Pakistan Policy Note—Mobilizing Revenue 79583 Pakistan Policy Note 16 Jose R. Lopez-Calix and Irum Touqeer 1 Mobilizing Revenue J une 2 0 1 3 This note reviews key shortcomings in Pakistan’s rev- One of Pakistan’s major challenges is to expand enue mobilization system and provides directions for government revenues. The economy is structur- revitalizing it and raising collection by 3–4 percent- ally weak on the revenue front, as evidenced age points of GDP over the next five years. Pakistan by large and recurrent fiscal deficits, financed has one of the world’s lowest tax ratios, stemming with loans from commercial banks or the from five main weaknesses: complexity, a narrow State Bank of Pakistan, which until recently tax base, low compliance, inefficient tax administra- contributed to double-digit inf lation. Rev- tion, and low and declining provincial tax revenues. enue c­ ollection—at 12.5  percent of GDP in Complexity provides scope for discretion and corrup- 2010/11—is much lower than averages for the tion. A narrow tax base and low compliance are the world, South Asia, and emerging and develop- outcomes of inequitable exemptions and preferential ing countries (Figure 1). The tax to GDP ratio, treatments, low tax registration or filing, and mas- declining from a 10.8  percent average in the sive tax evasion by potential taxpayers that prefer to 2000s to a bottom 9.6  percent in 2010/11, is stay informal. Provincial taxation is low and declin- now among the world’s lowest. The authorities ing. For its part, nontax revenue is also declining. need to address this to raise public investment Proposed reforms aim for a tax system that is and secure stronger growth and develop- broad, simple, and equitable, that facilitates tax- ment. Indeed, public investment also fell, from payer registration and compliance, and that pro- 5.6 percent of GDP in 1999/2000 to 2.6 percent motes provincial revenue efforts commensurate with in 2010/11. THE WORLD BANK GROUP SOUTH ASIA REGION their new expenditure responsibilities. This implies implementing effective tax policy and administra- The public debt burden is above the upper limit tion, particularly eliminating exemptions and zero allowed by the Fiscal Responsibility Bill, and the fis- rates to broaden the base, adjusting income tax rates, cal space is shrinking. With inadequate tax reve- simplifying tariffs, expanding user-friendly electronic nues, to create fiscal space the government has registration and filing, enforcing a zero-tolerance relied increasingly on high nontax revenues policy for noncompliance and evasion, and overhaul- (Figure 2), but since 2009 this source has also ing the technical capacity and accountability of Fed- declined—due to falling State Bank of Paki- eral Board of Revenue staff, especially in information stan profits, defense receipts (coalition support technology systems, auditing, and enforcement. At funds from the U.S. government for military the provincial level, this implies introducing incen- expenditures), and dividends from state-owned tives for collecting provincial taxes, enhancing the enterprises.1 The wide fiscal deficits reached capacity of tax administration, and updating selected 8.5 percent of GDP in 2011/12, the financing rates. In this regard, broadening the general sales of which added to a public debt burden that tax on services, collecting the motor vehicle tax more exceeded the 60 percent of GDP ceiling allowed efficiently, and revamping the property tax would be by the country’s Fiscal Responsibility Bill (Fig- desirable. ure 3). More important, despite a benevolent Pakistan Policy Note—Mobilizing Revenue Figure General government revenue, 2000/01–2011/12 1 Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka World Emerging and developing economies 40 30 Percent of GDP 20 2 10 0 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 (estimated) (projected) Source: World Bank 2012a. Figure Pakistan’s tax and nontax revenue position 2 Pakistan (1999/2000–2009/10) Pakistan (2010/11) Pakistan (2011/12 estimate) India (2000–10) South Asia (2000–10) Latin America (developing, 2000) World (2001–10) 5 7 9 11 13 15 Tax to GDP ratio (percent) 2.0 Pakistan Bhutan Nontax revenue buoyancy 1.5 Afghanistan Nepal Bangladesh Maldives 1.0 India Sri Lanka 0.5 0.0 0 2 4 6 8 10 12 14 Nontax revenue (percent of GDP) Note: Pakistan’s tax ratio refers to federal revenue. Nonfederal tax revenue is about 0.5 percent of GDP. Buoyancy was calculated using log regression from data spanning a number of years (number of years varied for countries and was based on data availability). Nontax revenue as a share of GDP was based on the latest available GDP or estimates, in most cases 2010. Source: World Bank 2012a; International Monetary Fund database; World Bank staff calculations based on World Bank (2012b). Figure Declining revenues and rising deficits, 2000/01–2011/12 3 Overall scal de cit Nontax revenue Tax revenue 15 12 Percent of GDP 9 6 3 3 0 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 (estimate) Source: International Monetary Fund database. negative differential between real interest rates investment and become more p ­ rofitable—and and growth that points to a decline in the real biased away from personal income tax, whose value of debt given currently high inflation lev- revenues are dismal (panel e). Overall, federal els, the rising primary deficit endangers debt revenue collection remains quite low, and the sustainability. The country’s medium-term budgeted revenue targets have been missed in fiscal space depends less on declining nontax recent years (panel f). revenue and more on mobilizing additional revenue (with a goal of 3–4 percentage points Key Shortcomings in Tax Policy of GDP in the next five years) to finance the and Administration country’s development agenda. Pakistan’s tax system underperforms because of a complicated and unfriendly taxpayer sys- The buoyancy of the country’s tax system is low and tem, a narrow tax base, low compliance, weak declining. Tax buoyancy (for taxes collected and inefficient tax administration, and inad- by the Federal Board of Revenue, or FBR) equate subnational taxation. decreased from above unity in the 1960s to 0.93 in the 2000s, indicating that tax revenues Complexity are growing more