Withholding Tax Regime: Doing Business Perspective
This paper looks at the withholding tax regime and assesses the impact of the present regime on taxpayers. We found that the Emphasis of Pakistan’s revenue stream is on indirect taxes rather than direct taxes, both at Federal level and Provincial level. During FY2021-22, 67% of FBR’s direct taxes came from withholding taxes. Similarly, share of indirect revenue in total provincial revenue of Sindh, Punjab, Khyber Pakhtunkhwa and Balochistan, remained at 98%, 85%, 86% and 95% respectively.
Vertical Distribution of Divisible Pool of NFC Award for Azad Jammu Kashmir and Gilgit-Baltistan
Vertical Distribution of Divisible Pool of NFC Award for Azad Jammu Kashmir and Gilgit-Baltistan
Jammu and Kashmir, either administrated by Pakistan or India, is declared ‘disputed’ by the United Nation. The administrative responsibility of one part of Jammu & Kashmir (J&K) is entrusted to Pakistan through “trust obligation” of UN Security Council resolutions (UNSC) and UN Commission for India and Pakistan, UNCIP. The paper is about the fiscal decentralization for these ‘disputed’ territories i.e., Pakistan Administrated Jammu & Kashmir (PAJK) and Gilgit-Baltistan (GB).
The National Finance Commission (NFC) award is distribution of financial resources between the Centre and provinces – the vertical distribution – and among the four federating units – the horizontal distribution. The federal government has two sources of revenue i.e., tax income and non-tax income. The tax income is the divisible part under the NFC award. First, vertical distribution of divisible pool is decided between the federal government and four provinces i.e., Baluchistan, Khyber Pakhtunkhwa (KP), Sindh, and Punjab. Subsequently horizontal distribution among the provinces takes place. The current arrangement under the 7th NFC award is such that out of gross divisible income, the first 1% goes to KP as reconstruction relief due to ‘War on Terror’, and 0.66% goes to Sindh as compensation for abolishment of Octrio and Zila Tax in 1997; afterwards 57.5% goes to four provinces and the remaining income comes under the domain of federal government. The federal government pays for its obligations under its domain including debt servicing, defense, salaries and pension of federal employees and development and non-development funds to two ‘disputed’ territories of PAJK and GB. It is important to note that there is defined formula to distribute the 57.5% revenue only among four provinces, not for the territories of PAJK and GB. Moreover, Clause 3(A) of Article 160 of the Constitution says that the share of provinces in the new NFC award will not be less than prescribed share in the previous Award (i.e., 57.5%).
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Concerns and Implications of Proposed Restoration of Withholding Tax on Cash Withdrawal and Banking Transactions
Concerns and Implications of Proposed Restoration of Withholding Tax on Cash Withdrawal and Banking Transactions
Authors: Mr. Usman Azmat (Advocate High Court) and Mr. Muhammad Anas Farhan (Vice President, Tax Department, ZTBL)
The Annual Federal budget is scheduled to be presented to the National Assembly on the 9th of June. Recent news regarding potential tax proposals from the Ashfaq Tola-led Revenue and Resource Mobilization Commission has been generating headlines for the past two weeks.
One of these proposals is the reinstatement of withholding tax on cash withdrawal, banking instruments, and other banking transactions. This reinstatement involves the revival of sections 231A, 231AA, and 236P of the Income Tax Ordinance 2001, which were abolished two years ago in the Finance Act of 2021.
The withholding tax on banking transactions was initially introduced in the Finance Act 2005 through the inclusion of section 231A in the Income Tax Ordinance 2001. It served as a significant source of revenue according to the Revenue Division’s Year Books.
The primary objectives of imposing withholding tax on cash withdrawal were: a) discouraging the cash economy, b) improving documentation, and c) broadening the tax base.
The rate of withholding tax on cash withdrawals started at 0.1% and, before its removal in 2021, stood at 0.6% for non-filers.
FBR’s Circular No. 02 of 2021-22 dated 1st July 2021 explained the rationale behind removing the withholding tax on banking transactions: “There were 38 withholding tax provisions in the Income Tax Ordinance 2001. This high number of provisions adds to complexity and creates undue burden of compliance on different withholding agents. It also impacts the country’s rating on the ease of doing business index.”
