Tax reforms and the future of the economy

Taxes and duties are collected by FBR in Pakistan therefore these words have become synonyms with FBR over time, and used collectively in common parlance and drawing room discussions, even in the policy echelons. Anything meant to reform the tax system actually means to reform the FBR, its structure, functions, and its legal Framework. Reform is a process which must continue unabated in each and every institution all the time and throughout the life cycle of any organisation. FBR is no exception, if history is any guide it has not happened as per the above universally accepted principle of change in an evolutionary manner, catering to the needs as and when they arose. It is the second big national institution after army and has an equally important function to perform. The job of this organisation is time bound, with deadlines and also quantifiable at the end of each financial year. This makes it distinct than the others in the state structure of Pakistan. The significance of the job that it does has its direct implications on the national economy particularly the fiscal deficit which always keep it in the lime light.

When the job shows any slackness, it is measured by only one parameter which is target, its bashing starts from right, left and centre. The most common critique is that it has failed to broaden the tax base, issue wiry firry notices, squeezes and teases the existing taxpayers and so on for achieving their targets. These arguments generally degenerate to outright and sweeping allegations on the integrity of the organisation. When the present govt took over, this attained more speed and significance as the prime minister publicly and particularly in his first speech to the nation repeated these allegations more forcibly specifying in a blunt and terse manner, making everybody believe in it. And why not, when it came from the chief executive of the state, under whose executive authority it was to perform for five years. The spat of these charges didn’t stop here, but trickled down to the Finance Ministry, the political tail enders, and the chambers of businesses. Without going to the merits of this tirade, its impact on the national revenue ‘up to around expected 400 billion plus’ is more important and biting the nation. The institution has come to a standstill and is at a complete halt now. Obviously, the officers are worried about their future and career, and why not? After all it was none less than the PM charging them as a mafia. The workforce got demoralised, de-motivated and went on the back foot.

In the same breath, the prime minister made a public commitment of getting rid of this evil by reforming it or doing it away altogether and replacing it with a new tax collecting agency. The commitment to fix it and reform it looks like a far cry even today, even after the lapse of almost eight long months. More worrisome is that there doesn’t appear anything on the scene known to the common man. A-team has been formed, consisting of some past and new members, most of them having no background knowledge of the working in FBR. Anything done so far has been done behind closed doors, without the participation of FBR, a major stakeholder. Coming back to FBR reforms, the history of reforms is important to take stock of. It has been reformed on a number of occasions in the past as well, as a project, by the government of Pakistan and some financed by the multilateral organisations. To enumerate the important ones, 1990 to 1991 Resource Mobilisation and Tax Reform Commission (RMTRC) was formed. In 1993 Structural Adjustment Facility (SAF) was signed with International Monetary Fund (IMF) and TARP programme under the World Bank assistance.

Reforming the FBR is a buzz word again, and every Pakistani wishes it to be fixed and reformed and quickly. To my understanding, more than everybody else, FBR officers themselves wish it to be reformed. They also wish that action should speak louder than the words and hollow rhetoric. Nobody doubts the intention of the present government for doing the same, but what is doubted is the capacity of team doing it and ground information available to them. The team derives it spirit from the TARP reforms programme and the recommendations of the tax reform commission in the previous government. A good work was done on both these occasions and most of the ground towards success was covered. This is a good idea to continue the effort as huge money was spent on those reforms. Quite a few of the recommendations made by TRC were also enforced, particularly the legal one.

Since the present members of reform commission include both the heads of these reforms’ programmes, we are confident they will contribute by informing the new reform members as to where these reforms were successful and where they failed. Furthermore, the failures will be picked up one by one and solutions found out. This is the way forward rather than the disastrous path of undoing FBR and making a new revenue setup. Referring back to the history of reforms for guidance, there is no denying the fact that the only meaningful reforms made, were under the TARP programme, as they were based on broad-based consultation of all stakeholders, researchers, intellectuals and international experts. These reforms made a difference also. The present structure of RTOs and LTUs is the product of those reforms. It changed the age-old territorial system of administration to functional, with universal self-assessment scheme. Risk audit management system was introduced. Technology was also introduced aiming at a paperless environment. Centralisation of authority occurred in administration. New income tax ordinance 2001 was introduced as a modern legal framework. Infrastructure changed to look like corporate outfits. This was a paradigm shift.

