Pakistan needs to broaden its tax base

Pakistan needs to broaden its tax base

By Maleeha Lodhi | 5 January, 2013
People protest against increasing inflation in Pakistan.
Tax as a percentage of GDP has remained virtually static for decades.

Pakistan's prize for the most disingenuous response of 2012 must go to a group of parliamentarians who cast a report on MPs' tax-paying record as a conspiracy and chose to shoot the messenger rather than address the message.

The findings of "Representation without Taxation" by an investigative journalist are important, though unsurprising, in a country where less than 1% of people pay income tax. The study revealed that nearly 70% of Members of Parliament did not fulfill their legal obligation to file tax returns in 2011. 88 lawmakers did not have a national tax number (NTN). Those who paid meagre amounts inconsistent with their lifestyle included the Prime Minister and Foreign Minister.

The report's conclusion was clear: "The problem starts at the top. Those who make revenue policies, run the government and collect taxes, have not been able to set good examples for others."

The reaction from most parties in Parliament was of indignant denial. Many castigated the report as an effort to "defame politicians". Others wrapped themselves in victimhood. "Why pick on us, why not others?" said one, as if "others" could serve as alibis for their malfeasance.

Instead of this transparent bid to obfuscate the issue, parliamentarians would have been better off welcoming a debate, admonishing tax-dodgers in their ranks, and above all highlighting the serious consequences that flow from the state's inability to collect taxes. They should have examined why the country lacks a tax culture and propose ways of addressing this.

Pakistan's tax to GDP ratio of less than 10% is at the heart of its enduring fiscal troubles. Failure to generate domestic resources is a major factor for economic stagnation and why the economy is in the critical ward today.

A decade ago, a task force established to reform the tax system held out a stark warning: "Pakistan's fiscal crisis is deep. Taxes are insufficient for debt service and defence. If the tax to GDP ratio does not increase significantly Pakistan cannot be governed effectively, essential public services cannot be delivered and high inflation is inevitable. Reform of the tax administration is the single most important economic task for the government."

This counsel has long been ignored. As a result Pakistan has been trapped in perpetual financial crises.

The sorry state of tax efforts is laid bare by the dismal statistics. Tax as a percentage of GDP has remained virtually static for decades. At 9% it is among the lowest in the world.

The number of income taxpayers remains abysmal. In 2011, the number of people registered with tax authorities through NTNs was 3.1 million. But only half or 1.5 million filed returns. The number of income taxpayers actually dropped from 1% of the population to 0.92% in the past five years. Only 17% of 4.5 million taxable Pakistanis — one in six — are verifiable taxpayers. The rest do not pay tax.

A more fundamental issue is the large swathe of the formal economy that is still untaxed. The most spectacular example of a privileged elite's refusal to pay is the absence of an agricultural income tax. Agriculture accounts for around 20% of GDP but yields little more than 1% of total revenue. The service sector, which now contributes the largest share to GDP — around 50% — contributes just 16% to revenue. This means that at least 70% of the formal economy is untaxed, lightly taxed or non-compliant.

The present tax regime is inelastic but also inequitious, putting a heavier burden by way of indirect taxes on those least able to bear it, while offering the powerful "legal" escape routes. Inability to raise enough direct taxes has led to reliance on indirect taxes, many of which are regressive. For example, Pakistanis pay a greater proportion of their income as tax on petrol than any other country in the world.

To resolve its chronic fiscal crisis and generate the means for its future progress Pakistan has to raise more revenue. Unless the present 9% of GDP is increased, reliance on deficit financing through borrowing, with all its pernicious economic effects, cannot be ended. This is essential to reduce inflation, the cruellest "tax" on the poor.

The key question is this: how can Pakistan chart a way out of a growing fiscal crisis and overcome economic stagnation without broadening its tax base? Parliamentarians ought to focus on answering this question rather than assailing those who only held up a mirror to their conduct.

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