Taxes are the levies imposed by the Government in exchange of services provided to the nation. Normally, major part of revenue to run the country comes from tax collection. Pakistan stands amongst those nations who have very low tax to GDP ratio ranging from 8.0 to 10.40 percent in recent years. System of tax collection in Pakistan is disorganized, unyielding and complicated. Since the independence, Government is trying make the tax system more transparent and credible but in vain. Intervention of international agencies like IMF (International Monetary Fund) and World Bank regarding betterment of tax system is also worth mentioning. Tax collection is one of the biggest challenges Pakistan's economy is currently facing. Unstable political culture, lack of political will, weak audits, exemptions, undocumented economy and corruption in administration can be held responsible for this failure. All the tax reforms were mainly focused on broadening the tax net, simplifying tax collection and improving administration functioning.
After the independence of Pakistan same system of taxation was continued as it was in practice in sub-continent before partition. Later, a research committee regarding taxation was established in 1958.New amendments were introduced later in Income Tax Ordinance on June 1979. National Commission on Tax Reforms was formed in 1985. Direct taxes include the personal income tax, the corporate income tax and the wealth tax. Indirect taxes in Pakistan include the custom duties, the sales taxes and the central excise duty. A special Sales Tax Act was also passed in 1990. Latest Income Tax ordinance 2001 was passed on 13thSeptember 2001. 1
Tax to GDP ratio of Pakistan for the year 2011-12 was 8.6 %.If we compare Pakistan's tax to GDP with neighboring and SAARC countries, the situation is indeed worse in Pakistan. For example Tax to GDP ratio of India is about 17.7%. Maldives' collects about 20.5 percent and Sri Lanka about 14.3% in terms of its tax to GDP ratio, as shown in Exhibit 1.
Failure to broaden the tax net in Pakistan includes the factors like feudal class is most unwilling to pay taxes as agriculture has virtually no share in tax collection and all the burden is on salaried class. Inequality in existing taxation system in Pakistan promotes the rich class to evade taxes and poor & middle class faces the entire burden. Other hurdles in tax collection includes, tax exemption and subsidies which has worsen the scenario.
IMPLEMENTATION OF SALES TAX ACT OF 1990 & ONWARDS:
Sales tax ordinance was legislated in 1990 and previous Sales Tax Act of 1951 was completely abolished. In this act Government tried to expand the tax net and to simplify the process of tax collection. This act was made effective on 1st July 1990.According to this act, tax was chargeable to all imports and taxable manufactured goods. The goods meant for export were zero-rated. This Act was brought because of the pressure from International Monetary Fund and World Bank to restructure the taxation process in Pakistan. World Bank also supported this Act and provided a major loan for support. Even after passing this Act, tax to GDP ratio was still low which was about 9% .So; Sales Tax Act of 1990 was not a success in achieving required goals.
Contribution of direct taxes in overall tax revenue shot from 15% in 1990 to over 30% in 2000; currently it is 37% 3. In indirect taxes column, contribution of GST increased while that of Custom Duties decreased but overall tax to GDP ratio didn't increased much. Later some improvement came by increasing the coverage of withholding taxes on interest income from financial institutions, dividends, exports, electricity bills, etc. However, Government failed to abolish the special concession, privileges, and exemptions to upper-class, agriculturist and businessmen. Similarly, Attempt to include VAT within the GST was failed and was not extended to wholesale and retail trade and services. Influence of various interest groups still remains effective.
Flaws in Sales Tax of 1990 were tried to be corrected in year 2000 to broaden the tax coverage, it empowered the state to gather GST revenues on services. Under taxed sector like Banking, Insurance and Telecommunication were imposed excise Tax in GST format. To attract foreign investment Government reduced the import duties. Still GST collection was not achieved a significant figure and remained at a low percentage of 3% of GDP. Considering the population like Pakistan of 190 million GST collection is still amongst worst in the world. In Pakistan agricultural income continues to remains exempted from tax though provinces have levied agricultural income tax but the collection is negligible and the tax is mainly based on land holding not on agricultural income.
GST: A SUCCESS OR FAILURE?
Pakistan is in an immense need to increase its tax revenues by implementation of modern sales tax systems. Although the basis Sales act of 1990 was accepted value added tax doctrine but due to political pressures and resistances it deviated from best international practice became narrow based. Deviations like special regimes, ever expanding exemptions and several others resulted in smaller tax base and lack of documented economy causing hindrance in effective tax policies.