FBR’s overall tax revenue experienced significant growth of 30% during FY2021-22, surpassing Rs. 6 trillion for the first time in Pakistan’s history. This growth can be largely attributed to the elimination of withholding tax on cash withdrawal, banking instruments, and banking transactions.
Cash flowed freely within businesses, leading to flourishing economic activities, and withholding tax on business activities became a significant revenue driver. People’s confidence in the banking system improved, prompting those who were hesitant to keep their money in banks to start utilizing them.
Overall, there was a boost in economic activities, resulting in increased earnings for taxpayers and naturally leading to an increase in tax revenue. Bank deposits also saw an extraordinary surge (Rs. 23.4 trillion as of April 2023, as reported by SBP), and bank earnings found their way into the Government Exchequer in the form of corporate income tax.
However, an analysis of FBR’s revenue collection from withholding tax on cash withdrawals reveals a dismal performance and negative growth in recent years. The compound annual growth rate (CAGR) of this tax remained at only 2%, which is an unhealthy sign.
Table 1: Collection of withholding tax on cash withdrawal
FY | Rs in Million | Growth YoY |
2007-08 | 4,098 |
|
2008-09 | 11,338 | 176.7% |
2009-10 | 12,863 | 13.5% |
2010-11 | 10,630 | -17.4% |
2011-12 | 12,538 | 17.9% |
2012-13 | 12,440 | -0.8% |
2013-14 | 19,063 | 53.2% |
2014-15 | 23,276 | 22.1% |
2015-16 | 28,619 | 23.0% |
2016-17 | 30,487 | 6.5% |
2017-18 | 34,003 | 11.5% |
2018-19 | 31,756 | -6.6% |
2019-20 | 15,169 | -52.2% |
2020-21 | 15,137 | -0.2% |
CAGR |
| 2% |
(Source: Revenue Division’s Year Books 2007-08 to 2020-21)
The State Bank of Pakistan (SBP) findings on the imposition of withholding tax on cash withdrawal, banking instruments, and banking transactions are not encouraging. According to SBP’s Annual Report 2016-17: “… the imposition of withholding tax on banking transactions apparently defeated the very purpose for which it was imposed, that is, to discourage the cash economy,” and “… the economic cost of imposing withholding tax on non-cash banking transactions needs rethinking.”
The forthcoming withholding tax on cash withdrawal, banking instruments, and banking transactions is justified on the basis that it will only apply to non-filers. However, being a non-filer does not necessarily mean being a tax evader. Instead of imposing taxes on non-filers, mechanisms should be devised to penalize tax evasion.
If someone files their tax return with nil income and the government receives no tax revenue from their return, or if the reported figures are manipulated, what benefit can be expected from converting their status from non-filer to filer?
Section 115 of the Income Tax Ordinance 2001 lists individuals who are not required to furnish their annual income tax returns. When the law itself designates them as non-filers, it is unfair for the government to label them as such solely based on the actual non-filing of their returns. The provision allowing individuals not to file their tax returns already categorizes them as “deemed filers.” Other means should be explored to include individuals from both categories in the Active Taxpayers’ List (ATL) and at least provide them with the benefits of withholding tax provisions—those who file their annual income tax returns and those who are not required to file their annual income tax returns.
If the government plans to reinstate provisions regarding withholding tax on cash withdrawal, banking instruments, and banking transactions solely to broaden the tax base, it may prove ineffective in the current economic environment. People may once again resort to keeping their cash outside of the banking system. To broaden the tax base, the FBR can explore alternative measures and make informed policy decisions while maintaining taxpayers’ confidence by excluding withholding tax on cash withdrawal, banking instruments, and other banking transactions.
There are other means to identify taxpayers engaging in cash transactions. Banks are also required to file statements under section 165A of the Income Tax Ordinance 2001, where Form-C entails reporting cash withdrawal transactions to the FBR if the aggregate monthly volume of cash withdrawal exceeds Rs. 1 million. This can serve as a useful tool to monitor cash transactions carried out by taxpayers.
Additionally, the concept of SWAPS (Synchronized Withholding Administration and Payment System), introduced in the Finance Act 2022, is part of the same series and, once fully implemented, will facilitate real-time reporting of such transactions through banks’ synchronized/integrated systems with the FBR, further contributing to the broadening of the tax base.
