Taxation or extraction?
The government has not completely ruled out the possibility of taking additional taxation measures and has shared some pro-posals with the IMF, said the sources. PHOTO: FILE
Taxation is probably one of the most important linkages between the state and citizens. It is a contract under which citizens involuntarily pay a portion of their income to an agency, which provides services to all citizens such as public goods, which the market is unable to provide.
When the state pays back, through investment in justice, infrastructure and education, for instance, it does not and must not discriminate between those who pay taxes and those who cannot afford. That is the core characteristic of a functioning state.
Over the years, the taxation regime in Pakistan, through a myriad of complex, discriminatory and unpredictable rules and legislations, has become an extractive regime. I will provide some examples of anti-business, complex and unpredictable taxation policies and will outline an alternative.
Super tax – This tax has continued in one form or another. As levied in the current Finance Act, it is a one-time additional tax of 10% over and above the very high corporate tax of 29%, which goes up to 39% when social security taxes are added.
The basic rationale of super tax is discriminatory. This is applicable to selected sectors including cigarettes, chemicals, beverages, LNG terminals, airlines, textile, automobile, sugar mills, oil and gas, fertiliser, steel, banking and cement.
As the tax burden will increase to 50%, the businesses in these sectors must now work six months in a year for the government and the remaining for their shareholders. Such taxes, when levied in the past, have continued despite legislative guarantees for keeping them temporary.
Deemed income tax: The present Finance Act has levied a new tax according to which a resident person is treated to have derived income equal to 5% of fair market value of the capital assets situated in Pakistan, which will be chargeable to tax at the rate of 20%, with the exception of one capital asset owned by the resident person and self-owned business premises.
As the word deemed indicates, this is not a realised income, but rather an imaginary income. This tax idea is not only unfair but should be challenged before a court of law.
Poverty alleviation tax: A poverty alleviation tax has been imposed on high-net-worth individuals and companies under which a tax of 1% to 4% will be charged if the annual income exceeds Rs150 million in different slabs. This has been questioned on the ground that no tax can be imposed for a specific purpose and if so it should be called a levy. In any case, given the secrecy and fragmentation of public finance, one can never be certain if the tax collected under this heading will be actually spent on the declared purpose. The example of Export Development Fund, a charge of 0.25% on all export incomes, is there.
This fund was accumulated and remained unspent for years and was eventually appropriated by the Ministry of Finance, when Ishaq Dar was the finance minister.
Fixed Tax: The Finance Act imposed a fixed tax to be collected from traders through electricity bills. The government has recently announced recalling the fixed tax. While all businesses must file and pay income tax, fixed taxes, irrespective of the income, remain an unfair idea.
This is same as the tax applied to the construction sector during Shaukat Tarin time, which was levied on a per-square-foot basis.
Admittedly, these are difficult sectors, when it comes to documentation, however, given the technology and accessibility of data to the FBR, the imposition of income tax on these sectors must not be compromised.
Tax policy for behavioural change: Instead of recovering taxes from where it is due, the state created a reason to remain a non-taxpayer by allowing additional taxes to be paid by non-filers. This has not brought any significant gains to the system.
The Finance Act has raised income tax on banks from 37% to 49% if their advance-to-deposit ratio is less than 50%. Banks may recover this through levying more charges on their users.
Similarly, the policy of imposing tax on cash withdrawals arguably led to greater circulation of cash in the economy, thus increasing inflation. Such policies have failed.
Conclusion: The state has continued to fail to impose a fair system of taxes. According to my estimate, there should be at least 11 million income taxpayers as opposed to the current number of 3 million.
However, it is not the responsibility of taxpayers who continue to face the brunt of an extractive state. Parliament, the Ministry of Finance and FBR collectively hold the responsibility of this state failure.
To mask this failure, our finance ministers have found shortcuts to collect more taxes. Above examples are sufficient to show the poorly conceived tax ideas, which have largely remained stillborn in terms of consequences.
Alternative: Prime Institute has proposed an alternative system of taxation – low-rate, broad-based, flat and predictable taxes with minimal exemptions and deductions as well as complete legislation. If implemented in true spirit, this proposal will restore the state-citizen social contract, revive economic growth by mobilising domestic investment and formalise a large chunk of economy.
Importantly, it will generate substantially greater income tax, which will contribute 67% to the total tax as opposed to the current 36%. It will also significantly help Pakistan to restore its honour, which is currently on a significant discount, as demonstrated through constant appeals for more loans and mortgage of taxpayer-financed national assets.
The writer is Executive Director of PRIME, an independent economic policy think tank based in Islamabad
Published in The Express Tribune, August 22nd, 2022.
Like Business on Facebook, follow @TribuneBiz on Twitter to stay informed and join in the conversation.