VAT’s effects on economy

Lenders are least pushed about the inequitable character of our tax system

By Huzaima Bukhari and Dr. Ikramul Haq

On November 25, 2008, the International Monetary Fund (IMF) approved the $7.6 billion standby arrangement for Pakistan to be delivered over 23-month. As expected, a number of conditions were imposed by the IMF. One of the demands of the lender was introduction of Value Added Tax (VAT) from July 1, 2010, coupled with surrendering control of monitoring of the revenue collection to the IMF; six of its directors and two of the World Bank since then are supervising revenue collection and the preparation of the federal budget of Pakistan.

There are remarkable similarities in the operations of the IMF/World Bank in Pakistan and the colonial era of East India Company vis-à-vis revenue collections. According to many historians, the East Indian Company’s tax collectors would take away one half to two-thirds of the crops. Therefore, the peasants’ lives were most miserable during the colonial period — the same is the case now for Pakistanis.

Our economic survival now lies in collecting taxes wherever due by abandoning the policy of appeasement towards the powerful and the rich. However, VAT is not an answer. Being regressive in nature it would push more people towards poverty — their number has already reached 50 million. The rich will pass on the burden of this tax to the poor consumers. The real solution is taxing the rich and mighty by introducing asset-seizure legislation. If they fail to pay taxes on their un-taxed assets — kept in or outside Pakistan — they should be seized at once. This legislation will be true manifestation of democratic rules confirming an unshakeable determination, consistency and political will to curb the 64-year-old habit of defying tax laws, together with complete purge in the tax machinery.

The primary function of any tax policy is to raise revenue for the government for its public expenditure. So the first goal of a development-oriented tax policy is to ensure that this function is discharged effectively but simultaneously it ensures removal of inequalities through redistribution of income and wealth. Higher rates of income taxes, capital transfer taxes and wealth taxes are some of the means for achieving economic justice. In Pakistan, an opposite approach has been adopted: there has been a complete shift from equitable to highly inequitable taxes. The progressive taxes aimed at removing inequalities are replaced with regressive ones favouring the rich.

Taxes collected are consumed on debt-servicing, defence, security of the rulers and their foreign tours. Besides regressive taxation, the government keep on borrowing at a high cost, from wherever source available, to run the day to day affairs. Interest payments on domestic and foreign debts during the ongoing fiscal year 2009-10 are likely to exceed Rs664bn (48 percent of revenue target fixed for the year) that is 17 billion more than what was estimated in the budget. If the defence spending — including cost of ‘war against terror’ — is added, the entire revenue collection of Rs. 1380 billion will be engulfed by just two items, meaning by for all other outlays more borrowings, domestic and international, will be made. It is a never-ending vicious circle.

It is now well-established that there is a direct link between growing poverty in Pakistan and distortion in tax base since 1991, when a major shift was made by introducing presumptive taxes (indirect taxes in the garb of income tax) and VAT-type sales tax. Since 1991, the burden of taxes on the poor is increased by 38 percent whereas on the rich it is reduced by 18 percent. The lack of judicious balance between direct and indirect taxes has pushed an overwhelming majority of Pakistanis towards the poverty line — their number is now 48 million according to official figures.

The FBR has in its reports admitted that in the first half of the current fiscal year 2009-10, the share of indirect taxes rose to 72 percent and that of direct taxes dipped to 28 percent. It confirms that the taxation system of Pakistan, contrary to the rest of the world, is highly regressive. If we take into account the portion of so-called income tax collection, which is in fact indirect in nature, the share of indirect tax would not be less than 82 percent in the total collection of FBR. The IMF and others lenders are least pushed about the inequitable character of our tax system, under which the burden of taxes is less on the rich and more on the poor. They are interested in getting their money back with interest.

Over a period of time, our tax system has become rotten, oppressive, unjust and target-oriented. There is a dire need for discussing the philosophical framework, the principles of equity and justice, which should be the main concern of our tax policy; not mere achieving of targets set out by the foreign lenders. Our tax managers are meeting budgetary targets through oppressive taxes, shifting incidence on the poorer segments of society and exempting the rich. We must reintroduce wealth tax, gift tax, estate duty and capital gain tax — progressive taxes abolished by military dictators.

The Senate Standing Committee on Finance is also of the view that VAT is inflationary in nature. It has pointed out in its recommendation forwarded to the National Assembly that 15 percent VAT will have a burden of 21 percent on taxpayers. It has asked for deferment of the VAT for a year at least. It is hoped that National Assembly and all the four provincial assembles, while discussing the IMF-drafted VAT laws, will reject them in totality and instead will go for progressives taxes mentioned above.

The legislators must reject iniquitous prescription of VAT as it will never solve our economic problems. The only solution is introduction of taxes on the rich coupled with reducing the monstrous size of the government. They should monetize all the perquisites and benefits available to them and to the civil-military bureaucracy. If we manage to drastically cut the size of government and formulate a rational tax policy through public debate and parliamentary process, and implement it through consensus and not coercive measures, there is every possibility to ward off the IMF and World Bank in the shortest span of time. However, if we continue following their prescriptions, we will neither tap our real tax potential, which is not less than Rs. 4 trillion, nor achieve the cherished goals of self-reliance, rapid industrial and economic growth, and socio-economic justice for all