Taxes for growth - I

One of the main tools of tax policy is to increase the level of savings and capital formation in the private sector partly for borrowing by the government and partly for enhancing investment resources within the private sector for economic development. On the contrary, Pakistani economic managers have not only failed to achieve this goal, they are ruthlessly taxing capital gains arising out of immovable property and shares to destroy creation of capital and incentives for investment that can boost growth. Tax is a by-product of growth. With more growth we would have more taxes. The prevalent anti-growth taxes are the real cause of retarded economic growth, burgeoning fiscal deficit and insurmountable debt burden.
Recent years have experienced closure of large industries and stagnation in growth. Besides inefficiency, corruption and incompetence of Federal Board of Revenue (FBR), inconsistent, illogical, burdensome, complicated and expropriatory tax policies have forced the business community to search for safe havens abroad, depriving the country of invaluable capital. Similarly, foreign investors are reluctant to avail the tremendous Pakistani talent that goes to waste for lack of proper funding.
Economic challenges faced by Pakistan are multiple and grim-we are trapped in a deadly debt trap, but there is no will on the part of the rulers to come out of it. They are least pushed to accelerate growth, induce investment, stop wastage of resources and tap the real tax potential. A continuous surge in wasteful and unproductive expenses is no cause for concern. Rather, the entire emphasis on daily basis is on "more" (sic) taxes. Our total debt at present is about 68% of GDP which is increasing due to sheer callousness of our rulers. The last government during its tenure added Rs 6.3 trillion to our debt burden-an increase of 103% while the record of the present government is equally appalling. It has been borrowing heavily to pay earlier debts and bridging the fiscal gap-pushing debt servicing alone to Rs 1.5 trillion in 2015-16-nearly 68% of total revenue collection. The reckless borrowing to bridge burgeoning fiscal deficit is estimated to cross Rs 2 trillion this year. The position of balance of payment is also worsening. Current account deficit widened by 91% in the first five months (Jul-Nov) of 2016-17, increasing to $2.6 billion from $1.36 billion in the same period last year, according to data released by the State Bank of Pakistan (SBP). Inward remittances and Foreign Direct Investment are also showing negative trends.
Pakistan also faces the herculean task of providing jobs to millions-on an average we need to create 1.2 million jobs annually for young people alone. For achieving this task we will have to ensure that economy grows at the rate of 8% to 10% per annum over a long period of time-for this we need investment of 20% of GDP. This challenge is also our great opportunity for economic progress. Majority of job seekers are young people, which are our greatest asset-imparting education and skills to them and creating matching jobs is the real challenge. This can be met successfully by assignment of taxes for productive investment and employment generation-our real engine of growth.
The prevalent pessimism is due to the attitude of rulers and financial managers, who cannot think beyond what they are "commanded" or "trained" to think. They keep on telling us about the symptoms of an ailing economy but never try to cure the real causes of illness. Unfortunately, no serious effort has ever been made in Pakistan to devise a rational tax policy for encouraging industrialisation through Corporatization of business leading to economic growth and documentation of economy. The sole stress on irrationally-fixed revenue targets-with main incidence on the weaker sections of society-has created an ugly fiscal mess.
The persistent failure of successive governments-military and civil alike-to broaden the tax net, crack down on untaxed assets and ill-gotten wealth, spend public money prudently and remove socio-economic imbalances has pushed Pakistan into a 'debt prison'. We can get out of it provided there is leadership having competence and unshakeable determination to pursue a pragmatic reform agenda to transform Pakistan into an egalitarian state-true social democracy with justice for all.
Pakistan is one of those very fortunate countries of the world that has an abundance of resources and a climate that is fit for simply any activity throughout the year. But thanks to donors' agenda of overemphasis on retrogressive taxation and incompetence of our economic wizards (sic), Pakistan's dependence on imported products has increased manifold, whereas value-added exports have not been given any attention, let alone promoting high-tech industries capable of technological innovations-modern economies are knowledge-based and future is for those people who can develop them as quickly as possible.