slowly than GDP (World Bank 2009, 2012c).2 The taxpayer system is complex. Most of the coun- try’s revenues—customs and general sales tax Tax revenues rely mainly on federal taxes, and much (GST)—are generated by trade. Customs regu- less on provincial taxes, but the overall level of fed- latory duties are an example of complexity (as eral taxes is low, despite their changing mix. Federal are sales and income taxes). The generalized taxes accounted for about 95 percent of total use of statutory regulatory orders (SROs) intro- tax revenues in 2010/11, with minimal contri- duces wide deviations between applied and butions from provincial taxes—0.4 percent of statutory official rates on an extremely disperse GDP in 2010/11 (Figure 4, panel a).3 The coun- range of tax slabs. The 2010/11 tariff schedule, try has, though, moved gradually from trade for example, had 17 slabs (16 plus zero rate) and excise taxes toward income and sales taxes under most-favored nation statutory official (panels b, c, and d). However, further efforts are ad valorem tariffs, ranging from 0 to 150 per- needed to mobilize revenues from corporate cent and with the greatest frequency (about and individual income taxes, as well as the sales 40 percent) on or below the low tariff slab of tax. Moreover, direct taxes are skewed heavily 5 percent. Yet Pakistan effectively applies some toward corporate income tax (CIT)—which 40 tariff slabs and, including SROs and partial provides disincentives to firms to increase exemptions, around 55 percent of the effective Pakistan Policy Note—Mobilizing Revenue Figure Stylized facts about Pakistan’s taxation effort 4 a. Taxes by administrative division b. Direct and indirect taxes Total tax revenue Federal tax revenue Provincial tax revenue 1981–90 1991–2000 2001–11 12 Trade taxes 9 Income taxes Percent of GDP Sales tax 4 (domestic) 6 Excise duties (domestic) 3 Surcharges Others 0 1999/ 2001/ 2003/ 2005/ 2007/ 2009/ 2011/12 0 2 4 6 2000 02 04 06 08 10 (estimate) Percent of GDP c. Indirect taxes d. Share of FBR taxes Sales tax Custom duties Sales tax Direct taxes Excise duties Custom duties FED 1999/2000 1999/2000 2000/01 2000/01 2001/02 2001/02 2002/03 2002/03 2003/04 2003/04 2004/05 2004/05 2005/06 2005/06 2006/07 2006/07 2007/08 2007/08 2008/09 2008/09 2009/10 2009/10 2010/11 2010/11 2011/12 2011/12 (estimate) (estimate) 0 2 4 6 8 0 25 50 75 100 Percent of GDP Percent e. Direct taxes f. Widening gap between budget revenue targets and actuals Corportate income tax Tax (target) Tax (actual) Individual income tax FBR (target) FBR (actual) 12 2000/01 2001/02 9 2002/03 Percent of GDP 2003/04 6 2004/05 2005/06 3 2006/07 2007/08 0 0 1 2 3 4 2006/ 2007/ 2008/ 2009/ 2010/ 2011/12 Percent of GDP 07 08 09 10 11 (provisional) FBR is Federal Board of Revenue; FED is federal excise duty. Source: Lopez-Calix and Touqeer forthcoming; World Bank 2009; International Monetary Fund database; World Bank staff calculations based on Government of Pakistan (2012b,c) and FBR (2012). tariffs are 5 percent or less in ad valorem terms biggest obstacle to doing business in Pakistan, (Figure 5). About 2  percent of trade tariffs after access to electricity (World Bank 2012d). are considered nuisance taxes (0–2  percent Of 183 countries, Pakistan ranks low at 158, ad valorem), as they have marginal revenue, or lower than most South Asian countries. have high administrative costs, and are prone Tax-compliance costs are also very high, with to corruption. Moreover, complexity also cre- firms taking about 560 hours (about 14 weeks) ates an anti-export bias: a 1  percent increase to make 47 tax payments a year. This is almost in tariff “complexity� (defined by a measure of double the South Asian average (311 hours a the number of changes in tariff brackets) leads year), and three times the Organisation for 5 to a 13.2  percent decrease in export growth Economic Co-operation and Development (Reis and Taglioni 2013).4 Finally, as develop- average (176 hours a year; Table 1). Matters are ing countries enter into trade liberalization undoubtedly further aggravated by frequent that leads to lower tariff duties, they generally and ad hoc changes to tax laws (Kularatne and recover as little as a third of the customs duty Lopez-Calix 2012). revenue loss with increased domestic consump- tion taxes (Baunsgaard and Keen 2005). A narrow tax base The complexity makes it harder and costlier for busi- Key economic activities, like agriculture and ser- nesses to pay taxes. Paying taxes is the second vices, are barely taxed, despite their large share in Figure “Most-favored nation� statutory and effective tariff rates by frequency, 2009/10 5 Distribution of most-favored nation tariff rates 40 30 Frequency (percent) 20 10 0 0 5 10 15 20 25 30 35 40 45 50 90 150 Speci c Protection rate (percent) Distribution of effective tariff rates 30 Frequency (percent) 20 10 0 0 2 5 7.5 10 15 20 25 30 35 40 50 60 75 90 >100 Protection rate (percent) Note: Effective tariff rates include regulatory duties. Source: Reis and Taglioni 2013. Pakistan Policy Note—Mobilizing Revenue Table Paying taxes indicators, 2011/12 1 Organisation for Economic Co-operation Indicator Pakistan South Asia and Development countries Payments (number per year) 47 30 12 Time (hours per year) 560 311 176 Total tax rate (percent of profit) 35.3 40.2 42.7 Source: World Bank 2012d,e. 6 total output; and those taxed, like industry, enjoy numbers (NTNs). And though 47,800 compa- significant exemptions or concessions. This is the nies have NTNs, this is a very low percentage outcome of structural factors, leakages, and of the 400,000 industrial electricity connec- low registration. Industry bears most of the tax tions (besides, fewer than 16,500 filed tax burden: relative to its share in GDP (25  per- returns). Similarly, NTN issuance to the four cent) it pays about 60 times more than agri- most important taxpayers fell from 157,030 in culture (21 percent of GDP) and 5 times more 2008/09 to 96,845 in 2011/12. These taxpay- than services (54 percent of GDP). Even within ers are business individuals, companies, and industry, some sectors have large tax exemp- associations of persons, accounting for about tions or are undertaxed, including textiles, fer- 43  percent of NTN holders in 2011/12. Only tilizers, and