Tax Efforts

M. Ali Kemal

Introduction

• Very low tax – GDP ratio

• Mostly relies on consumption taxes

• Low revenue collection then results in inflation tax as an alternative to raise revenues.

What’s in the Studies• Undocumented Economy

– Problem: Not under a tax net

• More than 50 percent of the informal economy is documented• Exemptions given to Agriculture income, KPK, certain

industries– Problem: Increase tax evasion

• Low tax revenues is the problem of enforcement Gordon and Li (2005)

• Large majority remain out of tax net because of overall low average incomes Bilquees (2004)

• Relying on taxing goods and services-Developing Countries and relying on taxing income profits and capital gains have better performance Gupta (2007)

Determinants of Tax Efforts

• Tax-GDP ratio is a proxy to tax efforts• Income (Wagner Law)• Openness (Rodrik, 1998)• Share of value added sectors• Underground Activities

• see for example Tanzi (1981, 1987, 1992), Leuthold (1991), Tait and Eichengreen (1978), Chellian et al (1975), Bahl (1971), and Etony (2002)

Structure• Direct Taxes

– Income Taxes: • 0, 5,10,15, and 20

– Corporate Taxes: • 25 for small companies and 35 for bigger companies (30 % new)

– Withholding tax• Dividends: 10 percent if they are above 10,000

– Capital Gains Tax • 10% (< 6 months holdings) and 8% (6-12 months holdings)

• Indirect taxes– Sales Taxes: 16 percent (17% new)– Excise Taxes:– Custom Duties: Normal maximum tariff rate is 20 percent

IMF Programs• Tax Concessions in 1980s leads to higher fiscal deficit

– 8.5% of GDP by 1987-88

• Pakistan had a chain of stand by, structural adjustment and stabilization agreements with IMF.

• Special focus on tax reforms including – Improved tax governance– Increasing share of direct taxes– Expanding the tax net– Imposition of sales tax on wider scales &– Improving the tax elasticity and buoyancy

Reform means change the tax structure by broadening the base and remove anomalies

from it.

It is not necessary that tax reforms are beneficial in increasing the tax revenues. It

could be done to rationalise tariff structure in favour of people and overall structure of the

economy.

One reason is to mobile resources.

REFORMS

Commissions and Reports• Report by the National Taxation Reform Commission (NTRC) (1986)

• Report by the Resource Mobilization and Tax Reforms Commission (1994)

• The Strategy Document on Tax Reform (2001)

• Report on Income Tax Law Reforms (2001) by Committee to Revise Income Tax Ordinance, 1979 (CRITO) –WITHOLDING Taxes

• Several Reports by the Task Force on Reform of Tax Administration (2001)

• Strategy and Priorities for Tax and Customs Administration Reform (2001)

• Pakistan: A Preliminary Assessment of the Federal Tax System (2006) and

• Tax Policy in Pakistan: An Assessment of Major Taxes and Options for Reform (2008)

Tax Reforms

• Tax reforms efforts since 1990s• Share of direct taxes in total tax revenues – 17.3 percent in 1990-91 and 35.28 percent in 2010-11

• Share of indirect taxes in total tax revenues – 82.7 percent in 1990-91 and 64.72 percent in 2010-11

• Share of sales tax in total tax revenues – 15.4 percent in 1990-91 and 37 percent in 2010-11

• The reform efforts remained ineffective due to the inherent weaknesses in the tax system and an ineffective tax administration – Economic Survey (2007-08)

Data• Tax variables: Central Board of Revenue and Economic Survey• GDP, Per capita income (in dollars), agriculture, manufacturing

and services: 50 years of Pakistan Statistics and Various issues of Economic surveys

• Exports and imports: International Financial Statistics• Underground economy as percentage of GDP: Omer and

Kemal (2016)• Period: 1974 to 2014• Share of value added sector is calculated by dividing each

value added sector with GDP. • Openness index is calculated by adding exports and imports

and dividing it by GDP. • Tax ratios are calculated by dividing each source of tax

revenues with GDP.

Buoyancy Elasticity

Mukarram (2001)

Shaikh (2012)

Rasheed (2006)

Bilquees (2004)Mukarram

(2001)

Bilquees (2004)Long run

Short Run

Long run

Short Run

Direct taxes 1.61 - - - - 1.13 - -Custom Duties 0.55 - - 0.48 -0.06 0.32 0.43 -0.2Excise Duties 0.76 - - -1.19 0.48 0.47 0.44 0.06Sales Tax 1.51 - - 1.41 0.42 0.99 1.5 0.38

Total Taxes 1 - 0.174 0.92 0.44 0.64 0.88 0.33Income and Corporate Taxes - 1.17 - 1.23 0.4 - 1.21 0.31

Correlation

Total tax revenues Direct taxes Indirect taxes-80.00%

-60.00%

-40.00%

-20.00%

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

Per capita Income Underground Economy Openness AgricultureManufacturing Services

Econometric Analysis• ARDL Approach of Cointegration by Hashem

and Pesaran (1997)

• Lags are chosen using AIC • General-to-Specific Methodology is used after

choosing appropriate lag length

TestJoCondition

xyxyy

CaseVariablesTwoFor

t

n

iit

n

iitttt

int;0: 21

14

1312110

Dependant Variable Total Tax Revenues

Direct Taxes

Indirect Taxes

Log (Per Capita Income)t-10.10

(0.86)0.97

(4.32)0.16

(1.59)Log (Openness)t-1

-0.66(-5.65)

-1.23(-3.40)

-0.67(-3.34)

