tax demands and there is no effective justice system to come to their rescue. The Commissioners of Appeal, being employees of FBR, do what their bosses in the Board tell them to do and most of the time their decisions are heavily biased against the taxpayer, forcing him to seek equity at higher forums.

It is a mockery of justice that in the hierarchy of the tax judicial system, the first appellate authorities are directly subordinate to the FBR. Everybody knows the problems of these so-called Commissioners of Appeal, who are nothing but part and parcel of the revenue collection machinery. The judicial system under the tax codes, or for that matter under any statute, should be completely and truly independent of administrative interference or control. It is an essential prerequisite for ensuring proper tax compliance and confidence of the taxpayer in the system.

The present tax culture is based on "bad faith" between the taxpayers and the tax collectors. Both are victims of self-interest and their main aim is to cheat each other. This culture can only change if an effective judicial system is introduced and properly implemented. All tax appellate authorities-Commissioners of Appeal and Tribunal- should be part of judicial service working under the administrative control of respective High Court. The present working of Commissioners of Appeal under FBR and Tax Tribunal under the Ministry of Law is against the principle of "independence of judiciary". The Tribunal as well as first appellate forum should work under the High Court of their territorial jurisdiction. The same system is presently in vogue for civil judges.

The Tax reform agenda will never succeed in Pakistan unless we bring transparency and faith in our tax system. If people get direct benefit of taxes, they would be more than eager to pay their dues. When they see that rulers waste billions on their comforts and luxuries and corruption is rampant they hesitate to pay their taxes. When they are subjected to arbitrary taxation, the justice system does come to their rescue. The corrupt officials get the benefit of the laxity of judicial organs. Tax Appellate system - like all other judicial institutions - should be independent in the true sense of the word. The apex court of Pakistan has elaborated this principle in Government of Balochistan v Azizullah Memon PLD 1993 SC 31 by holding that "separation of judiciary from the executive is the cornerstone of the independence of judiciary". This should be equally applicable to the tax appellate system. In the absence of independent tax appellate system, all efforts to improve the system are bound to fail miserably.

Our economy will never flourish unless we make our tax policies growth-inductive and business-friendly. The National Tax Policy should be devised with a 2025 vision with the consultation and participation of all the stakeholders. Once the consensus policy is reached, the real challenge of its implementation should be ensured. We have weak implementation structures that need to be reformed immediately. Presently, the Inland Revenue Service and Pakistan Customs Service are full of incompetence, inefficiency and corruption. The Revenue Service of Pakistan should be a modern, efficient and effective organisation to tap the real tax potential of Pakistan, which is not less than Rs. 5 trillion.

(The writers, tax lawyers, are Adjunct Professors at Lahore University of Management Sciences (LUMS)


Nature of Tax   Collection (Net)    Tax/GDP

(In million Rs.)  Ratio (%)


Direct Taxes           528             3.39

Indirect Taxes         800             5.48

Total Taxes           1328             8.87



(Rs Billion)

Collection              Difference

FY: 09-10    FY: 08-09   Absolute   Percent


Direct Taxes         528.6       443.6       85.0       19.2

Sales Tax (GST)      517.3       451.7       65.6       14.5

Federal Excise       121.2       117.5        3.7        3.2

Customs Duties       161.5       148.4       13.1        8.8

All Taxes           1328.6      1161.2      167.4       14.4


SOURCE: FBR report saying that figures for FY: 2009-10 are provisional