Shafiq Ahmad Khan
(School of Economics, Quaid-i-Azam University Islamabad)
This article aims to analyze the effects of taxation on the overall economic growth and economic activity in Pakistan. The real GDP examines the economic activity of a country. Tax to GDP ratio, Consumer Price Index and labor force are taken as the independent variables in the model estimation. Time series data from period 1978 to 2017 is used in estimation. Johansen Co-integration is used to check the co-integration between real GDP and tax to GDP ratio as both the variables are having the same integration order. Negative effects of taxes on the real GDP are found. Finally, it is concluded that Pakistan needs to revise the tax structure and policies carefully as it has negative effects on economic growth of country.
In the economy of any country, taxes play a crucial role and they are important for economic growth and development.
Efficiency of taxation system matters a lot for the rapid growth of any economy. Basically, the efficiency of tax system is related to the relative costs that system imposes on the taxpayers. A taxation system is said to be efficient if it is able to reduce the distortions caused by taxes and to reduce tax as an administrative burden.
This reduction in taxes being administrative burden benefits the economy as a whole. A tax system is made efficient on the basis of fairness, adequacy, simplicity, transparency, and administrative ease. Role of taxation and economic growth is very important subject under consideration keeping in view the current scenario of world’s economy. Increased prosperity provides basis for the economic growth. For this reason, economic development or growth is the key objective or goal to attain for economies and governments all around the world. The growth rate can be affected by the taxation policies adopted by the governments. Therefore these policies need to be in alliance with the standards set for economic development. In addition to objectives of raising revenue, wealth & income redistribution, economic growth encouragement, stabilizing the economy, tax policies also tend to preach morality and to prohibit certain actions by individuals.
Taxation in Pakistan is very complex. In case of Pakistan, 70 types of unique taxes are administered by at least 37 agencies of the government. These taxes are categorized in direct taxes and indirect taxes. Taxation system in Pakistan is inefficient with huge tax evasion, narrow tax base and administrative weaknesses (Inam and Khan, 2008). Due to preferential treatments towards certain segments of society and wide exemptions, the taxation system of Pakistan cannot be considered a fair one. Tax expenditures reduce tax collections by 2% to 3% of GDP each year. Apart from that, very small amount of tax revenue is raised through agricultural taxes, immovable property and gains on capital. Agriculture is one of the major contributors of GDP but its share in the total revenue is very negligible. Just 1% is the share of agricultural sector in total revenue whereas it contributes about 21% in GDP. 63% and 26% are shares of industrial and services sectors respectively (Economic Survey of Pakistan, 2010-11). Inefficiency or failure of taxation system of Pakistan can be seen from this statistics that around 61% of parliamentarians did not pay taxes on the basis of study carried out in 2011. 51% of Senators and around 62% of Ministers in Cabinets did not file tax returns. There is inadequacy to meet the basic standards and necessities of society from amount of tax collected in case of Pakistan. The total revenue comprises only 13% of total GDP and this revenue includes both tax revenue and non-tax revenue.
Due to lower tax revenue generated, there is unsustainable budget deficit and lower social sector spending. Over the years, the government of Pakistan’s ability has decreased and this is because of poor governance, ever increasing un-documented and informal economy size and tax policy & administration inefficiency (Pakistan Economic Survey, Ministry of Finance). The current taxation system in Pakistan has high compliance cost. Difficulty is faced by the taxpayers in filing tax reforms. Almost 560 hours – which are the highest in the South Asia, are taken for compliance with tax which makes our taxation system inefficient. The administrative burden of tax compliance is hardest in Pakistan.
There is lack of transparency and week tax administration in the system. ‘Tax Administrative Reform Project’ (TARP) was launched to improve tax administration in 2005 but it failed to achieve the desired goal and objective. The collection of taxes by Pakistan’s provincial and local governments is lower as compared to that of other emerging economies (World Development Indicators, World Bank). For developing countries like Pakistan investment is really important. But due to unpredictable investment environment, investors have been showing reluctance to invest in Pakistan (Economic Survey of Pakistan 2014-15). It was concluded by Hussain (2001) that complex tax structure in Pakistan is great hindrance for business friendly environment. There is lack of clarity, transparency, consistency, continuity and there are business unfriendly tax policies which keep investors reluctant to invest in Pakistan.
As per scheme conducted in collaboration with the Punjab Department of Excise and Taxation, it is found that performance pay for tax officials increased the total amount of revenue collected. Performance pay led to 46% growth rate whereas without performance pay, revenue grew at the rate of just 28%. One of the major loop-hole in Pakistan’s taxation system is that people are not willingly paying taxes or they try to avoid them somehow. Only 3.4% of Pakistan’s total labor force is the proportion of tax payers (London School of Economics, Federal Board of Revenue, 2011). Tax avoidance is really high.
The state tax paying individuals in Pakistan is 180 million – 3.4 million taxes registered – 1.7 million file returned – 0.75 million actually pay. In an economy, tax policy creates a framework for incentives (World Bank Pakistan estimates). Many areas are either taxed at lower rates or not taxed at all. In 2011-12, less than 1% of total tax revenue was collected through tax on capital gains and tax on purchase/sale of stock exchange shares as per Revised through the Finance Bill 2013-14. As per the World Bank’s Doing Business Report 2013, Pakistan’s ranks at no. 162 in ‘paying taxes’ index.
The empirical testing of taxes in Pakistan has indicated negative effects of taxes on economic growth. Increase in government expenditures on public services and reduction of gap between direct and indirect taxes can improve the taxation system in Pakistan as per findings. Negative effects of taxation on economic growth can be avoided by opting strong policy recommendations such as increase in tax base, increasing the number of tax payers, income tax amount should be collected efficiently, by reduction in distortions and by phasing out exemptions, cost of compliance should be reduced and government’s administrative cost should also be minimized; these steps are required to improve the tax system.