There exists resentment against the Federal Board of Revenue (FBR). Centralisation of authority occurred in administration. New income tax ordinance 2001 was introduced as a modern legal framework. Infrastructure changed to look like corporate outfits. This was a paradigm shift. Unfortunately, it had some unintended consequences, which incurred unanticipated collateral damages to system resulting in the present-day resentment. The very purpose was a sweeping change and complete overhaul of the system, dissociating itself away from the past thought to be bad and unwanted as we feel today. As unintended consequences, it developed gross functional anomalies like shrinking of base rather than broadening of base, deterioration of compliances to the worst in the history, and tax to GDP ratio had a free fall.

File movement on multiple desks, diluted the officer’s authority and ultimately created disciplinary issues. This became the major cause of corruption rather than combating it. Worst load shedding in the country at that time falsified the dream of paperless environment. Transforming taxpayer and tax collector relation to an interface with a faceless machine evaporated. The change created a new department of Inland Revenue Services (IRS) and income tax, as service was disbanded. The IRS got a sway over sales tax and federal excise in addition to the income tax for one window solutions and cross matching of information, cross match and catch new taxpayers and calculating income of existing taxpayers for detecting concealments of incomes and assets. However, the number of concealment cases fell sharply as against the goal.

The change boosted the revenue to a trillion in absolute terms for the, first time in the history of FBR, hailed and used as a justification to continue the change. Everyone, including myself celebrated, but without knowing that the most authentic parameter to gauge the success of reforms, tax to GDP ratio was steeply falling. The salutary impact in the beginning started phasing out with time. The drop in the tax to GDP ratio was pointed out to the bosses of that time, (privy to the discussion) and was brushed aside as the initial teething problem and adjustment phenomenon which was to be corrected with time. However, it was never corrected till today despite all efforts and we are still way low on the table if compared with the world and region. The number of amnesty schemes brought after the change is the evidence that it has failed to tap all domestic resources and even today, we are back to square one. We may be repeating it again tomorrow if not done as suggested.

Issues for consideration

There is no doubt in my mind that the present reform committee will be taking care of all the offshoots/ backlash of aggressive reforms in the past. They are also sensitive to the broadening of base and reducing tax burden on existing tax payers. The separation of policy board was an act in the right direction, but it was enacted in the FBR in the previous reforms. Frankly policy always remained with the Finance Ministry. The FBR was only the secretariat for doing the spade work for them so it was just a cosmetic change.

The team must analyse the malaise and ailments of the institution by diagnosing them one by one and then curing in a scientific manner based on data, home-grown solutions and experience on the ground. It is necessary, as ecology of administration is a full-fledged subject taught in all management schools in the world. The fact of the matter is that the tax base is very narrow, and taxpayers on record are overburdened.

The best system of taxation is more people paying and lesser rate of taxes. Therefore, the urgency of the reforms should be the treatment of this important symptom of the illness, resulting from low/no outreach of the department on one hand and policy changes on the other. Tax culture in the country has also not developed and paying taxes are not considered a matter of pride, rather the other way round. It is considered fine to hide tax, considered as penalties by the state. Nobody is named and shamed on the basis of tax evasion. Such culture is linked to the luxurious spending, misuse of their money, cars, bungalows and overbearing lifestyle of the political and bureaucratic elite. Moreover, taxes are not providing security, education, health and other social services.

They are considered as tax-saving and not tax evasion creating a moral base for evasion. The attitude of some officers and departmental processes, discretion of the taxmen and strong-arm tactics create resistance in taking the taxpayer away from paying taxes. Most of these are because of lack of training in public dealing and exposure embargo on tax officers to move horizontally in the provinces and other departments of the federation. Trust deficit between the taxpayer and collector, due to chasing wildly fixed targets, mostly not based on available tax and supporting resources with the officer, must be considered.

The physical absence of taxmen thus finishes the writ of the service. The universal principle of visibility of taxmen to taxpayer for more tax has been disregarded. Moreover, the territorial concept of administration is also a problem. Broadening of tax base is a true challenge for the success of any form of future taxation system in Pakistan. The economy of Pakistan consists of around 45 percent as an informal cash economy. This makes this challenge more formidable. Documentation is fundamentally a government job outside the preview of the FBR, and it consists of a number of actions required to be taken by the government. Since bashing the FBR has become a fashion all over the country at political rallies, by traders, in the media etc, the FBR has been pushed on the back foot. Whenever one department starts using the authority of others, the job remains undone, only the unscrupulous start growing in such a situation.

The stark reality is that anti-smuggling role has been taken over by the police, FC, rangers, coast guards; their own jobs remain to be done, by whom nobody knows. The custom department was left with nothing more than the blame of corruption which in most of the case was done by the encroachers.

Today the customs service is in a log jam with no authority, but it is getting bashed everywhere. The officers have no support staff to raid even a petty vendor, what to say of powerful smugglers. It is only the nation that suffers not the Federal Board of Revenue (FBR) if one considers the statistics of ice and heroine dealers and victim in schools and colleges. The outcome is frightening. We all have statistics of the country’s literacy, health and poverty rate, but the narcotics consumption rate, source, carriage and storage is not on record, primarily because of a powerless custom department. There was an effort made between 2016 and 2017 to remedy these pitfalls. New LTU and two corporate RTOs were created in Lahore and Karachi, with corporate zones all over the country. The territorial RTOs were to be separated and rearranged based on their jurisdictions. That package is a way forward and must be deliberated. The key of those efforts are briefly given below.

Philosophically, a hybrid system was in mind, taking care of all ills mentioned above as well as consolidating the gains made, without costing a penny to the state. This had approval of the department after wide consultations in house. Member ops gave a detailed presentation to the TRC and the finance minister, who was charmed to the extent that ordered its enforcement there and then. Less money and no donor support are required, with readiness for use at any time the government wishes.

The result will be instant and to the satisfaction of everybody, as it targets the ills and treats it one by one. Any experience of new setup will uproot the gains so far made and create new problems and more confusion and further loss of taxes.

1. School of finance, taxation and customs

An important part of these ideas was doing away with Directorates of Training (DOT) and making new schools. The school was to be affiliated with other schools in developed countries with exchange of trainee officers on reciprocal basis. The whole curriculum and syllabus of the DOTS, was mulled to be rewritten, as the one taught there was obsolete and has no relevance to the future knowledge and skill needs of the officers. The subject of ethics and sensitivity to the public grievances, including grooming in public dealing was going to make a difference in the future of the FBR. A few international institutions had agreed at that time to send their officers to our schools for two weeks and vice versa. Even the custom and the IRS probationers needed to stay in each others’ schools for 15 days to learn cross jurisdictional concepts for broader understanding and coordination in future. In addition to our officers, Pakistan could be a hub of training the officers of other countries, and earn revenue as well. This was to give the officers international exposure, broader vision, integrity support, and preparation to catch complicated cases, which DOT arguably, has failed to provide. The initiative of the young and talented tax officer was killed by the system in vogue in DOT, as they were called the glorified clerks at the outset, paralysing their initiative in all future discourse. On the custom side an international school of custom on the same lines and creation of at least two anti-smuggling collectorates across the country with the borders force for supporting these outfits could have yielded salutary results. Paperwork on these concepts in the shape of projects has been completed and available with custom wings of FBR.

2. District taxation officer

District taxation offices were to be established and district taxation officers were to be posted in each district without exception on the pattern of DCOs and DPOs. This idea was not merely sending officers to the district, but it covered all the gaps created by the previous efforts of reforms.

