Tax reforms — easier than expected

The Federal Board of Revenue’s (FBR) recent decision to block the mobile SIMs of 506,671 individuals who failed to file their tax returns for 2023 as a penalty is a controversial move that telecom operators may challenge in courts. It is yet another example of using diktat to expand the tax net and improve tax collection instead of introducing systemic reforms based on best international practices.

Earlier on April 1, 2024, the FBR initiated a mandatory tax registration scheme for retailers and wholesalers in six major cities. Major commercial cities like Faisalabad, Multan, and Sialkot were conspicuously left out. The FBR gave traders one month to register by April 30. Less than 100 traders reportedly registered during April. The number of retailers/traders is estimated to be around three million in the country.

Pakistan has been trying to reform the tax system for decades, but the tax-to-GDP ratio has remained low. Meanwhile, low-income developing countries have made progress, with the average tax-to-GDP ratios increasing by about 3.5 percentage points since the early 1990s to 13.8 per cent in 2020.

The World Bank committed $103m in 2004 to a tax administration reform project. However, according to their website, an independent evaluation rating in 2012 showed the outcome to be unsatisfactory. Another World Bank program with a commitment of $350m was approved in December 2023, but it has also made no progress.

Pakistan could increase its tax-to-GDP ratio without foreign assistance via Nadra’s stores of information, and an honest will to improve

Tax collections grew by just 4pc in real terms — adjusted for inflation — during five years from FY18 to FY23 at an annual average of just 0.81pc. Pakistan’s tax-to-GDP ratio fell from 10.4pc in 2017-18 to 8.5pc in 2022-23, far below the Asia and Pacific average of 19.8pc.

The shocking lack of progress is mystifying for a country that has gone to the International Monetary Fund (IMF) a record number of 24 times and received millions of dollars from the World Bank to reform its tax administration. Is it incompetence, lack of intent, or a combination of both?

As a first step toward reforming the tax system, the government should entrust the job of policymaking tax and regulation to a separate body of public finance specialists, and the role of the generalists in the FBR should be limited to execution and operating matters.

Many countries have benefited from the experience of East Asian countries and followed their policies. Some key features of successful reform programmes include subjecting the discretionary powers of the tax authorities to legislative oversight and legal checks and balances, reducing the overall number of taxes to a few, and slashing maximum rates, as high rates have historically encouraged tax evasion.

Moreover, rebates, exemptions and special treatments are eliminated or reduced, and finally, tax administration is simplified using technology.

According to a World Bank study published in 2020, improvements in the tax administration of over a 100 countries were largely driven by technological advances, specifically the implementation of electronic filing and payment systems. In 2004, only 43 economies had an online system for filing and paying taxes. Fifteen years later, more than twice as many did.

Developing countries like the Philippines, Indonesia, and Malaysia started using technology to improve their tax collection as early as 2001, 2002, and 2004, respectively.

Pakistan does not need McKinsey to help automate the FBR’s tax collection. The firm, though widely known for its management consulting practice, can hardly claim technology as its core competence. According to reports published by The New York Times, The Economist, and other respected international papers, McKinsey has been involved in numerous corruption scandals, questionable practices, and lawsuits related to insider trading from the United States (US) to South Africa.

Pakistan’s tax-to-GDP ratio fell to 8.5pc in 2022-23, far below the Asia and Pacific average of 19.8pc

Pakistan’s National Database and Registration Authority (Nadra) has a wealth of experience and technological expertise to help FBR automate its systems. It can get help, if needed, from technology companies who have experience doing similar projects in other Asian countries.

Pakistan needs to introduce an integrated digital system through which records of interest and dividend payments made by financial institutions to companies and individuals would be linked to the tax system. This is a widely followed international norm.

To introduce a digital tax regime, the National Tax Number (NTN) should be the same as the Computerised National Identity Card (CNIC) number of individuals without requiring the individuals to register. NTN/CNIC should be linked to the financial system through technology, as is the practice in the US, UK, Canada, Singapore, and many other countries.

At the end of every year, all interest or dividend-paying institutions must communicate the total payment (interest and dividend) made to each recipient, including tax withheld, to the tax authority with the NTN as the reference.

To ensure that the financial institutions have correct and valid mailing addresses, over-the-counter delivery of chequebooks or debit cards or any such payment instrument should not be allowed. This delivery must take place through the post. This small but critical detail would ensure that the addresses are correct. Proof of address is now a common requirement of banks worldwide to prevent money laundering and tax evasion.

All individuals with income greater than the minimum exemption limit should be required to file tax returns and include the details of interest and dividend payments received from the financial institutions. Since these details would have already been communicated by the financial institutions to the FBR, there would be no question of inaccurate reporting. This single step, if properly implemented, would instantly expand the tax net.

All tax assessments and correspondence should be available to the income tax filers online through a central portal maintained by the FBR. The FBR should communicate through post or electronic means, and no physical presence of tax filers should be required except in the event of a legal case.

These simple but critical measures can dramatically increase tax collections and reduce corruption. Pakistan has nearly 177m bank accounts and around 165m mobile phone users. There is no reason why Pakistan’s tax-to-GDP ratio cannot be increased to catch up with that of other Asian countries in a matter of a few years. This has been done in so many countries. There is no need to reinvent the wheel, just the will and intention to execute.

The writer is former head of Citigroup’s emerging markets investments and author of ‘The Gathering Storm’

Published in Dawn, The Business and Finance Weekly, May 6th, 2024