THE recent wide-ranging tax reforms have failed to improve the tax-to-GDP ratio and may be seen as counterproductive as the pre-reform tax regime.
The old system offered plenty of discretion to the tax administration. It did not have the universal self-assessment scheme, and the tax authority was empowered to assess the income of the taxpayers either on the basis of estimation or definite information.
There was no automation and the rules of business were conducted manually, which offered ample space for manipulation of records. The overall tax environment was not friendly and the tax procedures were complex and time consuming. The tax base was narrow and subjected to higher tax rates.
To make the Federal Board of Revenue a modern, progressive, effective, autonomous and credible organisation for optimising tax revenue by providing quality service and promoting tax compliance, the government, with help from the World Bank, launched the Tax Administration Reform Project (TARP) in 2003. It continued until 2011. The total cost of the project was Rs9.5bn, of which Rs7.3bn was funded by the World Bank and Rs2.3bn by the government.
An analysis indicates that during and after the completion of the tax reforms, tax collection as a percentage of GDP actually fell, from 12pc in 1996-97 to 8.9pc in 2013-14. A study found a significant decline in the tax-GDP ratio during and after the reforms (2002-03 to 2013-14) as compared to the pre-reform period (1990-91 to 2001-02).
Tax collection from customs duty and federal excise duty decelerated more than the expected rise in revenue from income tax and sales tax
Nonetheless, the decline has been contributed by the tax policy shifting from customs duty and federal excise duty (FED) to income tax and sales tax. Tax collection from trade taxes (customs duty) declined from 4.1pc of GDP in 1990-91 to 0.95pc of GDP in 2013-14, a drop of 3.15pc. Similarly, tax revenue from FED decreased from 1.9pc in 1990-91 to 0.6pc in 2013-14.
On the other hand, the income tax-to-GDP ratio rose from 1.5pc to 3.5pc during the period, up 2pc. Similarly, sales tax revenue as a percentage of GDP shot up from 1.4pc in 1990-91 to about 4pc in 2013-14. Nominal GDP showed a massive growth, going up from around Rs908.4bn in 1990-91 to Rs25,402bn in 2013-14.
However, tax collection from customs duty and FED decelerated more than the expected rise in revenue from income tax and sales tax. The tax enforcement measures were not strong enough to ensure legitimate tax collection during the tax-reform period (2002-03 to 2010-11).
For example, tax audits remained suspended and there was massive tax evasion during the period; the corporate tax evasion rate reached 45pc. Taxpayers inflated their expenses while filing returns, eroding the tax base drastically. Resultantly, effective tax rates plummeted significantly as compared to high statutory tax rates.
Furthermore, income tax is the only direct tax levy left, as the wealth tax and the capital value tax were abolished. Tax exemptions and concessions from income tax resulted in big revenue losses during and after the tax reforms. The income tax base remains narrow due to poor tax culture, as indicated by low voluntary tax compliance.
Achieving an optimum level of taxpayer facilitation remains a day dream as the time required for tax compliance is as high as 594, as compared to 133 hours in Malaysia, 167 in Sri Lanka, 243 in India, 302 in Bangladesh and 334 in Nepal. Lack of fiscal transparency is also posing a challenge in promoting tax culture.
Published in Dawn, Economic & Business, February 23rd , 2015