Taxation in Pakistan is a very complex system including more than 70 different taxes and nearly 37 different government agencies administer the tax system. Around 10 million people are registered to pay taxes but only 1.9 million people pay taxes [1]. In 2002, Transparency International studied 256 respondents, among which 99% were facing corruption regarding to taxation. Furthermore, 32% of respondents were paying bribes to lower their tax assessment, and around 14% reported receiving fictitious tax assessments [2]. Pakistan is one of the developing countries where tax to GDP ratio is very low. (Exhibit 1)
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From 1947 the sales tax was introduced at provincial level which was covering a limited area of commercial activities. In 1951 it was converted into a federal tax in 1951. The Government of Pakistan setup a National Tax Reforms Commission in 1985 to provide recommendations to improve the taxation system in Pakistan. The Commission submitted its final report in December 1986. As a result, the Sales Tax Act was introduced in 1990, it was a value added version named as General Sales Tax (GST). In 1995-96, GST was transformed into a complete VAT mode tax with its basic structures. In 1997-98 the tax base was extended to importers, retailers and wholesalers. GST was only covering the goods before 1990, which later on covered the services sector also. Tax collection was increased from 1990’s to 2000’s collecting US$ 2.67 billion in the recent years.
Comparing With Some Similar Economies [3]
The Indian economy is the 2nd fastest growing economy of the world and 12thlargest in term of exchange rate. Although, India does not have impressive track record in the growth of revenues, rising from6.8% of GDP in 1950’s to 10.3% in 1990’s and maximum of 12.9% in 2009. But the important thing is that the tax-to-GDP ratio is increasing constantly from 2004 onward. On the other hand, tax-to-GDP ratio in Pakistan has a declining trend from peak 13.2% to 8.9 in 2009. (Exhibit 2)
Sri Lanka has been facing a worsened law and order situation since early 80’sand economy of Sri Lanka showed a very low GDP growth. Although, tax revenues as compared to GDP has decreased in Sri Lanka but still they have high rate of 14.3% which is higher than Pakistan. Sri Lanka has coped with the problems in economy by focusing on its Tea exports, Tourism sector. Furthermore, government has also tried to improve the revenue collection. (Exhibit 3).
Sweden is considered to have highest tax-to-GDP ratio in the world. Tax revenues in Sweden have touched a highest level over 50% of GDP. The personal income tax rate is highest in Sweden which is about 56.4%. Tax rate is progressive for the personal income in Sweden while in Pakistan we are facing a regressive taxation. (Exhibit 4)
Reasons of low tax to GDP ratio in Pakistan
There are several reasons why we are unable to collect the tax. Corruption is one of the important aspects which are casting great hindrance in taxation system. Other important reason is low literacy rate, which is very low as compared to many countries in the world.(Exhibit-5Literacy).Demography of a country also play an important role in the tax to GDP ratio. Pakistan has about 36.7% population which is 14 years of age or below. Hence working class is not growing to generate taxes. Terrorism, law and order situation, poverty and unemployment are also playing important role in low tax collection. Tax base in Pakistan is stable at 1%, on the other hand tax base in USA is about 24% and it is 20% in Malaysia. Tax policy is also not suitable in order to generate taxes and to extend the tax net. Another problem that we are facing is documentation of economy; nearly 52% of our economy is undocumented. Audit and enforcement is so weak in Pakistan that the audit agencies themselves are involved in corruption. Looking at different sectors, we can see agriculture has above 20% share in GDP but tax collected from this sector are only 1% of total tax collection. In this way contribution of different sectors is not properly distributed. Political influence is also a big hurdle in the taxation system. [4]
Main Concern of Pakistan’s Tax Policy
Government collect taxes from its people in order to spend the collection on the welfare of its people which includes national defense, debt servicing and other welfare related issues. While designing the tax policy a country should account the equity and justice for its people because a system is most effective when it is designed on the bases of equal and fair treatment of each tax-payer. But in case of Pakistan the situation is bit different, as a nation we are in debt by the foreign and domestic lenders which is due to our extra expenses incurred due to recent war on terror, our habit of corruption at national and international level and we are also tax averse society in which we don’t feel ourselves responsible to pay taxes.
Our current tax collection system is very weak which comprises of loopholes in the system accompanied by the corruption of Federal Board of Revenue (FBR) officers which speaks about the justice and equity of our government officials for their people [5]. After analyzing the height of corruption, special favor given to government officials or their friends, our undocumented economy and failure to increase tax net it has become necessary for any lender to set the target in order to continue the money lending and to make sure that their borrowed money can be repaid by the borrower.