pharmaceuticals. the final category of taxpayers—salaried indi- viduals—recorded a proportional increase The implementation of the GST also distorts tax col- during this period (Figure 7). As a result, most lection, by following a system of discounts and exemp- corporate income and trade taxation comes tions (Table 2). Beyond hurting large businesses, from a few large corporations and manufactur- this system forfeits government revenues, partly ing firms and the imports of a small group of because the preferential tax rate for small com- commodities (the top 10 commodities contrib- panies5 (and overregulation) induces firms to ute about 81 percent of import taxes). Similarly, stay small or informal.6 income tax rates are high and have some space for reduction. Pakistan falls in the category of The narrow tax base also stems from low registra- countries with high rates, at 35 percent, world- tion. On GST registration, a reason for low wide (Figure 8).7 GST collection is also the small and declin- ing number of registered taxpayers among Low compliance retailers and service providers. Indeed, for the estimated 210,000  registered taxpayers Pakistan has a very poor tax filing record. Less at the end of 2011/12 (manufacturers being than 1  percent of Pakistan’s population files the largest group), from 2009/10 to 2011/12 for taxes, well below 5  percent of India or annual growth in GST registrations fell from 16  percent of Argentina (Ahmad and Best 60  percent to 4  percent (Figure 6). More 2012). About 70  percent of legislators do not broadly, on national tax registration, there file income tax returns (CIRP and CPDI 2012). are barely 3.1 million holders of national tax Taxpayers evade taxes by simply not filing tax Table Effective and nominal tax rates (general sales tax) for selected sectors 2 (percent) Cotton Carpets Sports Surgical Printing and Bidis ginning and rugs Pharmaceuticals Footwear goods instruments publishing Glass Cement Nominal 0.0 0.0 0.0 0.0 1.4 0.0 0.0 0.0 20.1 12.1 Effective 6.5 2.5 9.1 16.8 7.3 6.7 5.5 8.0 40.0 27.1 Source: Ahmad 2010. Figure Trends in tax registration 6 General sales tax registration, 1997/98–2011/12 Number of registered personsa Growth 225 80 150 40 Thousands Percent 7 75 0 0 -40 1997/98 1998/99 1999/2000 2000/01 2001/02 2002/03 2003/04 2004/05 2009/10 2010/11 2011/12b Sales tax registration, by activity (until 2011/12) Others 6% Exporters 7% Manufacturers 29% Service providers 11% Importers 21% Wholesalers and retailers 26% a. Cumulative registration of persons. b. Data include actual figures until February 21, 2012, and forecast for remaining period. Note: In 2004/05, the sales tax base was increased (for retailers and manufacturers by PRs 8.5 million) and records of nil filers were separated, cutting numbers of registered persons. Source: World Bank staff calculations based on Ahmed and Ahmed (2012) and Federal Board of Revenue data. Figure New national tax numbers issued to different categories, 2008/09–2011/12 7 Salaried individuals Company Association of persons Business individuals 2008/09 2009/10 2010/11 2011/12a 0 25 50 75 100 Percent a. Data are forecasts based on actual figures until February 21, 2012. Source: World Bank staff calculations based on Ahmed and Ahmed (2012) and Federal Board of Revenue data. Pakistan Policy Note—Mobilizing Revenue Figure Corporate income tax rates worldwide, 2009/10 8 Low (0%–20%) Medium (21%–30%) High (31%–46%) 50 Bahrain Chad Libya Seychelles 40 Bangladesh India Pakistan (35%) Argentina Australia Bhutan Indonesia Philippines 30 United Percent Brazil China Italy Malaysia Kingdom Luxembourg 8 20 Nepal Turkey Albania Cyprus 10 Switzerland 0 Source: USAID 2011. returns or by paying low taxes due to special in 2010/11 was still low: only about 43 percent privileges obtained through legal concessions. of companies, and 25–28  percent of business For instance, many GST-registered taxpayers do individuals and associations of persons filed not pay taxes. Of the total registered persons tax returns; salaried individuals had the high- (114,953) in 2004/05, only 70 percent filed sales est compliance, at 68 percent. Overall, 1.5 mil- tax returns, and those with the lowest compli- lion taxpayers filed income tax returns out of ance (wholesalers and retailers, at 45.4 percent) about 3.1  million NTN holders (Ahmad and had the highest sales tax registration (Ahmed Best 2012). and Ahmed 2012). As a result, tax payments are concentrated among few taxpayers. In 2007, Pakistan’s low compliance is reflected by one of the about 90 percent of GST was paid by only 3 per- world’s worst tax productivity records. Low tax com- cent of taxpayers (Ahmad 2010). Tax reforms pliance is seen in low and declining GST pro- improved compliance over 2008/09–2010/11, ductivity. Under the best possible case, the GST as electronic return filers increased 18 percent (value added tax–like) productivity ratio would for sales tax and 58 percent for income tax, and approach unity.8 Worldwide estimates for 2010 as registered and active tax payers for income show that Cyprus is closest to one, with a ratio tax and sales tax increased 29  percent and of 0.8, but that Pakistan is in the lowest bracket 13 percent, respectively (Figure 9). Yet tax filing at 0.2—below Nepal and Sri Lanka  (0.3) and Figure Pakistan’s tax filing record, 2008/09–2010/11 9 Federal Board of Revenue Filers Active taxpayers 120 Percent of general sales tax 110 100 90 2008/09 2009/10 2010/11 Source: World Bank 2012c. similar to the Philippines and Turkey, among about 39 percent of collections. Services, min- others (Figure 10, top panel). Further, the ing, and manufacturing show large tax evasion, ratio has been declining—especially since the while agriculture shows minor evasion (Table 2008/09 global economic crisis—and it has 3). Some of the widest tax gaps by subsector declined faster than the FBR tax to GDP ratio are in cigarettes, paper and printing, chemical (Figure 10, bottom panel), partly because of the products, cement, electricity, retail trade, and recent economic shocks and partly because of hotels and restaurants. Other low-compliance poor enforcement of tax collection. Pakistan subsectors include sugar, pharmaceuticals, and also has one of the lowest GST C-efficiency fertilizers (Ahmed 