Reintroducing withholding tax on cash withdrawal can have negative repercussions on the economy, financial inclusion, and could potentially lead to the emergence of a parallel banking system. When withholding tax is imposed on cash withdrawals, individuals may seek alternative methods to evade the tax, leading to an increase in parallel banking activities.
Policymakers should focus on alternative measures that can achieve the desired objectives of curbing corruption, tackling black money, and reducing tax evasion while also promoting digital transactions to curb the shadow economy. Measures like the demonetization of high-denomination currency notes, such as the Rupees five thousand note, can be considered. Although this may cause temporary disruptions and have a slight impact on the GDP growth rate in the short term, it can lay the foundation for long-term economic sustainability.
To strike a balance between revenue generation and the long-term goals of financial inclusion and stability, it is crucial to strengthen existing tax frameworks, promote digital payments and banking, and enhance financial literacy. Effective policies and collaborations among stakeholders can contribute to a robust financial ecosystem that minimizes risks and encourages sustainable economic development.
PRIME has always advocated for progressive, equitable, and fair taxation. In the Federal Budget 2023-24, PRIME has strongly recommended and proposed to the FBR to simplify the existing withholding tax regime and introduce measures that can reduce the compliance burden on withholding agents. The institute is also in the process of publishing a working paper titled “Withholding Tax Regime: Doing Business Perspective,” which highlights the problems associated with the existing withholding tax regime and proposes measures to effectively address these issues.
PRIME’s Position Paper on Tax Reforms
PRIME's Position Paper on Tax Reforms
In December 2022, the Finance Minister, Senator Ishaq Dar, established the Reforms and Resource Mobilization Commission (RRMC), comprising of 11 members tasked with suggesting tax and economic reforms to the government. According to reports from the media, the RRMC has presented an interim report to the Finance Minister detailing proposed reforms. However, it appears that some of the suggested reforms, particularly those with progressive taxation, require concerning and require reconsideration.
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5 Ways Government of Pakistan Hampers Free Trade
5 Ways Government Hampers Free Trade
Pakistan is a country that has traditionally struggled to achieve economic growth, and international trade has often been seen as a key driver of development. However, despite the potential benefits of trade, the Pakistani government has been criticized for placing restrictions on trade, hindering economic growth and development.
If you are more interested in solutions, check out the section on Free Markets, Trade and Price Controls in the Pakistan Charter of Economy.
Import Tariffs
Pakistan imposes high import tariffs on a wide range of goods, including raw materials, capital goods, and consumer goods. These high tariffs make imported goods less competitive in the local market and increase their cost, leading to reduced consumer choices and decreased international trade. According to the World Bank’s 2021 report on “Trading Across Borders,” Pakistan ranked 167th out of 190 countries in terms of ease of importing goods. This poor ranking reflects the country’s high import tariffs and complex regulatory procedures, which can be a significant barrier to trade.
Non-Tariff Barriers
In addition to import tariffs, the Pakistani government also places non-tariff barriers on imports. These barriers include quotas, licensing requirements, and technical regulations that can be difficult for foreign exporters to navigate. According to the United States Trade Representative’s 2021 report on “Foreign Trade Barriers,” Pakistan has a number of non-tariff barriers in place that hinder trade, particularly in the agriculture and services sectors. These barriers can be particularly problematic for small and medium-sized enterprises (SMEs) that may not have the resources to navigate complex regulatory frameworks.
State-Owned Enterprises
Pakistan has a large number of State-Owned Enterprises (SOEs) operating in various industries such as energy, transportation, and telecommunications. The government owns and controls these SOEs, which can lead to inefficiencies, lack of competition, and reduced economic growth. According to a report by the International Monetary Fund (IMF), SOEs in Pakistan have been plagued by governance issues, leading to poor financial performance and a lack of transparency. This can be a significant barrier to foreign investment and trade, as foreign investors may be hesitant to invest in a market dominated by government-owned enterprises.
Energy Subsidies
The Pakistani government provides subsidies on energy products such as electricity, gas, and oil to keep prices low for consumers. While these subsidies benefit low-income consumers, they also lead to inefficiencies and market distortions. According to the IMF, energy subsidies in Pakistan amounted to 1.7% of GDP in 2019, with a significant portion of these subsidies going to the power sector. These subsidies can lead to the overconsumption of energy products and a lack of investment in more efficient energy sources, hindering economic growth and development.