The expectations from domestic revenue generation were not being met and GST collection rate was on a decline. The tax to GDP ratio in 2009 went below 9 which is one of the lowest in the world for a population of 180 mn. Indeed the GST performance of Pakistan was pushed to the worst ranks as compared to rest of the world with C-efficiency of .23. This is shown in the Exhibit 2 of C-efficiency which measures effectiveness of GST base utilization.
The legal framework remained same as it was in the previous tax system. Input taxation was completely ignored. Collection Board of Revenue (CBR) was able to diverge the tax base according to their will through without referring to parliament. This empowered CBR to do deals the consigned interest. As a result Legal provision disallowed the implementation on consumption tax and fell back on the Producers. Formal sector enterprises of GST net were castigated. This backward shift transformed Ex-Proponents to the opponents of Pakistani version of GST. This all gave birth to distrust in the entire taxpaying system i.e. CBR couldn't trust taxpayers and vice versa. The suspicion relationship gave the tax payers chance of rent seeking and a system of bogus companies making flying invoices became customary.
After 9-11, foreign capital assistance increased. With capital coming in and imports becoming cheaper, the government had to control the exchange rate which acted negatively towards exporters. To bring about a solution for the decaying export industry and also to address the problem of fake invoices, the government introduced the "zero-rate" policy. Zero-rate was the exemption of paying a value-added tax toward all transactions of the domestic sales and the main exporting industrial divisions. The main cause of this policy was to end having to give refunds to exporters because most of the invoices were fake. As a result, the zero-rate policy broke the input tax credit chain and brought upon cascade taxing again which was the expected effect that the government intended.
IMF & ITS INFLUENCE ON PAKISTAN'S TAX POLICY:
Pakistan has been facing natural disasters on frequent basis which have slowed down the economic activity in past few years. These disasters have destroyed the agricultural land and made millions of people homeless. To accommodate Internally Displaced People (IDPs), Pakistan needed huge amount of funding from International monetary fund (IMF). Moreover the country is suffering from huge power and gas crisis, political instability and war against terror all of which require funding.
Although the loan of $11.30 billion was granted by IMF in 2008 but it suspended disbursement in May 2010 and Pakistan ended up receiving only $7.5 billion because Pakistan was unable to comply with the agreement. The agreement was constituted of conditions like lowering the central bank borrowing, implementation of Value added tax, elimination of power sector subsidies and keeping the budget deficits within agreed limits. Pakistan was not able to cut down the financial deficits and also enhanced the subsidies.
IMF wanted Pakistan to raise its tax to GDP ratio from around 10% in 2008 to 15% in 2013 but the ratio declined to 8.6% in 2012 instead of increasing. Thus due to violation of all conditions Pakistan has to repay the received $7.5 billion loan as per schedule mentioned in Exhibit 3.
Pakistan might have to pay approximately 5% more than the total repayment amount due to dollar-rupee parity. Loan repayment will stress upon foreign exchange reserves in the next 3 years. Moody's (Credit Rating Agency) has cut down the rating of Pakistan further into junk grade on lack of reserves and political instability. Any sort of proposed tax amnesty will might have positive consequences but only for short period of time. According to Ministry of Finance
Only 1.5 million people i.e. less than 1% of total population of Pakistan files tax returns. So Pakistan should rather than trying to make amendments in current tax system Government of Pakistan should focus upon broadening the tax base permanently.
THE VALUE-ADDED TAX:
Although VAT has been claimed to be the best tax method, it is vulnerable to fraud & evasion, especially in Pakistan. A comparison of Value Added Tax & Sales tax can be found in Exhibit 4. Value Added Tax is defined as, "A tax on the value added to a product at each stage of its production, from raw materials to finished product." 6
According to some advocates of VAT, it is 'Self-Enforcing', as it gives an incentive to each supplier to pay VAT, so that they can claim an appropriate credit. On the other hand, the traders have the encouragement to ensure that they are provided with the invoices, which gives them the right to refund. But in the absence of such mechanism the self-enforcing concept becomes questionable.
AN INCREASED POSSIBILITY OF FRAUD AND EVASION:
VAT is quite vulnerable to fraud because of its collection mechanism. Therefore, the state may have to face the loss of income tax. President of the Business Alliance of Slovakia, Robert KiÄina once said, "…..tax evasion, especially VAT evasion, is a huge problem for the state but also all decent taxpayers, who have to pay higher taxes [as a result]," 7
There are many ways in which the VAT can be fraudulently exploited or evaded,
• Under-reported sales: Sales can be made 'off the books'or falsified
• Failure to register: Small businesses often fail to register, saving VAT payment.
