Taxation for Growth

Direct taxation theories support taxation for redistribution of income from high-income earners to low-income earners so as to reduce income inequalities and to ensure equity that is essential to promote societal welfare, the ultimate objective of a state.

In recent decades, taxes have largely been used to reduce fiscal imbalances by collecting maximum tax revenue to narrow down the gap between public revenues and public expenditures so as to reduce reliance on domestic and foreign debts because too large debt-to-GDP ratios have a deleterious impact on long-term growth. Arguably, the negative growth effect of high debt may start from levels of 70%-80% of GDP. Private saving, public investment, total factor productivity and sovereign long-term nominal and real interest rates are the channels through which public debt impacts the economic growth rate.

In spite of huge significance of tax revenues, developing countries like Pakistan are struggling to optimize revenues from taxes due to tax evasion and avoidance by foreign and domestic entities.

Tax evasion is perceptible from the fact that an overwhelming number of potential taxpayers are out of the net of direct taxes and many existing taxpayers are involved in the concealment of income, expenditures and investments and are, thus, escaping taxation. Many taxpayers involve in tax avoidance by misinterpreting and manipulating provisions of tax statutes. A number of taxpayers have sought stay orders from courts against tax payment, contesting certain provisions of tax statutes and hence are successful in delaying payment of due tax.

The tax authorities do not have enough resources to deal with each and every case to prevent tax evasion and avoidance. Nonetheless, the involvement of certain persons within the working strength of the Federal Board of Revenue (FBR) in facilitating certain taxpayers to evade and avoid taxes for ulterior motives or otherwise may not be completely ruled out. The rules for public office-holders require to be made vibrant and robust to plug the loopholes.

Tax evasion and avoidance also vary from sector to sector. The extent of tax evasion and avoidance seems to be higher in sectors that are more undocumented and, therefore, hard to tax. The real estate sector is one such sector so much so the tax authorities prescribed valuation rates of immoveable properties in major cities to overcome the problem of tax evasion and avoidance through undervaluation of immovable properties.

Tax amnesties offered by the governments from time to time to enable potential taxpayers to declare their tax-evaded money by paying nominal tax provide an illustration of the extent of tax evasion and avoidance within the country. The introduction of tax amnesties also provides evidence regarding the lack of resources and incapacity of the tax authorities to deal with tax evasion and avoidance, though different logic and rationale are being cited for offering tax amnesties.

Tax amnesties are offered to facilitate potential and existing taxpayers to declare black and/or untaxed money. The motive behind this may be to enhance the tax base for future taxation, to increase the level of investment and to promote industrialization by persuading people holding illegal money to invest that in the economy, among others. The ultimate goal is to boost economic growth by encouraging consumption, investment and expenditures.
The PTI government announced its first amnesty scheme on April 18, 2018, under the Foreign Assets (Declaration and Repatriation) Ordinance, 2018, to raise additional tax revenue in a time of widening fiscal deficits, to promote documentation of the economy in a time of low tax compliance, to boost foreign exchange reserves to overcome the problem of dwindling forex reserves and to improve the balance of payments in amidst ballooning current account deficits. However, such black and/or untaxed money was subjected to payment of nominal tax.

The second tax amnesty of the PTI government was declared on April 17, 2020, through the promulgation of the Tax Laws (Amendment) Ordinance, 2020, to offer an incentive package for the revival of the construction industry and for creating jobs. To encourage investment in the construction sector, the tax authorities were not allowed to ask the taxpayers regarding sources of capital investments either in money or land.

The most recent tax amnesty was launched by the PTI government on March 3, 2022, under the Income Tax (Amendment) Ordinance, 2022, for promoting growth by encouraging taxpayers to invest black and/or untaxed money in setting up new industrial units. The tax authorities will not ask the source of funds to be utilized for setting up the new industrial undertakings. However, 5% tax shall be levied on such back and/or untaxed money.

Apart from the above-stated tax amnesties, the tax statute governing the direct taxation provides for massive incentives in the form of tax credits, tax exemptions and tax concessions to different classes of persons to add an impetus to the economic activity of different sectors, including the energy sector so as to generate employment and boost economic growth.

The impact of the aforementioned taxation policies on economic growth is not as perceptible and visible as desired as the gross domestic product (GDP) contracted from 5.53% in 2018 to 2.08% in 2019 and further to -0.47% in 2020. Nonetheless, significant contraction in GDP could be attributed to other factors such as Covid-19 pandemic and understandably could not be accredited to the aforementioned policy alone.

Since economic growth significantly declined in the years following 2018, the unemployment rate increased from 3.98% in 2019 to 4.65% in 2020 – a 0.67% increase. Nonetheless, there has been a considerable reduction in per-capita income from $1482 in 2018 to $1288 in 2019 and further to $1188 in 2020.

Tax revenue sacrificed by the government during 2020 due to allowances, tax credits, exemptions and other tax concessions was Rs.36 billion, Rs.104 billion, Rs.212 billion and Rs.26 billion, respectively.

Needless to mention that scarcity of revenue is one of the major impediments to accelerating economic growth and ensuring an adequate supply of public services. Less-than-potential tax collection is a recognized factor for amassing public debt which causes further pressure on the national exchequer.

The author is serving as Additional Commissioner Inland Revenue at Federal Board of Revenue, Pakistan. He can be contacted at bilal.hassan@fbr.gov.pk