Political Instability
Finally, political instability in Pakistan can be a significant barrier to trade. The country has experienced periods of political turmoil, including military coups, protests, and terrorist attacks, which can disrupt trade and deter foreign investment. According to the World Bank, political instability is a significant obstacle to economic growth and development in Pakistan, as it can lead to reduced investment and increased risk for businesses operating in the country.
In conclusion, the Pakistani government has placed a number of restrictions on trade that can hinder economic growth and development. These restrictions include high import tariffs, non-tariff barriers, state-owned enterprises, energy subsidies, and political instability. While some of these restrictions may be well-intentioned, such as energy subsidies to benefit low-income consumers, they can have negative effects on the overall economy. In order to promote economic growth and development, the Pakistani government should work to reduce trade barriers and improve the business environment for both domestic and foreign investors. This can include measures such as simplifying regulatory frameworks, reducing import tariffs, and improving governance
Social Security issues in Pakistan and Solutions in the Charter of Economy
Charter of Economy: Social Security
Pakistan’s social security programs have been facing significant challenges for years. Pakistan has a high poverty rate, with approximately 24.3% of the population living below the poverty line. The country also has one of the highest rates of income inequality in the world, with the top 10% of the population holding 67% of the wealth.
According to the World Bank, Pakistan has one of the lowest social safety net coverages in the world. The country’s existing social security programs have been unable to provide adequate protection to the vulnerable population, including low-income households, women, and children.
Pakistan’s social security programs only cover a small proportion of the population. According to the Pakistan Economic Survey 2020-21, only 4% of the country’s population has access to social security.
The country’s social security system is fragmented, with multiple programs running simultaneously. There is a lack of coordination and integration among these programs, which leads to duplication and inefficiencies.
Pakistan’s social security programs have limited funding, which restricts their ability to reach a larger population. According to a report by the International Labour Organization, Pakistan’s social security expenditure was only 0.3% of GDP in 2017.
There are reports of corruption in the distribution of social security benefits. This has led to the exclusion of deserving beneficiaries and has increased the cost of providing social protection.
There is a lack of transparency in the administration of social security programs, which has eroded public trust in the system.
The failures of Pakistan’s social security programs have been evident in multiple instances. Here are some recent examples:
In 2019, the Supreme Court of Pakistan took notice of the exclusion of deserving beneficiaries from the BISP, which led to protests and public outcry.
In 2020, the government faced criticism for excluding transgender people from the Ehsaas Emergency Cash Programme.
In 2021, the government faced criticism for the delays in the distribution of cash grants under the Ehsaas Emergency Cash Program, which was launched to help the poor during the COVID-19 pandemic. The program was plagued by a lack of transparency, bureaucratic hurdles, and technical glitches, which resulted in delays and discrepancies in the disbursement of funds.
By merging various social protection programs and centralizing zakat collection, the government could eliminate duplication and improve coordination. PRIME (Policy Research Institute of Market Economy) has created a Pakistan Charter of Economy to address issues in public finance management.
There are three proposals (Proposals 24, 25, and 26) that specifically address long-term outcomes in the social security sector. As follows:
Proposal 24 in the Charter suggests the merger of various social protection programs to eliminate duplication and reform the zakat collection system.
The government has been running multiple social protection programs, such as the Benazir Income Support Programme (BISP) and the Ehsaas Emergency Cash Programme, among others. Merging these programs can eliminate duplication and create a more efficient and effective system. Furthermore, the reformation and centralization of zakat collection can create a more reliable funding source for social protection programs.
According to the State Bank of Pakistan, zakat collection reached PKR 87.6 billion in FY 2021. Redirecting 80% of zakat receipts to be spent on recipients can significantly increase the coverage of social protection programs. Additionally, independently auditing zakat accounts every year can increase transparency and accountability.
Proposal 25 suggests that the government should not incur any debt to fund social security programs and should only rely on taxation and private charities.
This can help create a more sustainable funding source for social protection programs. According to the Pakistan Economic Survey 2020-21, the total revenue collection of the Federal Board of Revenue was PKR 4,691 billion.
The government can allocate a portion of this revenue for social protection programs. Furthermore, private charities can also play a significant role in providing social protection. In 2021, Pakistan was ranked 26th in the World Giving Index, which indicates that the country has a strong tradition of giving.
