A seven-decade mess in taxation

In 1215, a group of barons and wealthy urbanites made King John of England sign the Magna Carta, a document that gave birth to the idea of modern parliamentary democracy. At its heart was the concept that the power of the ruler is not absolute, and that taxes cannot be levied on the people without their explicit consent, granted through their elected representatives. In other words, modern democracy came into existence because of a tax dispute. Our right to vote is the direct result of our obligation to be taxed. In Pakistan, of course, we famously have a culture of rampant tax evasion and so perhaps it is not surprising that we have still not completely solidified our democratic foundations. If we plan on changing that, it would help to first understand what our tax system currently is and where all of our worst attributes come from.

Let us start with some basic facts. The government gets only half of its budget from tax revenue. The other half comes from a combination of foreign aid and loans from domestic banks, with only a minuscule portion coming from the dividends from profitable state-owned companies. While Pakistan’s tax-to-GDP ratio is appallingly in the 10 per cent range, our government spending as a percentage of the GDP is closer to twice that level. Yet, despite all the yelling and screaming about foreign trips by the prime minister and president, the bulk of Islamabad’s financial problems are not on the spending side, but rather on the earnings side.

Unfortunately, Pakistan’s tax machinery is so completely broken that it is sometimes difficult to imagine how it can ever be fixed. Here is an astounding fact to remember: just under 55 per cent of all taxes collected by the government of Pakistan are collected at Karachi Port or Port Qasim under circumstances where the Federal Board of Revenue (FBR) can literally hold importers’ goods hostage until they pay their taxes in full. About a quarter of all taxes come from the energy sector, where the government either directly owns the companies that sell oil, gas or electricity, or control the supply chains of the private companies engaged in the business. Substantial chunks (about five per cent each) also come from telecommunications, banking and tobacco — three industries that are either completely documented by definition or else dominated by multinational firms.

Less than five per cent of all taxes collected by the government are done so because of voluntary payments, and most of these come from large companies paying income taxes and sales taxes because they want to have published financial statements for their lenders. Everyone else who can get away without paying taxes does not pay them. The FBR, even if it were filled with completely honest people, is grossly understaffed, with a total staff of 27,492 people, of whom only 2,206 are officers — the only people actually authorised to take action against tax thieves. The government does not actually know how many people in Pakistan pay their taxes, but it estimates that the number of taxpayers is anywhere between 770,000 and 1.4 million. Of the 200 million people in Pakistan, only about 4.5 million make more than the Rs400,000 per year minimum that would render them eligible to pay income taxes. The system is so bad that the FBR is actually under instructions not to question even blatantly falsified tax returns if they include a payment because the government is so desperate for revenue that it does not want to discourage even gross underpayments.

So how do we fix a system so badly broken? I could give you some theoretical examples of how things could be improved, but here is the harsh reality: we will not fix this system unless we are absolutely forced to fix it, until we are left with no choice but to confront this monumental challenge. And the only way that will happen is if the United States stops giving us money, both directly and through multilateral agencies. Only when the financial pain gets unbearably bad — when Islamabad starts to resemble Tehran — will we wake up and fix this gigantic mess nearly seven decades in the making. Could we come to our senses before that point? Yes, but I highly doubt it.

Published in The Express Tribune, March  6th,  2015

Farooq Tirmizi

CEO, Elphinstone

Farooq Tirmizi is the founder and CEO of Elphinstone, the financial services firm that operates SmartRupee.

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