Brief guidelines are as under:

The DTO will have permanent establishment like DPO, DCO as district tax house and tax payer facilitation centre for all taxes and taxpayers, with tehsil as assistant DTO having an assessment authority on all cases except corporate cases in his tehsil. DTO to have ‘revisional’ authority to reconsider any order passed by TTO, pointed by the aggrieved party, or take a suo moto notice if any wrong has been done to the taxpayer or revenue both, thus facilitating taxpayers within his districts limits rather than to far away stations for redressal of the grievances where RTO’s are located. DTO to be administratively competent to recruit his staff and transfer it as he deems fit for his setup. He will ensure that each business/sale/income is registered on his record, (massive BTB) and documentation of economy. DTOs to be financially competent to spend money allocated to him like petrol, vehicle hiring etc. Will have designated vehicle and support staff both technical and non-technical to enforce the writ.

The DTO to be a composite tax authority for federal provincial and even municipal taxes. His office will be common tax house of the district where all taxes including provincial, municipal and vehicle taxes will be collected. The revenue collected will go directly in respective government accounts through a coded challan. This will be in consonance with ease of doing business as taxpayers will be going to one place for all taxes. It will reduce the support staff load on all three tiers of government. Above all the constitutional right of provincial government to collect their taxes will not be violated. The concept of one authority by federation may be resisted by the provinces and create bad blood which can be avoided by win-win situation of DTO. Investment is needed if not in lump sum at least on incremental basis in IT infrastructure, logistics and physical infrastructure to provide a decent working place for each officer. Let me state, based on my personal experience that the rate of return on investment in FBR will be highest in the world and sustained for many more decades to come. It is worth it and let us go for it, we cannot afford more wastage and surrender to the status quo and inertia. This will enable govt to select the successful DTO as future departmental leaders, by training them further and placing him on future executive positions. Further test of them will make it easy to select the future members and even chairman, on merit and not on discretion bases as is in vogue today.

3. Growth of officers in hierarchy

For any successful taxation system to be in place on ground the most critical factor is an organised well trained, dedicated, honest and hardworking officers/officials. For all the above to happen, motivation is one big critical factor and works like fuel for the engine. Motivation will only come when officers are convinced of the protection of their rights, posting, growth in the hierarchy, and recognition of performance. The hybrid system which has been discussed at length automatically cares and fits into all the pits. The system of taxation will not only consolidate the grounds of previous reforms but also cater to its weakness for more revenues. In the centre of this thought there is an inbuilt hierarchy of officers of the inland revenue, which is essential to give force and impart efficiency and effectiveness to the system of taxation which so emerges. The young officers from the training school will join in a salary setup as beginners to start testing skills and knowledge that they learnt in the training school. The application of their initial knowhow will make them suitable to be moved to the minor commercial and major commercial units, one after the other. In around five six years of such exposure, the officers will then be fit to be moved to the corporate sector in the corporate RTO and later on to LTUs. This will establish a system of merit as well as a grooming on the job of the officers. The same round will be repeated when they go to the senior grades like additional commissioner and commissioner. The officer having completed the round from salary to LTU will be a qualified resource for being posted as DTO and to be tested on ground for future leadership.

4. Integrity and performance management

Integrity of the FBR and its officers is measured every day and at every place. It is essential to place systematically organised, methodical and scientific measures for integrity management in place. The already available mechanism like internal audit and directorate general I&I, both are virtually dysfunctional. The functional overlap of I&I and field formations and audit directorate needs to be carefully studied and removed for clarity of work and efficiency. Collective responsibility is nobody’s responsibility at all. Any of these setups needs to be geared and mandated with sweeping powers, to take action against any departmental functionary on account of corruption, tax losses etc on the pattern of NAB. The present PER measurement is out dated therefore needs to replaced by third party performance audit through universally accepted parameters.