Proposal 26 suggests the use of Negative Income Tax to target households earning below the income tax threshold.
Negative Income Tax can create a more targeted and efficient system of providing social protection. The NIT is a system where the government provides financial assistance to households whose income falls below a certain threshold. According to a report by the World Bank, Negative Income Tax has been successfully implemented in countries such as the United States and Canada.
The current social security programs in Pakistan have numerous weaknesses and have failed to adequately address poverty and inequality. The fundamental principle to a diverse and effective social security program is sustainable funding. Unfortunately, previous social security programs in Pakistan were not designed for sustainability. Social security has become a political tool, and its present usage is not conducive for saving lives, feeding hungry mouths, or providing sustainability and recovery outcomes for those struggling in hard times.
How Pakistan’s Federal Government is Sabotaging Its Own Economy
How Pakistan's Federal Government is Sabotaging Its Own Economy: 10 Examples of Fiscal Indiscipline
Fiscal indiscipline is a persistent challenge for Pakistan’s federal government, and it is essential to analyze the ways in which it manifests. This article provides an analysis of 10 common ways in which Pakistan’s federal government expresses fiscal indiscipline.
Detailed suggestions on the resolution of Budgetary policy issues can be found within the Pakistan Charter of Economy.
Low Tax Collection
Pakistan’s tax collection is considerably lower than other countries with similar income levels. The Federal Board of Revenue (FBR) reported that Pakistan’s tax-to-GDP ratio was 11.2% in 2020, which is well below the average for middle-income countries. This low tax collection is a significant contributor to fiscal indiscipline, as it limits the government’s ability to fund its expenditures adequately.
Unproductive Spending
Pakistan’s federal government also engages in unproductive spending, which is another contributor to fiscal indiscipline. For example, the government has a history of investing in large, expensive infrastructure projects without proper cost-benefit analysis. These projects often lead to increased debt, which can lead to further financial instability.
Poor Management of Public Sector Enterprises
Pakistan’s public sector enterprises have a history of mismanagement and financial inefficiencies, which can lead to a significant drain on government resources. According to the Pakistan Economic Survey 2020-21, state-owned enterprises’ accumulated losses reached Rs. 2.6 trillion in 2020. This mismanagement leads to increased government spending to keep these enterprises afloat, contributing to fiscal indiscipline.
Lack of Transparency
The government has been criticized for its lack of transparency in awarding contracts and allocating resources, which can lead to increased corruption and inefficiencies.
One example of the lack of transparency is the inadequate public disclosure of information on government spending. The lack of comprehensive and timely information on public spending hinders accountability and makes it difficult to monitor and assess government spending. The Public Financial Management Act of 2019 aims to improve transparency and accountability in public financial management. However, implementation has been slow, and transparency remains a significant challenge.
Another example is the lack of transparency in tax administration. Pakistan’s tax administration has been criticized for its lack of transparency and accountability, leading to low tax compliance and revenue collection. The absence of clear and consistent procedures, as well as limited access to information on tax administration, contribute to this problem.
The lack of transparency in public procurement processes is another area of concern. Public procurement processes are often opaque, leading to mismanagement and corruption. The absence of clear rules and guidelines, coupled with a lack of transparency, often leads to the awarding of contracts to politically connected individuals or firms, which may not be the most qualified for the job. This results in the misallocation of resources and reduced effectiveness of public spending.
Excessive Defense Spending
Pakistan’s defense spending has increased significantly in recent years, which can contribute to fiscal indiscipline. According to the Stockholm International Peace Research Institute (SIPRI), Pakistan’s military expenditure was $10.3 billion in 2020, which represents 4% of the country’s GDP. This excessive defense spending limits the government’s ability to fund other critical areas, such as health and education, contributing to fiscal indiscipline.
Dependence on Loans
Pakistan’s federal government also has a high dependence on loans to finance its expenditures, which can contribute to fiscal indiscipline. According to the Pakistan Economic Survey 2020-21, external debt and liabilities increased to $117.8 billion at the end of March 2021, which is 38.8% of the country’s GDP. This reliance on external financing can lead to increased debt and financial instability.
Lack of Long-Term Planning
Pakistan’s federal government also lacks long-term planning, which can contribute to fiscal indiscipline.
