The federal budget for the fiscal year 2011-12 would be announced on May 28 according to a Business Recorder exclusive leading to intense speculation as to what new taxation measures the government would decide to levy in its effort to raise tax collections and thereby appease the International Monetary Fund (IMF) and through which the government is focused on containing the burgeoning fiscal deficit.
Reports from the Federal Board of Revenue indicate that the proposals put before the Ministry of Finance would include (i) withdrawal of a number of income tax exemptions including amending the Second Schedule of the Income Tax Ordinance 2001, thereby withdrawing a number of income tax exemptions including on immovable property, and (ii) bring the informal sector into the tax net by implementing the reformed general sales tax (RGST).
It is unfortunate that the FBR proposals have focused as in the past, on the need to generate revenue through raising the taxes that are the easiest to collect. It is this mindset that accounts for the levy of a petroleum levy, as well as a sales tax, on petroleum products at a time when the international price of oil has skyrocketed and the domestic increase in price is sucking up Pakistanis in droves into the quagmire of poverty. The sales tax on sugar could also be similarly defined as it has compelled the poor to reduce their consumption of the item. Additionally, the FBR has been accused of proposing taxes that are in violation of the constitution but which are deemed equitable and non-anomalous by international donor agencies/bilaterals, as well as the general public.
The wealth tax on capital value of assets is one such proposal under consideration. Three critical aspects of this tax need to be highlighted. First and foremost, the power to levy a tax on the capital value of immovable property - be it in the urban or rural areas - no longer resides with the federal government subsequent to the passage of the 18th Amendment.
The Fourth Schedule (50) pre-18th Amendment stipulated "taxes on the capital value of the assets, not including taxes on capital gains on immovable property" are not a federal subject; while the 18th Amendment stipulates that in entry (50), after the word "taxes" the words "on capital gains" shall be omitted. In short, the federal government has given up the right to tax the capital value of immovable property and in the event that the FBR recommends a tax on immovable assets, the matter would almost certainly be taken to the courts and the courts would be compelled to strike it down eventually. In short, such an exercise in the light of the 18th Amendment would be a waste of time and achieve no purpose with respect to revenue generation.
Second, wealth from immovable property is not taxable. However, the federal government retains the right to tax capital value of assets employed in business and trade and savings that generate economic activity. This would be counterproductive in an environment where the economy is in a downturn and massive injection of investment is needed to build the infrastructure, and in the exploitation, development and production of energy to overcome the energy deficit and increase industrial production. This would be most unfortunate given the revelation in the State Bank second quarterly report 2010-11: "foreign direct investment continued to perform poorly for the second consecutive year; foreign portfolio investment (FPI) recorded a net inflow of US $232 million compared to US $304 million in the corresponding period last year.
This improvement was entirely on account of larger outflows under debt securities, compared to the same period last year." Thus a rise in equity investment is not a component of the FPI and needless to add a tax on it would further dampen equity investment in this country - both local and foreign. Let there be no doubt that Wealth Tax is a punitive tax that penalises savings and investment.
Furthermore, this is a tax that is levied on assets that have been created from tax paid money. No wonder, all countries except for France and India, do not tax wealth as it tantamounts to taxing capital formation, asset building and savings. Imposition of wealth tax would lead to capital flight. France has enough clout to pressurise Swiss banks to release data of hidden wealth of its nationals, a process that is ongoing, while India's rate of return is so high these days in comparison to the international market that there is little or no incentive for capital flight. Pakistan, as a case in point, is the exact opposite of India: capital flight is continuing due to the inability of the government to provide basic infrastructure, like energy and security, as well as the high cost of borrowing with many industrialists moving to other countries.
Another proposal being considered is to somehow dilute the immunity that is available to home remittances. The government would also be well-advised not to tax remittance income, whatever its end use, as at present, it is the only major source of foreign exchange for the country. To begin taxing it, depending on its use, may well reverse the current inflows.
The FBR must also keep in mind that before proposing the RGST for the third consecutive budget, it must first get all the stakeholders on board. That appears to be lacking two and a half years after the government signed on the IMF programme that envisaged the implementation of the RGST with the objective of enhancing documentation.
It is critical for the government to propose taxation proposals that have a chance of being actually implemented. The Finance Ministry team led by Dr Hafeez Sheikh and the FBR Chairman, former Secretary Finance, must begin a series of meetings with not only the coalition partners and members of the opposition, notably the PML (N), but also begin an intense advertisement campaign to ensure that the people of this country back such a tax.