Initially the foreign lenders did not set any targets for us because they somehow believed in our commitments and also felt that we will pay them back their money as per the signed agreement but after the several failures of debt servicing, lenders started to analyze the root cause of this issue in which they found our tax collection system complied with old methodology of taxation i.e. General Sales Tax (GST) in which all the tax collected at the last stage which makes them aware of the fact that as a corrupt nation and low tax net economy it will become more difficult for them to collect their lent amount from us which lead IMF to set targets for us[6].
The reason they feel our system is outdated because now most of the countries in the world including the developing countries are eliminating the loopholes in tax collection system by introducing the Value Added Tax (VAT) and by increasing the tax net through VAT. Now the question arises what are the reasons for government to obey the rules set by International Monetary Fund (IMF). Firstly, we do not have enough liable system and funds by which we can manage our economy because of which we need IMF’s support so that we can run our affairs smoothly. Secondly, reforming Pakistani taxation; certain actions such as reestablishment of the State Tax Organization, restructuring the law of direct taxation, introducing and implementing the value added tax, as a complimentary to the reformation of the existing law of direct taxation and as an efficient and co-ordinate tool with the economic situation of the country has been taken in to account. Also, In General Sales Tax (GST) which is based on the percentage of sales, State loses 100 percent when someone evades tax whereas in Value Added Tax (VAT), a taxation system in which tax is applied in production process whenever the value is added to the product, if tax is evaded at one value addition stage government loses only some part of the tax
Another reason for suggesting implementation of the value added tax is that, it is a suitable substitute for many other duties and indirect taxes, which has vast distortion effects on the productive sectors and on the welfare and behavior of the consumers. Omission of the indirect taxes and duties causes great decrease in the government revenues. Thus, the value added tax, in addition to compensating the income decrease of the government, can also increase the government tax revenues.
VAT also justifies itself more effectively because by implementing VAT it will result in the increase of tax revenues and also help to decrease the pressure on taxation for production sector also better for the investment by the adjustments in the income tax rates. It will also reduce the time and costs related to tax collection and also bring the sense of participation among the peoples [7].
On the proposal for introducing VAT in Pakistan by the government officials there was a huge resistance from the opposition parties because the main negative effect of VAT in economy of Pakistan is the need of accounting which needs to be done which will also effect on the accounting which business might need to perform. It affects small businesses because such business may lack in terms of accounting proficient peoples in order to track the tax of business.
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It is also highlighted by opposition that VAT will also result as a regressive tax policy in which rich person will get a fair deal by transferring their tax burden upon the poor people which will ultimately cost a lot for the poorer one but after analyzing the research paper of so many author we came to understanding that initially at the time of imposing VAT for the first time such problems do occur but there are also some ways by which government can address these issues. And it is also the reason that some of the critics of VAT states that it will also lead to inflationary price level which will hurt the economy as a whole but this is not as much true because the rationale behind VAT states that it will create the deflationary effect on the economy which will result in stable or low price as the time passes. And to respond the previous critic of VAT about being regressive policy, we can compensate the low salary class of people by introducing new tax policies which could help them particularly [8].
The main concern of Pakistan’s tax policy is to increase the tax revenue which can only be done through applying VAT in which tax can be collected at every level whenever the value has been added. Its positive effects are more as compare to the reasons for resistance which government is facing in order to reinforce it and these resistance are natural because if we see other countries who are same as Pakistan have also faced the similar kind of issues while implying their tax system from GST to VAT and not just that but also we are running out of funds for which we have to comply with the requirement of Foreign Lenders i.e. IMF so that we can manage our economical issues comfortably.
In the long run perspective, the VAT will not just increase our tax net but also make us self sufficient in terms of managing our self and we will also be able to service our debts which will results us as a freedom from the loan from IMF in the coming time period.
Only critical fact which needs to be address while setting the tax policy on VAT is the corruption related matters which can be minimized by the VAT by its own self but government should also take some initiative while dealing with VAT implementation face because it’s more easy and possible to cheat if VAT is the system but on the other hand it will just miss the percent of Value Addition while on the other hand GST miss the whole hit if the tax payers manage to get rid of tax.