The lack of long-term planning results in poor decision-making and the misallocation of resources. Short-term policies often lead to incomplete projects and the inefficient use of resources, which results in cost overruns and further drains on the budget. This issue is evident in the government’s energy policies, where frequent changes in policies and a lack of long-term planning have resulted in an inadequate and unreliable energy supply system.
Another example of the lack of long-term planning is insufficient investment in infrastructure development. The government’s failure to prioritize infrastructure development has led to inadequate road networks, limited access to clean water and sanitation, and poor quality of public transportation. This hampers economic growth and development, as businesses struggle to transport goods and services efficiently, and individuals face challenges in accessing basic services.
The government’s lack of planning also affects social welfare programs. The government often introduces social welfare programs without adequate planning, which results in poor implementation and inadequate funding. This is evident in the government’s poverty alleviation programs, where a lack of long-term planning has led to inadequate funding, inefficient implementation, and limited impact on poverty reduction.
Weak Revenue Administration
One of the key challenges facing Pakistan’s federal government is the weak revenue administration, which contributes to fiscal indiscipline. The government has struggled to increase its revenue collection and improve tax compliance, resulting in a low tax-to-GDP ratio and an over-reliance on borrowing.
According to the World Bank, Pakistan’s tax-to-GDP ratio stands at around 11%, which is significantly lower than other developing countries in the region. The low tax-to-GDP ratio is due to the government’s failure to effectively implement tax policies, a narrow tax base, and a lack of enforcement.
The government has also struggled to broaden the tax base by including more taxpayers and sectors into the tax net. A significant portion of the economy remains undocumented and operates in the informal sector, which limits the government’s ability to collect taxes effectively. Furthermore, tax exemptions and concessions granted to influential individuals and industries also contribute to a narrow tax base and revenue losses.
The weak revenue administration also results in a high degree of tax evasion and non-compliance. Tax evasion is prevalent in Pakistan, and it contributes to a significant loss of revenue for the government. According to a report by the Federal Board of Revenue (FBR), around 72% of registered taxpayers in Pakistan do not file tax returns. Tax non-compliance not only results in revenue losses but also contributes to a lack of trust in the government and a culture of impunity.
Dependence on External Financing
Pakistan’s dependence on external financing is a significant contributor to fiscal indiscipline. According to the Pakistan Economic Survey 2020-21, the country’s external debt and liabilities increased to $117.8 billion at the end of March 2021, which is 38.8% of the country’s GDP. This indicates that the government is relying heavily on external financing to finance its expenditures.
Simplification of the Pakistani Tax Regime
Simplification of the Pakistani Tax Regime
Pakistan’s tax system has been faced with several challenges including low tax-to-GDP ratios, a narrow tax base, and high rates of tax evasion.
Pakistan’s tax-to-GDP ratio was only 10.4% in 2020, which is significantly lower than the average of 15.3% for countries in the South Asian region (World Bank). Economists and policymakers have proposed that a low rate, flat, broad-based, and predictable tax regime can help Pakistan overcome these challenges and achieve greater economic growth and development. The proposals are reflected in the Pakistan Charter of Economy.
Low Rates
Several reasons support the implementation of a simplified tax system with a low tax rate. First, low tax rates encourage taxpayers to comply with their tax obligations. High tax rates can discourage people from working, investing, or saving, as the cost of these activities may be too high compared to their after-tax returns. Conversely, low tax rates provide individuals and businesses with more financial resources to engage in productive economic activities, which leads to increased economic growth and development.
Furthermore, a one-percentage-point reduction in tax rates can lead to a 0.3% increase in GDP in the short run and a 0.6% increase in the long run, according to a study by the International Monetary Fund (IMF). Tax evasion in Pakistan amounts to about 70% of the total tax revenue (Pakistan Institute of Development Economics).
Lower Administrative Costs and Compliance
A simplified tax system can lead to lower administrative costs, resulting in significant cost savings for the government. According to a World Bank report, Pakistan spends approximately 1.7% of its GDP on tax administration, which is higher than the average for countries in the South Asian region. Streamlining the tax collection process and reducing the need for expensive technology and personnel could lower administrative costs.
The current tax system in Pakistan is characterized by a multitude of tax rates, exemptions, and deductions, making it complex and difficult for taxpayers to understand and comply with. A flat tax rate would simplify the system, reduce the need for tax planning, and promote greater transparency and accountability. A World Bank study found that a flat tax rate could increase compliance by up to 7%, as taxpayers would be less likely to engage in tax evasion or avoidance.