5. Mending the legal framework

To do the least, we need to immediately enforce the system of value-added taxation in the sales tax to document and tap the wholesalers and retailers. The general sales tax has not delivered over a period of more than 20 years of its life in practice. It is the real need of the hour and true test of the government’s resolve if they are serious and sincere in going for a change. There will be resistance from the market consisting of these two very important and crucial components of the value/supply chain, as they have successful experienced in the past on this account. The reason to argue in favour of value-added tax vs GST is that it is levied at the level of manufacturing and imports as its starting point. It trickles down along the supply chain/value, but at the level of wholesaler/retailer the chain is broken. The consumer, who actually is the taxpayer, pays the tax but it does not reach the treasury and is stuck in one of these two places. The government will have to take all the provincial governments and trade bodies into confidence for the change, and collect data of all businesses across the country by compulsory registration. Unfortunately, there is no shortcut to this mode of taxation, and its successful implementation will document trade, broaden the base, and also enable the government to reduce the rate of taxation to even single digit. After sometime, this job will be well done by the DTOs. The present tax system is based on the universal self-assessment scheme primarily designed to facilitate the taxpayer, believing him as honest and removing discretionary powers of the tax officers, allegedly corrupt. Regrettably, this assumption did not prove by the experiment. Immediately after the enforcement of this doctrine, the taxpayer started declaring less and less by each passing year, to the extent that his income as per his statement fell below the taxable level, resultantly being a BLT, he stopped filing a return as he thought it was not required. The logical conclusion of this exercise was reduction in the number of tax filers, creating a gigantic challenge for the government to tackle this monster. Broadening of tax becomes a far cry on the face of the fact that the government machinery becomes ineffective by even enforcing return on the registered taxpayers. Today, less than 50 percent of the registered taxpayers in all the streams of revenue are filling their return and the remaining are thus non filers. As a compensatory response to the above situation, the government has been moving to the levy of withholding taxation. It is a disparate move to compensate for the loss they made due to the USAS and its gross misuse by the existing taxpayers. It further deteriorated to an embarrassing level of transactional taxation, as a covering up of tax losses. Income taxation has virtually been replaced with withholding tax and a transactional tax system.

Though withholding tax is a direct tax being indirectly collected, it is a glaring admission of the state that it has lost its writ in the matter of taxing its citizens in a straight and direct manner.

This has killed the age-old philosophy of direct taxation, proportionate to the capacity to pay (more income more taxes, no income no taxes), thus burying the universal principal of taxation. If you carefully study the pie of revenue, the share of direct taxes has gradually gone down. The withholding tax/transaction/tax/sales tax/FED are the major revenue spinners pushing out the direct tax into a marginalised level, looking like indirect, regressive and unrealistic. Through this step, the government defended its short-term interest, revenue in absolute terms for a short period of time but with steep fall in tax-to-GDP ratio, and above all, rapidly consumed the space of expansion or any growth in future.

Thus, a state of stagnation and stalemate in revenue has arrived. Taxation is a strong economic tool of social justice, reducing income inequality, and economic development. None of this is being achieved and this is the major reason why the rich are getting richer and the poor becoming poorer. It can be hoped that the present government has a solution to this.

This system of taxation definitely needs a change, but a home-grown one, and with the ownership of applying machinery. The FBR manpower and its satisfaction in terms of infrastructural and logistical support coupled with monetary rewards will play a critical role in enforcing the writ of the state, for collecting due taxes. FBR hierarchy needs to be consoled rather than bashed, which always proved counterproductive. FBR is state machinery, and state has full authority to mend it the way it wishes to, but treating them as opponents is costing more to the state in terms of losses than gains.

The mechanism of accountability of the delinquents, unruly and corrupt officers/officials is a prerequisite for the success of the change. To make the change permanent, all these steps need to be institutionalised rather than done in a rash, emotional and irrational manner to save it from failure as has been done in the past.

In the present system, there are taxpayers who have no tax officers and conversely there are officers who have no taxpayers to tax. It is essential to place district taxation officers with full legal, administrative and financial competence as mini chief commissioners, for broadening of tax base. Stricter compliance to the tax laws must be ensured as well. The school of finance and taxation and international school of custom are essential, for creating human capital that matches international standards. Legal framework needs to be re-visited to wash it out from the anomalies and encroachments on the custom and IRS authority for any fair and transparent accountability in future.

The application of value-added tax vs GST is essential for broadening of tax base, and to avoid any future amnesty on the request of the traders who actually are opposing the VAT. The present amnesty may be used as a trade off with traders for accepting the VAT against the GST. It is for the government to see for itself as what is best for national revenue interest in future. It they listen to sane voices they are going to benefit more than anyone else.

— Written by: Dr Muhammad Irshad. The writer is a former FBR chairman. This article was published in The News International in May 2019.