Article was Published in the Money Matter on April 1, 2013
|Why pay taxes|
|By M. Ali Kemal|
Poor tax collection translates into poor living conditions. This is a point that has been brought home time and again by numerous researchers. Only recently, Sayem Ali wrote in this magazine about health indicators which suggest that Pakistan’s infant mortality rate is worse than that of many African countries. He also cited the embarrassing information that 67 percent of parliamentarians and senators did not file their tax returns in Pakistan. Most interestingly, one senator paid only Rs 82 in tax.
The main idea he raised was that we don’t collect enough taxes nor do we have a strict inspection and punishment system for those who are evading taxes. Due to the low level of tax collection, we cannot finance our basic needs. It is important for any developing country to provide basic education and health services to everyone. In this article I have attempted to identify other problems which emerge when taxes are not paid.
Since I started studying economics I have been listening to four major problems Pakistan’s economy has been facing: (i) exchange rate depreciation (ii) high inflation (iii) balance of payments crisis, and (iv) high fiscal deficit. Since the scope of this article is taxation, which is a fiscal variable, this analysis is restricted to the fourth problem.
Budget deficit is the difference between taxes and revenues. It is commonly argued that to reduce the deficit, we should increase taxes or decrease expenses. However, when asked how this should be done and which taxes should be increased, the answer is, usually along the lines of “tax the rich and give relief to the poor.” As for the how part, the most common answer to this is: “I don’t know; it’s the government’s job.” Those who know about taxes are likely to say, “Increase direct taxes and not indirect taxes.” Since direct taxes can be more progressive and indirect taxes are regressive by nature, the answer is correct.
Certainly, if everyone pays their share of taxes, we may have a lower budget deficit than we do at present. The most important consequence of having greater revenues and a lower budget deficit is lower borrowing and a sustainable deficit. Sustainable deficit means GDP growth rate is higher than the deficit, which implies that the government may not need to ask the SBP to roll over debt and may not need to borrow from scheduled banks. Moreover, chances of bankruptcy and solvency will be reduced and both government and banking sector credibility will improve. This may attract private and foreign investment in the country. Nevertheless, other measures should also be taken to attract investment.
Informal activities are mostly outside the tax net. Recent estimates show that the unrecorded economy is 91.4 percent of GDP. This implies that tax revenues can be doubled if measures are taken to document unrecorded activities in the recorded economy. If this is done then, we may not need to pay higher taxes. Since the government needs revenue to spend on public goods such as parks, roads, interest payments and debt repayments, the required amount of revenues are collected by taxing us at a lower rate instead of higher rates. Permanent reduction in tax rates would have a beneficial impact on the economy through increase in consumption and savings. Decrease in overall tax rates increases the profitability of investors and may boost investment.
Managing tax collection is a difficult task when we have deductions and exemptions in the tax system. The purpose of deductions is to legally decrease the taxable income of a taxpayer. The rule of calculating taxable income is to deduct all those expenses that are incurred to generate income. Thus a retailer will deduct transportation cost, rent of a shop, utility expenses, and investment before calculating his taxable income.
Tax exemptions, which also reduce taxable income of taxpayers, however are entirely different from tax deductions. Exemptions are usually given to grant relief to specific type of organisations, activities or persons. New industries were exempted from paying taxes during the first half of the 1990s, which promoted industrialisation in Pakistan.
Similarly, money given to charities is also exempted from taxation. Moreover, teachers and researchers pay 25 percent as taxes. Taxpayers often avoid paying taxes by hiding their income behind these deductions and exemptions which reduce the overall tax revenues. Consequently, the rest of the population pays the cost incurred.
Since income from agriculture has zero income tax, passing off income as agricultural income is an easy way to evade tax. Even the amnesty scheme, which is probably going to be implemented soon, includes all the sectors but income from agriculture is again exempted. Thus people who still want to evade taxes therefore have the option of showing their income as agricultural income.
Thus from the above discussion we can summarize that what is the real cost of not paying taxes? (1) higher taxes (2) higher borrowings (3) higher public debt (4) higher inflation (3) higher interest rate (5) lower investment (6) solvency and bankruptcy issues and (7) inadequate public facilities.
We have discussed several loopholes in the tax systems which explain lower tax revenues. Apart of these problems Dr Faiz Bilqees, in her paper, wrote that we have lower direct taxes because overall average income is lower. Some researchers argue that if we have lower overall average income then can’t we live modesty? Why do we need to collect 15 percent of tax revenues? On the other hand, it is also argued that policies are not implemented in developing countries, which is the main reason why we don’t benefit from them.
According to the chairman FBR, with Nadra’s help, 3.2 million potential tax payers have been identified. These are people who travel frequently, having multiple bank accounts, live in affluent areas, possess weapons and send their children abroad to study but do not pay taxes. Further details can be gleaned from information such as whether the children attend private or public schools/universities of these non-filers and how much they pay in utility bills each month.
Since it is not obligatory for everyone to file tax returns in Pakistan, people can get away with it quite easily. There is no punishment for non-filers/non-taxpayers. As a result, people are not afraid of being caught by the authorities. As a reform process, I believe that it should be mandatory for everyone to file tax return. This may unleash a new set of complications altogether because a majority of the population does not come under the tax net.
Moreover, literacy rate is just 58 percent. Of this, very few can understand the taxation system and fill the tax returns form. Thus it would be better to make it mandatory for all those potential taxpayers who live in or near urban areas. Furthermore, provinces should be asked to collect agriculture income tax from large landholders and use it for the development of their province. Simultaneously Federal government should cut their funding by some percentage so that provinces make as much efforts to collect revenues from agriculture income tax.
To increase our revenues, non filers should be brought into the tax net. Instead of inventing new taxes to increase tax revenues, we need reforms. We may need a new policy but implementation of policies, rather than changing policies frequently, is what matters. Renowned economist and former governor State Bank of Pakistan, Shahid Kardar, once said that we need to abolish exemptions if we want our tax system to work better.Why