A Broader Base
A broad-based tax system is desirable because it ensures that all individuals and businesses contribute to the tax base. Pakistan’s tax base is narrow, with only a small proportion of the population paying income tax. A broad-based tax system would ensure that all individuals and businesses, regardless of their income or status, contribute to the tax base. This would increase the revenue raised from taxes and promote greater fairness and equality in the tax system.
Broadening the tax base by just 1% could lead to an additional Rs. 50 billion in revenue, according to a study by the Pakistan Institute of Development Economics. Dr. Ikramul Haq in 2019 estimated that a flat tax rate of 15% could result in a tax revenue increase of up to 0.9% of GDP in Pakistan
Predictability and Certainty over the Long Run
A predictable tax system is desirable because it promotes certainty and stability for taxpayers. The current tax system in Pakistan is characterized by frequent changes in tax laws and regulations, leading to uncertainty and instability for taxpayers. A predictable tax system would provide taxpayers with greater certainty and stability, allowing them to plan their finances and investments more effectively. Countries with more stable tax systems tend to have higher rates of economic growth and development, according to a study by the Tax Justice Network.
Limiting Corruption
A simplified tax system can reduce corruption and tax evasion, leading to higher tax revenues for the government. According to the Pakistan Institute of Development Economics, tax evasion in Pakistan amounts to approximately 70% of the total tax revenue. A simplified tax system with lower tax rates and reduced complexity could reduce opportunities for corruption and increase tax compliance, resulting in higher tax revenues for the government.
Economic Efficiency
Simplified tax regimes can allocate resource more efficiently, as individuals and businesses are not deterred from engaging in economic activity due to high taxes or a complex tax system. According to a study by the International Monetary Fund, a simpler tax system can lead to higher investment, greater innovation, and higher levels of economic growth. This is because a simpler tax system reduces the time and resources required to comply with tax regulations, which can be a significant barrier to economic activity.
Low rate, flat, broad-based, and predictable tax regime can bring significant benefits to Pakistan’s economy. Such a tax regime would incentivize taxpayers to comply with their tax obligations, simplify the tax system, broaden the tax base, and promote certainty and stability for taxpayers.
Fiscal Indiscipline in Pakistan’s Public Sector
Pakistan’s economy has been facing severe financial challenges for several decades, and one of the primary reasons for this is the government’s lack of fiscal discipline. The government’s spending has been increasing rapidly in recent years, leading to a significant surge in the country’s budget deficit. To address these issues and ensure sustainable economic growth, the government needs to exercise fiscal restraint and focus on reducing its expenditures.
In the most recently published Pakistan Charter of Economy by the Policy Research Institute of Market Economy, we try to address some of the issues. Check out the section on spending restraint.
The government’s high level of spending is the primary reason for the country’s fiscal challenges. Pakistan’s government expenditures have been increasing significantly over the past few years, which has led to a substantial increase in its budget deficit. The government has been borrowing heavily to finance its spending, leading to a significant increase in the country’s debt burden.
Government Employees
- The government of Pakistan employs 3.2 Million persons, or 5.1% of total labor force, and 1.57% of the total population.
- The total government expenditure is 22% of GDP, and wages account for 3.6% of GDP and 19% of combined current expenditures of the Federal and Provincial Governments.
- The provincial government employees constitute half of the bureaucracy while the remaining work with the Federal Government.
- 35% of Federal employees work in security, 20% in infrastructure, and 18% in the energy sector.
- At the provincial level, 41% of the government workforce is engaged in the education sector. Together with health and security, constitute 75% of employees, and 72% of wage expenditure.
- 95% of government employees are in the unskilled (50%) and semi-skilled (45%) categories and constitute 85% of the wage bill.
- 1.4 million persons are employed by the military.
- In comparison, the ruling British raj needed no more than 1200 officers to conduct public services.
To address these issues, the government needs to reduce its spending. This can be achieved by cutting down on non-essential expenditures, eliminating all subsidies, and redirecting resources to more critical areas such as health, education, and infrastructure development. The government should prioritize spending on programs and projects that yield the most significant benefits for the country and cut down on expenditures that do not contribute to economic growth.
