Bridging tax gap — II
Huzaima Bukhari and Dr Ikramul Haq
Presently, collection of sales tax is concentrated in few commodities. This is confirmed by the fact that petroleum products alone contribute around 44 percent of the total sales tax domestic collection. Just 10 items including POL and natural gas yielded 73 percent of the total net sales tax domestic in 2015 and 2016 [FBR’s Biannual Review (January-June 2014-15)]. Against the prescribed rate of 17%, the effective sales tax rate for total domestic sales is 4.55 percent. This rate is 6.81 percent, 7.96 percent, 8.36 percent and 13.56 percent for top 40, 30, 20 and 10 sales tax paying entities respectively. This shows that domestic sales made by more than 99 percent of taxpayers contribute sales tax at effective rate less than 4.55 percent [effective rate is the actual rate that yielded the total collection—see details in Effective rate of Sales Tax on 60 major sectors stands at 4 percent, Customs Today (online edition, January 31, 2015)].
The study recommends simplified sales tax of 8 percent by federal government and ultimately the introduction of Harmonised Sales Tax (HST). Sales tax collection and compliance can be improved by introducing simplified regime and enforcement through single tax collection agency—National Tax Agency (NTA). The NTA is presented as a model for trusted tax and benefit administration, providing unparalleled service and value to its clients, and offering its employees outstanding career opportunities. The present tax agencies at federal and provincial levels would merge in NTA. An integrated Tax Intelligence System would be implemented by NTA that can capture all inflows and outflows and correlate sales tax collections on goods and services with income tax returns and monitor all transactions at all levels. This alone can ensure proper tax compliance as mere reduction in tax rates may not induce many to discharge their tax obligations diligently.
A fully automated, professional and efficient NTA would alone be in a position to enforce tax obligations. Before establishing NTA, major information technology and human resource improvements in tax collection methods as well as effective audit techniques should be developed. The estimate for collection of simplified, low-rate sales tax is not less than Rs 3 trillion.
Customs collection is Pakistan faces serious issues of smuggling, under invoicing, over-invoicing, misdeclarations and valuation rulings etc—these are not only causing a loss to national exchequer but also hurting open markets. The enhanced collection from 2015-16 to 2017-18 was due to imposing regulatory duty on hundreds of items. The rationalisation of customs revenue is not possible through narrow bases (10 items contribute more than 80% receipts), in the presence of numerous statutory regulatory orders (SROs) and numerous valuation rulings — all leading to complexity and leakages. The existing tariff slabs with the peak of 20 percent and floor of 2 percent is source of corruption and leakages.
“Such a menu of tariff rates endows custom officials with the opportunity to extract rent from the importers. If officials have sufficient discretionary power, they might threaten to misclassify goods into more heavily taxed categories unless importers pay them a bribe. Because of the bribe, the effective tariff rate faced by the importing firm increases and the demand for the imported good therefore decreases. It can be easily shown that the resulting drop in import demand implies an efficiency loss as well as lower government revenues, when compared with the optimal taxation benchmark without corruption. A similar argument applies when customs officials offer to classify goods into low tariff categories in exchange for a bribe. The empirical evidence confirms that the interaction described might have significant relevance, as a robust association between standard deviation of trade tariffs–a measure of the diversification of tariff menus–and corruption emerges across countries” [‘Corruption and Trade Tariffs, or a Case for Uniform Tariffs’, Roberta Gatti, The World Bank, Development Research Group].
“The issue of a uniform tariff across goods has received substantial attention by both economists and policymakers. Among other things, uniform tariffs have been shown to reduce gains from lobbying for protection and thus enhance economic efficiency, increase the cost to future governments of protecting favoured sectors, and in general improve transparency” [Panagariya and Rodrick (1993)].
The study suggests uniform rate of 2 percent for all items that will eliminate the menace of smuggling, arbitrary and/or favourable valuations, complicated registration processes as well as the SRO-ridden system. This low, uniform rate will generate at least revenue of Rs 1200-1500 billion.
Federal Excise Duty
The study suggest that Federal Excise Duty [FED] should be imposed as a sin tax on tobacco, alcohol and other harmful items. The amount so collected should be utilised for improving national education and health services. In the same manner, FED should be imposed as carbon tax for fighting environment degradation as well as on luxury goods to discourage their consumption, especially import. The study also recommends imposition of FED on natural gas and oil at well-head as provided in Article 161(1)(a) & (b) so that provinces can get more revenue in the form of net proceeds from these sources.
The above discussion shows that tax collection under the model suggested in Towards Flat, Low-rate, Broad and Predictable Taxes (PRIME Institute, Islamabad, 2016) would be at least Rs. 9 trillion, much higher than what is being collected at the moment. Additionally, the proposed tax system being simple, predictable and growth-oriented will be taxpayers’ friendly. It will also remove the bases of shadow economy, corruption, rent-seeking and lobbying by the unscrupulous businessmen.
(The writers, lawyers and partners in Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences)