The interim report presented to the fourth-time Federal Finance Minister of Pakistan, Muhammad Ishaq Dar on April 29, 2023 by the Chairman of Reforms and Resource Mobilization Commission (RRMC), as reported in the press, appears to be yet another routine document prepared behind closed doors without any meaningful public debate and input from experts and stakeholders. However, it is too early to comment on it as an official transcript is yet not available for the public at large.
The salient recommendations, according to a Press report, despite a lack of cooperation by the Federal Board of Revenue (FBR) include a 5% advance income tax on future dividends of listed companies and 7.5% on non-listed companies. The tax is being proposed to be charged on the distributable reserves of taxpayers. Also included are proposals to increase tax incidence on sole business operators by 10% over and above the standard rates, increasing tax on non-corporate exporters from 1% to 8%. It has been proposed that the current final tax regime should be turned into a minimum tax regime, in a move that would ensure proper documentation and due contribution by the sacred cow. Also included are plans to charge an additional income tax on gains on higher value of the dollar to exporters who kept their proceeds abroad beyond the mandatory period, and simplifying multiple tax rates for wholesale dealers, distributors and retailers at 1% for only those who are active for income tax and sales tax purposes. For all other businesses, the recommended rate is 4%.
The recommendations include provisions for increasing the withholding tax rate for commercial importers to 8% and rationalization of minimum tax on the provision of various services. For minimizing the misuse of tax exemption by real estate on gains made on the sale of properties, the facility should be available to only those who have declared the property in their wealth statement in the year of acquisition and subsequent years until it is disposed of.
According to another report, the RRMC has suggested levying “a one percent tax under on deemed income on land held by non-filers in the upcoming budget. Collection should be made like the non-utilisation fee collected by various authorities if the value of such unpaid one percent tax on land held by non-filers increases beyond Rs.10 million." Federal Excise Duty (FED) is applicable to international air travelers, both filers and non-filers. To encourage filers and penalize non-filers, it should be replaced with advance income tax, which should only be made applicable to non-filers. To promote recycling and value addition of waste material, and to promote environment-friendly business structures, the purchase of waste/used material should be exempt from income tax and sales tax withholding as an initial step for at least five years.”
The above proposals are in the nature of patch work here and there, whereas there is a general consensus that Pakistan needs full throttled reforms in all areas of governance and institutions if it has to achieve high, equitable and sustainable growth of seven percent and above assuring prosperity for all citizens (Pakistan Institute of Development Economics, April 2021). This level of growth is, however, not possible unless fundamental reforms are made in the existing tax structure as highlighted (PRIME Institute, Islamabad, December 2020).
There are a number of studies and models presented by local economists, authors and researchers for tax reforms facilitating higher growth, but none was considered by successive governments and now by the RRMC. Reliance on International Monetary Fund (IMF) and prescriptions by World Bank and others for reforming the outdated and oppressive tax system have failed to yield desired results as highlighted (PIDE, 2020).
In Tax reforms: Agenda for Self-Sustainability, it was established with facts and figures that the real tax potential, at the level of FBR alone is Rs. 12.4 trillion, if not more. The complete working of actual tax gap is available in Towards Flat, Low-rate, Broad and Predictable Taxes that is shockingly ignored by RRMC in its interim report.
On this basis of above published work, total income tax potential alone is not less than Rs. 8400 billion. Sales tax collection in fiscal year 2021-2022 was Rs. 2525 billion, whereas actual potential was not less than Rs. 3500 billion. Similarly, the potential of Customs Duty is Rs. 1500 billion but FBR collected Rs. 1000 billion in financial year 2021-22. The potential of Federal Excise Duty is Rs. 500 billion, if not more, but FBR collected Rs.322 billion in the FY 2021-22.
The disastrous outcome of mindless and costly borrowing, both external and internal, has resulted in 44 percent increase in debt servicing. According to the Summary, in the first six months of FY 2023 total expenditure on debt servicing was Rs. 2573 billion against Rs. 1453 billion in the corresponding period of FY 2022. It was against the full year allocation of FY 2023 at Rs. 3950. According to press reports, debt servicing at the close of FY 2023 may reach to Rs. 5.5 trillion. Resultantly, fiscal deficit, mother of all ills, will be much higher than budgeted and expected. In six months, it has already reached Rs 1.7 trillion.
