Thursday, October 07, 2010

Pakistan: As systemic poverty and corruption go unaddressed, it's the survival of the richest

Source: International Relations and Security Network (ISN)

In a country where 33 percent live below the poverty line, and where the state has a tax-to-GDP ratio of 10 percent, apathy and inability to work toward reducing poverty are fundamental, leaving progress a distant pipe dream for those stuck at the bottom.

By Salma M Siddiqui

As the Pakistani government appeals for additional flood relief aid, one of the sources being considered for generating the much needed revenue is a flood tax. A senior finance ministry official told the Financial Times that the new tax is “actively under consideration” and likely to increase the individual income tax bill for Pakistanis by up to 10 percent.

This practice has a precedent with an Internally Displaced Persons Tax (IDPT) levied following the Warizistan campaign against the Taliban. The IDPT consisted of a five percent tax on incomes exceeding Pakistani rupee (Rs) one million payable for the tax year 2009 and an additional 30 percent tax on bonuses to corporate employees for the tax year 2010. However, in response to a petition from the taxpaying community of Sindh, the Sindh High Court declared the tax “unconstitutional” and “discriminatory” and abolished the IDPT applicable on bonuses based on the notion that the government was targeting and punishing more efficient employees.

The flood tax is also being perceived as a new way to tax the salaried class. Members of the Tax Bar Association across the country have expressed frustration at the prospect: “Each time a natural calamity occurs, the government decides to levy a tax at the rate of 5 to 7 per cent when it should actually be prepared for such disasters. Why always push the salaried class to pay more?”

The previous finance minister, Shaukat Tareen, has also warned that a flood tax could backfire: “Why should only a small segment of society be forced to pay the bill? The annual loss in public sector companies is Rs 300 billion. Why should this loss not be curtailed first through reforms to save money for flood relief?” In a country where a rickshaw driver and his family of four recently committed group suicide due to poverty, and where the trade deficit is likely to go up to two billion dollars, additional tax is hardly what is required. What is needed is an inflow of funds and services for the people not just by them.
The trouble with tax avoidance

The real issue that Pakistan needs to address is tax avoidance. According to The New York Times, less than a million Pakistanis voluntarily filed income tax returns last year, a rate that is amongst the lowest in the world. Taking into consideration that the Federal Board of Revenue’s 10 month tax collection stood at a commendable 1.025 billion against the target of 1.060 billion, some analysts correctly point out that the problem is not so much evasion as avoidance.

Describing tax avoidance as “the legal utilization of tax laws to minimize the amount of payable tax,” analysts have noted that a structural overhaul is necessary to streamline the system. A key component of the overhaul should be the extension of the narrow taxation base to the elite. According to the World Bank, out of the 39.1 million employed only 2.14 million pay taxes, and almost none of these taxes are generated in the ‘high’ income bracket (over Rs 3 million per year.) Local press have reported on the utilization of transgender tax collectors in the affluent neighborhoods of Karachi in an effort to embarrass these ‘avoiders’ into paying - hardly a sufficient strategy.

The simple fact is that the development of the taxation system in Pakistan has been shaped so that it favors the rich rather than the poor, and a complete reconstruction would be required to set things right. As pointed out in the NYT, “Under a 1990s law that has become one of the main tools to legalize undocumented — or illegally obtained — money made in Pakistan, authorities here are not allowed to question money transferred from abroad.” Several commentators have noted that unless an equitable tax- and penalty-based system is introduced, tax avoidance will continue to thrive.

Change, however, seems unlikely as such measures would impact the enforcers themselves the most. A glaring example of this trend is Nawaz Sharif, the opposition leader who admitted to paying no personal income tax for three years. Sharif is an industrialist and a landholder who is widely believed to be a millionaire, making the admission all the more shocking.

Taxing the land

Tax ‘avoidance’ is deeply embedded in Pakistan’s existing taxation structure in the form of tactical exemptions. It is no mistake that agriculture, which makes up almost one quarter of Pakistan’s economy, is exempt from taxation. It serves as one of the main examples of “legal utilization of tax laws to minimize payable tax.”

Tax exemption for agricultural incomes was provided as early as 1886, and the exemption was retained after independence. Although the finance minister announced this year that agricultural tax will be imposed from the next fiscal year, the fact is that successive governments have failed to extend the taxation net to this sector, and powerful landholders have asserted their influence to make sure it stays that way. The landed elite will ensure that their assets remain off the tax radar, and furthermore, if flood taxes are levied, they will be based on income rather than wealth.

This issue is further complicated by the fact that under the constitution, taxation of agricultural incomes is the jurisdiction of the provincial governments, while taxation of incomes and profits from non-agricultural sources is the responsibility of the federal government. Although the National Assembly adopted a bill to bring agricultural taxation within federal jurisdiction in 1977, the law was later canceled and its implementation suspended. Agricultural income tax has remained stagnant for more than a decade, whereas prices of agricultural commodities have tripled; the only province where agricultural income tax is collected is Punjab, whereas in Sindh, Baluchistan and Pakhtunkhwa recovery remains insignificant.

Although agriculture remains the heart of Pakistan’s dwindling economy ,and therefore at the heart of any attempts to reform the taxation system, the abolition of tax exemptions in real estate, for example, remain equally important. As the editor from one of Pakistan’s leading newspapers suggests, “These two sectors have enormous potential of generating revenue […] The principle of equity demands that nobody be exempted from paying taxes irrespective of the source of their income.”

High stakes

As the government struggles to raise money for what is now being called Pakistan’s worst calamity, tackling these endemic issues plaguing recovery and progress becomes a matter of survival. With US Special Envoy to Afghanistan and Pakistan Richard Holbrook recently asserting that “the outside world cannot foot the entire bill for Pakistan’s recovery,” the responsibility for reconstruction has been placed squarely on the shoulders of the government.

Now more than ever, the elite must contribute toward bridging the perpetually widening gap between the rich and poor in Pakistan. The most glaring impediment to poverty alleviation is still corruption, including tax avoidance, as well as the structural problem of tax exemption for agriculture and real estate. The words of a former tax collector sum up the reality of the country’s deep malaise: In Pakistan “the poor subsidize the rich.”

Pakistan may survive the floods and even the war on terror, but if systemic poverty and corruption are not addressed, there will not be much left to survive for.

Salma M Siddiqui is currently a Lecturer for the University of London International Programme in Islamabad. She is also a freelance writer and a graduate of the London School of Economics.