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EDITORIAL: In a webinar last week, Punjab Revenue Authority (PRA) chairman said that high rates of taxes remained the primary reason for non-compliance in Punjab. In fact this argument does hold true for the whole country. But there are jurisdictions in the world where the high compliance and high tax rates go hand in hand. The key is the trust factor between the taxpayers and the government. In Scandinavian economies, better service delivery and numerous elements of state support to citizens result in acceptance of higher tax rates. Unfortunately, however, in countries like Pakistan, with poor government service delivery, and prevalent corruption, people try to avoid and evade taxes. The problem is especially true for indirect taxes. The GST in Pakistan with the standard rate at 17 percent is very high. This is regressive in nature. The implied tax rate inequality is too high given that majority of the population’s income is below the minimum income tax threshold. In developed economies, direct tax rates are high (more than those in Pakistan) but indirect taxes (GST or VAT) are relatively lower. This is despite the fact that their per capita income is many times more than Pakistan’s.

The recognition of this fact by a chief of a tax authority is not new. But the problem is that most of the time the government is running short of its revenue targets, and the short-term approach to meet the targets sways policymakers away from the desirable and prudent objective of broadening the tax base. It’s a chicken and egg problem. For instance, Shabbar Zaidi is a big proponent of lowering the GST rates but as FBR Chairman, he too was overwhelmed by an impossible tax collection target of Rs5.5 trillion. Back in the days, when VAT was in still in process of implementation during the PPP government’s tenure, the then Finance Minister Shaukat Tarin wanted to lower rates and was thinking of introducing a lottery and other schemes to incentivize tax compliance. But in the end, the GST was increased from 15 percent to 16 percent. Then Ishaq Dar was also vocal about lowering tax rates; and the GST was increased to 17 percent in his ministership.

The story is simple. Short-term tax targets are the deciding factor. GST in Pakistan is way too high and that is adding a burden to the cost of doing business for those in the formal economy. The manufacturing industry is inherently more formal as it is hard to hide production assets and other attendant facilities such as power connection and consumption, whereas in case of services tax evasion is much easier – be it on income or indirect tax. Therefore, the brunt of higher taxes is disproportionately high on manufacturing. That is one reason (apart from other components of cost of doing business) that has triggered this premature transition from manufacturing to services sector in Pakistan. With higher tax rates, the manufacturing contribution to GDP kept on falling. Such trends are simply not sustainable. This falling manufacturing base is one reason for the all too frequent boom and bust cycles in Pakistan.

There is no easy solution to this puzzle. The only way to increase tax collection (from existing base) without increasing tax rates is to let the economy grow at a higher pace for a number of years. For that to happen, investment must come in manufacturing. To attract manufacturing, taxes have to be low. The other way to solve the equation is to improve the service delivery – but here beyond the argument of corruption or incompetence, limited revenues are a big constraint for improving basic services such as health and education. The problem is not as bad for provinces as it is for the federal government. The major chunk of provincial finances comes not from their own revenues but from the federal divisible pool. They have the liberty to play and experiment on taxes within their domain – such as GST on services. Then basic public service delivery responsibilities – education, health, environment and policing - are in the provinces’ hands. If a province works better on service delivery, it can gain the trust of taxpayers. Then the province can work on lowering the rates and can come up with nudge techniques to improve compliance. Services’ contribution is high in Pakistan and not many sectors such as medical, legal, and engineering professionals are complying with their tax liabilities. The provincial taxation machineries have a big opportunity to experiment and their learning could be useful for FBR as well.

Copyright Business Recorder, 2021

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