Jan 31, 2011

RGST, an open and shut case?

The solution does not lie in replacing a tax code with another,
but strict implementation of existing tax laws
By Huzaima Bukhari and Dr. Ikramul Haq

The Finance Minister, Dr. Abdul Hafeez Shaikh, while addressing the members of Federation of Pakistan Chambers of Commerce and Industry (FPCCI) in Karachi on January 22, 2011, claimed that “elements who do not want to see the documentation of economy have financed and supported an anti-Reformed General Sales Tax (RGST) campaign”. He alleged that “anti-RGST campaign is a conspiracy against the efforts aimed at documenting the economy and despite removal of all disputes, RGST has not been implemented”. Dr. Hafeez requested all Pakistanis, who want self-reliance, to support RGST Bill. It is presently pending in National Assembly after adopted by the Senate. While defending the RGST, the Finance Minister said “some people” were afraid of it only because they did not want documentation of their businesses”.

The Finance Minister is campaigning for RGST whereas the fact is that we have already VAT-mode consumption tax in Pakistan, levied under the name of Sales Tax Act 1990. It is strange that instead of removing distortions in the existing law by withdrawing unnecessary exemptions and taking to task the corrupt officials responsible for its non-enforcement, the Finance Minister is pleading the case for yet another tax code. The solution does not lie in replacing a tax code with another, but strict implementation of existing tax laws without any concessions and exemptions.

In 2001, we destroyed income tax law by promulgating Income Tax Ordinance 2001, adjudged by the apex court in 2009 PTR 23 (S.C. Pak) as a law that was hurriedly enacted and carelessly amended. The new income tax law has not helped in generating more revenue but has created more litigation. In this backdrop, there is justification in repealing Sales Tax Act, 1990. It is not a stumbling block in the way of documentation of economy. The real problem is lack of will to implement the existing tax laws.

The main reason for non-documentation of economy is existence of unholy alliance between tax evaders and unscrupulous tax officials. Pakistani tax experts have been repeatedly pointing out that the country would be much better off with across the board single-stage simple sales tax (at a low rate of 3pc to 5pc) without any exemption -- this is the case in Singapore and Japan, two highly developed economies. However, vested interests in Federal Board of Revenue (FBR) and elsewhere prefer the present situation: complex rules and cumbersome procedures coupled with legal loopholes and unfettered discretionary powers -- creating ideal conditions for corruption to thrive. The Finance Minister needs to re-examine his revenue-generation strategy taking these facts into account.

We are facing serious problems like high inflation, burgeoning fiscal deficit, unemployment, poverty and low-economic growth. Our survival now lies in eliminating all kinds of wasteful expenditure, boosting economic growth by diverting funds lying in unproductive sectors to productive areas through a rational tax policy, promoting tax culture, enforcing the existing laws and combating tax evasion with an iron hand.

The Finance Minister has yet not unveiled the fundamental features of taxation policy, if he has devised one. His emphasis on RGST -- without taking into account the entire economic matrix of Pakistan -- is totally misplaced.

Of late, besides IMF and other donor agencies, all and sundry, including the US and Western diplomats posted in Islamabad, are advising us to levy VAT as a main instrument for documentation of the economy. They know little about our peculiar milieu -- rich persons pay millions as charity but are not ready to pay a single penny as income tax due to complete distrust in the government that wastes taxpayers’ money. Common people are paying taxes heavily but in return do not get basic social services like education, health, transport, and even clean drinking water.

Many independent thinkers stress that from pure economic point of view, leaving aside the political dimensions of the conflict, a public debate is needed to justify levy of VAT at 15 percent in the prevalent economic conditions. They apprehend that this imposition would be a final blow to the country’s critically sick economy and would lead to more inflation, recession and poverty.

Taxation is a potent instrument to shape and influence the socio-economic polices of a country. Though the concept of an ideal tax system for a country is linked with the peculiar characteristics of its economy, tax policy is usually assigned the four functions in the stated order in a typical developing economy: resource mobilisation, resource allocation, distributive justice, and stabilization.

Resource mobilisation: The first and foremost objective of tax policy is to raise resources for administration and development. Taxes are the main instrument for transferring resources from private to public use. By designing an appropriate tax structure, resources can be raised from those who are holding them idly or squandering them on luxury consumption. In Pakistan, we need higher revenues from the rich who are holding wealth but not employing it for productive purposes. Pakistan needs not only reintroduction of progressive taxes like inheritance tax, wealth tax, gift tax, capital gain tax -- abolished by military dictators -- but also higher VAT at 23pc to 25pc on luxury items. We should slash the existing GST rate of 17pc to 10pc on commonly used items but withdraw all kinds of exemptions. If revenue leakages are stopped and tax policy is rationalised, current tax to GDP ratio of 9pc can jump to 18pc in just one year.

Resource allocation: By imposing high tax rates on luxury goods and other low priority items (such as motor cars, air conditioners etc), the government can discourage the consumption and production of such items, ensuring in the process, release of resources for high priority sectors. Conversely, production of necessities of life and employment-oriented industries can be encouraged by offering tax concessions or even subsidies.

Distributive justice: Distributive justice or economic justice is an important function of tax policy. Economic justice relates largely to distribution of tax burden and benefits of public expenditure. It is a component of the broader concept of social justice, which encompasses, besides distributive justice, such questions as treatment of women and children, ethnic and religious tolerance in a society. Tax policy is a democratic method to influence the distribution of income and wealth on desired lines. The main ingredients of this policy can be (a) progressive direct taxation of income, wealth, and property transactions, (b) taxation of commodities (customs duty, excise levy, and sales tax) purchased largely by high-income groups, and (c) subsidies (negative taxation) on goods purchased by low-income groups.

Stabilisation: Initial development efforts are generally marked by inflationary tendencies in an economy. Inflation, if uncontrolled, may thwart all development plans and bring misery to the poor. A reasonable degree of price stability should be the primary concern of a government’s economic policies. The overall level of economic activity in an economy depends upon aggregate demand, relative to capacity output. At times, the level of aggregate demand may be insufficient to secure full employment of labour and other factors of production. At other times, aggregate demand may exceed available output at full employment level. Government intervention in both the cases becomes essential to correct such disequilibria in the economy.

Reduction in taxes during deflation would leave greater disposable incomes with the people, giving a boost to aggregate demand. The reverse is true in times of inflation. Dr. Hafeez Shaikh and other economic wizards must prepare a long term tax policy first and then fit in it RGST at a reasonable rate conducive for economic growth, not its retardation; and avoiding a possible tax rebellion.

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