Direct vs Indirect tax

Taxation is an extremely important source of funding for any state to finance the running of the governmental functions. Even the oil rich Arab states are now beginning to recognise the importance of this and starting to shift towards a lasting economy with citizens contributing to the national treasury with their share of the taxes.
To put it simply, in all global economies there is taxation, both direct and indirect (in different combinations).

Direct taxation is a tax directly levied on an individual or business’s income

while indirect taxation entails taxes on products and services whereby consumers are made to pay taxes when they consume these.

During the last financial year, the share in the GDP of direct taxes in the national tax revenue was 3.50pc and of indirect taxes 6.40pc.

Big companies pay billions in taxes which are collected from customers through the supply chain, as companies merely act as collectors and consolidators of those tax sums.

About 25 pc tax revenue is collected through direct taxes and the remaining 75 pc through indirect taxes.

Consumers mostly do not know as to whose burden they are made to carry. Even if some of them realise it, the individual burden is so small that they do not consider it worthwhile to mount a challenge socially or legally.

In Pakistan, ordinary people are taxed indirectly on just about everything.
Nowhere in the developed world is indirect taxation utilised as heavily as in Pakistan due to the negative effects that it creates for the economy. In Pakistan’s case (and that of many other developing countries following this strategy) the negative impacts far outweigh the contributions raised in this manner due to the missed opportunity costs.

For example, 25-30% had been routinely charged as an indirect tax on every litre of fuel (mainly petrol, diesel, etc) in Pakistan which is a basic necessity for everyday life compared to only 13% in the USA.

This way of collecting taxes indirectly leads to inflationary pressures in the economy as the increased transportation costs translates into increased prices for just about everything including the commonly used commodities.

The effects are hyper-inflationary in nature because there is a multiplicative rather than an additive element in the inflation passed-on at every level.
Furthermore the pay-rises are not proportionate to inflation thereby

forcing people to rely on expensive credit to make their ends meet.

Similarly businesses also require more finance to run their operations.

This hyper-inflationary environment then leads to higher interest rate which negatively affects the businesses.

With higher finance costs many business projects which would otherwise be viable becomes non-feasible.

The resulting lack of employment opportunities combined with the limited money-supply puts recessionary pressures on the market.

The above issues lead to the devaluation of the currency which in turn results in increased foreign debt burden.

As a result, financing costs of the foreign debts rise leading to a higher proportion of GDP spent on debt financing.

All this combined with hyper-inflation drags the already estranged economy further back in Pakistan’s case.
The above is a summary of the mess created by the taxation policies pursued by the previous government which are unfortunately continued by the incumbent finance ministry.