The federal government finally unveiled its long-awaited tax policy by formally announcing a 5-point ‘tax reforms’ package last month. Later, President Mamnoon Hussain promulgated as many as 4 different Presidential Ordinances to give effect to this tax reform package. Besides a one-time tax amnesty scheme, a substantial reduction in the income tax rates is another prominent feature of these so-called tax reforms. A lot of has been said and written about the incumbent government’s controversial tax amnesty scheme, but, unfortunately, the government’s decision regarding significantly altering the minimum threshold of income tax liability has yet not been properly analyzed and adequately discussed. This decision will give rise to an unprecedented three-fold increase in the income tax exemption threshold. This decision would adversary affect the already-troubled direct taxation regime in the country.
It essentially shows the seriousness and sincerity of the PML-N government about improving the miserable state of our direct taxation system.
Based on the ability-to-pay principle, a direct tax is paid directly by an individual or organization to an imposing authority. Unlike an indirect tax, this tax can’t be passed onto a different person or entity. Indeed, this equitable principle of direct taxation is a cardinal principle of any good taxation system. Pay As You Earn (PAYE) is an important form of direct tax whereby an employer deducts income tax from an employee’s wages before paying them to the employee and sends the deductions to the government. On account of its justness, propriety and reasonableness, direct taxation is a preferred taxation system in the civilized world. This is the reason direct taxation is currently taking precedence over the indirect taxation in many developed countries in the world where direct taxes form the major part of the tax revenues. In UK, the direct taxes (income tax, national insurance contributions, property tax, corporation tax etc.) constitute more than 60% of the country’s tax revenue. Regrettably, the state of direct taxation in Pakistan is anything but satisfactory. Direct taxes constitute only around 12% of the tax revenues in Pakistan. In our region, Bangladesh has achieved an impressive target of direct tax collection which currently stands at 47% of government revenues. Similarly, India collects one third of its tax revenues through direct taxes.
There has hardly been made any serious endeavour to improve the poor state of direct taxation in Pakistan. The incumbent PML-N has been vowing to improve the direct tax collection for the last five years. However, in this respect, its measures have just been revolving around ‘filers’ and ‘non-filers’ of income tax returns. Now, it has visibly abandoned its policy to improve direct taxation through its recent decision to enhance the minimum income threshold for income tax from Rs0.4 million to Rs12 million. This is indeed a significant reduction in the income tax rate which will certainty affect the direct taxation in Pakistan. So, out of 1.45 million people who have filed income tax, now more than five hundred thousand taxpayers will either be filing no tax return or simply be paying a nominal amount of upto Rs3000 as annual income tax. Thus FBR would instantly lose a substantial amount of its revenues. Therefore, this taxing decision will result in substantially eroding the FBR’s direct tax base which is already not in a healthy condition.
In the absence of an efficient tax regime and any healthy tax culture in Pakistan, there is a common phenomenon of tax noncompliance in the form of tax evasion and tax avoidance. Similarly, there also doesn’t exist any effective direct taxation mechanism. So, the successive governments have been considering it quite expedient and convenient to impose certain indirect taxes to overcome their revenue deficit. Currently, there exists an extensive indirect tax regime in the country in the form of sales tax, federal excise duty, customs duty etc. This practice has just given rise to a sort of cost-push inflation in Pakistan. This unjust taxation has constantly been impairing the purchasing capacity of the lower and middle income groups, which are otherwise not liable to pay taxes under the normal tax regime.
It is quite ironic that direct taxes in Pakistan are also being levied and collected in an indirect way. Obsessed with the indirect mode of taxation, our economic managers and tax planners have transformed the country’s meagre direct taxation system into indirect one. So, now an intensive presumptive tax regime is part and parcel of the income tax in the country. Income tax is a major and the most significant direct tax collected by the FBR in Pakistan. A large number of advance withholding and transactional taxes are being collected in the name of income tax. These withholding and transactional taxes are being collected through certain withholding agents in the same manners as Sales Tax and other indirect taxes are generally collected. Similarly these adhoc taxes hardly confirm to the so-called ability-to-pay principle, which is the fundamental principle of direct taxes. These repressive taxes should certainly not be part of the country’s direct tax regime.
There should have taken some serious and effective measures to significantly broaden the direct tax base by bringing the affluent and non-tax paying individuals into the tax net. However, the incumbent PML-N government has done just the opposite. Through its newly-introduced ‘tax reforms’, it is going to help potential taxpayers evade or avoid income tax. In order to achieve its tax revenue targets, the government will certainty have to resort to indirect taxation, which simply means price hike and more trouble to the overburdened taxpaying consumers.
In addition to an efficient tax regime, there also requires a healthy tax culture to improve the state of direct taxation in Pakistan. There are generally two components of a tax regime- a set of stringent taxation laws, and an efficient tax administration to effectively enforce these laws. This sort of tax regime essentially ensures the adequate and prompt collection of taxes. Like most of the countries in the world, in Pakistan too, the tax reforms primarily revolve around the tax regime while ignoring altogether the other important aspect- the tax culture. Usually, in the absence of a healthy tax culture, even an efficient tax regime may also fail to perform well by missing the ‘tax targets’. Therefore, for a tax regime to be successful, it should necessarily be compatible with its tax culture.
We direly need to improve the dilapidated state of our taxation system. Currently, there are numerous flaws and shortcomings in our tax collection mechanism, including the widespread corruption and inefficiencies prevalent within the tax collecting agencies. So, all the loopholes in our taxation system must be plugged. The economy of the country should be properly documented. Instead of introducing any controversial and unjustified tax amnesty schemes and unnecessarily allowing tax holidays and exemptions to potential taxpayers, the government should try to evolve an effective, efficient and just direct tax regime based on the fundamental ability-to-pay-principle. Those who are liable to pay taxes should be made to pay taxes rather than those who are not supposed to bear this cumbersome tax burden.
The writer is a lawyer and columnist based in Lahore.