The World Bank has recommended Pakistan to start taxing monthly salaries below Rs50,000 and further reduce the Rs500,000 per month income threshold for charging the highest income tax rate of 35% from salaried individuals.
The recommendation, if accepted by Pakistan, would further burden the already highly burdened income group that pays tax on its gross earnings—contrary to the facility of adjusting expenses before paying taxes available to Pakistan’s richest people.
The proposals have been made as part of the Washington-based lender’s recommendations for restoring fiscal sustainability, which include measures to broaden the tax base to untaxed areas and rationalise expenditures.
It wants to limit federal spending within provincial mandates to reduce federal expenditures and improve accountability for service delivery. In a major recommendation, the World Bank has proposed revisiting the 7th National Finance Commission Award to ensure that financing is aligned with functions for provincial and federal governments.
“Within salaried individuals, the income tax exemption threshold is set sub-optimally high, leaving formally employed salaried individuals outside of the tax net”, reads the Pakistan Development Outlook report that the WB released on Tuesday.
At present, the monthly salaried income of Rs50,000 is exempt from any tax, and the lender has proposed to lower this threshold. But the recommendation is not in sync with Pakistan’s ground realities as people are being buried under inflation, which the same report projected at 26.5% for this fiscal year too.
The report further stated that the threshold for the top income tax bracket for salaried individuals is also very high, which needs to be lowered.
“The threshold for the top income tax bracket for salaried individuals is also very high and is likely to only capture a very limited number of taxpayers,'' stated the report. The government charges a maximum 35% income tax rate from people earning per month over Rs500,000. Just in June this year, the government had halved this ratio from Rs1 million per month income under the International Monetary Fund (IMF) pressure, which the WB now wants to see further going down.
In the last fiscal year, the salaried class paid Rs264 billion in taxes compared to Rs74 billion paid by Pakistan’s richest exporters. The recommendations by the World Bank and the IMF have put the country’s poor salaried class at the disadvantageous position, which may lead to social unrest.
The WB said that tax-free allowances, tax brackets, and tax rates differ significantly between salaried individuals and other taxpayers, which risks generating economic distortions and creating opportunities for tax avoidance through income shifting.
A significant tax base comprising unsalaried individuals and sole proprietors including retailers are out of the income tax net.
The lender has proposed broadening the tax base by bringing individuals and individually owned businesses, including retailers, into the tax system, reducing the tax-free threshold, and simplifying the structure of the personal income tax.
It has suggested merging the tax schedules for salaried and non-salaried taxpayers to eliminate opportunities for tax arbitrage.
On the agriculture front, the WB has also proposed to reduce the current tax-free slab of 12.5 acre to bring more agricultural land into the tax net. The farmers owning 12.5 to 25 acres pay just Rs100 per acre tax.
The lender has also proposed reforming the sales tax law, which is full of concessions mostly availed by Pakistan’s richer people and businesses.
The concessional sales tax rates should be ended by withdrawing the 8th schedule of the Sales Tax Act and there is a need to limit the zero-rating facility to exports, said Adnan Ghuman, an economist with the World Bank. He added that the sales tax exemptions should be limited to only very few essential goods.
The report noted that the sales tax system allows for concessionary rates below the standard 18% rate for select products and sectors. It also allows certain domestic supplies to be zero-rated, which further narrows the tax base. A value-added tax gap analysis based on 2019 data reveals that concessionary tax rates, exemptions, and zero ratings for non-exported products cost Pakistan 15% of its revenue potential.
All domestically sold goods mentioned in the 5th schedule of the Sales Tax Act could initially be moved to the exempt list under the 6th schedule before exemptions are also rationalised, it added.
c. Limit exemptions: Reduce items included in the 6th schedule of the Sales Tax Act, limiting exemptions only to those considered as basic food, basic public health services, and selected financial transactions.
The lender has also proposed that three different regimes of Corporate income tax (CIT) rates generate incentives for firms to split or stay small. Additionally, Pakistan provides certain firms access to a simplified turnover tax regime, which is both financially lucrative for the firms and reduces incentives for them to invest in accounting systems, business formalisation, and expansion. It has proposed rationalising the corporate tax regime too.
In order to rationalise expenses, the World Bank has recommended conducting a review of PSDP development expenditure and cancelling all projects that have not undergone proper project preparation, selection, and prioritisation. It has also proposed delaying previously vetted projects that are unlikely to bring any benefits to the poor.
The report says that Pakistan’s expenses on pension are the highest in South Asia and there is a need to constrain the growth of pension spending through automatic indexation to inflation, subject to a cap, instituting a minimum retirement age to receive benefits and circumscribing dependents eligible for survivorship benefits.
The WB said that there was a need to resurrect institutions for fiscal coordination, including the Council for Common Interests and implementing legal reforms to support a national fiscal policy.
Published in The Express Tribune, October 4th, 2023.
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