SBP calls for tax system reforms

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.