Pakistan has one of the lowest tax to GDP ratios and, even considering developing countries alone, it is in the bottom ranked nations in terms of the proportion of population registered as taxpayers - less than 5 percent. of household population. There is rampant tax evasion, partly with the collusion of the official machinery. Whereas 3.1 million people have the National tax Number, a mere 1.2 million filed an income tax return in 2010/11. What is even more startling is that of 47,800 companies that have NTNs, less than 16,800 filed an income tax return against 400,000 industrial electricity connections.
As admitted by FBR, there is a tax gap of 79 percent. (the difference between potential revenues under the existing system and that actually collected). Revenues can be raised through broadening of bases, improving the equity of the tax regime, incentivising documentation, checking evasion by embracing a zero-tolerance policy, checking harassment of, or collusion with, taxpayers by simplifying tax returns and making FBR a faceless bureaucracy, with interaction between taxpayers and tax officials limited through greater reliance on automated computerised systems.
The general tax reforms would include taxation of all incomes of same levels equally irrespective of source, with a swift reversal of the travesty of the recent amnesty granted to trading in shares. There is also need for legislation that will render all Benami Transactions illegal and subjecting all cabinet members, who should all be taxpayers, to detailed tax scrutiny throughout period of office, and they should all be taxpayers. The tax returns and Wealth Statements of all parliamentarians and holders of key public offices and their spouses (including Secretaries, Chief Justices, Chief of Army Staff, Governor State Bank, Auditor and Attorney Generals) should be public during period of office and one year thereafter. Finally, following good results of tax mobilisation initiatives, individual and corporate income tax rates and the GST rate could be lowered under a phased programme.
The specific reforms under different tax heads would be the following: For Income Tax: Greater dependence needs to be placed on technology and through that on the CNIC for tracking commercial transactions to identify potential tax evasion/evaders, including movements in bank accounts of large deposit holders. The FBR should periodically reconcile the property tax registers of all provincial governments, names of credit card holders and members of private clubs with those allotted National Tax Numbers, for the system to generate notices to non-filers. All presumptive taxes should be replaced by withholding taxes (which presently contribute 60 percent. of income tax revenues). And the rates of all withholding taxes should be increased by at least two percentage points as a revenue enhancing measure, to incentivise documentation and penalise those trying to avoid capture in the tax net.
To prevent tax arbitrage by major shareholder executives the tax differential between the highest individual tax rate and the corporate income tax rate should be narrowed sharply, if not fully eliminated. For individuals there should be a Minimum Asset Tax of 2 percent. which should be allowed as a tax credit. Such a measure is being proposed for reasons of equity and for ensuring that large farmers do end up paying some tax, considering the poor success that provincial governments have had in collecting tax on their incomes. Any CNIC holder receiving remittances of more than US$50,000 a year should be required to pay a tax at 5 percent. on receipts in excess of US$50,000.
There is also a need to consider re-introducing the scheme whereby unlisted companies paying a 20 percent. higher tax than that paid n the previous year would not be subjected to any audit. Adequate safeguards should be built into the system to prevent incentive abuse by entrepreneurs closing down existing companies/businesses and starting new ones. Bills in excess of Rs.10,000 per month of domestic and all bills of commercial consumers of electricity should be subject to a withholding tax of 10 percent. and 15 percent. respectively. Compared with 3.2 million commercial electricity connections (excluding countless illegal connections) in the country today (including retail and wholesale outlets, offices of companies, partnerships, restaurants and hotels) last year only 22,000 wholesalers and 12,000 retailers paid income tax of Rs.6.2 billion and Rs.1.8 billion respectively paid income tax, either directly or under the withholding tax regime. By levying a minimum flat rate of Rs.12,000 to Rs.25,000 on small retailers more revenue can be raised. Large, well-known, retailers would be assessed for income tax in the normal way. However, it is recommended that the withholding tax on cash withdrawals in excess of Rs.25,000 be abolished to incentivise the entry of the Rs.1.7 trillion currency in circulation into the banking system thereby helping lower the government’s debt servicing costs.
Moreover, provincial governments should tax agricultural incomes, using lease rates in the area or the revised produce index units as proxies of taxable income from agriculture. The current exemption limits for income tax purposes should continue to apply. However, to ensure that the database in the system at the Federal level is up to date all farmers with holdings of more than 50 acres should be required to file a tax return.
To augment revenues from the under-exploited provincial property tax, “rental values” for determining property tax liability of residential accommodation should be assessed at 1 percent. of property “market values” with a small tax credit for self/owner-occupied residential properties and appropriate exemption limits for small sized residential space. For commercial properties “rental values” should be assessed at 3 percent.
In the case of GST the proposed reforms are: the rate for sales to entities registered for GST should be 12.5 percent. while for unregistered it should be retained at the base rate of 16 percent., the latter being the rate that is charged to the final consumer. For extending sales tax to retail trade, we need to examine the possibility of a single-stage sales tax to be levied by a provincial government based on location, shop area and nature of business.
For Customs Duties, to check abuse we need to identify items prone to dumping and under-invoicing and a system of ITPs should be introduced. As long as this list is a short one, the country will not run-foul of WTO rules and regulations. To both enhance revenues and simplify the tariff structure there is a need to consider levying a minimum rate of duty on all imports other than those protected by sovereign agreements (currently Rs.1 trillion worth of imports are duty free). We have a highly distortionary tariff regime that levies different rates of import duties on the same material based on the consuming industry, thereby creating opportunities for “extracting rent”. There is a need to simplify the tariff structure further by considering a system of “one-chapter one-rate”.
Finally, to address issues related to Afghan Transit Trade, we should consider incentivising use of Pakistan Railways for transportation and employ use technology-tracker and GSP systems. We can also consider using quantitative restrictions for items prone to smuggling.
On the administration side, focus should be a) on improving the quality of FBR’s data warehouse and IT systems; b) ensuring that the taxes collected by the “withholding agents” or from the end consumer in the GST are eventually deposited in the governments’ coffers; and c) on audit/tax notices being generated electronically stating in detail the reasons why the system raised the notice. And to check collusion, two tax officials should be required to sign the notice and interview the assesee.
The above should represent the minimum tax reform agenda for any new government to assume office after the forthcoming elections. It should be able to generate additional revenues of 1 percent. of GDP per annum. However, while some proposals will be politically tough to implement as they will require legislative changes or face resistance – not to mention the estimate of additional revenues each year looks ambitious in a sluggish economy – the continued postponement of fundamental revenue, expenditure, policy and institutional reforms is also no longer sustainable.
The writer is a former governor of the State Bank of Pakistan.


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