Daily Times

The recent changes to taxation introduced in the budget have caused uproar among trading and business circles. Most of the uproar has been on the imposition of 0.6 percent withholding tax on banking transactions. Added to that is the imposition of eight percent revenue tax on service businesses. The government argues that these tax changes are necessary because of the high rate of tax evasion by businesses and the wealthy. Businessmen label the imposition of the bank transaction tax as double taxation, especially owing to the government’s poor record of dispensing tax refunds. And just when both sides have weight to their claims, it is anyone who is trying to do business honestly who is squeezed and strangled to choking by this tax regime.
It is true that Pakistan has a very low tax-to-GDP ratio and most of it has to do with very the high level of tax evasion present in the system. Rather than fixing this issue of tax evasion since the times of Ziaul Haq, the government has always resorted heavily to indirect taxation and from there on the trend has been irreversible. This is a signal that the government has given up on collecting income tax and lacks the ability to determine and tax the incomes of individuals properly. This has led to the expansion of the withholding tax net. The consequences of these indirect taxes weigh heaviest on the common man or on businessmen who want to conduct their businesses fair and square. When the government decides to tax consumption rather than income, this impacts the most those people with little surplus income. This erodes their savings and takes away opportunities they have of investment and thus achieving upward economic mobility. More importantly, with free trade on the march, the government’s ability to tax luxuries is significantly diminishing and thus the bulk of the load of consumption and indirect taxation is falling on the common middle and lower class salaried people.
Similarly, the withholding tax regime, particularly the way taxes are deducted and deposited, puts businesses that want to act fair at a big disadvantage. This was already particularly true for services and trading businesses operating in the business-to-business domain. Since most of the sales are done on credit, sales tax usually means an additional working capital burden of two percent of annual sales. Needless to say, Pakistan is that rare country that has a universal sales tax on sale of services, including basic professional services. This makes it extremely difficult to run a services business, particularly one focused on the local market. The advent of eight percent revenue tax will turn this difficulty into something almost impossible. But impossible it is as long as businesses are willing to comply with the tax code in letter and spirit. Unfortunately, that is not what businesses do and thus all these steps will lead to an increase in tax evasion. It will encourage businesses to resort to transacting through grey channels more and more. And businesses will not find it hard, thanks to the Federal Board of Revenue (FBR) and government policies spanning decades.
When the government decides to push the indirect, withholding tax route, it found an easier way to meet short-term revenue targets. That has led to complacency and every time the government feels pressure to expand the revenue base, it does so through indirect taxation. This road to indirect taxation has led to further weakening of the government’s ability to levy and collect direct taxes. On the other side, it has made those who would want to conceal their incomes and wealth more daring in doing so knowing the government’s inability and lack of tools at its disposal to do so. So, this downward spiral has led the government more and more towards indirect/withholding-centric taxation. On the one hand, it discourages incentives to doing business by the book and, on the other, it leads to expanded income and wealth inequality in society. With this ever-expanding withholding, indirect taxation regime, the income tax process has become a mere extension of the extortion mechanism being carried out by extortionists in Karachi.
What the FBR and government need to realise is that to have a sound direct taxation system, states need to do capacity building of the tax machinery, empower it with skillful financial and legal human resources, and eradicate corruption within the tax machinery. No amount of draconian powers like access to bank accounts and other measures aimed at breaching privacy will do it. Countries have done it with basic common sense practices without resorting to these draconian laws by sticking to basic tax mechanisms.
The government also needs to realise that taxation leading to income and wealth inequalities will lead to social strains that have the power to wipe out any economic gains or development. The basic principal of taxation has to be taxation proportionate to income. This includes withdrawing protections from industries like auto, taxing agricultural income or surplus land of big landowners and carrying out a complete overhaul of the government’s tax machinery. At present, we are ready to protect dying, crony industries and economic interests, and in the process are killing our chance at having a footing in the industries of the future.

The author can be reached on twitter at @aalimalik