FeaturedNationalVOLUME 19 ISSUE # 30-31

The imperative for comprehensive tax reform in Pakistan

Pakistan’s tax system is in dire need of a comprehensive overhaul. For years, the country’s fiscal structure has been hampered by an over-reliance on indirect taxes and a reluctance to implement direct taxation measures. This approach has disproportionately burdened lower-income groups while allowing the wealthy to evade their fair share of contributions. The resulting fiscal imbalance has exacerbated economic inequality and hindered sustainable growth. Addressing these issues through meaningful tax reforms is crucial for the country’s economic stability and equitable development.

That Pakistan’s decrepit tax infrastructure urgently necessitates an exhaustive revamp is a truth long acknowledged, yet it has never precipitated meaningful reforms, thus intensifying the nation’s tenuous fiscal predicament and perpetuating the unchallenged dominance of elite factions. The Federal Board of Revenue (FBR) surpassed its May target by Rs15.21 billion, driven by augmented income tax and import duties collection, according to provisional data. The FBR adjusted the tax collection targets downward by nearly Rs66 billion for May and Rs8 billion for April, accommodating the tax amounts from last year’s budgetary measures obstructed in courts during FY24.

May’s revenue collection amounted to Rs760.21 billion against a forecasted target of Rs745 billion, marking a 32.8% increase from Rs572.29 billion in the same month last year. These figures are expected to improve post-book adjustments. In the initial 11 months (July-May) of FY24, the FBR amassed Rs8.122 trillion compared to the Rs8.162 trillion target. This represented a 30.8% increase over the Rs6.208 trillion collected during the corresponding months of the previous year. Revenue collections fell short of budgetary targets in February, January, April, and May.

The FBR must collect Rs1.253 trillion in June to reach the FY24 budgetary goal of Rs9.415 trillion. The June target was initially projected at Rs1.178 trillion, now augmented by a Rs75 billion backlog from prior months. The government disbursed Rs438.110 billion in refunds/rebates to taxpayers during 11MFY24, up from Rs315.223 billion in the corresponding period last year, a 38.98% increase. Tax-wise analysis revealed that income tax collection surged by 40.6% to Rs3.857 trillion in 11MFY24 from Rs2.743 trillion in the same months last year, demonstrating a significant uptick. In May, income tax collections rose by 48%.

Sales tax collection reached Rs2.767 trillion in 11MFY24, up from Rs2.314 trillion over the corresponding months last year, reflecting a 19.6% growth. In May, sales tax collection increased by 20%, which was below projected targets despite unprecedented inflation. Federal excise duty collection soared by 54% to Rs503.034 billion in 11MFY24, compared to Rs326.496 billion over the same period last year. The previous year, the government introduced new FEDs on several products, which bolstered collection.

Significant amendments to tax laws are imminent, poised to be enacted through the Finance Bill 2024. These aim to increase the financial transaction costs for non-filers of income tax returns and introduce enforcement measures amounting to Rs300-400 billion in 2024-25.

Nonetheless, it remains to be seen how earnestly the government will pursue structural tax reforms to address the fundamental issues plaguing our tax system, from a narrow tax base to an over-reliance on indirect taxes and widespread tax evasion.

The government must grasp the critical need for structural reforms in both direct and indirect taxation. A persistent reluctance to utilize direct taxation mechanisms, such as taxing incomes and assets, has led to an excessive dependence on indirect taxes, predominantly sales tax. This regressive approach disproportionately affects lower-income groups, exacerbating economic inequality.

This reliance on high rates of indirect taxes is not only highly inflationary but also fundamentally unjust. It unfairly burdens lower-income groups while allowing the wealthy to evade their fair share of tax contributions. Consider the simple act of recharging mobile balances on prepaid SIM cards. This activity, which is common among the poorest segments of the population, is subject to both sales tax and advance income tax. This dual taxation is inequitable, as the affluent can claim credits for the advance income tax paid, while poorer individuals, who do not earn enough to file tax returns, have no such recourse.

Furthermore, the current income tax regime exempts large segments of the population without generating significant economic activity. For instance, the annual pension bill, projected to surpass Rs1.5 trillion this year, remains entirely untaxed. This growing expenditure is unsustainable, necessitating that pensions above the statutory exemption level be taxed.

In addition to integrating the retail and wholesale sectors into the tax net, another overdue area of reform is agricultural income taxation. Federal governments have long claimed that agriculture, being a provincial matter, precludes federal tax reforms in this sector. However, this excuse is no longer tenable. The PML-N and PPP, which are part of the ruling coalition at the center, govern the two largest provinces, Punjab and Sindh. If they are truly committed to economic reform, they should institute agricultural income taxes in these provinces. Moreover, they should devise a system to ensure that middlemen in the agriculture sector do not escape taxation. This does not require overcoming constitutional barriers and can be implemented immediately.

Policymakers must recognize that indirect taxes have never resolved issues related to our fragile fiscal reserves. The almost criminal exemptions granted to various economic segments have entrenched elite capture, with lower-income groups essentially subsidizing the lifestyles of the affluent. Persisting with the current tax policies will only spell disaster for our economy and exacerbate our fiscal constraints.

The path forward for Pakistan’s economic health lies in robust and equitable tax reforms. By shifting the focus from indirect to direct taxation and ensuring that all sectors, including agriculture, contribute their fair share, the government can alleviate the disproportionate burden on lower-income groups and reduce the inflationary impact of high indirect taxes. Addressing tax exemptions and integrating previously untaxed income sources, such as pensions and agricultural incomes, into the tax net is essential. Failure to act will only perpetuate economic disparities and fiscal instability. It is imperative for policymakers to implement these changes to secure a prosperous and just economic future for Pakistan.