Resource Mobilization
Taxation
Understanding Pakistan's Taxation
Structure
• Some of the key issues and components of Pakistan's revenue and taxations
system and structure,
• primarily of the federal government, given its dominance in the taxation
structure
• The revenue receipts of the federal government constitute tax revenue receipts
and non-tax revenue receipts.
• The revenue receipts of the federal government are derived from the following
sources:
• i) proceeds from taxation;
• ii) net revenue of the Commercial Departments;
• iii) interest on loans advanced by the federal government;
• iv) return on investments made by the federal government;
• v) fees and other receipts realized by administrative ministries and divisions
of the federal government;
• vi) surcharges on petroleum and natural gas, and
• vii) dividends.
• Tax revenue collected by the Federal Board of Revenue (FBR) comprises of
inland revenue and customs.
• Inland revenue comprise of income tax, sales tax,· and federal excise duty.
• Tax revenue is of two types,
• direct and
• indirect,
• Where direct taxes comprise
• income tax,
• workers' welfare tax,
• workers' participation fund and
• capital value tax.
• The indirect taxes are comprised of
• customs,
• sales tax,
• federal excise duty,
• surcharge on gas,
• petroleum levy;
• taxes collected by the Islamabad Capital Territory (ICT) administration and
• airport tax.
• The major part of the revenue is administered by the Federal Board of
Revenue.
• The non-tax revenue of the federal government is administered by various
ministries/divisions and comprises the following sources:
• i) income from property and enterprise;
• ii) receipts from civil administration and other functions; and
• iii) miscellaneous receipts.
• In recent years, the largest component of non-tax revenue has usually been
State Bank of Pakistan's profit.
• The second major source has been Coalition Support Fund (CSF) from the
United States of America, although this depends on Pakistan-US relations.
• The other heads of non-tax revenue constitute
• profits from Pakistan Telecommunication Authority and
• dividend from OGDCL, Pak Arab Refinery Ltd, and PSO.
• Other sources include receipts from the auction of 3-G/ 4-G License
• The sales tax is a tax on consumption levied on manufacturers and retailers
with an annual turnover of more than Rs. 5 million,
• as well as on importers, wholesalers, distributors, dealers, and specified
services at a standard rate of 17 per cent,
• However, some commodities are subjected to sales tax at 19 per cent and 22
per cent and
• there are others, such as basic foodstuff, agricultural produce (not subjected to
any further process), medicines, books, and live animals, etc. which are
exempted from the sales tax.
• Petroleum products and edible oil remain the top revenue source of sales tax on
imports.
• Within the domestic component of sales tax collection, the largest contributions
come from POL products, telecom, services, natural gas, sugar, and cigarettes.
• Changes in what should be taxed take place periodically as and when the
government decides.
• In terms of collection from federal excise duties (FEDs), there are six major areas
of revenue which include cigarettes, beverages, POL products, cement, natural
gas, and special excise duty.
• Almost 76 per cent of excise duty collection ( domestic) is collected from these
six commodities.
• The main source of customs receipts is from the duties levied on vehicles and
from POL products.
• Prior to the passing of the 18th Amendment and the 7th NFC Award, about 90-
93 per cent of resources were generated at the federal level
• whereas only 7 per cent resources were generated by the provinces.
• Provinces relied on the federal government for meeting their expenditure
requirements.
• In order to maintain inter-governmental fiscal relationships, Article 160 of the
Constitution provides for setting up of the National Finance Commission
(NFC) at intervals not exceeding five years.
• The mandate of NFC is to recommend to the President for the distribution of
resources between the federal and provincial governments
KEY ISSUES IN TAXATION
• Pakistan's tax system is characterized by a number of structural problems.
• First, the overall level of fiscal effort is low and the tax-to GDP ratio has
remained, more or less, stagnant at between 12 to 13 per cent.
• This is one major explanation why budget deficits have been high, generally in
excess of six per cent of the GDP.
• Second, there is overdependence on indirect taxes, which until recently
accounted for a share in revenues of over 80 per cent.
• This has increased the regressivity of the tax system and imposed a higher
excess burden of taxation.
• Third, within indirect taxes there is domination of taxes on international trade,
which has promoted inefficiency, distorted the allocation of resources and
encouraged illicit trade.
• Fourth, the effective tax bases of most taxes is narrow due to wide ranging
exemptions and concessions and rampant tax evasion.
