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Tax- the Life Blood of the State:

Taxation is defined as the process or means by which the sovereign, through its law-

making body, raises income to defray the necessary expenses of government.

Expressed in another way, taxation is the power vested in the legislature to impose burdens

or charges upon persons and property for the purpose of raising revenue for public

purposes.

The nature of the state power to tax is two-fold. It is both an inherent powerand a legislative

power.

It is inherent in nature being an attribute of sovereignty. It has been argued that it is literally

impossible for the state to run its affairs without taxes. Its existence and operations are dependent

primarily from the revenues and charges imposed from various sources.

It is a legislative power because it involves promulgation and implementation of rules. Taxation

is a set of rules, how much is the tax to be paid, who pays the tax to whom and when it should be

paid.

Government financial operations are well-nigh impossible without taxation. Apart from this,

taxation can be a powerful means in order to achieve the goals of social progress and the

objectives of economic development. It serves as a device to encourage the growth certain

activities by way of giving exemptions, discourage use of certain products by way of imposing

heavier charges like those taxes which are imposed upon tobacco products, or strengthen anemicenterprises, also by way of tax exemptions. Local industries may be protected through taxation

by imposing high customs duties to foreign goods. Moreover, taxation can also be used to reduce

inequities or inequalities in wealth and income by progressively higher taxes as in the case of

estate and income tax.

So based on the foregoing premises, it is clear that taxation is indeed the lifeblood of the state,

without which the existence of the state will be put to jeopardy.

TAX LAWS IN PAKISTAN:

So, considering the above things, each country has developed rules to collect revenue from its

public; Pakistan has also done legislation for this and at current the followings are observed to

collect tax under various kinds (which will be discussed later in Section 2 Pakistan Tax

Structure);

A)Direct Tax:

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1. Income Tax Ordinance, 2001

2. Income Tax Rules, 2002

B) Indirect Tax:

1. Sales Tax Act, 1990

2. Sales Tax Rules, 20063. Sales Tax Special Procedures (Withholding) Rules, 2007

4. Sales Tax Special Procedures Rules, 2007

C) Federal Excise:

1. Federal Excise Act, 2005

PAKISTANS TAX SYSTEM IN RESEARCHCYCLE:

Pakistans tax system has undergone significant reforms over the last two decades, leading to the

modernization of direct and indirect taxes. More recent times have seen the rationalization of

income tax rates, the introduction of self-assessment for filing income taxes, some expansion of

consumption taxes, and the rationalization of the customs tariff structure with a reduction of

tariff bands and maximum rates. The Federal Board of Revenue (FBR) engaged in a

comprehensive plan to re-structure and modernize the entire tax administration and customs

operations, and has taken steps in the recent past to increase the number of taxpayers and

broaden tax bases.

As a continuing effort to improve the tax system in Pakistan and complementing the ongoing

work of the Tax Administration Reform Project, the International Studies Program was

contracted by the World Bank and the FBR to conduct the Pakistan Tax Policy Review Projectfrom 2007 - 2009.

As part of the project, the ISP (International Studies Program, a fiscal policy research center

that is part of the Andrew Young School of Policy Studies at Georgia State University) produced

a series of policy papers to further analyze and evaluate the tax system in Pakistan, as well as to

extract lessons from the international experience in tax reform in order to obtain specific policy

recommendations. The final report provides a comprehensive assessment of Pakistans tax

policies and lays out options for reform. Both the final report and policy papers were a joint

product of a team from the Federal Board of Revenue (FBR), Government of Pakistan, the

Andrew Young School of Public Policy (AYSPS) at the Georgia State University, and the World

Bank, which are listed as below;

1. Pakistan Tax Policy Report: Volume I

2. Pakistan Tax Policy Report: Volume II

3. Pakistan Tax Policy Report: Tapping Tax Bases for Development

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4. Incidence of Taxes in Pakistan: Primer and Estimates

5. Pakistan: Comprehensive Individual Tax Reform

6. Pakistan's Tax Gap: Estimates By Tax Calculation and Methodology

7. Assessing Enterprise Taxation and the Investment Climate in Pakistan

8. Pakistan - A Globalized Tax World: An Analysis of its International Tax

Practice

9. Tax Policy in Pakistan: An Assessment of Major Taxes and Options for

Reform

10.Pakistan: Provincial Government Taxation

Further, the following studies have also been done in the context to bring Tax Reforms and to

evaluate the tax gap;

1. Ahmed, Robina Ather and Rider, Mark.Pakistans Tax Gap: Estimates by TaxCalculation and Methodology.

2. Alm, James and Khan, Mir Ahmad.Assessing Enterprise Taxation and theInvestment

Climate in Pakistan.

3. Bahl, Roy, Wallace, Sally and Cyan, Musharraf.Pakistan: Provincial GovernmentTaxation.

4. Martinez-Vazquez, Jorge.Pakistan A Preliminary Assessment of the Federal Tax

System.

5. Michelse, Geerten.Pakistan a Globalized Tax World An Analysis of its InternationalTax Practice.

6. Thirsk, Wayne. Tax Policy in Pakistan: An Assessment of Major Taxes and Options for

Reform.

7. Wahid, Umar and Wallace, Sally. Incidence of Taxes in Pakistan: Primer and Estimates

ORGANIZATION OF THIS RESEARCHWORK:

This research work has been organized into four (4) sections.