2011). Tax gaps are related 9 indexes (0.27 in 2009) in the world.9 directly to lax enforcement and corruption that goes undetected or, if detected, unpunished. Low compliance is also reflected in big tax gaps. A measure of tax evasion, the tax gap marks Tax expenditure is high and rising. Tax expendi- actual versus potential revenues if everyone ture is the revenue loss due to preferential legal complied with tax laws; and recent estimates provisions (in the finance bill or through ad confirm Pakistan’s low (and decreasing) tax hoc SROs) in the tax laws that provide certain compliance. In 2004/05, for example, the taxpayers with special concessions—zero or sales tax gap was estimated at PRs 45 billion, reduced rates and tariffs or duty and tax exemp- or about 31 percent of collections; by 2010/11, tions that are not available to other taxpayers or the gap had increased to PRs 152.4 billion, or sectors and that result in the collection of fewer Figure General sales tax and value added tax productivity 10 0.8 Value added tax productivity 0.6 0.4 Nepal Sri Lanka 0.2 Bangladesh Pakistan 0.0 2.5 3.0 3.5 4.0 4.5 5.0 GDP per capita, 2010 (PPP, log scale) General sales tax Federal Board of Revenue tax to GDP ratio 120 General Sales Tax Productivity Index 110 (2004/05 = 100) 100 90 80 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Note: Value added tax (general sales tax) productivity versus GDP per capita figure relates to 2010 data. Source: World Bank 2012b,c; USAID 2011. Pakistan Policy Note—Mobilizing Revenue Table Sales tax gaps by sector, 2010/11 3 (PRs billion) Net sales tax Actual collection Tax gap Agriculture 0.00 –2.87 2.87 Mining 69.26 17.78 51.47 Manufacturing 288.20 257.88 30.31 Services 187.47 119.78 67.68 Total 544.92 392.58 152.34 10 Source: Ahmed 2011. tax revenues than would be collected under the tax revenue authorities to escape paying taxes basic tax structure. Tax expenditure increased (Transparency International 2012). According from 0.8 percent of GDP in 2000/01 to 0.9 per- to the government’s National Anti-Corruption cent in 2007/08 (World Bank 2009) and then, Strategy, tax collection losses by corruption according to Ather (2013), doubled to 1.8 per- were highest in the corporate and personal cent in 2010/11. This estimate should be consid- income taxes (64 percent), followed by the cus- ered as a lower bound, as significant exemptions toms (48 percent) and sales taxes (45 percent; in income tax were not included in these esti- National Accountability Bureau 2002). mates. Results show that the highest losses are in customs duties (Table 4). For its part, the ser- The government implemented some reforms during vices sector exhibits large tax exemptions, with the mid-to-late 2000s but failed to achieve most of its its tax expenditure amounting to PRs 82.5 bil- desired outcomes. Noteworthy reforms included lion, and the transport subsector represents improving the FBR’s physical and IT infra- about half such amount (Ather 2013). structure, establishing an online tax registra- tion system, establishing Large Taxpayer Units Inefficient tax administration and Medium Taxpayer Units, attempting to provide some stability to the tenure of senior The big tax gap and low productivity ratios are symp- management,10 moving the FBR under the toms of weak tax administration. Pakistan’s tax oversight of a Cabinet Committee on Finance administration is constrained by poor man- and Revenue, approving a previously nonex- agement, low capacity due to weak human istent human resource management policy resources, and a lack of effective key supporting framework, and preparing a rationalization information technology (IT) systems, which all plan for nonessential FBR staff. The FBR Act together provide enough scope for discretion 2007 was enacted, supported by sufficient and corruption. The incidence of bribes paid funding for restructuring the organization. As to tax officers is high, particularly by large a result of these capacity-building reforms, ser- firms (World Bank 2009). The Global Corrup- vices to taxpayers improved initially. However, tion Barometer 2010/11 finds that at least two the following years showed slow and piecemeal of every five surveyed households have bribed implementation impairing the consolidation Table Tax expenditure, 2010/11 4 (PRs billion) Tax category Amount Income and corporate tax 126.01 Sales tax import 58.40 Sales tax domestic 89.57 Custom duties 128.06 Total 402.04 Source: Ather 2013. of tax administration reforms for the following revenue collection has become a serious concern reasons (World Bank 2012c): because it puts greater stress on scarce federal • The FBR board and management have resources in a context of expanded outlays asso- changed frequently due to political interfer- ciated with the new devolved functions from the ence. In 2012, the FBR had four chairpersons, 18th Amendment toward social sectors, infra- and of the 14 board members that started the structure spending, and the like. In 2011/12, all year, only 3 remained at the end of the year. provinces spent about nine times the revenue • Integration of the FBR along functional they collected from tax and nontax sources lines has moved too slowly and remains (provincial revenue accounted for 11.4 percent 11 incomplete due to resistance from staff. of expenditure in 2011/12); in 2007/08, spend- Staff complaints include a lack of IT and ing was six times revenues (Figure 11, bottom managerial staff support, ineffective moni- panel). These gaps are a problem for all of them toring and evaluation mechanisms from (Figure 12, top panel). Among the four prov- FBR headquarters, and frequent rotation of inces, Sindh was the largest collector (16  per- senior and mid-management at decentral- cent of its revenues were generated by taxes in ized Large Taxpayer Units and Regional 2011/12), followed by Punjab (7.1 percent), Khy- Taxpayer Units. ber Pakhtunkhwa (1.7 percent), and Balochistan • New IT-based systems, essential for effective (0.8 percent; Figure 12, bottom panel). Provin- cross-checking enforcement and audits and cial taxes are even smaller than federal grants focused on large taxpayers, have remained and loans from the federal government, which underused due to their poor integration in also creates