At present, out of total registered companies, about 53,900 are not filing income tax returns. Assuming average tax of Rs. 5 million per company, tax potential comes to Rs. 269.5 billion. Collection of income tax by FBR in fiscal year 2021-22 was Rs. 2278 billion (companies, individuals, firms and association of persons).
In view of above, even under the prevailing system and prevalent rates, total tax potential at FBR level comes to Rs. 13.65 trillion [Income Tax: Rs. 8.3 trillion; Sales Tax: Rs. 3.5 trillion; Customs Duty: Rs. 1500 billion and FED Rs. 350 billion] and if we withdraw all exemptions/concessions and waivers as a further amount of Rs. 1.5 trillion can be collected.
Pakistan has been facing grim challenges on the fiscal front as evident from the Summary of Consolidated Federal and Provincial Fiscal Operations, 2022-23 [“the Summary”], released by the Ministry of Finance (MoF) on February 8, 2023, for July-December 2022, the first six months of the current fiscal year [FY 2023]. The emerging most startling fact is that the entire defence spending was met with borrowed funds. It is more than a fiscal fiasco—a serious cause for concern threatening economic viability and national security of the state.
The Federal Board of Revenue (FBR) collected Rs. 3.4 trillion from July to December 2022. After transferring Rs. 1549 billion funds to provinces under 7th National Finance Commission (NFC) Award, the net available to federal government from tax and non-tax revenue (Rs. 914 billion) was Rs. 2463 billion that could not even meet debt servicing of Rs. 2573 billion (domestic Rs. 2273 billion and foreign Rs. 300 billion). Hence, the total defence spending of Rs. 639 billion was met from expensive borrowed money.
As a consequence to Constitution (Eighteenth Amendment) Act, 2010, progressive taxes e.g. inheritance tax (called estate duty in Pakistan), wealth tax and capital gains tax on immovable property, and gift tax etc. are with the provinces. However, Punjab like other provinces, has shown no interest in levying these taxes to reduce overall fiscal deficit so that our reliance on domestic and foreign debts could decrease.
The data released by MoF show that in FY 2022, the four provinces received Rs. 3.589 trillion from the federal government. The Punjab government suffered a deficit of Rs. 352 billion even after receiving Rs. 1.8 trillion as its share under the NFC Award, which was equal to 82% of its total revenues. The situation in first half of the current year has not improved, as there is meagre surplus of Rs. 38 billion and that too at the cost of development expenditure.
All the governments in Punjab, Sindh, Khyber Pakhtunkhwa and Balochistan since 2010 have failed to undertake fundamental reforms to merge three tax departments, namely, Board of Revenue, Excise & Taxation Departments and revenue authority collecting sales tax on services. These could have been merged into one single tax agency in each province to provide one-window facility to the citizens, avoid duplication of expenses and ensure efficient and better collection, but no such effort has been made despite making promises to this effect during election campaigns.
In FY 2022, debt servicing by federal government was Rs. 3182 billion (domestic Rs. 2829 billion and foreign Rs. 354 billion) against net revenues of Rs. 4774 billion after transfers to the provinces. Debt servicing was 67% of total net revenues of the federal government and 52 % of tax collection of FBR. In the first eight months of FY 2023, it increased to Rs.3.18 trillion, exceeding total net income of the federal government by Rs. 9 billion. This is the real dilemma and challenge on the fiscal front faced by Pakistan. All the four provinces are heavily relying on transfers from the Federal Government under the NFC Award and other grants, rather than achieving growth and resultantly collecting enough to be self-reliant.
In the wake of 18th Amendment, fiscal management, both at federal and provincial levels needs fresh thinking. The federal government, having all buoyant and broad-based taxes is not tapping real tax potential even though the country is heavily indebted. On the other hand, provinces, which are almost entirely dependent on the NFC Award, have failed to raise their own sufficient resources for the increasing needs of the ever-growing population.
The provinces must be included in national tax policy and collection apparatus as their share (57.5%) in NFC Award is larger than the federal government’s, and Article 156(2) of the Constitution of Islamic Republic of Pakistan requires federalized and not centralized economic planning.
There is a dire need for a new tax model entailing harmonized sales tax on goods and services, uniform personal income taxation, including agricultural income, and its collection through a single national agency as well as low tax rates on broader base, though distribution would be strictly through Article 160 of the Constitution—all participating in retiring debt burden that would eliminate fiscal deficit. This will also facilitate citizens/taxpayers through one window facility, ensuring the State to collect taxes of Rs. 12 trillion, if not more. This is the only way to meet the emergent economic challenges faced by the state and achieve fiscal stabilization for the entire federation without disturbing the 18th Amendment, as well as for achieving the cherished goal of self-sustainability.