Curbing Expenditures
The government can also consider implementing austerity measures to reduce spending. These measures can include freezing salaries and benefits for government employees, reducing the number of government employees, and cutting down on travel and entertainment expenses. These measures will help the government save money, reduce the budget deficit, and improve the country’s fiscal health.
Efficiency
Another essential aspect of reducing government expenditures is improving the efficiency of public spending. In recent years, Pakistan’s government spending has been characterized by inefficiencies and waste. The government needs to implement policies that ensure public spending is directed toward projects and programs that yield the greatest benefits for the country. The government can achieve this by implementing a results-based management system that measures the impact of public spending and ensures that resources are allocated to projects that deliver the most significant results
Leakages from Corruption
The government also needs to focus on reducing corruption in public spending. Corruption has been a significant challenge in Pakistan, and it has contributed to the country’s fiscal challenges. The government needs to implement anti-corruption measures that promote transparency and accountability in public spending. This can be achieved by strengthening anti-corruption institutions, increasing transparency in public procurement, and improving oversight and monitoring of public spending.
Finally, the government needs to explore opportunities for public-private partnerships to reduce government expenditures. Public-private partnerships can help the government deliver public services more efficiently and cost-effectively by leveraging private sector expertise and resources. The government can partner with private companies to provide services such as healthcare, education, and infrastructure development, which will help reduce government spending and improve the quality of public services.
In conclusion, Pakistan’s government needs to exercise fiscal restraint and focus on reducing its expenditures to address the country’s fiscal challenges. The government should prioritize spending on programs and projects that contribute to economic growth and reduce non-essential expenditures. The government should also implement policies to improve the efficiency of public spending, reduce corruption, and explore opportunities for public-private partnerships. By taking these steps, the government can reduce the budget deficit, improve the country’s fiscal health, and ensure sustainable economic growth in the years to come
Withholding Tax Regime: History, Consequences for Business and Implications for Policy
The contribution of Withholding Taxes in direct tax revenue has surpassed 75 percent, and it has brought in more than Rs. 860 billion to the government kitty in 2014-15. On the other hand, the number of tax return filers has gone down considerably from 1.8 million in 2006 to 0.85 million in 2014-15. The decision to apply a differentiated rate of Withholding Tax (WHT) on filers and non-filers, while penalizing the later, is seen as government’s attempt to bring people back into tax net. However, the unseen and unintended consequences of an increasingly complex WHT regime might be exact opposite. This analytical report discusses the history of WHT in Pakistan, its consequences for businesses and implications for the tax policy as well as tax administration.
To read the full report or download for offline reading, click here: Withholding Tax Regime: History, Consequences for Business and Implications for Policy
Towards Flat, Low-rate, Broad and Predictable Taxes
Federal and provincial governments in Pakistan have shown a lukewarm attitude in restructuring the country’s tax system to achieve efficiency, equity and to promote economic growth. Complex tax codes, complicated procedures, reliance on easily-collectable indirect taxes, weak enforcement, inefficiencies, incompetence and corruption are main factors for low tax collection.
Instead of broadening the tax base and simplifying laws, federal and provincial governments offer amnesties, immunities, tax-free perks and perquisites to powerful segments of society. As a result of this policy mindset, ordinary businesses and citizens suffer. This paper argues radical revamping and restructuring of the entire tax system, suggesting flat, low, broad and predictable taxes.
To read the full report or download for offline reading, click here: Towards Flat, Low-rate, Broad and Predictable Taxes
Provinces Tracking Report 2016-2017
Provincial Tracking Report reviews economic performance of three provinces, Khyber Pakhtunkhwa, Punjab and Sindh by tracking the progress made on the implementation of economic manifesto announced by the parties in power in these respective provinces i.e. Pakistan Tehreek-e-Insaaf (PTI), Pakistan Muslim League-Nawaz (PML-N) and Pakistan People’s Party-Parliamentarians (PPP-P). In case of Balochistan, the report includes a commentary on the socio-economic status of the province instead of following any manifesto
because of a mid-term change in the government. The purpose of the Provincial Tracking Report is to initiate and inform policy dialogue and public debate on the progress made by political parties vis-à-vis their electoral promises. This tracking directly serves the basic principle of a functioning democracy: accountability.
To read the full report or download for offline reading, click here: Provinces Tracking Report 2016-2017
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