disincentives for provincial govern- business processes, weak governance and ments to increase their revenue.11 partial use by senior management, lack of training, and staff resistance to adopting Stark interprovincial structural disparities lead to new technologies, which would limit their different tax bases and expenditure needs. Punjab opportunities for bribes and discretion. and Sindh have greater potential to raise tax • The audit function has remained very revenue, given their higher income per capita, weak due to a lack of an effective, central- while Balochistan and Khyber Pakhtunkhwa ized, parameter-based risk-audit function have greater social needs. According to the (supported by solid planning, staffing, and latest reliable estimate (2004/05), Sindh had monitoring of results) and to poor training, the highest estimated income per capita at leading to unfavorable results for the FBR PRs  6,900, or 1.3 times the national average, on legal disputes. followed by Punjab at PRs  5,400 (about the • There was a lack of political consensus on national average). Balochistan and Khyber the approval of the government’s reformed Pakhtunkhwa had incomes about half that of GST (RGST) by the Parliament. This cen- Sindh. Unsurprisingly, Balochistan and Khy- tral policy decision slowed momentum for ber Pakhtunkhwa featured the highest poverty reform. rates in 2004/05 (Lopez-Calix and Touqeer 2013). Thus, from a social perspective, Baloch- Low and declining subnational tax revenue istan and Khyber Pakhtunkhwa would need to make a greater revenue effort and collect pro- The revenue effort by provinces is extremely weak, is portionally more revenues than the other two. worsening, and falls well short of their new expenditure responsibilities under the 18th Amendment to the con- Different tax composition and administrative obsta- stitution approved in 2010. In the last two decades, cles keep provincial tax bases low. Tax composition the provincial tax to GDP ratio has oscillated differs across provinces (Figure 13). Obstacles between 0.35 and 0.55 percent of GDP but on to tax collection include only a few, low-revenue a declining trend (Figure 11, top panel). In sources; constitutional restrictions of federal 2011/12, it stood at 0.5 percent of GDP, whereas policy (provinces can levy GST only on profes- its share in national tax revenue was 5 percent. sions, trades, and callings while tax exemptions The falling trend and inadequacy of provincial and preferential treatment make it hard even Pakistan Policy Note—Mobilizing Revenue Figure Trends in overall provincial tax revenue 11 0.6 0.5 Percent of GDP 12 0.4 0.3 1987/88 1990/91 1995/96 2000/01 2005/06 2011/12 (provisional) 20 Percent of expenditure 15 10 5 0 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 (provisional) Source: World Bank staff calculations based on Provincial Government Fiscal Operations (various years). to reach the available tax base); and low rates weight for trucks. The many exemptions on agricultural income, stamp duties, and capi- include agriculture tractors and trailers, tal gains and capital value taxes on immovable ambulances, school buses, noncommercial property. government vehicles (including National Issues facing three provincial taxes are as Logistics Cell vehicles), and vehicles used by follows: foreign missions. Rates vary across provinces • Sales tax on services. The main issue is its nar- (and federally administered areas), provid- row base for only a few services. Poor incen- ing incentives for vehicle owners to underpay tives deter the federal government from the tax by registering the vehicle in low-tax expanding this tax base, keeping revenue areas and using it elsewhere. low. In 2011/12, Punjab and Sindh started • Urban immovable property tax. Despite rapid collecting this tax, and early results are urbanization and a sharp escalation in capi- encouraging. The provinces are interested tal and rental values of urban properties, in expanding the tax base by expanding to the revenue from the urban immovable other services, such as the retail trade. property tax is extremely low due to exemp- • Motor vehicle tax. Collection of this tax tions, underassessment of property values, remains overly cumbersome, and it imposes rate differentials (leading to tax evasion), heavy compliance costs on payers. It has to be and weak administration. This tax is lev- paid quarterly, and it is levied on all vehicles ied only on owners of buildings and lands based on unladen weight for motorcycles, in urban areas,12 and properties of govern- seating capacity for cars and buses, and laden ment, religious parties and their affiliates, Figure Provincial revenue position and composition 12 Provincial revenue, 2010/11 and 2011/12 2010/11 2011/12 Sindh Punjab 13 Balochistan Khyber Pakhtunkhwa 0 5 10 15 20 Percent of expenditure Provincial revenue composition, 2011/12 Share in federal revenue Federal loans and grants Provincial nontax Provincial taxes Sindh Punjab Balochistan Khyber Pakhtunkhwa 0 25 50 75 100 Percent Note: Provinces’ own revenue includes provincial tax and nontax revenue. Source: World Bank staff calculations based on Government of Pakistan (2011, 2012c). Figure Provincial tax revenue by source, 2011/12 13 Property tax Excise duties Stamp duties Motor vehicle tax Other Sindh Punjab Balochistan Khyber Pakhtunkhwa 0 25 50 75 100 Percent Source: World Bank staff calculations based on Government of Pakistan (2012c). Pakistan Policy Note—Mobilizing Revenue charities, and education institutions are electronic filing, permitting zero tolerance for exempt. Other exemptions include proper- noncompliance, and strengthening the techni- ties of cantonment areas and segments of the cal capacity and accountability of tax adminis- population especially vulnerable to adverse tration (that is, the FBR). At the provincial level, shocks (such as the poor, widows, orphans, for the relevant issues this implies introducing and retired government employees). Huge incentives for provincial taxes (linked to fiscal underassessment of rental values of taxable transfer mechanisms), enhancing the capacity properties13 stem from infrequent revision of tax administration, and updating selected 14 of valuation tables, which are based on a rates. Broadening the GST on