The battle for tax revenue is on!

The first few weeks of Abdul Hafeez Shaikhs tenure as Finance Adviser have been rather challenging. A delay in IMFs fifth tranche and the fallout between Sindh Government and Islamabad over tax collection has tasked Hafeez with brokering an agreement between the various halls of power in the country.
Multilateral organizations and the IMF in particular, have urged Pakistan to widen its tax coverage to be able to become a sustainable economy. The covenant signed between GoP and IMF in October 2008, stipulates the introduction of an integrated VAT in the country. Draft laws have been tabled before all legislative bodies already.
The 7th NFC award signed late last year recognized the constitutional provision that tax revenue on services is a provincial subject. And, provinces may choose to collect tax on services on their own, if they wish so.
Officials in the Sindh provincial government have made clear their reservations with the Presidential order on the NFC award that ignores this provision, in favour of tax collection by FBR. Sindh has dug its heels in, vowing to uphold its constitutional right to collect tax revenue on services itself.
The prevailing tax collection regime essentially violates the constitution. Revenue on goods and services is collected by the FBR, dumped in the NFC divisible pool and then transferred to the provinces. Now for consumption of goods this makes sense. But for services, it depends on per capita income. Sindh, rightly so has objections with it.
One may wonder why provinces didn invoke their constitutional right to collect tax on service until today. All provinces have relied on the federal government due to a lack of capacity in their own establishments. If Sindh insists on developing its own revenue agency, it will be at least a few years, before it becomes viable. Unfortunately, improvement in the tax-to-GDP ratio is an urgent need.
Reportedly, the highest public offices are scrambling to find a solution. Without an amicable resolution in a swift fashion, the cash starved economy will be unable to receive the much-needed money from the IMF later this month.
The President is being tipped as the only individual who can pull the government out of this quagmire. He may be able to draw some help from two proposed solutions.
First, Sindh should be allowed to collect revenue on services under a direct head. Proceeds received should be deposited in provincial governments account. In other words, the revenue from tax on services should not be distributed through the NFC divisible pool.
Perhaps, a better solution would be applying tax on all transactions without distinguishing between services and goods. To make this viable, a team of technical experts would have to devise a sharing formula based on volume of service and goods transactions.
Neighbouring India has been toying with a similar solution for years. A taskforce recently proposed a framework for India whereby a single tax rate of 12 percent, of which 7 percent would be the provincial share and 5 percent for the central government.
Mind you, in India, services are taxed by the centre and goods by the states. Perhaps, while the proportions may need to be different in Pakistan, a similar model can work.
This model of proportionate VAT allows for a simpler tax credit system. Tax credits for goods and services must be maintained separately with no cross utilization between the two.
Indeed, increasing the tax base should be the most urgent priority for the government. Keeping that in mind, the federal government must address the interests of all the stakeholders for the priority to become actionable.