Tax under weak enforcement
IN the wake of a Rs356 billion shortfall in targeted revenues during the first five months of the current fiscal year, the government has introduced the Tax Laws (Amendment) Bill 2024, marking the second amendment to tax laws this year.
In my op-ed, ‘Negotiating effectively with the IMF’, published in Dawn on May 31, 2024, I cautioned the government to tread carefully when agreeing to the contours of the IMF programme. Surprisingly, the government committed to collecting Rs13 trillion in FY25 in taxes — a target over 40 per cent higher than in FY24. For an economy undergoing adjustment policies under the programme, this was highly ambitious, especially with projected nominal GDP growth of about 12pc.
Achieving this target required additional tax measures worth Rs1.7 trillion or 1.4pc of GDP. Even with stringent enforcement of tax compliance on retailers and wholesalers, enhancing revenue administration, and the harmonisation of the provincial agricultural income tax regime with federal personal income tax, consistent with IMF structural conditionality, it was unrealistic to expect that the new measures would yield substantial revenue within the year, given lengthy tax processes.
The government’s nervousness is evident from the introduction of the tax amendment bill within six months of the approval of the FY25 budget, as it appears unlikely to meet the IMF’s tax target. What is worrisome is that, in response, it is introducing capricious tax measures that are unlikely to improve actual tax collection.
The new measures are unlikely to significantly boost tax collection.
The new bill — reportedly devised by the FBR chairman — aims to prohibit ‘ineligible persons’ from purchasing cars, properties, and opening bank accounts. It also limits an ‘eligible person’ from making major purchases exceeding 130pc of the value of the cash and assets declared in their tax return and wealth statement. Ineligible persons would also be barred from withdrawing cash beyond a specified limit from their own bank accounts. Furthermore, the bill proposes to share taxpayers’ confidential data with commercial banks and privately hired tax auditors.
‘Filers’, ‘non-filers’, ‘late filers’, ‘eligible’, ‘ineligible’ — these terms have become the pillars of our inefficient and ineffective tax system. In essence, they represent an admission of FBR’s failure to collect due taxes from individuals whose income is subject to taxation.
Unfortunately, since the term ‘non-filer’ was introduced in the Finance Act, 2014, by the PML-N government, with the aim of broadening the tax base, these irrational ‘innovations’ in tax policy and administration have done little to broaden the base or improve Pakistan’s dismally low tax-to-GDP ratio. Also, the fate of the much-trumpeted Tajir Dost Scheme has tarnished the FBR’s reputation as a tax authority, and serves as evidence of its inability to enforce tax laws, ensure compliance, and collect due taxes from the powerful.
In evaluating the effectiveness of a tax system, economists traditionally invoke five principles. A good tax system should be equitable, first, vis-à-vis its treatment of individuals in roughly similar straits (the principle of horizontal equity); and second, vis-à-vis its treatment of individuals in different economic circumstances (the principle of vertical equity).
Third, a good tax system should minimise the distortions it introduces (the principle of efficiency). The fourth principle is that a good tax system should not impose undue administrative costs, either directly or indirectly, on taxpayers or withholding tax agents (the principle of administrative simplicity). Finally, a good tax system is one in which individuals know what they are paying (capacity to pay or the principle of political responsibility). In practice, the policymakers should balance the trade-offs between these principles.
With these principles and facts in mind, the new measures are unlikely to significantly boost tax collection or address equity issues within our tax system. Instead, they will create distortions by imposing undue restrictions on economic transactions. Moreover, since they shift the burden of enforcement on to banks, property registrars, and car dealers, this will increase compliance costs for economic agents, compromise administrative efficiency, and jeopardise tax data privacy. We must liberalise our economy, rather than attempting to control it implicitly through impractical tax measures.
Though it may be too soon to make a pronouncement, I am willing to venture that the act that emerges from parliament will be a failure. This is because: first, policymakers have been unable to convince the public of the appropriateness of their thinking. Second, individuals tend to find ways to circumvent the imposed restrictions. Third, there is a lack of detailed tax costing for the new tax measures, ie, the revenue impact of each of these measures.
The lack of vision and understanding of tax principles underpins the continuous failure of successive tax reforms. Instead of reforming the tax system based on sound principles of efficiency, equity, and simplicity, policymakers with an administrative mindset have complicated the tax system. Efforts to reform our tax system must aim at reducing distortions, simplifying the tax codes, closing loopholes, and enhancing the global competitiveness of Pakistani businesses and companies.
To shape effective tax policy and develop revenue-generating proposals, we need an independent policy board of competent professionals comprising fiscal economists and experienced taxmen of integrity. Before introducing any taxation measures, they should be thoroughly evaluated for both short- and long-term impacts. Unfortunately, the government itself hinders such reforms in order to keep control over the FBR by appointing its apparently handpicked chairman.
A fair and equitable tax system for corporates, businesses, and individuals is central to funding economic growth. Rampant tax evasion torpedoes the notion of inclusive growth and is a structural cause of growing inequality. In this context, weak tax enforcement and tenuous tax compliance lead to an overflow of tax evasion.
Therefore, the best approach for FBR is to enhance tax collection by strictly enforcing tax laws, along with a stringent penalty structure targeting specific tax evaders and delinquents. Without this, it will continue to move in circles, with unintended consequences from imprudent measures.
The writer is a former senior adviser of the IMF, and holds a PhD in economics from the University of Cambridge.
Published in Dawn, December 28th, 2024