services, enhanc- flawed formula.14 (Property valuations are ing collection efficiency of the motor vehicle made annually based on property rental val- tax, and revamping the property tax would also ues.)15 Tax evasion is heightened by different be desirable. Adopting this proposed mix of pol- rates between owner-occupied and rental icy and administration at both the federal and properties (the latter charged a rate about 6 provincial levels would produce a simplified tax times that of the former) and between indus- system that is broad-based, efficient, and effec- trial and commercial properties (the latter tive for addressing Pakistan’s revenue mobiliza- charged a rate about 10 times that of the for- tion needs (now discussed in greater detail). mer). Finally, administration is affected by confusion around jurisdiction of the tax.16 Activate tax policy and broaden the tax base Policy Recommendations This reform aims to increase collection (tax policy) and buoyancy (broadening) by removing exemptions. If we separate nontax revenue as part of a different The latter agenda covers the sales tax, income agenda, successful additional revenue mobilization for tax, and customs duties. The decision about 3–4 percentage points of GDP in the next five years the final mix of these measures would involve will have to walk on two legs: tax policy and admin- political considerations. istration. Desirable features of tax policy are • Tax policy. Publishing a tax expenditure well known (Box 1). The ultimate objective is to annex in the annual budget would identify raise revenues based on a system that is simple and facilitate gradual removal (under a and predictable, encourages investment, and sunset clause that takes up to three to five facilitates taxpayer compliance. This usually years) of most tax exemptions (except food, implies employing an active tax policy, broad- medical supplies, and the like) and zero rat- ening the base by eliminating exemptions, sim- ings, along with their projected fiscal impact plifying rates and tariffs, offering user-friendly (while possibly leaving only those protected Box Desirable features of tax policy 1 In lieu of an optimal tax structure, international best practice suggests the following benchmark patterns of tax policy: • Minimize exemptions and tax incentives that jeopardize revenue and good governance and generate no clear, offsetting social benefit. • Remove minor taxes and fees that are costly to administer. • Build CITs that are simple, broad-based, and competitive by international standards and set effective tax rates that are reason- ably low and uniform across investments. A single statutory rate is recommended. Adopt an accelerated depreciation schedule. • Extend the coverage of personal income tax with an effective rate structure that is consistent with the authorities’ distribu- tional preferences, while keeping the effective maximum personal income tax rate equal or close to the uniform CIT effective rate. Keep the rate structure simple. • Replace the production tax or sales tax with a simple value added tax (VAT) that has a broad base and a high threshold— minimizing exemptions and the number of rates, preferably to one nonzero rate. • Lower trade tax rates that have fewer bands and replace the loss with domestic sources (for example, VAT). Eliminate export taxes. Source: World Bank 2012a. by the constitution). Creating a joint FBR- GST-related SROs, and ensure the passage Ministry of Finance unit on tax policy would of a clear schedule of gradual elimination support sound policy design and solid rev- (cleansing) of the remaining SROs in three enue forecasting. years; fully revamp customs duties by con- • Sales tax. The goal is to have a simple broad- solidating effective tariffs into fewer slabs based and nationally integrated RGST on (ideally three), while reducing tariff peaks goods and a provincially harmonized RGST to a predefined ceiling; streamline special on services. To fill exiting leaks that affect tariff regimes for selected industries (such compliance, serious consideration should as automobiles and pharmaceuticals); and 15 be given to eliminating most exemptions complete the gradual phasing out of the and zero rates that would have an impact negative list with India in the first half of equivalent to about 1.8  percent of GDP. 2013, while allowing for a few still applica- Alternatively, zero rates could be converted ble, well-justified but temporary exceptions into exemptions for domestic sales of main (list under preparation). exports. Exemptions on special regimes • For strengthening compliance, carry out (particularly preferential trade agreements) effective audits of a significant share (30– should be scrutinized. 50  percent) of large taxpayers selected • Corporate and individual income taxes. In the through parametrized risk-based criteria, medium term, the high CIT needs to be with quantitative performance benchmarks lowered from 35  percent to a 25–30  per- to attain; complete the audit of withholding cent international benchmark and its base agents and eliminate illegal input adjust- widened with new registrations, as current ments; and adopt a zero-tolerance policy coverage is low. A lower CIT would encour- against tax evasion detected through audits age investment and attract new businesses by penalizing nonfiling of or understate- to file. Similarly, the individual income tax ment in tax returns. requires a massive registration and filing effort. Continually simplifying tax returns Modernize tax administration and streamlining personal tax credits would also encourage tax compliance. Stability in tenure of senior tax managers, invest- • Other measures. A complementary but not ment in key soft infrastructure (IT) and qualified exhaustive agenda for the government human resources, and governance improvements are includes reintroducing special excise duties; all urgently required. These actions have been on introducing a retail tax similar to that intro- the tax reform agenda for years, if not decades. duced successfully by China, which favors Their success depends largely on the deci- lottery tickets for new registered sales tax- sion power—and sustained implementation payers; bringing in a capital gains tax on ­ capacity—of the political