Saturday, January 1, 2011

Taxing wealth would be unproductive?

Pakistan has a very low rate of tax collection to GDP ratio which hovers around 9 percent and is among the lowest in the region. Currently, only 2.75 million Pakistanis or 1.6 percent of the country's population, are registered tax-payers. Out of these, only around two million people file their tax returns. If salaried class is excluded, the share of other categories as taxpayers is very little. In India, the share of taxpayers to population is 4.7 percent.
That too is not a very satisfactory ratio, but if we take India as an example due to its similarity of culture, we should have around 7.5 million taxpayers in Pakistan. There is a room to widen the tax net by at least another five million tax assesses. It remains government's wish to expand tax net but unfortunately, the desired wish could not be materialised due to outdated and conventional tax collection policies and indifference attitude of tax collection agencies.
Whenever revenue collection falls short of its budgetary targets, the existing taxpayers are treated with excessive tax demands through amending their tax assessments and new ways are found to tax them. This was evident from the newly introduced Capital Gains tax during the current fiscal year. In fact no serious efforts were made to widen the tax base through sound, effective and transparent policies.
Instead, efforts were diverted to increase direct tax collection from the existing taxpayers. This resulted in over-milking the existing taxpayers without realising that it would be unproductive and all sort of legal or illegal ways would be adopted to avoid additional and excessive tax liability. That is why, FBR is under serious criticism that over 500 billion rupees leakage of revenue exists within the system itself through unfair practices by its officials.
During the last budgetary proposals for the fiscal year 2010-11, demands were raised to tax capital gains on shares and leaving capital gains tax on sale and purchase of land exempt. The objective was to collect more taxes from the wealthy investors, as it was thought that the imposition of this new tax would reduce the tax collection gap and improve our ratio of tax collection to GDP.
It was a sentimental decision. No one ever thought how it will be implemented? What would be the size of additional tax collection and what would be the rules of capital gains tax that should be followed by the taxpayers to compute their tax liability? As a result, capital gains tax was imposed in haste without any rules in place.

It is almost six months now that Federal Board of Revenue (FBR) is still struggling to finalise the Capital Gains Tax rules under which the tax liability has to be computed. FBR did not do its home work properly when the new capital gains tax on shares was imposed. We have not witnessed this type of gross negligence in any other tax regime, where tax has been imposed without first putting in place detailed rules for taxpayer's guidance.
The fiscal year 2010-11 projected revenue based upon 657.7 billion rupees as direct taxes and 1.12 trillion rupees as indirect taxes. Currently, to achieve these targets seem difficult. The latest estimates released indicate that the fiscal deficit for the current fiscal year may go up by 7.5 percent, around 2.8 percent higher than the target agreed with International Monetary Fund (IMF).
This indicates that the gap between tax collection and government expenditure is growing gradually. So far no study has been conducted to identify reasons of this growing gap. Is it because of lesser economic activity or lack of trust in government or its tax collecting agencies? It may also be a cause of government's spending habits where a sizeable portion of tax collection is wasted on lavish spending, unnecessary security measures for officials and careless use of government provided transport to its employees, and officials.
On IMF dictation, the government was prompted to impose (Reformed General Sales Tax) RGST as one of the conditionality for its funding programme to enlarge the tax net. Additional tax collection through whatever source seems easier for the government rather than improving the existing tax collection system. Growth in national economy should also enlarge tax collection base easily by concentrating on business-friendly policies and building trust and confidence through austerity measures in government spending.
Extreme steps are taken either by being very liberal and accepting all self-assessed income from the assessee without asking any question or we start milking the existing taxpayers through re-assessments and new taxes.
These extreme steps are viewed as unproductive and affect the transparent system, thereby shaking the taxpayer's confidence. Therefore, the proposed legislation of RGST met severe opposition throughout the country and demand was made from those opposing the implementation of RGST that rich class should be taxed by taxing their wealth to reduce the income and expenditure gap without looking at its previous history.
The wealth tax was abolished in 2002. Since its abolition, it is estimated that the declared economic assets of taxpayers have almost gone up by at least five times during the last eight years. This indicates that wealth tax resulted in non-declaration of assets and its undervaluation when the wealth tax regime was in place.
Several disputes arose as to the type of assets that attracted wealth tax and its valuation for wealth tax purposes. To determine an acceptable valuation for wealth tax liability, wide discretionary powers were given to the wealth tax officers responsible to assess the wealth tax.
This gave birth to serious corrupt practices within the tax administrative system and more money went into the wealth tax officer's pockets than collected by the government under this system. Consequently the annual collection remained far below 1 to 1.5 billion rupees annually under this head, which was uneconomical for the exchequer. Even if it is five-time of the previous size, its adverse impact in future years would offset this meagre collection.
The very concept of taxing wealth is regarded as double taxation in our society as the wealth is accumulated out of income that was already taxed. Therefore, wealth tax imposition is considered punitive in nature that hinders economic growth, an important requisite for economic development.
Imposition of wealth tax due to its punitive nature is regarded as one of the major reasons of flight of capital to other tax haven regimes that retarded our economic growth for several years. This can be witnessed in developed countries where wealth tax did not exist but there was consistent economic growth in those economies.
It also results in serious corrupt practices in tax assessment system where vast discretion exists with the assessing authorities for valuation of taxable wealth. Therefore, it is suggested that the government should not yield under pressure to impose wealth tax without studying its negative results upon our economic growth in coming years.
There is an urgent need to redouble tax collection efforts by examining some alternative sources of revenue that includes other sectors that are still not taxed. Income from agriculture has so far remained untaxed. Agricultural sector that contributes over 20 percent of Pakistan's total GDP and employs over 40 percent of population has remained untaxed since long.
This is a large sector that should not be excluded from the tax net for whatever reasons. Unless this sector is gradually brought into the tax net, all efforts to tax the existing taxpayers whether they are small, medium or large would be unproductive and would not generate enough revenues to fill the growing gap and would not enlarge tax base.
Taxing agricultural income should have a moral impact upon other non-taxpaying classes to pay their taxes. If a sector that comprises 40 percent of population remains untaxed, we should not expect that the tax net would be enlarged and country's economy would grow.

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