SBP calls for tax system reforms

RECORDER REPORT

KARACHI: The State Bank of Pakistan (SBP) said Thursday despite improvements in tax collection, the developments during the years exposed some inherent weaknesses in the tax system. According to SBP's State of Economy Pakistan Annual Report (FY16), although Pakistan has achieved an obvious improvement during FY16, the tax-to-GDP ratio still stands as one of the lowest in the world and calls for wide-ranging reforms in the country's tax regime.

"Given the low revenue elasticity, Pakistan cannot achieve its potential without broadening the tax base, bringing down tax evasion, and strengthening tax administration across all levels of the government," the SBP suggested. However, to ensure uniformity in the system, tax collection should improve without further burdening the already compliant taxpayers. In this context, provincial governments should particularly gear up their administrative capacities, because most under-taxed sectors like agriculture, services and immovable property, come under their domain, the report said.

Federal government should also enhance its efforts in identifying non-compliant taxpayers and minimize under-declarations of incomes and transactions, it added. According to report share of withholding taxes has been increasing steadily over the past few years and presently withholding taxes constituted the bulk (over 60 percent) of overall FBR tax collection. These withholding taxes become indirect taxes when these are treated as final tax and are passed on to the ultimate consumers.

Higher revenue collection in FY16 represented the momentum in construction, transport and trading activities in the country, however, despite higher collections, the composition of taxation underscores the need to get through structural constraints. "Direct tax collection still relies heavily on withholding taxes; in fact, the share of withholding tax has increased further, which downplays the role of revenue authorities on the one hand, and increases the compliance costs of businesses on the other," the SBP added.

The government had envisaged a 30 percent growth in direct taxes for FY16; however, it could achieve only 17.8 percent growth during the year. Major contribution came from withholding taxes, which grew by over 20 percent. This increase stemmed from both a rise in tax rate (especially for non-filers), as well as an increase in the volume of activity. Within withholding taxes, the contribution of contracts, trade and salary was over 60 percent of the collection, which represents too much reliance on few items.

Furthermore, on sectoral basis, the incidence of overall tax collection continues to fall disproportionately on industry and trade activity. Contributions from other sectors are quite insignificant; e.g., agriculture income tax constitutes only 0.8 percent of the total tax collection, and stands at around 0.03 percent of agriculture GDP.

Similarly, certain measures announced in FY16 Budget, to widen the differential taxation structure for filers and non-filers, had an unintended negative fall-out and the imposition of withholding tax on banking transactions for non-filers led to a decline in deposits growth (particularly those of private businesses); increase in the use of hard cash (and prize bonds) for the settlement of transactions, leading to 2 percentage points increase in currency in circulation to GDP ratio; and a fall in investments in savings instruments.

The Report said that Pakistan already has one of the highest currency-to-overall money supply ratios in the world; with the imposition of withholding tax on non-cash banking transactions, the use of cash would increase further. Not only would these developments constrain future tax collection, these may also undermine financial inclusion efforts of the government and the SBP.

Surpassing the annual target for the first time in seven years, FBR revenues posted a growth of over 20 percent during FY16. This sharp growth can be traced to various tax measures introduced by the government from time to time including increase in customs duties, upward revision in regulatory duties on a range of consumer items, change in the duty structure of petroleum products, increase in FED on cigarettes and 0.4 percent withholding tax rate for non-filers on financial transactions.

The FBR's revenue generation gained further momentum from ongoing infrastructure activity that boosted the demand for cement, steel and other building material. Importantly, the country's tax-to-GDP ratio reached a 17-year high level of 10.5 percent in FY16, however it is still significantly lower than the country's potential.