leadership. property transfers; and increasing levies like • Consider presenting a bill to the Parliament con- those on petroleum and gas. verting the FBR into a fully autonomous institu- tion. This is consistent with best practices Simplify taxes and make compliance worldwide. It would help prevent political effective and noncompliance expensive interference, foster accountability, and sup- port its move into a performance-based A simple tax system that does not rely on only a few institution. people or sectors for revenues and that has low rates • Fully integrate automated computerized systems. encourages voluntary compliance and reduces the As a myriad of different systems work at vari- incentives for tax evasion. Recent improvements ous levels, functioning in “silos,� they are in tax administration allowing a high percent- inefficient, disconnected, and unreliable. age of e-filers are encouraging, but further Upgrading and effectively integrating the gains are needed: current IT software and databases (to facili- • For simplicity, make an immediate freeze tate multiple taxes cross-checking and data in issuing the distortive trade, income, and exchanges with NADRA and other national Pakistan Policy Note—Mobilizing Revenue databases—credit cards, banking accounts, mobilization, which has a narrow lens. At the heart and so on), providing IT equipment to field of the tax problem is that provinces have the offices, and making special arrangements wrong incentives to collect taxes, though from for safe data storage for the interrelated the pure perspective of raising taxes, the pro- systems would be beneficial. It would also vincial agenda is quite straightforward. help to improve e-filing, make the refund • Approve a provincial tax-friendly fiscal process more reliable, improve the auditing transfer mechanism. This implies review- function by field offices, and facilitate their ing the current fiscal transfer mechanism to tasks by preparing the long due tax ledger, rebalance provincial revenue collection with 16 using computerized discrepancies to cross- expenditure needs. As the 18th Amend- check or detect potential tax evaders and ment stipulated that the share of provinces noncompliers. in the divisible pool of federal revenue can- • Invest in human resource capacity building. not drop below the level defined by the Governance effectiveness of the automated 7th National Finance Commission Award IT-supported tax system and its piloting (57.5 percent), this requires a constitutional require massive training for senior and mid- amendment. level staff both at Large Taxpayer Units and • Enhance capacity of provincial tax administra- Regional Taxpayer Units, in parallel to the tion. The original model adopted by Sindh new system’s design. Some accreditation and Punjab for creating a new revenue mechanism should be considered. authority is a workable model of moderniz- • Improve management and human resource ing tax administration.17 policies. This implies improvement in the • Broaden the base of GST on services. The split in FBR’s human resource management poli- the GST regime between federal and provin- cies, which should include new job descrip- cial entities is not optimal, and an obvious tions, hiring policies, and performance, measure is to bring more services into the merit, and integrity criteria for staff evalu- tax net, including retail trade. Merging pro- ation. Bonuses should be attached to fessional tax and stamp duties into the GST function-specific targets to evaluate job are also promising approaches. performance. Managers should be made • Enhance collection efficiency of the motor vehicle accountable in enforcing codes of conduct tax. This would require harmonizing vehicle across the institution. registration rates. Replacing the one-time • Strengthen the FBR along functional lines. Its registration tax and annual token tax on organization should strengthen perfor- motor vehicles with an annual license tax mance reporting and monitoring tools and and a fixed fuel levy (provincial) would also procedures per function. Preparing an help increase tax collection. annual action plan as a management tool • Revamp the urban property tax. First is a need including key performance indicators to for removing the confusion surrounding be regularly assessed (perhaps monthly or ownership. The tax should be devolved to quarterly) is essential; and the plan should the larger Tehsil Municipal Administration include corrective actions. Stability of ten- (or municipal corporations), while smaller ure at mid-management levels also needs to municipalities retain the provincial collec- be ensured. FBR staff ownership of change tion of the tax, with a transparent revenue- management will require extensive and reg- sharing arrangement. Further measures ular consultations with all stakeholders, as include rationalizing exemptions and tax well as constant training. rates, re-indexing the base and prepar- ing realistic property valuation tables to Increase provincial tax revenues increase the tax base, and reducing dispari- ties between owner-owned and industrial The government probably needs to step back and and commercial properties. A potential look at the entire intergovernmental fiscal system, second-best option would be to reform the which is broken and unbalanced, and its revenue urban property tax in combination with the property transfer tax and an agricultural to their relevant bases) were 0.88, 0.85, income tax (Bahl, Wallace, and Cyan 2008). and 0.5, respectively, in the last three years • Eliminate the myriad minor provincial taxes that (World Bank 2012a). generate little revenue. 3. According to recent rough estimates, Sindh collects about 50  percent of total To sustain the proposed policy reforms, it is impor- provincial taxes; Punjab 25 percent; Khy- tant to prioritize them in the correct sequence, which ber Pakhtunkhwa and Federally Admin- implies a mix of technical and political considerations istered Tribal Areas 13  percent; and (Table 5). One possibility is to give high priority Balochistan 12 percent. 