Tax Policy and Growth
Tax policy is one of the most critical instruments that can boost growth if used properly. If used incorrectly business activity within an economy suffers. A PIDE conference on taxes “Doing Taxes better: Shifting the Paradigm of Tax policy and Administration” at the Planning Commission asked the question: What is an effective tax policy for Pakistan.
The consensus among the eminent experts was that there is an urgent need for a paradigm shift. A shift in what we envision as objectives of the policy and how we administer it. The agreement on changes required with the tax policy, both at the stage of policy formulation and its administrative process, came in the face of pointed anomalies.
Do We Need A Paradigm Shift in Tax Policy?
Why does Pakistan need such a significant paradigm shift within the taxation policy? The core of the argument as built through analysis of specialists was that yes, Pakistan might have a relatively low tax to GDP ratio of around 11.6% compared to some developed countries. Yet, the focal point of current and past tax policies and reform has primarily become an attempt to raise this ratio. This focus has been a faulty standard.
To support this point, experts provided a comparison of Pakistan with its international counterparts. In the case of Sri Lanka, what comes out is that it has three times higher GDP than Pakistan, yet its tax to GDP ratio is comparable to that in Pakistan (11.7%). Malaysia has GDP that is eight times higher GDP than us, but the tax to GDP ratio is very close to us (15.5%). To complicate the puzzle further, take the case of Bangladesh. It has GDP higher than us despite having a much lower tax to GDP ratio (8.5%). So these very examples make one wonder what is Pakistan’s real problem – the low tax GDP ratio or something else?
Further, this emphasis on raising the tax-to-GDP ratios is not just arbitrary, but it has also created a narrative that we as a nation are tax evaders. However, as per Dr. Nadeem Ul Haque’s analysis, if one compares with other countries, the rate of tax evasion within Pakistan may not differ greatly from any other developed country. Hence we should put this narrative to the test through research.
Pakistan is Not A Tax Cheater Nation
Challenging the account of Pakistan as a tax cheater nation is essential for many reasons. As a consequence to this notion, not only has the tax system become over-complicated, but two legal classes have emerged. The filer citizens and the non-filer citizens. This practice is not found anywhere else in the world and is open for further research. Moreover, such classifications do have economic and social costs that need assessment.
The administrative complications that have arisen from this system of filer and non-filer not only include that all sorts of transactions (both business and non-commercial) has become complicated but because the government has shifted most of the burden of tax collection to the private sector through stress on withholding taxes (60% of tax collection in Pakistan currently is through indirect taxes). This is found to be holding back the business environment in two important ways; firstly, by making the transaction processes complicated and secondly by raising the cost of businesses, especially for those that are collecting withholding taxes for the government.
Further, besides disincentive to business in general, there are some equity concerns related to filer and non-filer division and its legal implication since all those people who are not meeting the income threshold for filing are by default excluded from the market activity. Hence legality of filer and non-filer and its management does not only increase administrative costs for businesses collecting withholding taxes but is limiting opportunities for poor too – an important issue that needs more debate.
Effective Tax Policy Consensus
For effective tax policy, the consensus is that simplification of tax structure is the key. Only then will our tax policy be conducive to growth and be non-distortionary. For meaningful tax reforms, the paradigm shift most needed is for our policymakers to realize that the fiscal challenge we face is not because of a low tax-to-GDP ratio. Instead, problems on the expenditure side such as circular debt, losses from PSE, bloated size of government and institutional reforms for containing these are more fundamental puzzles.
Another essential paradigm shift is shifting the aim of tax policy from merely revenue generation to increasing global competitiveness. A detailed discussion took place on how tariff have been used for revenue generation rather than promoting industrialization. This misdirected focus has stifled our exports and their competitiveness.
Pakistan Loves Protection
So Pakistan has traditionally followed a policy of too much protection but has heavily relied on import taxes to fill in gaps in revenue targets. This is in contrast to other countries, which use this tool to encourage industry and not to create inconsistencies for the business activity by using it as a revenue-maximizing tool. The new national tariff policy tries to correct these policy loopholes.
The emerged consensus favored the elimination of the inconsistencies that have come because of SROs and using tariffs as a means of revenue generation. Hence agreement was for trade liberalization and reduction of import taxes and filling in the lost revenue through the utilization of domestic taxable avenues. A few missed channels of direct taxation that were pointed out included the sector of agriculture and tobacco and petroleum products, to name a few. Further, for the sustainability of this policy shift, it is was emphasized that more research is required as to how the reduction of tariff through new tariff policy has and will be impacting exports.
Finally, the most ignored aspect is how much of our tax policy changes are in accordance with the constitution. It was stressed that this element requires attention, especially post 18th Amendment, to make federation and provinces to come on the same page and remove the inefficiencies that arise due to mis-coordination.
A Last Note
As a last note, debate generated at the forum of PIDE left the audience with an important thought-provoking issue that whether technological improvement implemented across the tax administration has added to its efficiency or has complicated the matters even further through over documentation. In this context, a valuable insight that came out was that yes, technological advancement could help, but until and unless we improve the processes and laws to support the process in the context of sharing and integrating data between governmental organizations, we cannot fully gain the benefits of such technological advancement.
The simplification of taxes both in its application and also in its procedure, I believe if focused as the main objective of tax policy, will also have an unintended consequence of raising the tax to GDP ratio. Hence this paradigm shift will not only boost the economic activity but through the removal of inconsistencies and complications within the taxation, will serve as a means of meeting the revenue targets more effectively. However to have such measures implemented, the will of FBR not just at higher management level but also of the tax collectors is required and hence reform of the Federal Bureau of Revenue (FBR) is most important and most needed in my opinion.