• For example, there is less than one income tax assessee per 100 persons and less
than 60 per cent of imports actually pay duty.
• Consequently, tax rates have had to be pitched at high levels which has created a
vicious circle of more tax base erosion and higher tax rates.
• Fifthly, tax administration is characterized by primitive and out moded
procedures, complex laws and considerable arbitrariness and discretion.
• The common perception is one of high levels of corruption and inefficiency
• The World Bank, in its extensive evaluation of the economy prior to the
commencement of the first major Structural Adjustment Programme of
1988,identified the issues of resource mobilization and the budget deficit as
amongst the most important.
• Revenue generation has been a perennial problem in Pakistan, one which is at
the core of taxation and the political economy of revenue generation.
• The World Bank report argued that the budget potential of an increase in
resource mobilization comes from strengthening Pakistan's tax base, since tax
revenues accounted for only 13-14 per cent of GDP
• The income elasticity of the tax system is low because of the very narrow tax
base and the large number of exemptions given in sales tax, excise duty, income
tax, and customs duties.
• The report emphasized that there was a need to 'broaden the tax base and
increase the elasticity of the tax system by shifting the emphasis in indirect
taxes towards domestic consumption( of both domestic and foreign products)
and
• raising the contribution of the income tax'.
• A theme which continues to be repeated in most analysis of the taxation
structure, the need to subject agricultural income to taxation, was also
identified by the World Bank.
• While the need to increase direct taxes as a share of total tax revenue has been
an important realization,
• Attempts to change the structure of indirect taxes have found equal emphasis.
• With trade taxes by far the key feature of Pakistan's taxation regime in the past,
Pakistan's resource mobilization efforts have been subject to impacts not
necessarily of Pakistan's own doing.
• Hence, there is need to develop another sort of tax that is consumption based
and domestic.
• A key feature of the change in the taxation structure suggested was to cut the
excessive number of exemptions under the existing taxation regime,
• which would then fulfil the objective of increasing the tax burden on
consumption.
• The emphasis was on implementing VAT-a 'manufacturer's level consumption-
type VAT'.
• This shift from a sales tax to a value added tax would require the extension of
the coverage of taxation to almost all products at the manufacturers‘ level and
would tax domestic and imported products at the same rate
• The need to subject agricultural income to taxation, was also identified by the
World Bank.
Vested Interests and the Taxation Structure
• Hafiz Pasha argues that the taxation structure needs to be seen in the context of
different interest groups active in the economy.
• Behind each major tax exemption or concession there is a strong, entrenched
vested interest group in Pakistan.
• Each group has organized itself as an effective lobbying entity, which has not
only blatantly demonstrated its power in political terms,
• but developed credible arguments for the retention of these exemptions and
fiscal incentives in the greater national interest.
• Perhaps the best example of this is the agricultural lobby.
• It is extremely well organized and enjoys enormous political power.
• Over 80 per cent of the elected members of the parliament either represent the
feudal class or are sympathetic to the interests of this group.
• It is not surprising, therefore, that any legislation to change the status quo is
effectively blocked.
• A number of arguments have also been developed to justify the exemption of
agricultural income tax
• the sector is already 'overtaxed‘ through the pricing mechanism (domestic
prices below world prices),
• that food production is vital for national security
• and that the high costs of collection of the tax on agricultural income will
not be justified because of the likely low revenue yield.
• Tax holidays have been aggressively supported by industrial interests who
have formed an alliance with the provincial governments.
• They have been successful in playing up the sensitive issue of large and
widening regional disparities in the country.
• The Ministry of Finance has justified the exemption of interest income on
government savings instruments on the ground that this actually improves the
income distribution
• because the bulk of participation in such savings schemes is by lower and
middle income households,
• and this incentive reduces the need to resort to inflationary mechanisms for
financing the budget deficit.
• The need for retention of the capital gains on financial assets has been
successfully argued by representatives of stock exchanges in the
country.
• Various associations of members of stock exchanges have portrayed
the share market as a barometer of the performance of the
government and the economy.
• They have stressed the need for fiscal incentives to attract foreign private
portfolio investment and thereby improve the balance of payments position.
• Altogether, tax reform involving broad-basing of direct taxes through the
removal of major exemptions and concessions has been effectively frustrated
by entrenched, powerful, well-organized and articulate interest groups.
• The government has had to retreat in the face of opposition from such groups.
• It has been left with the worst possible outcome.