The salient recommendations, according to a Press report, despite a lack of cooperation by the Federal Board of Revenue (FBR) include a 5% advance income tax on future dividends of listed companies and 7.5% on non-listed companies. The tax is being proposed to be charged on the distributable reserves of taxpayers. Also included are proposals to increase tax incidence on sole business operators by 10% over and above the standard rates, increasing tax on non-corporate exporters from 1% to 8%. It has been proposed that the current final tax regime should be turned into a minimum tax regime, in a move that would ensure proper documentation and due contribution by the sacred cow. Also included are plans to charge an additional income tax on gains on higher value of the dollar to exporters who kept their proceeds abroad beyond the mandatory period, and simplifying multiple tax rates for wholesale dealers, distributors and retailers at 1% for only those who are active for income tax and sales tax purposes. For all other businesses, the recommended rate is 4%.
The recommendations include provisions for increasing the withholding tax rate for commercial importers to 8% and rationalization of minimum tax on the provision of various services. For minimizing the misuse of tax exemption by real estate on gains made on the sale of properties, the facility should be available to only those who have declared the property in their wealth statement in the year of acquisition and subsequent years until it is disposed of.
According to another report, the RRMC has suggested levying “a one percent tax under on deemed income on land held by non-filers in the upcoming budget. Collection should be made like the non-utilisation fee collected by various authorities if the value of such unpaid one percent tax on land held by non-filers increases beyond Rs.10 million." Federal Excise Duty (FED) is applicable to international air travelers, both filers and non-filers. To encourage filers and penalize non-filers, it should be replaced with advance income tax, which should only be made applicable to non-filers. To promote recycling and value addition of waste material, and to promote environment-friendly business structures, the purchase of waste/used material should be exempt from income tax and sales tax withholding as an initial step for at least five years.”
The above proposals are in the nature of patch work here and there, whereas there is a general consensus that Pakistan needs full throttled reforms in all areas of governance and institutions if it has to achieve high, equitable and sustainable growth of seven percent and above assuring prosperity for all citizens (Pakistan Institute of Development Economics, April 2021). This level of growth is, however, not possible unless fundamental reforms are made in the existing tax structure as highlighted (PRIME Institute, Islamabad, December 2020).
There are a number of studies and models presented by local economists, authors and researchers for tax reforms facilitating higher growth, but none was considered by successive governments and now by the RRMC. Reliance on International Monetary Fund (IMF) and prescriptions by World Bank and others for reforming the outdated and oppressive tax system have failed to yield desired results as highlighted (PIDE, 2020).
In Tax reforms: Agenda for Self-Sustainability, it was established with facts and figures that the real tax potential, at the level of FBR alone is Rs. 12.4 trillion, if not more. The complete working of actual tax gap is available in Towards Flat, Low-rate, Broad and Predictable Taxes that is shockingly ignored by RRMC in its interim report.
On this basis of above published work, total income tax potential alone is not less than Rs. 8400 billion. Sales tax collection in fiscal year 2021-2022 was Rs. 2525 billion, whereas actual potential was not less than Rs. 3500 billion. Similarly, the potential of Customs Duty is Rs. 1500 billion but FBR collected Rs. 1000 billion in financial year 2021-22. The potential of Federal Excise Duty is Rs. 500 billion, if not more, but FBR collected Rs.322 billion in the FY 2021-22.
The disastrous outcome of mindless and costly borrowing, both external and internal, has resulted in 44 percent increase in debt servicing. According to the Summary, in the first six months of FY 2023 total expenditure on debt servicing was Rs. 2573 billion against Rs. 1453 billion in the corresponding period of FY 2022. It was against the full year allocation of FY 2023 at Rs. 3950. According to press reports, debt servicing at the close of FY 2023 may reach to Rs. 5.5 trillion. Resultantly, fiscal deficit, mother of all ills, will be much higher than budgeted and expected. In six months, it has already reached Rs 1.7 trillion.
At present, out of total registered companies, about 53,900 are not filing income tax returns. Assuming average tax of Rs. 5 million per company, tax potential comes to Rs. 269.5 billion. Collection of income tax by FBR in fiscal year 2021-22 was Rs. 2278 billion (companies, individuals, firms and association of persons).