• Misrepresentation of commodities: liability may be reduced by overstating the sales in the lower-taxed level.
• Omission of self-deliveries: The Goods or services produced by the business and consumed by the proprietor or employees may not be declared.
• Tax collected but not remitted. This may be possible either through false accounting (under-reported sales, as above), By engineering bankruptcy before tax is paid, or in other ways.
Thus, the presence any of the above mentioned condition could hinder the successful application of VAT & result in increased burden for the lower level strata of the economy. The implications of VAT in different countries has quite oftley depended upon the habit & character of tax payers, i.e. the willingingness of the tax payers to pay tax and contribute towards the betterment of the economy as whole.
LIMITATIONS IN THE STRUCTURE OF VAT:
Although Pakistan has seen improvements in the design of VAT, it further needs refinements in order to fully implement it. VAT still does not cover the major portion of service sector. However it has been observed that the some services have been brought under the VAT net. The endorsers of the policy believe that the structural issues of VAT can be sorted out by adjusting its design with respect to its implementation in other countries.
VAT's success in Pakistan requires fair audits & strict application of penalties. Rather than contributing the Legal systems have resulted in the blockage of revenues & have curtailed system's effectiveness by allowing large delays in the application of penalties. Similarly absence of appropriate audits & investigations will further decrease tax revenues, as fraudulent activities will flourish without danger of being caught. Another important factor of great apprehension for the application of VAT is TAX compliance. Unfortunately in Pakistan we see quite low level of tax compliance, as only 50 % of businesses & registered population file monthly tax returns.
The credit & refund mechanism may offer chances for abuse. The invoice based mechanism of credit can be maneuvered to achieve tax exemption. Similarly under refund mechanism the tax payer can manipulate the input & output tax invoices to get away with Tax.
Several efforts from government for greater documentation of economy have failed due to strong resistance from business lobby. GST could not be implemented in true VAT mode. It was not extended to wholesale trade and services due to strong resistance from trading community. Government planned to introduce new system of VAT (including removal of exemptions) in the budget 2010-11, which would replace current GST. However, introduction of VAT was delayed due to strong opposition from business community as well as from political parties.
FBR has started a thorough campaign to make the businesses to abide by the VAT laws when they become applicable. Although the initiative is targeted towards achieving less probable outcome, i.e. the complete removal of all fraudulent activities by which almost half of the tax payers are to make way to non-payment. The overall, application of VAT revolves around an equal approach between enforced & Voluntary compliance.
As a matter of fact, even the fluctuations in the tax revenue collection, as showed in Exhibit 5, portray the inability of the GST (General Sales Tax). The existence of such problems with the existing method puts a question on the successful application of a new, even more complicated, VAT.
CONCLUSION:
Implementation of GST from 1990 Tax Act and onward was not up to the mark and the required results were not obtained. Still there is lot of room for improvement in implementing the GST which can easily be done rather than implementing the VAT; which would create new hurdles and unforeseen challenges in terms of tax collection. If we introduce VAT on the pressure of IMF and ignoring our national interest then it would be a debacle for economy in the long run. New methods of Tax evasion would prevail and the entire burden will be forwarded to end user. Implementing the VAT would accelerate the inflation rate on rapid pace.
Rather than implementing the VAT we can focus on broaden the tax net and imposing actual taxes on agriculturist and upper-class. Tax net of Pakistan constitutes major part of salaried class and around 60% of economy is out of tax net. Another recommendation is that if we reduce the subsidy on power which is around 170billions rupees now, we would not need to go for IMF and World Bank borrowing and inflicting their conditions on us. Implications on VAT can be worse in the economy like Pakistan where major problem is tax evasion. There should be imposition of wealth tax in Pakistan and wealth should be taxed irrespective of whether the wealth has earned in Pakistan or abroad. VAT will increase the loopholes in the Taxation system .So, we should not go for VAT and we should improve our existing system.