• Tax rates have come down, while the multitude of tax expenditures continues.
• The failure of government to broaden the base of direct taxes by
reducing tax expenditures leads to
• identification of a number of factors which mitigate against success of
reform initiatives as follows:
• Lack of commitment to the reform by agents of the state, arising from a
perception that the reform may damage vital national interests like food
production, savings, exports, etc.
• 'State capture' by special interest groups like the traditional feudal elite,
bureaucracy and the emerging corporate business interests which
extract substantial rent from the existing tax-expenditure system and
are unwilling to give up their privileges.
• Wrong strategy of implementation of reforms.
• By first reducing tax rates the opportunity which existed for bargaining
with (and compensating) losers was lost.
Fiscal Development
• In Pakistan, fiscal sector has faced multifaceted challenges over the years due to
unproductive and rigid expenditures on one hand and lower tax revenues on the
other.
• This has narrowed the fiscal space for public investment and social safety nets.
• High fiscal deficit has therefore become a norm, with high interest payments,
untargeted subsidies, including energy subsidies, loss making PSEs, and
security related expenditure all contributing to the expanding fiscal deficit.
• A brief review of fiscal performance during last five years exhibits a deceleration
in revenues and increase in expenditures compared to targets, causing an
increase in the fiscal deficit to 6.5 percent of GDP in FY2018 - highest during
the last five years.
• In FY2016, fiscal deficit was brought down to 4.6 percent of GDP but the low
trajectory could not be maintained and increased to 5.8 percent and 6.5 percent
during FY2017 and FY2018, respectively.
• The total revenue growth experienced a slow down (5.9 percent in FY2018
against 11.0 percent growth in FY2017), while, total expenditure growth was
contained at 10.1 percent in FY2018 as compared to 17.3 percent in FY2017.
• During first nine months of FY2019, consolidated fiscal indicators performance
suggests that total revenue registered zero growth over same period last year,
• Total expenditures increased by 8.7 percent for the same period.
• Therefore, fiscal deficit as percent of GDP reached 5.0 percent as compared 4.3
percent in comparable period of last year.
• The incumbent government inherited the economy facing multiple economic
challenges which required considerable adjustments.
• The priority of the government is to undertake structural reforms and fiscal
adjustments to correct the underlying imbalances in the economy.
• In addition, the government is focused on taking various policy measures to
address structural problems which have plagued the economy over the years.
• The focus is on exploiting the overall growth potential of the country and
achieving higher growth trajectory through higher investment, efficiency and
enhanced productivity.
• On fiscal side, the government is committed to implement structural reforms to
narrow the fundamental revenue-expenditure gap.
• This will ensure an efficient and fair tax system with the ability to generate
ample revenue to finance a large part of public expenditures.
Fiscal Policy Developments
• Fiscal indicators during FY2018 suggest that total revenue at 15.1 percent of
GDP remained below the revised target of 16.0 percent.
• Tax revenue reached 12.9 percent of GDP against the target of 13.2 percent, of
which FBR tax collection remained at 11.1 percent against the revised target of
11.4 percent.
• Similarly, non-tax revenue reached 2.2 percent against the target of 2.8 percent.
• Total expenditures stood at 21.6 percent against the target of 21.5 percent.
• Hence, fiscal deficit surpassed its revised target of 5.5 percent and stood at 6.5
percent of GDP in the last fiscal year.
• During the last five years, total revenue as percent of GDP on average reached
14.9 percent, with tax revenue and non-tax revenue at 11.8 and 3.1 percent,
respectively.
• Primary deficit1 increased from 1.6 percent of GDP in FY2017 to 2.2 percent
of GDP in FY2018.
• Simultaneously, revenue deficit increased to 1.8 percent of GDP in FY2018
compared to 0.8 percent in FY2017 due to uncontrollable current expenditures.
• Revenue deficit and primary deficit budgeted at 0.2 and 0.7 percent of GDP,
respectively for FY2019.
• The present government is focused on improving the fiscal accounts
particularly, focusing on improving the tax revenues.
• The tax system is being streamlined.
• As a first step, tax policy and tax administration functions have been separated
so as to remove the apparent conflict of interest in tax collection.
• Tax policy is being designed to be fair, equitable and productive.
• The revenue and fairness objectives are pursued by expanding the tax base,
reducing tax exemptions and through more efficient tax administration.
• Tax administration is being strengthened by allowing its access to third-party
data and modern tools to identify and tapping tax defaulters.
