Domestic Resource Mobilisation (DRM) provides governments with much-needed funds for development, alleviating poverty and delivering public services. The complex external environment, weak tax administration capacity, low tax morale and compliance, corruption, limited tax base and weak management of resources pose significant challenges in many developing countries including Pakistan.
Pakistan has been undergoing tax reforms since 1990 but still struggles to raise its overall tax-to-GDP ratio beyond 13% and the Federal Board of Revenue (FBR) tax-to-GDP ratio beyond 11%. Is it such an impossible feat? Something that is unachievable even with all the help from international organisations and expertise they maintain to be provided to Pakistan.
So what is going wrong? Is the focus on wrong areas or a wrong strategy? Pakistan continues tinkering with tax rates; trying to broaden the tax base by providing amnesties or through allocating pre-assigned tax numbers to potential taxpayers (which mainly leads to more non-filers), and trying to improve compliance through traditional ways of communication. The retail sector still largely remains out of the tax net while the property and agricultural income tax remain less understood.
A fair conclusion is that doing more of the same is not achieving much impact. The emphasis, so far, has been on structural and policy reforms, as administrative reforms in Pakistan have not been able to provide many results. However, tax policy reforms alone are not enough. Policy reforms will be more effective if the tax administration is more efficient.
There is a need for a more sweeping approach to breaking free from the ongoing practices in tax administration. Instead of doing more of the same, the need is to make a deeper change. Following the example of other countries like South Africa, who took immediate steps to change the culture and mindset of the tax organisation leading to more voluntary compliance — a drastic increase in income-tax payers from 2.6 million to 4.1 million in less than 10 years — can provide the transition Pakistan is looking for. Other countries in the region like Thailand, Indonesia and Vietnam have undertaken successful tax reforms to improve their DRM through efficient and effective tax structures and administration.
A focus on people, processes and provision of professional service is required. A diagnostic analysis of the tax administration identifies the main weaknesses in FBR being risk management, internal controls, enforcement of rules, taxpayer education and monitoring and evaluation of initiatives undertaken, which leads to the low achievement of outcomes.
A major transformation in terms of organisational change will assist in improving FBR’s performance. For FBR to become effective and perform the professional role of a revenue institution, infusion of qualitative human resources is necessary. The challenge is to rebuild the upper and middle management by hiring people of integrity, managerial and leadership competence while retaining staff with skills and experience. A group of 8 to 10 people with the technical competence and managerial skills may be retained in key positions at the senior level in FBR headquarter and the rest may be asked to apply for all other positions, competing with the applicants from outside of FBR. The best person may be then selected for the job. Professionalising FBR through remuneration reform, performance-based human resource management and training is essential. Introducing more effective integrity and internal audit programmes will help control abusive and corrupt practices within the organisation, especially if they are complemented by a strict no-tolerance policy.
In an effort to automate processes, improve risk management and provide better services to taxpayers a specialised set-up may be established in parallel to the regular FBR headquarter. This set-up will provide an over-arching, whole-of-tax approach for large taxpayers by integrating all their information (for all taxes), and coordinating all activities and approaches to engage with them. This set-up will also help separate the back and front office functions leading to minimal contact between the taxpayer and the tax official making informal dealings more difficult. Teams of this set-up will work virtually to share all information about a taxpayer to give a complete picture of the business which will help identify and resolves risks and provide a more accurate determination of the level of engagement based on risk profiling.
The approach towards enforcement to detect and deter inaccurate reporting may be focussed on developing a comprehensive risk-based audit plan for each year based on risks identified for different sectors of the market. The plan could be formulated using techniques like brainstorming and pre-mortem to identify risks, consider threats and opportunities to pursue these risks and determine tools and techniques to carry out such audits. Effective compliance risk management processes are an integral part of a tax administration. Risk profiling of taxpayers by data matching through an exchange of information from third parties (domestic and international), to identify tax evasion and avoidance is imperative. This set-up will also be responsible for data mining and risk management.
Taxes paid by companies remain a key source of government revenues, especially in developing countries. Conservative estimates by OECD in 2015, report Base Erosion and Profit Shifting (BEPS) by Multinational Enterprises (MNEs) to cause revenue losses to governments in the range of USD 100-240 billion. The impact of BEPS as a percentage of tax revenues in developing countries is estimated to be higher than in developed countries. Pakistan, being a member of the Inclusive Framework on BEPS and the Global Forum on Transparency and Exchange of Information, stands to gain significantly from implementing these international standards for improving tax compliance.
In the current context where information and transactions transcend all boundaries, a different type of capacity building to be able to use this information to ensure tax compliance and prevent tax avoidance and tax evasion is required. Specific custom-built and long-term initiatives to address these challenges are required to support sustainable and effective tax reform. Borrowing from what other countries have successfully done, Pakistan can evolve a tax system that meets requirements posed by international and regional integration. Separate specialised teams may be designated with measurable targets to focus on MNEs, High Net Worth Individuals (HNWI) and asset recovery. Building capacities, especially for transfer pricing audits and HNWI audits will improve credible enforcement. This can also be managed under the specialised set-up.
To build a tax culture and improve tax morale in the country, outreach and taxpayer education play a key role. Analysis of tax compliance attitudes in Kenya, Tanzania, Uganda, and South Africa finds credible enforcement, tax knowledge and awareness to be important and beneficial. Using similar techniques, awareness campaigns can be conducted by FBR through educating schoolchildren and university students in tax literacy, internet-based technologies, television and entertainment media, and outreach to the citizens, firms as well as tax advisors and the informal sector.
Successful tax reforms involve political support and sufficient administrative follow-up such as in Georgia, matched with visible improvements in public service delivery in order to ensure the sustainability of achievements. Building local capacity — at the level of the individual, the organisation, and the enabling environment — contributes to institutional sustainability and quality. Prioritising reforms by creating dynamic and engaged management in FBR, credible enforcement and changing the taxpayer service approach can contribute to DRM in Pakistan.
Tax administrations can play a critical role not only in shaping economic development but in developing an effective state. The success of these reforms will greatly depend on stringent monitoring at the highest level to oversee the performance of FBR and the new specialised unit as well as the implementation of reform measures undertaken.
Published in The Express Tribune, October 20th, 2019.