There is a hot news that the government of Pakistan has been told by the International Monetary Fund (IMF) that since the existing General Sales Tax (GST) in Pakistan is not a complete value-added tax (VAT), the government should, therefore, introduce VAT and abolish GST system.
After heated arguments and debates, the IMF and government of Pakistan were convinced that the GST is the VAT tailored to the needs of Pakistan. A chartered accountant in ICAP magazine suggested that the name of GST be changed into VAT. So in 2010-11 budget, the government has proposed to change the name of GST to Reformed General Sales Tax (RGST) but with all the basic characteristics of VAT.
The following will be the possible impacts on economy and end-consumers (usually common men) of Pakistan if RGST with all the basic characteristics of VAT will be introduced in Pakistan.
HOW RGST HITS END-CONSUMERS The concept of RGST (VAT) is that tax increases at each progressive stage of production of goods and under the input and output device of RGST, such tax is paid and get adjusted/refunded at each progressive intermediary stage of production of goods and ultimately end-consumer will bear the burden of RGST unless any intermediary stakeholder under the RGST chain makes default and has not availed input adjustment/refund.
To understand the mechanism of RGST, let us take an example of production of garment through the following RGST chain. To understand it easily, I have taken an example, which is simple and straight and has avoided complication:
-- A spinner purchases raw cotton from the ginner for Rs 100 and pays Rs 15 being 15% RGST to the ginner. who deposits Rs 15 received RGST to the government.
-- The weaver purchases yarn from the spinner for Rs 140 and pays Rs 21 being 15% RGST to the spinner. who deposits Rs 6 to the government (Rs 21 received RGST from weaver and deduct Rs 15 paid to ginner).
-- The garment industry purchases fabrics from weaver for Rs 200 and pays Rs 30 being 15% RGST to the weaver, who deposits Rs 9 to the government (Rs 30 received RGST from the garment industry and deduct Rs 21 paid to the spinner).
-- Wholesaler/distributor/dealer purchases garment from garment industry for Rs 300 and pays Rs 45 being 15% RGST to the garment industry. The garment industry deposits Rs 15 to the government (Rs 45 received RGST from wholesaler/distributor/dealer and deducts Rs 30 paid to the weaver).
-- Retailer purchases garment from wholesaler/distributor/dealer for Rs 360 and pays Rs 54 being 15% RGST to the wholesaler/distributor/dealer. Wholesaler/distributor/dealer deposits Rs 9 to the government (Rs 54 received RGST from retailer and deducts Rs 45 paid to the garment industry).
-- End-consumer purchases garment from retailer for Rs 400 and pays Rs 60 being 15% RGST to the retailer, who deposits Rs 6 to the government (Rs 60 received RGST from end-consumer and deducts Rs 54 paid to the wholesaler/distributor/dealer).
-- End-consumer absorbed cost burden of Rs 460 being price of the garment of Rs 400 and RGST expenses of Rs 60 as the end-consumer cannot take adjustment/refund of RGST from the government.
The following table will also give the clear picture of the mechanism of RGST:
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S. No RGST Chain RGST RGST
to burden
Government on RGST
Chain
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1 Ginner Rs 15 Rs 15 0
2 Spinner Rs 21 Rs 06 0
Less: Rs 15
3 Weaver Rs 30 Rs 09 0
Less: Rs 21
4 Garment Industry Rs 45 Rs 15 0
Less: Rs 30
5 Wholesaler Distributor Rs 54 Rs 09 0
Dealer Less: Rs 45
6 Retailer Rs 60 Rs 06 0
Less: Rs 54
7 End Consumer Rs 60
Rs 60
Total Rs 60 Rs 60
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One can see from the above illustration that government will pay Rs 60 to businessmen in RGST chain at different stages and recover entire amount of Rs 60 from end-consumer in one go. Here the end-consumer may be a common man or a manufacturer/exporter, who consumed at the end. The clear impact of this entire exercise is high and multiple inflation will take place. While the government will not get any thing, export will become uncompetitive and the corrupt people may be benefited.
Hyper-inflation: Hyper-corruption and economy-crush will take place if the RGST is implemented without exemptions, zero-rating and different rates
The government representatives from the FBR said the government wants to introduce the RGST in full in letter and spirit, because the GST is a total failure as it is not complete VAT/RGST and the GST has distorted the preamble and basic concept of VAT/RGST by introducing exemptions, many rate of taxes, zero-rating etc and that is why refund of sales tax was also stuck up and the government is not getting desired results. Let us see from the following table the quick difference between incomplete GST and complete VAT/RGST:
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S. No Functional areas GST RGST / VAT
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1 Sales Tax Regime Incomplete Full and complete
2 Many rates of taxes 12 Only 1
3 Exemptions Many No - But why try to
introduce few, which
will defeat the
concept of VAT?
4 Zero-Rating Five sectors No
5 Refund of tax Stuck up Smooth - What a
big question?
6 Businesses that may Cottage Industry and Person with turnover
not charge RGST / GST Retailer turnover up to Rs 7.5 Million
upto Rs 5 Million (It is too much)
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We should appreciate and accept the facts that it is not a new concept being introduced by the IMF and the present government, but previously also the governments wanted to introduce VAT in complete form since the late eighties, which they did not find feasible in our existing economic conditions as we are still a developing country so the government decided to introduce GST under Sales Tax Act 1990 by replacing Sales Tax Act 1951 based on the following strategic factors/assumptions introduced gradually and which are workable in Pakistan since the economy was balanced and booming, inflation under control, the government has not paying more than collection and common man was not much affected:
1. Previous governments introduced VAT but not in its complete form due to our existing economic conditions. So it has introduced GST, being the first step towards VAT.