• Fiscal reforms will ensure an efficient and fair tax system which will be
capable of generating sufficient revenue to meet a large portion of public
expenditure and investment needs, leading to a decline in fiscal deficit.
• On expenditure side, the government plans to enhance the efficiency and
effectiveness of public expenditure by framing laws to give greater autonomy to
the spending units,
• but with greater accountability, enforcing rules to stem leakages from the system,
• improving coordination between the federal government and the provinces and
• reorienting expenditure priorities towards social welfare.
Fiscal Performance (July-March, FY2019)
• Consolidated fiscal position during first nine months of current fiscal
year shows zero growth in total revenue and
• 8.7 percent growth in total expenditures over same period last year.
• As a result, fiscal deficit during this period reached 5.0 percent of
GDP as compared with 4.3 percent in comparable period of last year.
• To finance the higher fiscal deficit, the government mobilized financing of Rs
524.5 billion from external resources, which was at about the same level as last
year.
• Another Rs 1.4 trillion were mobilized as borrowing from the domestic
banking system and from public (mainly through national savings schemes)
and some other non-bank resources.
• Banking system contributed domestic financing during the first nine months of
FY2019 was 46 percent higher than last year.
• External resources contributed 27 percent of total financing, banking system
41 percent and non-bank sources the remaining 32 percent.
Structure of Tax Revenue
• Over the years, narrow tax base, large number of concessions and exemptions,
tax administration challenges and weak tax compliance resulted in a low tax to
GDP ratio.
• In this connection, the present government is aiming to introducing measures
to remove these weaknesses and disincentives in the tax system.
• The government intends to implement such fiscal reforms that will ensure an
efficient and fair tax system.
• It will be proficient to generate sufficient revenue to meet a large portion of
public expenditure and investment needs, leading to a decline in fiscal deficit.
• The share of direct taxes needs to be increased further to make taxes more
progressive as well as equitable and further reduce reliance on indirect taxes
Provincial Budget
• For FY2019, total expenditure of the provinces is budgeted at Rs
3,540.8 billion, an increase of 3.7 percent over revised estimates of Rs
3,413.4 billion last year.
• Overall provincial revenue receipts posted a growth of 8.7 percent to
Rs 3,585.3 billion in FY2019 compared with Rs 3,297.0 billion in
FY2018.
Fiscal Federalism
• In accordance with the distribution of resources formula agreed under
the 7th NFC award, the net transfers to the provinces were estimated at
Rs 2,711.6 billion for FY2019 which was 11.5 percent higher than the
revised estimates of Rs 2,430.9 billion for FY2018.
Public Financial Management Reforms in
the Federal Government
• The present government has given highest priority to reforms for improvement
of governance, economic management and public service delivery.
• In this regard, the Prime Minister constituted an Economic Advisory Council
(EAC) headed by eminent economists and policy experts.
• One of the sub-groups of the EAC was dedicated to Public Financial
Management reforms.
• These reforms are aimed at
• improving legal basis,
• decentralizing authority to improve management,
• strengthening fiscal discipline,
• enhancing revenue mobilization,
• broadening results-based management system, and
• improving coordination between Federal and provinces on public finance
issues.
• In addition, with support of the World Bank, Ministry of Finance in coordination
with other relevant stakeholders, is implementing a Public Financial
Management Reform Initiative under a Program for Results (P4R) modality.
• The main objective of the program is to improve system and process to improve
management of public finances.
Conclusion
• Pakistan’s fiscal accounts remained under intense pressure over the years owing to
poor revenue collection and over run in current expenditures which caused a sharp
increase in fiscal deficit in recent years.
• In addition, they limited the fiscal space available for public investment and expansion
of social safety net.
• The fiscal deficit which was brought down to 4.6 percent of GDP in FY2016 has
increased to 5.8 percent and 6.5 percent during FY2017 and FY2018, respectively.
• Whereas, during first nine months of CFY, fiscal deficit as percent of GDP stood at 5.0
percent as compared 4.3 percent in comparable period last year.
• The present government has inherited the macroeconomic imbalances, however,
the government is cognizant of this challenge and taken up on priority to revamp
the fundamentals of economy.
• Sharp fiscal adjustment is dire need of time.
• In addition, improving fiscal federalism and strengthening provincial autonomy
to rely less on federal transfers and more efforts on increasing revenues would
help the federal government to meet additional financing requirements
