GROWTH-FRIENDLY TAX REGIME

A must to attract investment in Pakistan

To boost economic growth, to reduce unemployment rate and to keep inflation rate low: these are the three primary goals every government aspires to achieve and works for that vigorously. Pakistan’s current rates of economic growth are not encouraging. In 2006-07, GDP growth was 7 percent, but it fell to 2.4 percent in 2010-11. However, the growth rose to 5.8 percent in 2017-18. Pakistan’s fiscal deficit was 6.7 percent and debt-to-GDP ratio was over 70 percent at the end of fiscal year 2017-18. Therefore, the country’s fiscal sustainability risk is rising in view of large fiscal deficits and higher debt-to-GDP ratios, as well as fast depleting foreign exchange reserves.

Experts are of the opinion that in order to boost economic growth and achieve fiscal sustainability, the government needs to reform tax collection regime and work towards tax collection through growth-friendly policies. Prime Minister Imran Khan, while speaking at the Pakistan Economic Forum, pointed towards change of tax regime and investment policies for improving ease of doing business in the country.

The best way to reduce budget deficit is to enhance economic growth, implying more revenues. Taxation of property would not only enable the government to raise sufficient revenues, but will also pave the way for reducing income inequality; as one percent of the country’s population controls over half its wealth, with the other 99 percent struggling to survive on less than $500 annually.

There are different types of taxes on property and transfers, such as recurrent taxes on residential property, transactional taxes on the sale of real estate and financial instruments, taxes on wealth transfers (on estate, inheritances and gifts), and recurrent taxes on net wealth (assets minus liability).

Despite the fact that property taxes are relatively growth-friendly and can serve as a better fiscal tool for redistribution of resources for equity purposes, these are largely underutilized in Pakistan. There are virtually no taxes on wealth transfers, i.e. no estate duty, inheritance and gift taxes going by the poor revenue collection.

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Likewise, the wealth tax on net assets held by a person remained in force on an annual basis for quite some time under the Wealth Tax Act, 1963, but it ceased to be charged from FY2001-02.

The Capital Value Tax (CVT) on purchase of certain immovable properties (and vehicles for some years) remained operative from 1989-90 to 2009-10, but it ceased to exist as a federal tax from July 1, 2010.

In advanced economies, property taxes are an important source of tax revenue. For instance, countries like the United Kingdom, the United States, Canada, France, Japan and New Zealand raise around two percent of their GDP in revenue from recurrent taxes on immoveable property.

Similarly, recurrent taxes on net wealth, and taxes on estate, inheritance, gifts and financial and capital transactions also constitute a significant portion of tax revenues in developed economies.

And, after property taxes, the value-added tax (VAT) is relatively growth-friendly as well. Though a VAT-type GST was introduced in the country back in 1990-91, its base remains highly concentrated today. About 89 percent of the GST is being collected from top 15 commodities, including POL products, telecommunication, natural gas, services, power, cigarettes, sugar, beverages, tea, cement, scraps of iron and steel, iron and steel products, food products, motor cars and auto parts.

As a result, collection efficiency is quite low due to the large policy and compliance gap. In addition, constitutional constraints are key obstacles to developing a real VAT in the country, as GST on services became a provincial source of revenue from 2010.

The potential of the GST has also not been exploited adequately. A number of goods are exempted from this tax. Reduced rates on certain types of goods also make the effective tax rate low as compared to the standard GST rate of 17 percent. Such a GST regime also creates difficulties for effective enforcement and thus provides opportunities for tax evasion and avoidance.

Implementing a real VAT would not only improve revenue collection, but would also have a healthy impact on economic growth, as experience of other countries suggests.

However, the share of the GST in total tax revenue has increased from about 15 percent in 1991-92 to around 43 percent in 2011-12. On average, the contribution of GST to total revenue from 1991-92 to 2011-12 was 32 percent.

Income tax revenue from individuals as well as corporations is a significant source of revenue in the country. Its share in total revenue was about 20 percent in 1991-92, and increased to about 38 percent in 2011-12.

But, more than 58 percent of the income tax revenue comes from withholding taxes. However, a majority of withholding taxes are non-adjustable at the time of filing of income tax returns. And, about 33 percent of the income tax revenue is being collected in the form of voluntary payments. The remainder of the income tax (about nine percent) came through official assessment in 2011-12.

Historically, customs duty and federal excise duty have also served as a major source of revenue for the country for balancing the budget. The share of customs duty in total tax collection was 44 percent in 1991-92. However, it went down to around 12 percent in 2011-12.

This is not only because tariff rates have been reduced over time, but also because many products have been declared duty-free under WTO rules. The share of excise taxes in total tax revenue was 20 percent in 1991-92, and had gone down to around seven percent in 2011-12.