According to experts VAT benefits are highly artificial and overly described. Imposition of VAT in view of experts still lack readiness amongst the social level as well as at the Federal Board of Revenue (FBR). If we implement the 15% of VAT, it would actually cost 21% to final taxpayers. According to Senator and Ex-Finance Minister Ishaque Dar "Our negotiating team should have informed the IMF that Pakistan already has implemented GST in VAT mode over many years and instead may have focused on taking care of the loopholes of the existing tax regime," he believed. "Our negotiating team does not owe its loyalty to Pakistan but has either come from the IMF or wants to get a job at the IMF or wants a job at the IMF for their children." 10
EXHIBIT 1
Exhibit: 1 Comparison of Tax to GDP ratio of Pakistan with Neighboring Countries2
EXHIBIT 2
C-efficiency of VAT-Pakistan in an International Context4
Standard rate
Revenue/GDP
C-Efficiency
Pakistan (1 990s)
1 5
0.39
Pakistan (2005)
1 5
3.4
0.3
Pakistan (2009)
1 6
3.1
0.27
Sri Lanka
1 5
6.7
0.47
Philip pines
1 2
4.3
0.45
Turkey
1 8
7.1
0.48
Lebanon
1 0
5.1
0.5
Jordan
1 6
1 0.1
.6 2 (with luxury excises)
Korea
1 0
6.7
0.67
Singapore
5
1 .8
0.63
New Zealand
1 2.5
8.9
0.93
EXHIBIT 3
Repayment Schedule of Pakistan to IMF5
Payment Period
Amount to be paid (billions)
2012-13
$3.4
2013-2014
$3.43
2014-2015
$1.34
EXHIBIT 4
Comparison Of GST And VAT Regimes 8
Characteristics
GST
VAT
Tax Base
Goods
Yes
Yes
Services
A few services only
Yes
Intangibles
No
Yes
Tax on business inputs?
Yesa
No
Exemptions and Zero Rating
RST exemption/VAT exemptionb
Tax imposed on purchase by consumer?
No
No
Tax burden borne by seller?
Maybec
Yes
RST exemption/VAT zero ratingd
Tax imposed on purchase by consumer?
No
No
Tax burden borne by seller?
Maybec
No
Tax Rates
Range
5-10 percent
5-25 percent
Average
8.5 percent
17-18 percent
Cross-Border Adjustments
RST use tax/VAT reverse charge
Seller collects tax from consumer?
No
No
Buyer accrues/self-assesses?
Yes
Yes
Registration Requirements
When required to register?
Physical presence
Meet turnover threshold
EXHIBIT 5
Summary of Consolidated Fiscal Accounts 2004/05-2009/10 9
2004/05
Actual
2005/06
Actual
2006/07
Actual
2007/08
Actual
2008/09
Actual
2009/10
Proj.
Total revenue and grants
14.1
14.8
15.2
14.9
14.3
14.9
Total revenue
13.8
14.2
14.9
14.6
14.1
14.4
Federal revenue
13.0
13.0
14.0
13.5
13.1
13.7
Tax revenue
9.6
10.1
9.8
10.2
9.8
10.1
Non-tax revenue
3.4
3.0
4.2
3
3.3
3.6
Provincial revenue
0.9
1.1
0.9
1.2
1.0
0.8
Grants
0.3
0.6
0.3
0.3
0.2
0.5
Total expenditure
18.4
18.7
20.2
n i
19.1
19.5
Current expenditure
14.5
14.4
15.8
18.1
16.0
16.2
Federal expenditures
10.6
10.0
11.2
13.8
11.8
12.5
Interest payments
3.2
3.1
4.3
4.8
4.9
4.4
Defense
3.3
3.2
2.9
2.8
2.5
2.8
Subsidies
0.9
1.2
1.2
4.0
1.9
1.3
Others
3.2
2.5
2.9
2.3
2.5
4.0
Provincial Expenditures
3.9
4.4
4.6
4.3
4.2
3.7
Development Expenditure
3.9
4.3
4.4
4.1
3.1
3.4
Federal
2.5
2.5
2.3
2.0
1.6
2.1
Provincial
1.4
1.9
2.1
2.1
1.5
1.3
Deficit(excluding grants)
-3.3
-4.3
-4.3
-7.6
-5.2
-5.1
Deficit(including grants)
-3.0
-3.7
-4.0
-7.3
-5.0
-4.6
Financing
3.0
3.7
4.0
7.3
5.0
4.6
External(Net)
1.7
2.7
2.0
1.2
0.5
1.8
Domestic
1.3
1.0
2.0
6.1
4.5
2.7
Bank
1.1
0.8
1.2
5.1
2.7
1.1
Non-bank(incl. privatization receipts)
0.2
0.2
0.9
1.0
1.7
1.6
Memo items
FBR revenue (percent of GDP)
9.2
9.4
9.7
9.S
S.S
9.2