2. Just after a short period, the government has realised that the exchequer/treasury lose many billions of rupees due to high corruption included in, by the businessmen and government officials, especially in five sectors (on which economy is based and common man's basic needs depend upon them) - textile, leather, carpets, surgical instruments and sports goods. So they introduced zero-rating concept to curb corruption.
3. Different high rates of GST were allowed for some sectors keeping in view their economic priorities and problems.
4. To control inflation strategically due to introduction of mild VAT, which is called GST, the government has modified GST by introduction of exemption to few sectors, goods and services, zero-rating to five sectors and maintaining small amount of threshold of Rs 5 million.
5. For speedy refund of sales tax, the government has introduced many devices like STARR, CREST, CSTRO, Fast Track Channels etc, but could not succeed, because full amount of sales tax is not in the GST/VAT regime due to exemptions, zero-rating, lower rate of tax, use of funds by the government etc. I bet so-called proposed automated sales tax refund system will also not work; it is just an eyewash, as complete VAT/RGST cannot be introduced. In early days of the new government, the FBR said that with the introduction of VAT, the government will get additional revenue of around Rs 500 billion to Rs 600 billion in three years, which will be used in "welfare of the people". It means we are going to fare worse under proposed VAT/RGST, than the existing GST system.
TWO UNJUST ECONOMIES WILL EMERGE If all goods and services are subjected to RGST with the exception of business/persons with turnover up to Rs 7.5 million, then it will work like a blast and chaos in the economy of Pakistan because people/manufacturers will rather buy from shops which are not charging RGST, the shops which are charging RGST will have to close their businesses and may lose their money as well as the money borrowed from financial institutions.
PAKISTAN EXPORTS WILL GO TO OTHER COUNTRIES If all goods and services are subjected to RGST, then naturally cost to the end-consumer, which includes manufacturers/exporters, will increase substantially and exporters will add it to the export price, which will not be acceptable to the foreign buyers who will prefer to go to other countries. Hence, the exporters will have no choice but to close their businesses.
ADD FUEL TO THE FIRE OF UNEMPLOYMENT If the Pakistani products will become expensive/non-competitive nationally and internationally as input cost will increase due to RGST, their sale/export will decline substantially and as a result, there will be downsizing or termination of services of employees in the business sectors, resulting in mass unemployment in the country.
LAW AND ORDER WILL BE ADVERSELY AFFECTED Due to mass unemployment, closure of businesses and increasing inflation, definitely people will come out on the streets. Crimes and deteriorating law and order situation will prevail.
CONCLUSION AND SUGGESTIONS There is no need to abolish GST and to introduce VAT type RGST from scratch. My following suggestions to the government may be workable in our existing economic conditions being a developing country:
-- What the government needs to do is that they should tune and modify existing GST laws, keeping in view strategic economic need and priorities of Pakistan and to keep control over galloping inflation.
-- The government may easily continue existing GST laws, as existing GST has all the characteristics of VAT modified to our conditions and is the outcome of real VAT. Frankly speaking, VAT in its complete form is nowhere applicable globally.
-- Existing five zero-rating sectors must be kept intact to curb inflation and corruption as just making export zero-rating will not serve the purpose. Take an example 15% VAT/RGST on textile product means billions of rupees, which will be a burden on people, and spark an outburst of inflation. On top of it, vested interests in business and government will be rich and ultimately the government will lose.
-- Khawaja Tanveer of the FBR has given the following information during a seminar on 30th March 2010 with the worry how to increase tax-to-GDP ratio:
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Sectors GDP % TAX %
===================================
Agriculture 20.9% 1.2%
Manufacturing 16.8% 62.2%
Service 59.6% 32.2%
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-- I have following suggestions to improve tax-to-GDP ratio in the scenario where the government is poor and people and administration are rich:
a. We should not look exclusively to the above percentages. Service sector is emerging and we should not hammer them further, otherwise it may decline further. For agriculture, we cannot raise taxes too much as most of the people involved in agriculture are poor, and of course, very few are very rich. But too much tax burden may add to inflation as the food of people is based on agriculture. Manufacturing seems to be over-burdened with high tax that is why its contribution to GDP is low. To encourage manufacturing, we should re-visit tax to reduce.
b. Yes, large scale exemptions are there, but we need to re-visit it strategically as most of them are basic need of the people and relevant to inflation. Exemption of flourishing sectors may be withdrawn strategically.
c. Education and health must be on top priority to get real benefit tangible and intangible, in the form of flourishing business and economy, economies and saving in cost and expenses, high employment's, good environment and social values, controlled law and order, good politics around, civic sense in society, revenue from manpower exports and much more.
d. Underground economy may be tapped with iron hands, although influential people must be behind it. GST, income tax and other levies may be introduced on this area under documented system with severe punishments for violation with no exceptions. Under ground economy is around 40% of Pakistan's real GDP.
e. Physical and judicial controls with no exceptions on leakages and evasion in administration will bring massive increase in tax-to-GDP ratio. This needs to be practically done and should not be confined to lip-service only as we are doing since 1947.
f. Steps be taken to induct professional people, with high integrity in government administration. People will start paying Zakat and other similar things to the government from which the government may easily reduce poverty level drastically. It seems to be a dream but achievable only if we have good and sincere intentions.
More sales tax will get with controlled inflation if the rate of GST is low and retailers should be exempted, because corruption and leakages emerge at this stage where there is no staff to maintain documentation. Small business owners, usually not educated, may play tricks to avoid payment of taxes. The government gets minor amount and the administration personnel will become rich. Fixed non-refundable GST/VAT should be imposed at import stage of luxury items, which can be afforded by rich class.
Reverse charge and 25% advance concept should not be introduced as it will create problems. Federal and special etc excise duties should be abolished to make the GST law and documentation simple and straight. More complication in laws creates corruption which discourages growth in GDP.
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