PAKISTAN continues to rely heavily on indirect taxes, with about 55 per cent of its tax revenue coming from such sources. Inherently regressive in nature, indirect taxes are the low-hanging fruit that policymakers turn to time and time again to increase federal revenue because it is easy.

Regressive taxes take a bigger percentage of income from those who earn less. For instance, a person earning Rs25,000 a month pays the same amount of tax when loading credit on their mobile as someone earning Rs2.5 million, highlighting the disproportionate burden on lower-income individuals.

One of the proposals being floated to in­­crease the Federal Board of Revenue (FBR)‘s collection, in line with the International Monetary Fund’s conditions, is to raise the General Sales Tax (GST) from the current 18pc to 19pc.

Research by the Pakistan Institute of Development Economics (Pide) indicated that about half of the household income for roughly 30pc of the poorest households is spent on food. This was based on the Household Integrated Economic Survey of FY19, when the GST was at 17pc.

One proposal being floated to increase FBR revenue is to raise GST from 18pc to 19pc

While it is true that when a homemaker shops for vegetables, the vendor pushing the hand cart doesn’t charge GST while selling eggplants. However, from the field to the table, the process adds GST all along the way at various stages of inputs and processes.

Besides GST, customs duties and the federal excise duty are the other major indirect taxes imposed on the economy. In the run-up to the budget, rumours abound of tariff hikes on imports of used cars and increased FED proposals for tobacco. While the petroleum levy is classified under non-tax revenue in the budget, it is similar to regressive in nature. Proposals to reintroduce a carbon tax or significantly raise the petroleum levy to Rs100 per litre are spine-chillingly alarming.

An increase in indirect taxes burdens those already crushed under the weight of inflation. An increase in direct taxes has a similar effect of taxing those who are already taxed — already roughly 3pc of filers pay 90pc of income tax collected.

Various stakeholders, including institutions such as the Asian Development Bank and the International Monetary Fund, have repeatedly called for widening the tax net through real estate, agriculture and retailers. However, these sectors have stubbornly and successfully resisted all efforts to be taxed in proportion to their revenue.

Fighting a ‘mafia’

Last month, the Regional Tax Office in Rawalpindi awarded certificates to honour the first four traders who have officially registered themselves under the Tajir Dost Scheme. The scheme is the latest attempt to integrate traders and wholesalers into the formal tax net. Introduced at the start of 2024, the voluntary registration period concluded on April 30. In the first month of its voluntary registration, fewer than 100 traders signed up, indicating the absolute lack of interest in joining the formal net.

Retailers and wholesalers contribute 18pc to GDP but their tax contributions stand at a mere 4pc, probably because only 300,000 of about 3.5m retailers are actively filing tax returns. Taxing retailers may net an increase in revenue of Rs400 billion to Rs500bn, according to some estimates.

Since 2019, three distinct schemes have been proposed to bring the retail sector into the net. However, insufficient political will and strong opposition from the trading community have brought the efforts to nought.

Comparing the retailers to the ‘mafia’, former chief of the FBR Shabbar Zaidi lamented the ‘failed’ system of the state that has been unable to tax the retailers. “They bring down the shutters and block the entrance to the markets,” he says, explaining why the government has repeatedly failed to impose taxes.

The agri anomaly

Similar to the retail sector, the agricultural sector’s tax revenue is insignificant compared to its contribution to GDP. Agriculture accounts for roughly a quarter of Pakistan’s GDP, but agricultural income tax (AIT) is only about Rs2.5 billion, far below its potential of around Rs800 billion, suggests a study by Pide.

Farmers must file two income tax returns: one to the FBR and the other to the provincial authorities. Tax return filing to the FBR is mere paperwork to ensure that the farmer remains on the filers list — the provincial authorities collect the actual tax, explains Khalid Wattoo, a farmer and development professional.

However, there is an anomaly. AIT is taxed at a much lower rate than other industries. For example, up until Rs4.8m, agriculture income is taxed at 10pc, whereas income from other sources is taxed at over 30pc, says Mr Wattoo.

A farmer, who is also an industrialist — a definition that may apply to many feudal landlords who are incidentally in politics as well — can declare his income as agricultural and pay a lower tax rate, effectively turning his income “white.”

Reduce taxes to increase tax revenue

The real estate sector presents another challenge. Its actual value is difficult to gauge and even more complicated to tax due to much of its capitalisation existing off the books.

Pakistan Stock Exchange’s (PSX) capitalisation is about $30-40 billion, but real estate capitalisation (across Pakistan) is about three to four times that of the PSX, estimates Hassan Bakhshi, former chairman of the Association of Builders and Developers (Abad).

About $30bn in remittances flow in every month, and roughly half of it is used to purchase real estate and renovations, says Mr Bakshi, supporting his estimate by quoting a State Bank of Pakistan report. However, since the wealth does not exist on paper, it remains largely untapped as a source of tax revenue.

Anecdotal evidence suggests that an increase in tax rates will result in a decrease in registrations, he argues. Higher tax rates promote the transfer of property through the power of attorney. For example, a man wants to sell his bungalow to a builder. Instead of outright selling the property, he transfers it through a power of attorney to evade the higher taxes. This creates additional litigation problems since if the man dies before the bungalow is demolished, the property is transferred to his heirs, and the power of attorney is void. The heirs can choose to honour the agreement, or it can get tied up in the already overburdened courts.

In Pakistan, the paper value of a property and its market value are vastly different. Mr Bakhshi contends that to bring the paper value closer to market value, the government needs to decrease taxes and close the gap over time. The DC values cannot be hiked overnight with a stroke of the pen but increasing them over a span of five to 10 years will close the gap realistically.

All praises for the housing and construction policies under the PTI government, Mr Bakhshi compared the real estate sector to Bollywood of the 1970s. “In the past, Indian producers had to go to the underworld to raise financing for their films. Similarly, builders had to resort to informal credit before PTI’s focus on real estate. By opening financing lines for builders, builders got access to formal financing,” he says.

Under PTI’s taxation system for builders and developers, a fixed tax rate per square foot of construction was implemented, leading to about 2,200 projects being registered for the first time because of the system’s simplicity and its predictability of costs.

“If you want to raise tax revenue from real estate, replicate what the PTI government had done in terms of fixed tax per square feet,” he says.

Published in Dawn, June 8th, 2024