Pakistan’s taxation system remains all wrong
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One of the major contributory factors leading to the political upheaval that resulted in the French revolution is said to have been the taxation system of the Ancien Régime, which was derided for being “excessive, inefficient and unfair.” It was excessive because France in the late 18th century became one of the highest taxing states in Europe, driven by spending on its army, its expanding bureaucracy and the profligate monarchy. It was inefficient because it encouraged corruption and tax avoidance. It was unfair because the bulk of the nation’s direct taxation was levied on the Third Estate – the common people. The privileged First and Second Estate, or the clergy and the nobility respectively, paid little or no taxes, despite possessing much of the wealth of the nation.
Not unlike in pre-revolutionary France, there is a growing sense of grievance among the Pakistani urban salaried classes and corporates that they bear the burden of generating a disproportionately large part of direct taxes. The sense of unfairness is exacerbated by the fact that many other affluent segments of society with vast amounts of wealth that generate considerable income stubbornly refuse to contribute taxes to the national exchequer.
This has been highlighted by the latest set of budget proposals, which has raised tax revenue targets for FY2023 to contain the fiscal deficit, but resolutely shies away from bringing into the net traditionally untaxed segments of the economy, such as agriculture. Furthermore, very negligible fixed taxes have been proposed on retailers’ incomes. While Pakistan’s overall tax-to-GDP ratio remains one of the lowest among comparable countries, there is a widely-held perception that those who are in the tax net pay a lot. Despite personal income taxes on average being lower than in comparable regional countries such as India and Bangladesh, the latest budgetary proposals reinforce the perception of unfairness since those who avoid documentation have once again escaped the tax net altogether or pay very little.
A pattern set by successive governments of expanding treasury revenues by either increasing corporate taxes or imposing one-off taxes is exemplified by the latest proposal to impose an additional 10 percent super tax, over and above the regular corporate tax rate of 29 percent (35 percent for banks), on companies in thirteen sectors that declare annual profits of above Rs300m. The government has stated that the super tax is a one-off tax only applicable to FY2023, but as the economist Milton Friedman said, “Nothing is so permanent as a temporary government program.” Where no fundamental changes have been taken to broaden the tax net and therefore expand the source of potential revenue, it is likely that supposedly one-off tax measures will end up being continued in perpetuity.
Far from ensuring tax neutrality, and enabling an environment where investment decisions and the choice of resource allocation are driven by efficiency and competitiveness, the government is tipping the scale in favor of the undocumented, and arguably less productive, sectors.
Javed Hasan
Additionally, as the budgetary proposals presently stand, the government has indicated that it intends to reverse its earlier decisions to exempt those earning up to Rs100,000 a month from income tax, and also roll back the plan to reduce the highest income tax rate from 35 percent to 32.5 percent. It has set the minimum income tax rate of 2.5 percent for those earning up to Rs100,000 per month as well as a maximum of 35 percent on the monthly income of over Rs1 million. Unless there are further revisions to the budget, the tax burden on the salaried class will be increased through the withdrawal of various tax reliefs in the outgoing fiscal year as well as the reversal of tax reductions announced when the budgetary proposals were first presented on June 10. For example, under the proposed upward revised tax slab, the salary slab of salaried individuals from Rs100,000 to Rs200,000 will now pay tax 12.5 percent as compared to 7.5 percent in the outgoing fiscal year.
The latest set of tax proposals will not only be seen as unfair in further burdening the already heavily taxed segments of society, but will also lead to inefficient allocation of resources. That will have long-term consequences for the overall direction of the economy. For instance, the supertax will significantly squeeze the profits of companies coming under its ambit, which in turn is likely to discourage their future investment plans. The state through its tax measures is effectively encouraging tax evasion among individuals and disincentivizing businesses from corporatizing or getting documented into the formal economy. The additional taxes on large companies penalizes growing in scale. Far from ensuring tax neutrality, and enabling an environment where investment decisions and the choice of resource allocation are driven by efficiency and competitiveness, the government is tipping the scale in favor of the undocumented, and arguably less productive, sectors.
Finally, policymakers should bear in mind that inefficient taxation where a small section of society bears the bulk of the burden of direct taxation, and one that appears to be impervious to reform, can spark civil unrest that leads to unpredictable political consequences.
– Javed Hassan has worked in senior executive positions both in the profit and non-profit sector in Pakistan and internationally. He’s an investment banker by training.
Twitter: @javedhassan
