Pakistan Reader

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Pakistan Reader
Pakistan's narrow tax base: Failures so far, challenges ahead

  Dhriti Mukherjee

What is the tax base?
Currently, Pakistan’s tax-to-GDP ratio stands at 11.4 per cent with an existing gap equivalent to 7.6 per cent of GDP.  As of 26 December 2023, the number of active taxpayers (ATL) in Pakistan reached 5.3 million, of which the number of individual taxpayers was 3.69 million and the number of corporate/association persons was 1.67 million. Shortly before the Federal Board of Revenue (FBR) released this data, it informed the Senate Standing Committee on Finance and Revenue that despite 11.4 million people being registered, not all of them were filing their income tax returns. As per the ATL released by the FBR on 1 March 2021, the number of active taxpayers declined by 30 per cent, meaning two out of every three persons who had valid National Tax Numbers (NTNs) and were doing business in Pakistan did not submit their annual income tax returns. A report released by the Organisation for Economic Co-operation and Development (OECD) in the same year highlighted that Pakistan’s tax-to-GDP ratio was 10.3 per cent in 2021, below the Asia and Pacific average of 19.8 per cent by 9.4 percentage points.
 
Why is it narrow?
First, as per the World Bank, Pakistan’s narrow tax base is due to “exemptions and concessions for some large economic sectors and industries, including agriculture, construction and textiles.” Tax exemptions and concessions for political gains have played a role in reducing the tax base. In 2022 alone, exemptions led to an estimated loss of PKR 400 billion as per the Pakistan Economic Survey. The tax system of Pakistan relies predominantly on indirect taxation, with indirect taxes contributing to over 60 per cent of the FBR’s tax collection in 2021-22. This in turn suffers from inequity as exemptions or zero ratings are granted to some sectors.
 
Secondly, tax evasion is a major issue. During a meeting on the FBR’s reform initiative, it was highlighted that in 2024, only 2.4 per cent of Pakistan’s population files returns, of which 55.6 per cent are Nil filers who pay no taxes, and only 3.3 per cent of taxpayers account for 90 per cent of the income tax collection. An analysis in Dawn pointed out that the “shadow economy accounts for roughly 40 per cent of the nation’s GDP,” enabling high levels of tax evasion. For instance, there is significant tax evasion in the tea sector due to “smuggling and illegal trade.” The automotive sector and pharmaceutical industry are also both vulnerable to tax evasion through smuggling. In the real estate sector, under-invoicing is rampant, and involves “deliberately undervaluing properties during transactions to evade taxes.” In 2021, in 300 property transactions in Karachi, an excess of PKR 13 billion was paid compared to the property valuation rates set by the FBR, indicating the “existence of considerable unreported or untaxed funds within the market.”
 
Third, failure of banks to comply with the law. As of March 2024, 80 per cent of bank accounts in Pakistan had not been declared to the tax authorities, meaning “less than 20 per cent of bank accounts appear in tax returns filed with the FBR” as per official documents. Despite commercial banks being legally obligated to share the details of their bank account holders with the FBR, banks do not comply with the law meaning the FBR is unaware of the wealth parked in more than 80 per cent of accounts.
 
What are the World Bank’s suggestions?
First, it asked Pakistan to adopt a national fiscal policy by aligning federal and provincial spending with constitutional mandates, merging federal and provincial revenue agencies into a single general sales tax (GST) collection agency, and taxing agriculture, capital gains, and real estate in the FY25 budget. It also asked the government to “implement the new Fiscal Responsibility and Debt Limitation Acts (FDRLA) at the federal and provincial levels, including through development and implementation of a national medium-term fiscal framework through the FY25 budget process.”
 
Second, on the GST, the World Bank asked for tangible progress on GST harmonization across the federation, “including through rollout of the GST portal” and move towards “rate harmonization to facilitate tax compliance and the provision of input tax credits.” The government was also suggested to consolidate “all GST collection responsibilities with a single agency, which could then distribute revenues in accordance with constitutional provisions” to make administration more efficient.
 
Third, the World Bank demanded actions to mobilize revenues from underutilized sources, especially those relating to the unfinished agenda of the 7th National Finance Commission (NFC) award of 2010: urban immovable property tax, agricultural income tax, and capital gain taxes. While the NFC recommended the federal and provincial governments to “streamline their tax collection systems to reduce leakages and increase their revenue through efforts to improve taxes and achieve a tax-to-GDP ratio of 15 per cent by terminal year 2014-15,” it was weakly drafted and unable to fulfil its objective.
 
Fourth, for agricultural income tax, the government was asked to make a consistent definition of land area and set common minimum rates on the basis of crop acreage. On capital gains tax, the World Bank instructed the government to unify the treatment of builders and property developers, simplify taxes related to capital gains, and remove differential rates. These broader revenue reforms, directed at expanding the tax base, would require closing existing corporate and sales tax exemptions, and enhancing social protection to compensate poor households for negative impacts.
 
Why have successive governments been unable to expand it?
First, the failure of the FBR. The last few years have unveiled the FBR’s dysfunctional nature, as it failed on the fronts of revenue collections, issuance of due refunds, plugging leakages, and widening tax base. In February 2024, the FBR’s tax collection fell short of the target by almost PKR 33 billion, due to lower collection of domestic taxes and customs duty. This followed a PKR nine billion shortfall in January. The FBR has also been slow in implementing the decision made three years ago to connect professional services online with tax machinery in eight major cities. Failure to fully implement this decision means professional service providers in urban cities who earn money mostly in cash have not been paying tax on it. Further, it failed to install point-of-sale (POS) systems at large retailer locations. An analysis in The Friday Times criticized the FBR’s performance for being “pathetically abysmal despite resorting to enormous withholding taxes and all kinds of highhandedness.”
 
Second, the government does not tax certain sectors for political reasons. As pointed out by an editorial in Dawn, the 2023 budget was designed in a way that would satisfy the IMF’s expectation of a broader tax base, as part of which the tax target was eventually revised upwards. Despite this, the then Finance Minister, Ishaq Dar, “tiptoed around the broader tax policy goal of effectively taxing undertaxed sectors such as retail, agriculture and real estate — especially incomes from these sectors.” However, the editorial argued that this was not unprecedented, as parties including the PML-N, and “the powerful civil and military bureaucracy are averse to taxing incomes from retail, real estate and agriculture, the economy’s three largest segments, because of their own vested interests.” For instance, former FBR head Shabbar Zaidi had claimed that he was prevented by the previous army chief from taking steps to document the massive ‘file’ business in real estate. Even the IMF pointed out that the “Pakistan government needs to collect higher taxes by withdrawing subsidies to the rich.”
 
Third, failure of federation and provincial executives. An analysis in The Express Tribune highlighted that almost 90 per cent of the tax collection comes from the FBR taxes, while “the contribution by provinces remains a dismal one per cent of the revenue effort, despite a reasonably good tax base of property, agricultural and services sales tax.” Thus the federation and provincial executives have failed in “levying and collecting a fair amount of taxes.”
 
Fourth, lack of fear of taxpayers. Both the FBR and provincial governments have failed to create a “perception in the mind of taxpayers about the high probability of being caught, if non-reporting or under-reporting one’s income,” as per an analysis in The Express Tribune. Even if an individual is found to be guilty of evading taxes, the “frail and weak prosecution and appellate system” means that there is “almost zero threat of penalties and consequences,” and the government has done little to change this effectively.

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