A look at the factors that affect its success
Many countries have introduced self-assessment for income taxation to encourage voluntary compliance so as to engender more efficient and cost-effective tax administration. Pakistan adopted universal self-assessment for all taxpayers in 2002-03 to ensure voluntary compliance for income tax collection.
Under the self-assessment system, a taxpayer is required to assess his tax liability using a tax return form wherein he declares his gross income, allowable deductions and net income. This tax return must, then, be filed either electronically or manually with the tax authority together with prescribed annexure, statements, and documents. Thus the basic feature of a self-assessment scheme is that it is the taxpayer rather than the income tax authority that assesses his tax liability. There is no checking of the return before assessment.
Assessment of the System
Based on a decade’s experience, it appears that voluntary compliance has not taken root in the socioeconomic and political setup of Pakistan, which is evident from the following reasons:
In Pakistan, tax return-filers represent around one percent of the total population. In similar economies, the number of tax return-filers as a percentage of population is much higher compared to Pakistan, not to speak of tax return-filers as a percent of population in advanced economies being much higher.
The low level of taxpayer compliance in Pakistan is evident from the fact that there is a significant number of individuals, associations of persons (AOPs) and corporations that do not file tax returns, despite their being liable to do so under section 114 of the Income Tax Ordinance, 2001. Furthermore, there is a huge gap between persons that file tax returns and those that actually pay.
Another yardstick for assessing the level of taxpayer compliance in a country is to monitor the trend in tax return filing over time. An increasing trend in income tax return filing shows improvement in taxpayer compliance (and vice versa). In Pakistan, the trend of tax return filing decreased in some tax years and increased in some other tax years. For example, tax return filing increased from the tax year 2007 to the tax year 2009 and then decreased up to the tax year 2012.
Last but not least, the share of voluntary payments, i.e. tax payments received in advance together with income tax returns, in the overall collection of direct taxes in Pakistan is also low. Traditionally, more than 70% of income tax collection in Pakistan has come from
Factors Responsible for Poor Contribution of Self-assessment Scheme
a. Ineffective Audits
It has been recognized that since 2006-07, the important source of revenue on account of voluntary payments has been on the declining trend mainly due to non-effective audits by the department. The primary objective of an audit to act as deterrent against possible tax evasions, rather than a source of revenue receipts, has been compromised. The cases selected for complete audit remained on lower side and the disposal of these cases, too, is quite discouraging and dismal.
b. Weak Enforcement
The share of collection on demand in gross income tax collection is also very low, which shows weaknesses in the enforcement mechanism. Because this component of income tax includes the amount detected through audit, penalties imposed for failing to comply with the provisions of tax laws, and taxes recovered for failure to deposit tax within the prescribed limit of time. This source of revenue is expected to be increased in the wake of poor and declining voluntary compliance but the performance is depressing. Another aspect of weak enforcement is that tax return-filers are less for a wide margin as compared to NTN-holders. Moreover, there are many companies that do not file returns while they are active on the record of SECP.
c. Inadequate Tax Policy
Administrative penalties (additional tax, additional charges, etc., are supportive elements for smooth functioning of the self-assessment system. On the one hand, administrative penalties are not effectively enforced while, on the other, such penalties are waived off by the government through statutory regulatory orders (SROs), which may be considered an element of weak tax policy. It is because if the taxpayer knows that he has not to pay additional tax or penalties for tax default, there is potential for him to avoid due payment of taxes and in time.
d. Weak Intelligence and Investigation System
The system of intelligence and investigation plays an important role in supporting the self-assessment system. Its selective and effective use is crucial to creating deterrence toward tax evasion. In Pakistan, the system of intelligence and investigation is not fully equipped with resources (staff and equipment) to create enough deterrence against tax evasion. As a result, tax evasion is rampant in Pakistan. For instance, the Chairman FBR said that there were three million citizens who had enormous wealth but had not been paying taxes.
e. Inadequate Taxpayers Service
The taxpayers promptly comply with the tax rules if it is easier and costless for them to pay taxes. In this regard, public relations activities are quite helpful. In Pakistan, the taxpayers have to spend considerable time in making tax compliance. In a recent study “Paying Taxes,” conducted by the World Bank, Pakistan ranked poorly with regard to tax dealing.
f. Limited Database
Recently, the Federal Board of Revenue (FBR) has shown some commitment to the development of a reliable online database for the effective monitoring of a person’s tax affairs. The ITMS and other software, including the Taxpayer Audit Management System and IRIS, are in place. But these software and databases have serious limitations. They neither provide adequate information about all taxpayers nor can they trace all transactions. Lack of a cohesive, comprehensive and unified database has been a major contributor to poor data-gathering and lack of research on various sectors of the economy.
g. Inadequate Taxpayer Education and Facilitation
Taxpayer education and facilitation remains a secondary concern for the tax authority in Pakistan. This needs serious reconsideration in view of the fact that the level of tax literacy in Pakistan is amongst the lowest in the world, affecting success of self-assessment advisedly.
h. Social and Psychological Factors
Social and psychological factors stem from a citizen’s conception of the state and the normative values of that particular society. Taxpayers take into account the fairness and transparency with which a government conducts its affairs. This implies that voluntary compliance levels may vary from government to government. A taxpayer’s decision is also motivated, in part, by the way society views taxation as a whole. If tax evasion does not stigmatize an individual’s social profile, he might indulge in evasion without any fear of social repercussions. But in societies where tax evasion is viewed negatively, there is little scope for an individual to evade tax without the risk of social stigmatization.
i. Political Factors
Political determinants pertain to the complexity of tax statutes and the structure of the administrative machinery. Legislators are tasked to make laws according to the socio-cultural and economic conditions of their particular society. If the laws made by the legislators are considered by citizens removed from reality, or are too complex to understand, the citizens tend to bypass those laws, either by finding loopholes in them or simply by not following them. This applies equally to tax laws as to other laws. If tax law is too complex or too removed from the reality of economic life, it will fail to inspire voluntary compliance. Moreover, if people consider that tax administration is too bureaucratic, they will seek to avoid coming into contact with it, thereby leading to poor levels of compliance.
j. Economic Factors
Classical economic theory – envisaged by, amongst others, Adam Smith – views a taxpayer as a rational utility maximizing person who, in a taxation context, carefully evaluates the costs and benefits of tax evasion. This calculation determines his propensity to engage in tax evasion or tax avoidance. Prima facie, the classical theory acknowledges that every taxpayer would want to evade taxes if the cost benefit analysis is in favour of tax evasion. But this is not the only economic consideration behind compliance decisions. The overall condition of the economy, the size of a particular taxpayer’s business, income levels, tax rates, audit rates, competition, inflation and the scope of growth also play a significant role in how a taxpayer discharges his tax liabilities. Furthermore, if the welfare of citizens is taken care of effectively, citizens are less motivated to evade taxes.
It takes time for the income taxation to be supported by the original style of self-assessment based on taxpayers’ voluntary compliance. Supplementary measures such as wise use of withholding taxes and appropriate administrative actions gradually prove helpful in penetration of self-assessment system in the income tax system. At the same time, efforts of the tax authorities and related private organizations are also helpful in elevating the bookkeeping standards of the taxpayers and enhancing their compliance level. Continued and improved taxpayers services supported by tax consultation will ultimately prove beneficial in diffusing and penetrating the self-assessment system backed by voluntary compliance.
The author is serving as Additional Commissioner Inland Revenue at Federal Board of Revenue, Pakistan. He can be contacted at email@example.com