The Shameful Tax Gap

The tax gap — the difference between sum of tax owed and amount of tax paid voluntarily and on time  — stands at 79 per cent of the actual tax receipts in Pakistan, according to Federal Board of Revenue chairman Salman Siddique.

This compares with the tax gap of nine per cent in the UK and 22 per cent in the US, he told the Supreme Court last month during the hearing of a case about pilferage of containers entering Pakistan’s territory under the Afghanistan-Pakistan Transit Trade Agreement.

Mr Siddique’s tax gap estimate is based on a study detailing the extent of tax non-compliance during the financial year 2007/08 and released by the World Bank in September 2009. The report – Pakistan Tax Policy Report 2009: Tapping Tax Base for Development – pointed out that the total tax evaded in 2007/08 stood at Rs796 billion against a collection of just over Rs1.1 trillion.

“Only 2.4 million people (out of a population of 180 million) file their tax returns. ‘’This is shameful,” tax expert Ikramul Haq told Dawnlast week. “The tax gap – which arises from tax evasion, avoidance and exemptions (given to certain groups like rural land owners and urban property holders at the cost of the others) – underscores collection inefficiencies and defective and inequitable tax policy,” he contended.

The World Bank report, too, emphasised the same, saying, “there is a broader consensus that the country’s tax system under performed as it has a narrow base, with taxes being levied on a limited number of sectors, businesses and individuals. A large tax gap suggests that the tax system is likely to under perform in terms of revenue, efficiency, equity and administration.”

Rampant tax pilferage explains the main reason for the country’s tax-to-GDP (gross domestic product) ratio of less than nine per cent, one of the lowest in the world. Only a fraction of taxes “illegally evaded or legally avoided (in the form of exemptions)” can be recovered through initiation of legal proceedings against the tax cheaters.

“This involves a cumbersome legal process and we are rarely able to recover the exact unpaid amount of taxes after delays of months and years because of lacunas in the laws, social and political pressures and widespread corruption (in the FBR),” conceded a senior tax official, who requested anonymity.

He said, it was difficult to state the exact size of tax pilferage. But he pointed out  that any increase in the collection of tax revenues in absolute terms did not signify actual reduction in the tax gap. “It simply means that the government might have imposed more indirect taxes to push its collection and protect the affluent segments of society. Indirect taxes are bad for the people because it forces many to pay taxes even though they shouldn’t be paying any. These also have implications for the economy and may retard growth,” the official said.

Tax experts say, the reasons for tax pilferage are numerous. “While some may evade taxes because of personal greed, others escape paying their share because of a lack of documentation of the economy and the fear of accountability/punishment. Some may under report their incomes because of high tax rates and absence of incentives for honest taxpayers. Lack of political will for stricter enforcement of tax laws, departmental corruption and inefficient collection machinery also contribute significantly to the anti-tax culture,” said Naveed Anwar, a chartered accountant.

The implications of tax pilferage for the economy and society can be serious and far-reaching. It leads to huge losses to the government revenues, which are crucial for meeting its development and non-development expenditure requirements, and encourages black economy. Additionally, say the experts, it causes accumulation of wealth in fewer hands and promotes wasteful consumption.

More importantly, argued Mr Haq, the tax pilferage and exemptions were an incentive for speculative investments. “The taxes are not merely a tool for revenue generation for the government alone. These are also an important tool for discouraging certain activities in the economy and encouraging the others,” he contended. “In Pakistan the taxes discourage productive investments and encourage unproductive and speculative investments in property, etc. Who would want to work hard and invest in the industry or other productive sectors if he can earn tax-free income through speculative investment in property?,” he asked.

He was of the view that the inequitable tax exemptions, particularly on property transactions and rental income, led to unproductive investments and imposition of inequitable taxes on productive economic sectors as well as on people who should be getting tax subsidies.

“We cannot measure exact tax gap because we are unaware of the country’s  tax potential. But we can say with certainty that the tax gap is created to benefit the wealthy and the powerful.”

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