Log (Manufacturing/GDP)t-1-0.45

(-2.64)-0.74(2.58)

0.46(2.92)

Log (Services/GDP)t-1-0.64

(-0.82)-5.97

(-3.59)-2.53

(-3.22)Log (Underground Economy/GDP)t-1

0.25(4.59)

0.77(6.58)

-0.04(-1.44)

Dummy – 1987 0.06(2.96) - -

Dummy - 2003 -0.18(-2.50)

0.24(2.29) -

Error Correction -0.52(-3.07)

-0.43(-3.52)

-0.424(-2.43)

Conclusions• Since the recent tax reforms of 1990s share of direct taxes has

substantially increased • Due to swapping of Custom and excise duties share of sales tax has

increased• Overall indirect taxes as percentage of GDP has declined. • Higher income is positively associated with Direct taxes but not with

overall and indirect taxes. • Openness is negatively associated with the tax efforts.• Share of manufacturing according to the expectation is positively

associated with the indirect taxes– Coefficient is less than half– The sector must be evading taxes

• Services sector is mostly part of informal exempted sector – Hurting both direct and indirect tax revenue efforts

• Indirect/consumption taxes are difficult to evade than direct taxes.

PML-N Government wants to increase the Tax-GDP ratio to 15 percent of GDP. Currently it is 9

percent of GDP

In addition to increase revenues…

• Equitable tax policy – Policy constraints • Efficient tax administration• Facilitation to taxpayers• Introducing ICT technology• Broadening the tax base• Increase income tax filers• Anti evasion efforts

Problems of Taxation• Tax base is not broad, 760,000 people are in tax

net (Less than 1 percent of the population)• 3.2 million potential taxpayers are now identified – Problem

• What do you call it, no voluntary compliance or lack of implementation– 47800 companies have NTN #s and 16500 filing tax

returns (Kardar, 2013)– 400,000 industrial electricity connection (Kardar, 2013)– 3.2 million commercial electricity connections and

50,000 file tax returns (Kardar, 2013)

Problems• Frequent reversals of administrative reforms• Lack of political will in maintaining fiscal discipline• Poor expenditure management, reduces desire to pay taxes• Delays in the system of enforcement• Political interference in important policy decision such as

implementation of agriculture income taxes• Low tax compliant culture• Mafias• Automation constraints (technical as well as administrative)• Undocumented economy• Sectoral contribution of GDP• Lack of proper training of tax auditors and other staff

Turkey

• Improve tax stability• Transparency• Equity• Minimise distortions

Success Story – New Zealand

• Single VAT system• Base Broadening• Low Rates• Closure of Loopholes• Removal of Distortions

What FBR Chairman Says…?

• Tax evasion• Excessive tax exemptions• Administrative weaknesses• Narrow tax base• Poor compliance by taxpayers• Too much centralization• Adverse taxpayers perception • Mismatch between sectoral shares in tax and GDP

ratio.

Suggestions …• FPCCI President said to pursue more people into

the tax net, all taxpayers should be issued a card on the pattern of credit card with the title FBR National Identity Card– taxpayers should be given one percent concession on

all transactions, government payments, utility bills and government challans while non-taxpayers should be charged one percent additional on all such transactions.

http://www.pakistantoday.com.pk/2013/05/01/news/profit/tax-reforms-necessary-for-economic-revival/#sthash.y7qkFhmn.dpuf

Solutions…• Good tax administration is only possible when – Tax administration is well educated and trained, – Handsome wages are paid to the administration and – Better equipment [Tanzi and Zee (2000)]

• Exemptions should be stopped (Kardar, 2005, 2012 & 2013) Everyone should be taxed on their income irrespective of their source.

• SROs should be abolished• Reduce income tax rates (0, 5%, 10%, 15% & 20%)• Governance structure• Less Centralization (Nasir Iqbal (2012))

Solutions …

• Documenting the undocumented sector– Solution as well as a problem

• FBR autonomy– Work under independent board of directors, which should be

the professionals• E-Governance Structure• Punishment System (imprisonment and fines) – Fines reduce tax evasion activities (Qasim 2011)

• Effective Audit System• Raise Pays• Monetize Perks

Prepared by Barrie Russell at the IMF• Improving tax compliance requires long-term reform efforts

– Strengthening the organization and management of the revenue agency– Implementing robust collection systems (e.g., payment and withholding

systems) – Building capacity in core tax administration functions (registration, fi ling and

payment enforcement, debt collection, audit, taxpayer services, and processing of appeals).

• Reform of the legal framework and judiciary to ensure that the necessary powers, penalty regimes, and dispute resolution processes are in place.

• Increasingly, information and communications technology (e.g., through automatic gathering of third-party information as a by-product of natural business processes; use of electronic invoices to facilitate real-time transaction monitoring and verification; and analysis of revenue risks).

• Reform priorities to improve tax compliance differ across countries and regions

• Taxpayer service operations and effective audit and enforcement should be the first step

WB TARP

• THE government of Pakistan subscribed to the World Bank’s Tax Administration Reform Programme (TARP) to fundamentally reform the Federal Bureau of Revenue ‘for a more efficient and effective revenue administration system’.– December 2004 - December 2011 – Costing $149 million. – The amount included a World Bank loan worth

$102.90 million which was to be borne by the taxpayers of Pakistan.

Another Program… Should we do it?

• Support for good governance in Pakistan – tax reform

• Overall term: 2010 to 2020• Commissioned by: German Federal Ministry

for Economic Cooperation and Development (BMZ)

http://www.giz.de/themen/en/35156.htm