Pakistan’s potential tax gap is Rs3,000 billion annually, owing primarily to tax exemptions for influential lobbies, significant tax evasion, and the machinery’s incapacity to collect due taxes.
On the orders of Prime Minister Shehbaz Sharif, the Federal Board of Revenue (FBR) has been tasked with conducting the first-ever formal study to assess the ‘tax gap,’ taking into account federal government jurisdictions under the 1973 Constitution for tax imposition.
Under the current constitutional framework, the federal government is responsible for the GST on products, while the provinces are responsible for the GST on services. Agriculture income taxes are the provinces’ responsibility.
Sharing the findings of the study, Chairman Asim Ahmad told that out of the total size of economy to the tune of Rs67 trillion, the federal government levied a sales tax of Rs32 trillion and then calculated income tax, customs duty and federal excise duty potential.
Read more: FBR collects Rs 5.4 trillion in taxes
FBR Chairman said, “we have found that the total tax potential under jurisdiction of the federal government stands at Rs9,000 billion out of which the FBR collected Rs6,000 billion so the tax gap was assessed at Rs3,000 billion on a per annum basis.”
He added that there was a tax gap of Rs3,000 billion out of which Rs1,800 billion was a policy gap, as it occurred mainly because of tax exemptions/incentives provided by the FBR to different sectors. He added, “there is a remaining compliance gap of Rs1,200 billion.”
The chairman said that if the FBR abolished all kinds of tax exemptions and ensure full compliance the tax to GDP ratio could touch 14 percent with a maximum collection of Rs9,000 billion on an annual basis.
He stated that our country’s tax-to-GDP ratio was the lowest, but even if all tax potential was collected to the tune of Rs9,000 billion, the tax-to-GDP ratio would not exceed 14 percent.
He stated that there were legal concerns, citing agriculture as an example, which contributes 22% to GDP but has a tax collection rate of less than 1% because it is not the federal government’s jurisdiction to collect taxes on the agriculture sector.
Read more: The misuse of taxation in Pakistan
He also stated that tax rates were on the lower side, with the highest corporate tax ceiling of 29 percent, while salaried individuals paid 35 percent. He stated that the corporate sector paid after adjusting all of its expenses, whereas the salaried individual paid tax on gross amounts, causing anomalies in our taxation system.
He stated that the FBR concentrated on direct taxes, taking taxation measures totaling Rs600 billion in the budget 2022-23, with net taxation measures being Rs545 billion after removing relief measures. “On the direct taxes side, 80 percent of the overall taxation measures of Rs545 billion have been taken,” he said.
After 2006, when direct taxes were expected to be the dominant revenue generator in comparison to indirect taxes, there should have been a significant shift in tax policy. It is now going to happen after 16 years as the contribution of direct taxes will be on the higher side than the indirect taxes.
He stated that broadening the tax base will be accomplished using technology to bring the entire supply chain into the tax net, and that the FBR had devised a plan to achieve this goal. Turkey had done it, but the FBR has been unable to move further with payment digitization.
He stated that the FBR was focusing on broadening the tax base with the help of technology in order to broaden the tax base. He proposed tax breaks to aid the FBR in meeting its goals. He stated that the FBR respected both taxpayers and tax consultants and that he believed in resolving concerns, thus the FBR’s senior management would get together to resolve issues. He said that the problem’s root cause will be addressed at all stages.
He stated that the FBR exceeded its revised target of Rs6,100 billion despite a monthly income impact of Rs45 billion due to zero percent sales tax on petroleum goods. According to the FBR chairman, the IMF forecasted that the FBR would not be able to meet the tax collection target for the fiscal year that concluded on June 30, 2022.
According to State Bank of Pakistan, the tax reform must be aimed at increasing tax bases, rather than imposing taxes on existing taxpayers. The recent reduction in tax rates is a welcome development that may encourage voluntary tax payments; however, this might exclude a large number of potential taxpayers.
On the flip side, the reduction in rates would help increase savings or consumption that would, in turn, support higher economic activity. Given the large tax gap, provinces must enhance their efforts to bring untapped sources into tax net to reduce reliance on federal transfers.
Moreover, Pakistan income tax system is based on universal self-assessment schemes and revenue capacity is limited due to the large informal sector. In FY13, 73.3 percent of employment was generated by informal sector, which means only a part of the remaining quarter would be paying taxes. A well thought policy aiming to improve tax compliance across existing sectors and bringing the informal sector into tax net can make the system more progressive.