Comparison of Complex VAT with Simpler GST
As we know, in GST, tax is charged as a fixed rate at the end of supply chain where as in Value Added Tax system, tax is charged at every value addition stage so suppliers/vendors in the middle stages of production can evade tax by not registering with Financial Bureau of statistics. In VAT system, for example If a stage two supplier is not registered with FBR and supplies goods to third level in value addition and FBR takes information about the production of good from level three vendor, the tax evader at level will be tracked sooner or later. The world experience has showed that VAT induces a strong tax culture. Under GST system, due to tax evasion, tax gap in 2010-2011 was 79 percent [9]. One way to stop organizations from evading tax is heavily penalizing them. For example if the organization has already filed a tax return and fails to pay the tax liability or evades it should be penalized on daily basis. If a person registered with VAT fails to file return, under section 88 of the Federal VAT Bill 2010, value added tax liability will increase. If the tax return is not filed within fifteen days of due date, the supplier would have a penalty of Rs.1, 000/- for every day of default. Penalties on failing to pay the taxes would help collecting tax and there would be an incentive for organizations to pay taxes on time because if they do not they will be charged more [10]. Also the suppliers in the supply chain who are not registered with FBR will not be in a position to claim the tax paid at purchase levels. The in-built invoice based credit of VAT will promote economic documentation. Tax invoice is the most important and significant feature of VAT-induced documentation. VAT has self-assessment features and records business transactions through tax invoicing.
Today Pakistan is facing a problem of undocumented and black economy. More than 30 %, calculated by electricity consumption approach, of Pakistan’s total economy is undocumented resulting in low tax revenues which in turn results in increasing tax rate and increasing tax burden on people who fairly pay their tax dues [11] see exhibit 7. VAT, with its features of penalizing and mandatory documentation of business activity, will help eradicate the norm of black economy from the nation.
When in 2010 implementation of VAT was proposed, online registration of tax payers was also proposed. Difficult and rigorous registration is also one reason of people and businessmen not registering for tax. Historically as well as in present registration, under GST, has been a troublesome process because of which people avoid it hence huge amount of revenue is lost by government. If VAT is introduced, registration would become easy and those who do not register just because of the complicated process would start listing themselves which would eventually increase government revenues and its ability to pay off debt.
It is also a general concern of people that the cost of compliance would increase dramatically if the VAT is implemented; this however, is not true. There will be no effect or increase in compliance cost of producers already registered/operating under GST regime and will automatically switch to VAT. But the new taxpayers who are not yet registered will have to pay nominal expense for VAT compliance. Because of IT- based VAT processes, cost of VAT compliance usually remains low for the taxpayers who release their tax obligations regularly on fair lines. [12]
One of the reasons Pakistan has not been able to progress as much as other emerging countries have is because of the lack of proper infrastructure, low quality of education, and lack of government’s ability to spend on public welfare. Almost all of the tax collected by government is spent on either defense or on debt servicing. The stage has come when Pakistan needs loan to pay its loan payments. With VAT the state would be able to collect more taxes with which Pakistan will be able to repay its loans sooner. Once Pakistan pays off all the loans it will be able to spend on infrastructure and improve quality of education. Better infrastructure and education would attract foreign investments which will increase GDP and eventually increasing the tax base; there has been a decrease of more than 3000 million $ from fiscal year 2007-2008 to 2009-20010 in FDI see exhibit 6. According to VAT law there is no difference between retailers and wholesalers. It also does not define manufacturer or manufacture. Every person, who is part of the production supply chain, is required to get registered with VAT if he/she is engaged in carrying out business activity of making supplies of taxable goods/services. Under GST only some of the industries are charged tax. For example, cellular services account for more than 80% of the total GST collected, rest of the country’s industries pay less than 20% of the GST revenue.[13] See Exhibit 5 . Now one problem could be that organizations tend to avoid taxes especially when VAT is practiced in the economy. But with the negative effects, payment of taxes has positive consequences as well; paying taxes improves the credibility of organization. People tend to purchase from organization that are ethical enough to pay its due taxes, it is most beneficial for small companies. If small organizations mention on their sites that the company is a regular tax payer, it will not just improves its credibility but will also enhance its ability to compete with larger firms.
Tax refund is also a major problem under GST regime, VAT, however has a solution to it. Under VAT system refunds will be paid through speedy Refund Payment System. The system has already been set-up for exporters from the tax period April, 2010 onwards. Under this upgraded system electronic refund payments will be made directly in the bank accounts of the taxpayers. This new refund system will be expanded to cover all other classes of refund claimants in due time. Thus, VAT is the most appropriate tax system for Pakistan as it has the ability to deal with tax refunds without taking much time, its ability to track un-registered business entities, and its ability to increase government revenues and reduce tax gap.
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