EDITORIAL: Ironically, tax-to-GDP ratio is below 10 percent in Pakistan, well below the level required for any meaningful economic growth. It is not because there have been no efforts to expand the tax base. There were years in between when revenues did jack up, albeit modestly.
However, the improvement was largely due to policies through which direct taxes were collected in indirect modes by relying more on imports and turning businesses into virtual withholding agents. In other words, FBR (Federal Board of Revenue) conveniently shifted its burden onto businesses.
Unfortunately, this thinking has encouraged more and more businesses to move from formal to informal economy. Needless to say, informal sector or grey economy is the part of any economy that is neither taxed nor monitored by any form of government. It is therefore important to recall that the concept of higher taxes on non-filers of tax returns was introduced by the incumbent finance minister, Ishaq Dar, in his previous stint as country’s finance minister.
It successfully persuaded businesses to remain outside the tax net and pay a higher tax in the shape of withholding tax in order to escape documentation and scrutiny by taxmen. Businesses absorbed the higher tax in their cost of doing business obligingly and priced their products accordingly. And the more adverse consequence of this fear of documentation to keep the FBR at arm’s length is the woeful increase in the cash in circulation, which is now 44 percent of bank deposits.
The unfortunate part is that the government is still not learning from its mistakes and yet the focus is on extracting more tax from existing tax base, which is thinning, and these efforts will shrink the base even further.
The budget proposals so far are focusing on tactics that were employed in 2015-18. There are plans for imposing taxes on banking transactions—perhaps with a distinction between filers and non-filers. The currency in circulation started growing right after that step in 2015-16 as its ratio to deposits was 30 percent before that.
The burden is highly skewed towards the documented manufacturing sector. There was a super tax imposed last year with retrospect effect and this may continue in the coming year as well.
Then there is a proposal to tax reserves of companies which were built up after paying due taxes. That is incentivising businesses to move more towards informal sector—a sector of distinctive nature or impunity that has become so deeply entrenched over the years.
The track-and-trace system to ensure documentation is not progressing as intended due to lack of required political will to go after the evaders who, in most cases, are politically powerful people.
This lack of will to take on the high and mighty is increasingly pushing people to move from the documented businesses to the informal domain, as the former is being rendered unviable. For example, there are 52 tobacco companies in Pakistan while track- and-trace system has been implemented in only two big multinationals while others have moved the court.
In the mini-budget of February 2023, federal excise duty (FED) was increased by around 150 percent on cigarettes and that has resulted in a steep fall in the sales of these two companies while those who evade taxes, as always, are thriving along with those who are into the business of smuggled cigarettes. In another example, the government has imposed 10 percent FED on fruit juices and that has resulted in decline in volumes of formal juice market by 45 percent.
It has also hampered investment in the backward value chain where pulp extraction helps farmers to reduce wastage and get better returns. Plus, this has great export potential.
And now the market is getting replaced by undocumented players, who at times have products not complying with the required food standards. The government’s tax collection from this segment is falling too. In both the cited cases (cigarettes and fruit juices), the Laffer Curve is in play.
One may rightly argue that consumption of cigarettes and sugary drinks should be discouraged through higher taxes, but then it should be done across the board. Confining this effort to the formal sector without curbing the informal one is doing more harm than good.
For MNCs (multi-national companies) operating in the sector, Pakistan is becoming too small a market to focus and invest.
The import restrictions which have been the very important highlights or features of this fiscal year have an adverse impact on taxation where collection is skewed at the import stage. With the reduction in imports, the tax collection is falling too.
And some imports are moving towards informal hundi/hawala channels. That is further hampering the government’s tax collection efforts. And it is also reducing the official remittances to lower the gains of import restrictions on the current account.
And the gap between the hawala and interbank market rate is widening, which is adding to official currency depreciation.
The situation, therefore, requires the government to seriously revisit its existing strategy that is strongly characterised by expediency and complacency. It is about time the rulers mustered the requisite will to tax the evaders and the untaxed. There is a lot of chatter about taxing retail and wholesale trade sectors, consultants such as doctors and lawyers, real estate.
There is also the talk about the criticality of a robust track-and-trace system to propel the economy. This should no longer remain confined to an informal talk but should be actively put in practice.
The question, however, is: will it be implemented in earnest, or the axe, as usual, will continue to fall on the shrinking taxpaying segment? Needless to say, not only have the federal fiscal accounts been rendered unsustainable, the ability of formal businesses to sustain higher taxes is also diminishing. In a nutshell, expanding tax base is the need of the hour. But it takes political will to get this done.
Copyright Business Recorder, 2023