In view of above, even under the prevailing system and prevalent rates, total tax potential at FBR level comes to Rs. 13.65 trillion [Income Tax: Rs. 8.3 trillion; Sales Tax: Rs. 3.5 trillion; Customs Duty: Rs. 1500 billion and FED Rs. 350 billion] and if we withdraw all exemptions/concessions and waivers as a further amount of Rs. 1.5 trillion can be collected.
Pakistan has been facing grim challenges on the fiscal front as evident from the Summary of Consolidated Federal and Provincial Fiscal Operations, 2022-23 [“the Summary”], released by the Ministry of Finance (MoF) on February 8, 2023, for July-December 2022, the first six months of the current fiscal year [FY 2023]. The emerging most startling fact is that the entire defence spending was met with borrowed funds. It is more than a fiscal fiasco—a serious cause for concern threatening economic viability and national security of the state.
The Federal Board of Revenue (FBR) collected Rs. 3.4 trillion from July to December 2022. After transferring Rs. 1549 billion funds to provinces under 7th National Finance Commission (NFC) Award, the net available to federal government from tax and non-tax revenue (Rs. 914 billion) was Rs. 2463 billion that could not even meet debt servicing of Rs. 2573 billion (domestic Rs. 2273 billion and foreign Rs. 300 billion). Hence, the total defence spending of Rs. 639 billion was met from expensive borrowed money.
As a consequence to Constitution (Eighteenth Amendment) Act, 2010, progressive taxes e.g. inheritance tax (called estate duty in Pakistan), wealth tax and capital gains tax on immovable property, and gift tax etc. are with the provinces. However, Punjab like other provinces, has shown no interest in levying these taxes to reduce overall fiscal deficit so that our reliance on domestic and foreign debts could decrease.
The data released by MoF show that in FY 2022, the four provinces received Rs. 3.589 trillion from the federal government. The Punjab government suffered a deficit of Rs. 352 billion even after receiving Rs. 1.8 trillion as its share under the NFC Award, which was equal to 82% of its total revenues. The situation in first half of the current year has not improved, as there is meagre surplus of Rs. 38 billion and that too at the cost of development expenditure.
All the governments in Punjab, Sindh, Khyber Pakhtunkhwa and Balochistan since 2010 have failed to undertake fundamental reforms to merge three tax departments, namely, Board of Revenue, Excise & Taxation Departments and revenue authority collecting sales tax on services. These could have been merged into one single tax agency in each province to provide one-window facility to the citizens, avoid duplication of expenses and ensure efficient and better collection, but no such effort has been made despite making promises to this effect during election campaigns.
In FY 2022, debt servicing by federal government was Rs. 3182 billion (domestic Rs. 2829 billion and foreign Rs. 354 billion) against net revenues of Rs. 4774 billion after transfers to the provinces. Debt servicing was 67% of total net revenues of the federal government and 52 % of tax collection of FBR. In the first eight months of FY 2023, it increased to Rs.3.18 trillion, exceeding total net income of the federal government by Rs. 9 billion. This is the real dilemma and challenge on the fiscal front faced by Pakistan. All the four provinces are heavily relying on transfers from the Federal Government under the NFC Award and other grants, rather than achieving growth and resultantly collecting enough to be self-reliant.
In the wake of 18th Amendment, fiscal management, both at federal and provincial levels needs fresh thinking. The federal government, having all buoyant and broad-based taxes is not tapping real tax potential even though the country is heavily indebted. On the other hand, provinces, which are almost entirely dependent on the NFC Award, have failed to raise their own sufficient resources for the increasing needs of the ever-growing population.
The provinces must be included in national tax policy and collection apparatus as their share (57.5%) in NFC Award is larger than the federal government’s, and Article 156(2) of the Constitution of Islamic Republic of Pakistan requires federalized and not centralized economic planning.
There is a dire need for a new tax model entailing harmonized sales tax on goods and services, uniform personal income taxation, including agricultural income, and its collection through a single national agency as well as low tax rates on broader base, though distribution would be strictly through Article 160 of the Constitution—all participating in retiring debt burden that would eliminate fiscal deficit. This will also facilitate citizens/taxpayers through one window facility, ensuring the State to collect taxes of Rs. 12 trillion, if not more. This is the only way to meet the emergent economic challenges faced by the state and achieve fiscal stabilization for the entire federation without disturbing the 18th Amendment, as well as for achieving the cherished goal of self-sustainability.