For technological transfers, rapid industrial growth and employment generation, foreign direct investment (FDI) is desirable. In Pakistan when local investment is dying, expecting FDI is like living in a fool's paradise. Tax incentives play an important role in attracting FDI-which has nose-dived in Pakistan during the last decade. Tax policy constitutes an important, if not a determinant factor, for favourable investment behaviour. Unfortunately, our budget makers have always been preoccupied with revenue targets and have never bothered to provide some long-term investment-oriented tax incentives for infrastructure development, investments and employment generation, without which sustainable growth is not possible.
Foreign investors will not come to Pakistan as long as unsatisfactory law and order situation and energy shortages exist. Due to these and other negative factors even the existing industrial units are closing down or working at low capacity. Nobody is willing to invest in special economic zones, where tax incentives are available. The main reason is lack of proper infrastructure. The result is unprecedented decline in foreign direct investment during the last ten years. Pakistani industrialists-fearing loss of life and property, threats from extortionists, acute power shortages, rising costs of doing business and hostile tax policies-are shifting their capital abroad. Investors, both domestic and foreign, prefer a place that characterises stability, consistency and requisite infrastructure facilities-we lack all these.
Tax incentives do matter but not as first priority-any feasible growth-oriented project can be profitable after paying reasonable taxes. In Pakistan, corporate taxation in 2016 is still as high as 42% (company tax rate plus tax on dividends). The corporate sector is the worst sufferer of FBR's designed policies and widespread corruption-top management of FBR has very myopic outlook as evident from over-emphasis on withholding taxes. With low tax rates we could have promoted corporate growth. On the contrary, in 2015 FBR imposed 'Tax on undistributed reserves' [section 5A of Income Tax Ordinance, 2001] ignoring the fact that reserves are created from already taxed income. Minimum taxation on service sector companies was another wrong move. In 2014, FBR imposed 'Alternative Corporate Tax' [section 113C of Income Tax Ordinance, 2001]. Such erratic, arbitrary and expropriatory taxation would further retard corporate sector and discourage future growth.
We need to incentivize Corporatization of business. At present there are only about 68,000 companies registered with SECP out of which 24,000 are active and file tax returns. There are numerous anti-corporate provisions in the tax codes. Companies are maltreated by FBR-after collecting billions as 'withholding tax agents' of the state without any compensation; they are penalised for small lapses that may neither be intentional nor wilful. Taxation of notional benefits eg concessional loans in the hands of employees, high corporate tax rate and double taxation of dividends and reserves out of already taxed profits are some examples of anti-corporate provisions-the list is not exhaustive. In these circumstances, no one would like to conduct business through a company, especially when audited accounts by independent and credible auditors are rejected on mere whims and without bringing any material on record, by taxation officers. Litigation is imposed on the companies and they have to hire costly professionals to get justice. It is thus no surprise that in the World Bank's 'Doing Business 2016' data for Pakistan, our ranking has gone down to 138 from 136!
Devising an efficient tax model for rapid economic growth in Pakistan requires an analytical study of all the irritants prevailing in tax codes, procedures and implementation processes. The main irritant is highhandedness, corruption and unprecedented high level of maladministration in tax apparatuses-both at federal and provincial levels. We need public debate for suggesting solutions to remedy the situation and to promote taxation and business growth attracting domestic and foreign investment and ensuring much-needed jobs.
On our part and for initiating such a debate, we are identifying some main maladies that need to be fixed through holistic tax reforms aimed at incentivising rapid growth and voluntary tax compliance:
Collection dilemma: flat-taxation is the answer At present, both the centre and provinces are not collecting taxes according to their respective potential due to weak enforcement and inherent problems of an out-dated tax system. Total tax potential of Pakistan is around Rs 12 trillion if agricultural income tax and other provincial and local taxes are also collected efficiently. As shown below, at federal level, income tax alone can be collected to the tune of Rs 7 trillion provided the entire undocumented economy is brought into tax net. So far, all efforts to achieve this objective have miserably failed. The existing tax system itself is the root cause for encouraging parallel economy, the reform of which is a fallacy. Patchwork here and there is just an exercise in futility and no matter how many tax reform commissions or committees are constituted the consequence would be attempting to cure the incurable. Remedy lies in dismantling the existing oppressive tax system and shifting to a flat-rate that is pragmatic, growth-oriented, workable and acceptable to all stake-holders. Under this flat rate taxation, those not coming into tax net or avoiding true disclosures would opt to pay voluntarily as rate would be minimal and compliance cost almost nil. Tax system is meant to incentivize growth and not otherwise as the present one is doing.
