Daily Times

In Pakistan, tax policy is often the art of the possible rather than the pursuit of the optimal. It is therefore not surprising that economic theory, especially optimal taxation literature, has had relatively little impact on the design of tax systems. In view of the tax policy issue today, Pakistan is advised by the International Monetary Fund (IMF) to consider these issues from both the macroeconomic (the level and composition of tax revenue) and microeconomic (design aspects of specific taxes) perspective.
In recent years, domestic revenue mobilisation in Pakistan has gained increasing prominence. Several factors explain this, including the potential benefits of taxation for state building, independence from foreign aid, the fiscal effects of trade liberalisation, the financial and debt crisis in Greece, and the acute financial needs of developing countries. Governments in developing countries face great challenges in mobilising tax revenues, which result in a gap between what they can collect and what they actually collect. Tax gaps are hard to quantify and we know that significant contributors to tax gaps include tax evasion and avoidance, tax exemptions and inequitable rent sharing in the extractive sector. Pakistan needs to improve revenue mobilisation and it has to explain its weakness in raising tax revenue.
The baseline model of what determines a country’s tax revenue as a share of GDP is critical. Laying out some basic relationships regarding how tax revenue as a share of GDP varies with per capita income and with the breadth of a country’s tax base in economics is useful. Not because it applies very directly to the real world but because it helps organise our thinking about what departures from the model are likely to be useful.
Pakistan has begun to take decisions that will have a profound impact on fiscal economics over the next 15 years and beyond. Tax collection in Pakistan will determine whether sustainable development goals can rival the success of predicted development goals. For most developing countries, tax revenue lies somewhere between 10 percent and 15 percent of GDP. That is low compared to an average of about 35 percent for developed countries. Historically, however, it is not that low since, throughout the 19th century, in all developed countries tax revenue remained below 10 percent. Thomas Piketty writes in his book, Capital in the Twenty-First Century, that it was only after 1910 that tax revenue slowly started rising.
Low tax revenues meant that Pakistan was able to fund only the most basic services; universal access to healthcare or education, infrastructure and a social safety net, the standard foundations for decent, prosperous lives. In practice, for instance, the fruit picker with a market stall pay is ending up paying more tax charges than the fruit farm owner himself. Businesses can use smart tax arrangements — tax avoidance tactics, in other words — to ensure they pay less than one percent in tax while the market seller has to pay four times that rate on the couple of rupees he earns. That is not only wrong; it is completely unfair.
This task can be achieved, perhaps sooner than many ever dared dream. Success in the fight against revenue collection, under the scheme of non-filers being penalised when paying taxes, has changed the perception of what is possible. To achieve this, Pakistan will begin to realise the full potential of developing countries. This is known as domestic resource mobilisation and it all starts with higher rates of tax revenue collection. Pakistan will have to increase tax revenue collection to about 20 percent of GDP. There are three main areas of importance and the urgency here is overwhelming. First, ensure fair taxation. The UN Conference on Trade and Development (UNCTAD) estimates that multinationals avoid $ 100 billion worth of corporation tax. Governments and international institutions now have to make good on promises to fight tax avoidance and tax evasion.
Second, strengthen the role and transparency of tax inspectors, broaden their tax base and build tax collection capacity. Two years ago, the Netherlands gave technical assistance to developing countries and we now should plan initiatives to generate extra resources for building tax collection capacity. Countries that want to use these extra resources will need to express the political will to reform their tax systems. In Pakistan, tax systems often have a regressive effect because they tend to rely heavily on consumption taxes like VAT and excise duty, or on import levies. Historically, the poor and civil services employees end up paying a relatively high amount of tax because they spend all their income on goods subject to VAT, such as groceries, consumer supplies and phone credit. There is no tax-free shopping for the poor.
Third, broaden the tax base. Pakistan needs more capacity to administer and collect more complex forms of tax, like income and wealth taxes. Apart from VAT, countries need a progressive income tax regime because it is the poor who are often hit harder by income tax reforms generally. However, the current profiling of filer and non-filer tax nomination by the Federal Bureau of Revenue (FBR) through national identity card number identification is an astute approach that will have far reaching consequences in a few years to come.
Fourth, income tends to be unevenly distributed. Although raising high tax revenues in this situation ideally calls for the rich to be taxed more heavily than the poor, the economic and political power of rich taxpayers often allows them to prevent fiscal reforms that would increase their tax burdens. This explains in part why many in Pakistan have not fully exploited personal income and property taxes and why their tax systems rarely achieve satisfactory progress.
Finally, Pakistan will need to be more discerning when awarding tax exemptions and should put its money where its mouth is. Along with other countries, Pakistan should be prepared to forgo tax exemptions on goods and services that fall under official development assistance. As well as looking at reducing tax breaks, robust action is also needed at the global level to crack down on revenue lost through tax dodging and other illicit financial flows. Ending tax corruption is a feat that seems inconceivable. The task before us is daunting and Pakistan must redouble its efforts. It is possible to make the billions we provide in official development assistance spark the trillions that we need in private sector resources.
Why does Pakistan tax the rich so little? Factors related to the economic structure of our economy vary but there is also an important role for political factors, such as weak institutions, fragmented polities and a lack of transparency due to weak news media. Moreover, sociological and cultural factors, such as a weak sense of national identity and a poor norm for compliance, stifle the collection of tax revenue. There is a need for a dynamic approach that encompasses the two-way interactions between these political, social and cultural factors, and the economy.

The writer is a professor of Psychiatry and consultant Forensic Psychiatrist in the UK. He can be contacted at fawad_shifa@yahoo.com