17 to broadening tax bases of the GST and income 4. Sectors with high effective rates of pro- tax and rationalizing tariff exemptions. After tection tend to have low value added the expected results from broadening the tax and to be domestically oriented, which base have materialized, the government should creates an anti-export bias and restricts consider reducing income and GST rates under Pakistan’s graduation from producing low- a phased program, then rationalize the federal value products (Lopez-Calix and Touqeer excise duty while reforming customs duties. It forthcoming). should accord CIT the lowest priority. The uni- 5. The system of compensatory export fication of and reduction in low-priority taxes rebates—applied to carpets, footwear, are also important but may be put on hold until sporting goods, and surgical instru- domestic revenues, especially the GST, reach ments—overcompensated for effective the level of revenues from trade taxes. Never- taxes that were significantly higher than theless, GST and CIT remain the most impor- nominal rates and formed a pure export tant tax reform areas for improving revenue subsidy (Ahmad 2010). mobilization. Under any of these scenarios pro- 6. The size of the informal sector of Pakistan viding alternative mixes of tax policy, however, could be as high as 35 percent of the offi- reform of tax administration and of provincial cial economy (Kularatne and Lopez-Calix taxation cannot wait and should be at the top 2012)—higher than the averages for South of the priority list. Asia (33  percent) and East Asia (32  per- cent; Schneider and Buehn 2009; Schnei- Notes der, Buehn, and Montenegro 2010). Information on provincial taxation drawn 7. Individual income tax is levied mainly on from the background paper prepared by Hanid workers and salaried persons (as well as Mukhtar. small unincorporated businesses). 1. Tax buoyancy measures the ratio of the 8. (GST/GDP)/GST tax rate. proportional change in tax (or nontax) rev- 9. The C-efficiency index is the ratio of enue to the proportional change in GDP. It GST revenue to consumption, divided by is obtained by regressing the natural loga- the standard tax rate. It also shows how rithms of tax (or nontax) revenue on GDP effectively the base of the GST is used. series. A ratio greater than 1 shows tax (or It reflects both compliance and the nar- nontax) revenue growth above GDP growth. rowness of the tax base. Most developing 2. Pakistan’s income tax, general sales tax, countries are around 0.45–0.50, advanced and customs tax buoyancies (with respect middle-income countries (such as the Table Sequencing of major tax policy reform priorities 5 First priority Second priority Third priority Broadening tax bases Rationalizing taxes Reducing tax rates General sales tax/income tax Provincial taxes, individual income tax, Customs duties, zero rates and exemptions federal excise duties corporate income tax Source: Authors. Pakistan Policy Note—Mobilizing Revenue Republic of Korea and Singapore) 0.6–0.7, 17. The Punjab model intends to reform one and developed countries (such as New Zea- provincial tax at a time, and the Punjab land) much closer to 1.00 (Ahmad 2010). Revenue Authority would be given author- 10. In 2007, the government confirmed the ity to collect the reformed tax. Over time, tenure of the Chairman of the FBR for all provincial taxes would be reformed. three years and renewed the terms of the This would remove fragmentation in the members responsible for functional areas. provincial tax administration. But as described, frequent managerial 18 changes continue to plague the institution. References 11. Other financing sources of provincial Ahmad, Ehtisham. 2010. “The Political- expenditure are drawings from balances Economy of Tax Reforms in Pakistan: The created by unfilled positions, slow dis- Ongoing Saga of the GST.� Asia Research bursements of project funds, and bank Centre Working Paper 33, London School of financing. Economics, London. 12. The Local Government Ordinance of 2001 Ahmad, Ehtisham, and Michael Best. 2012. abolished the distinction between urban “Pakistan: Using Third Party Information and rural municipalities, making it pos- to Plug Tax Gaps—Alternatives to Policy sible for local governments to levy the tax Reforms.� Mimeo, October 2012. on all properties. But no local government Ahmed, Athar M. 2011. “Revenue Analysis and taxed rural properties. With the subse- Forecasting: Sectoral and Tax-Gap Analyses.� quent lapsing of the 2001 Ordinance, the FBR-USAID-CSF Tax Assistance Program, former distinction was reinstated and the Islamabad. tax levied only on urban properties. Ahmed, Robina, and Athar M. Ahmed. 2012. 13. In Punjab, for a market-set rent of “Estimates of Domestic Sales Tax Gap.� Pre- PRs 50,000 a month, its tax-rental value is sentation made in Islamabad. PRs 18,518 a year (3.6 percent of the mar- Ather, Robina. 2013. “Study on Tax Expendi- ket rate). tures in Pakistan.� Pakistan Policy Paper 14. By law, these tables (prepared by excise Series, World Bank, Washington, DC. and taxation departments and based on Bahl, Roy, Sally Wallace, and Musharraf Cyan. surveys of properties) have to be updated 2008. “Pakistan Provincial Government Tax- every five years—a long period when real ation.� Working Paper 08–07, Georgia State estate and rental prices climb rapidly. University, Atlanta, Georgia. Worse, provincial governments generally Baunsgaard, Thomas and Michael Keen. 2005. take much longer to update them. “Tax Revenue and (or?) Trade Liberaliza- 15. The rental value is assessed based on the tion.� IMF Working Paper 05/112, Interna- valuation tables. Net value deducts repair tional Monetary Fund, Washington, DC. and maintenance costs, depreciation based CIRP (Center for Investigative Reporting in on their age, and any land tax that may Pakistan) and CPDI (Centre for Peace and be paid by the property owner. Moves to Development Initiatives). 2012. 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Wash- ington, DC. © 2013 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street NW Washington, DC 20433 USA All rights reserved This report was prepared by the staff of the South Asia Region. The findings, interpretations, and conclusions expressed herein are those of the authors and do not necessarily reflect the views of the World Bank’s Board of Executive Directors or the countries they represent. The report was designed, edited, and typeset by Communications Development Incorporated, Washington, DC.