After levying all kinds of oppressive taxes, the federal government has failed to bridge the ever-increasing fiscal deficit that is creating a greater debt burden-at present 65% of tax revenues are going towards debt servicing alone. On the other hand, provinces are critical of inefficiencies of FBR due to which their share in the overall divisible pool is insufficient to meet their annual budgetary requirements. Since the share of every province in federal taxes under the National Finance Commission (NFC) is dependent on how efficiently taxes are collected by FBR, it is important that the centre and federating units actively participate in tax collection apparatus/processes/efforts. No serious debate has ever been initiated on the issue as to how we should increase the size of the cake to ensure that both the centre and provinces flourish as sufficient funds are made available to run the governments and fulfil the needs of the people.
Tax system in perspective The ever-growing size of parallel, undocumented economy has much to do with the way taxes are being administered for the last many decades-from a tax compliant public to a tax rebellious one, from high tax-to-GDP ratio to an obnoxiously low one, from greater revenue from fewer taxpayers (2 million) to very low revenue from a broad-based population (approximately more than 20 million), from a relatively thriving economy where debts were at their lowest to an apparent prosperous one where share of debts is 68% of the GDP, from a comparatively greater reliance on direct taxes to a complete turn-around towards indirect ones (even in the garb of income tax law which is essentially a form of direct tax), from relative simplicity of compliance to complicated procedures both at the federal and provincial levels especially in the aftermath of the Eighteenth Constitutional Amendment for which the earlier government takes immense pride. Even the Inland Revenue Service has transferred a major portion of its responsibilities of collecting tax, on withholding tax agents leaving very little to justify its own existence.
In short, all that could have been done has been done to make the life of a compliant taxpayer as miserable as possible and snatching from him that little iota of motivation that was egging him on to be an obedient citizen of this country. The helplessness of seeing one's hard-earned money going down the drain has compelled many to look for greener pastures around the world where their taxes would trickle down in the form of some benefit coming back to them. With this in mind, it becomes imperative at this stage to rethink and devise a scheme that would alleviate the sufferings of the common man and help generate substantial revenue for governments to function comfortably. Our country is rich in resources and its people are very generous. There is no doubt that a logical scheme of things capable of sucking in large revenues without disrupting the common man's life would be a welcome respite from the constant lashing by tax collectors.
Another important factor that discourages compliance with tax laws is the extremely complicated and cumbersome nature of procedure involved in being registered with the revenue authorities. Even the corporate and educated class finds it difficult to comprehend, follow and observe the simultaneously applicable innumerable legal obligations, what to talk of the illiterate and ordinary man on the street. If a survey is conducted with respect to merely the advance tax provisions (almost 75 in number), it would reveal how a person is supposed to be aware of so many avenues where either tax is being withheld or he is himself paying income tax and the consequences of these taxes, the credit of which he may or may not be allowed to take while filing his return. In the first instance, a highly meticulous record of all such transactions that invoke taxes would have to be maintained and secondly, an even higher level of grasp over the law would be required to apply it.
Considering the present level of inflation and the high cost of living, the minimum threshold of income (Rs 400,000) where no income tax is to be paid nor a return needs to be filed is within reach of an overwhelming population including people who are earning income from simple employment, trade and vocations. With the prevailing standards of literacy in the country how can it be expected that the common man has any cognisance about tax laws let alone complying and then tackling the authorities who are perpetually ready to whip anyone-innocent or guilty. Had it been restricted to simple arithmetic, things could have improved but the cruel methods adopted to teach the nation lessons in paying taxes have only proved detrimental rather than motivating. People take pride in beating the authorities, no exemplary punishment has been meted out to confirmed evaders, no effort has been made at the grass root levels to educate the public about its obligations and instead of serving the nation, officials of the revenue department are poised to pounce upon the first stray taxpayer to squeeze him dry. Revenue officers are trained to look suspiciously at every registered taxpayer-their motto being "guilty until proven innocent." Even though law requires that officers should counsel and guide the taxpayer with respect to his duties and rights, he is conveniently forced to engage a tax consultant who, if professionally unethical, is capable of causing much more financial damage to his client than the amount of tax in question.
(To be continued)(The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS).