Taxes are widely used to support a range of government policies besides raising revenue for balancing budgets. Normally, taxes are levied to promote desirable economic and social activities and to discourage those activities that are considered harmful by a society.
Economically and socially, direct taxes, owing to their neutral and progressive nature, are preferred over indirect taxes. Like many other countries, tax authorities in Pakistan generate tax revenue from direct and indirect taxes. However, unlike many other countries, share of indirect taxes in the overall federal tax receipts is considerably high – more than 62pc as compared with 38pc of direct tax revenue – which signifies that low-income segment of the society bears higher tax burden as a proportion of its income.
To create a just society, a policy change from indirect taxation to direct taxation is urgently required. The best way to increase direct tax revenue is through voluntary tax compliance (hereinafter VTC).
To promote VTC and making it efficient and cost-effective, self-assessment schemes have been implemented in many countries as a fiscal tool to collect revenue through direct taxation with minimal intervention of tax authorities. Following its merits, Pakistan adopted universal self-assessment scheme, effective from tax year 2003, for all taxpayers to promote VTC in the country. Pursuant to Section 120 of the Income Tax Ordinance (ITO), 2001, all taxpayers are empowered to assess their income, expenses and to pay tax by themselves by means of filing tax returns.
Self-assessment scheme was launched on the premise that taxpayers will declare their correct taxable incomes and will thereupon pay due taxes. However, the scheme does not, so far, seem so successful in improving tax collection owing to advances and with tax returns. Just look at the evidence; less than 29pc of the total direct tax revenue was collected through advances (25pc) and with tax returns (3.2pc) during 2015-16.
A number of external and internal variables influence VTC. External variables such as tax rates, probability of audits and severity of fines affect taxpayers’ compliance behaviour. Similarly, internal variables e.g. taxpayers’ knowledge of tax laws, their attitudes toward the government and taxation, personal norms, perceived social norms and fairness, also have strong influence on voluntary tax compliance.
Taxable persons easily make compliance of tax laws if they have better understanding of the tax system. It is because detailed knowledge and positive attitudes contribute to trust in tax authorities and consequently improve VTC. Poor knowledge can create distrust and negative attitudes toward tax, whereas better knowledge of taxation can evoke positive attitudes. It has been empirically found that poor knowledge on the tax system breeds distrust.
Personal norms such as honesty and religious beliefs have positive impact on tax compliance. Similarly, social norms are among the most important predictors of tax compliance as people with a high sense of civic duty comply with tax law. People tend to correlate taxes paid with the amount of public goods received. In other words, tax compliance increases if taxpayers have feelings of fairness and procedural and distributive justice.
Equity and fairness of the tax system is an important determinant of voluntary tax compliance. Heavy tax exemptions and concessions to some sectors, or some taxpayers, leave tax system inequitable and unfair in terms of tax burden. If some taxpayers’ income is exempted from tax, the rest will share high tax burden to meet tax revenue target. It is empirically found that high tax burden have negative impact on VTC.
Owing to limited tax capacity in terms of number of tax administrators and skill level of tax authorities, the rich individuals, or those with high net worth, are not being taxed in accordance with their capacity to pay. Such a lopsided taxation has resulted in increased income inequalities in the country.
Taxpayers tend to comply with tax rules if it is easier and cheaper for them to pay taxes. However, taxpayers in Pakistan spend too many hours on paying taxes, filing tax returns, maintaining records and obeying other administrative orders. It is empirically found that investors shy away from investment in a country where either tax burden is relatively high or tax system is unfair and complicated. Despite that the Federal Board of Revenue (FBR) has adopted a series of measures such as online registration, e-filing, e-payment and e-notices to facilitate firms for filing and paying taxes, the country still lags far behind others in the list of 189 countries in terms of time to comply tax procedures – even higher than the world average. For example, taxpayers in Pakistan require 594 hours including 40 hours for each corporate income tax and labour taxes and 514 hours for consumption tax for paying taxes. On the other hand, average number of hours required for paying taxes in the Asia-Pacific countries is 229.
Lack of transparency and rampant corruption in the fiscal system are the other reasons for low and declining VTC. The National Accountability Bureau (NAB) has estimated corruption in Pakistan up to Rs 7 billion a day. Making the governance system transparent and public service-oriented is important for improving VTC.
To promote VTC, it is suggested to introduce structural tax reforms to develop a more equitable, efficient, effective, neutral and economically productive tax system. It is necessary to bridge the tax policy gap as well as the tax gap arising from weak enforcement by strengthening current enforcement mechanism through administrative efficiency and capability. Minimum exemptions require to be incorporated in the ITO, 2001, to provide level playing field to all sectors of economy to minimize distortions in the economic system.
At the same time, extending good tax services to taxpayers besides strengthening audit and enforcement is essential to increase tax collection through VTC. These services may include tax guidance, education, consultation, etc. Though such services exist in the taxation system, there is a considerable scope for improvement. Listening to public opinions and suggestions could improve mutual understanding and trust between taxpayers and tax officials and this has to be maintained at each level of tax management.