Section no. 1 states the introduction of the topic, identifying problems, significance of the

research work and the studies already done regarding this.

Section no. 2 explains the tax structure of Pakistan, tax collection in Pakistan and its

comparisons with other countries of the region.

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Section No. 3 elaborates the term Tax Gap, reasons, causes, effects and measures to minimize

it.

Section No. 4 discusses the tax reforms and challenges confronting FBR.

SECTION 2

PAKISTAN TAX STRUCTURE (TAX SYSTEM)

Taxation System

Federal taxes in Pakistan like most of the taxation systems in the world are classified into two broad categories, direct and indirect taxes. A broad description regarding the nature of

administration of these taxes is explained below:

Direct Taxes

Direct taxes primarily comprise income tax, along with supplementary role of wealth tax. For thepurpose of the charge of tax and the computation of total income, all income is classified under thefollowing heads:

1. Salaries

2. Income from property;3. Income from business or professions

4. Capital gains; and5. Income from other sources.

Personal Tax

All individuals, unregistered firms, associations of persons, etc., are liable to tax, at the rates

ranging from 0.75 to 35 per cent.Tax on Companies

All public companies incorporated in Pakistan are assessed for tax at corporate rate of 35%.However, the effective rate is likely to differ on account of allowances and exemptions related to

industry, location, exports, etc.

Unilateral Relief

A person resident in Pakistan is entitled to a relief in tax on any income earned abroad, if suchincome has already been subjected to tax outside Pakistan. Proportionate relief is allowed on such

income at an average rate of tax in Pakistan or abroad, whichever is lower.

Agreement for avoidance of double taxation

The Government of Pakistan has so far signed agreements to avoid double taxation with 39countries including almost all the developed countries of the world. These agreements lay down theceilings on tax rates applicable to different types of income arising in Pakistan. They also lay down

some basic principles of taxation which cannot be modified unilaterally. The list of countries withwhich Pakistan has concluded tax treaties is given below:

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Austria Belgium Bangladesh Canada

China Denmark Egypt France

Finland Germany Greece India

Indonesia Iran Ireland Italy

Japan South Korea Lebanon Libya

Malta Mauritius Saudi Arabia Singapore

Poland Romania Switzerland Thailand

Sri Lanka Sweden Turkmenistan U.K.

Turkey Tunisia Kazakistan U.A.E.

U.S.A

Customs

Goods imported and exported from Pakistan are liable to rates of Customs duties as prescribed inPakistan Customs Tariff. Customs duties in the form of import duties and export duties constituteabout 37% of the total tax receipts. The rate structure of customs duty is determined by a large

number of socio-economic factors. However, the general scheme envisages higher rates on luxuryitems as well as on less essential goods. The import tariff has been given an industrial bias by

keeping the duties on industrial plants and machinery and raw material lower than those onconsumer goods.

Central Excise

Central Excise duties are leviable on a limited number of goods produced or manufactured, and

services provided or rendered in Pakistan. On most of the items Central Excise duty is charged onthe basis of value or retail price. Some items are, however, chargeable to duty on the basis ofweight or quantity. Classification of goods is done in accordance with the Harmonized Commodity

Description and Coding system which is being used all over the world. All exports are exemptedfrom Central Excise Duty.

Sales Tax

Sales Tax is levied at various stages of economic activity at the rate of17 per cent on:

i) all goods imported into Pakistan, payable by the importers;ii) all supplies made in Pakistan by a registered person in the course of furtherance of any

business carried on by him;

There is an in-built system of input tax adjustment and a registered person can make adjustment oftax paid at earlier stages against the tax payable by him on his supplies. Thus the tax paid at any

stage does not exceed 17% of the total sales price of the supplies;

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PAKISTANS TAX COLLECTION ANDCOMPARISON WITHOTHERCOUNTRIESOF

THE REGION:

SECTION: 3

TAX GAP; UNDERSTANDING, REASONS, EFFECTS:

The tax gap is the difference between the annual amount of taxes owed and the amountvoluntarily paid on time.

Where does the tax gap come from?

The tax gap comes from three main areas of non-compliance with the tax law: underreporting ofincome, underpayment of taxes and non-filing of returns.

y 80 percent of the tax gap comes from taxpayers who either underreport income or overstateexpenses.

y On improper returns filed by individual taxpayers, more than 80 percent understate income,

rather than overstate deductions.

y Most of the understated income comes from small business activities, not wages or investmentincome.

Why does the tax gap cost honest taxpayers money?

The tax gap costs honest taxpayers money in three ways:

y It results in higher taxes. Honest taxpayers pay nearly 20 percent more in taxes due to taxcheating. Collecting the underpaid taxes takes time and costs money. Tax rates must be set

higher initially in order to cover the shortfall that results from the tax gap.

y It increases the national deficit, which further increases taxes.

y It reduces the level and quality of government service that can be offered.

What is being done about the tax gap?

The International Revenue Service has devised in its research work named as Comprehensive

Strategy for Addressing the Tax Gapbased on four key areas:

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y "First, unintentional taxpayer errors and intentional taxpayer evasion should both be

addressed."

The IRS (International Revenue Service) acknowledges that simplified tax return forms,

instructions and procedures would go a long way toward reducing unintentional taxpayererrors, and they continue to work for improvement in this area.

y "Second, sources of noncompliance should be targeted with specificity."

y "Third, enforcement activities should be combined with a commitment to taxpayer service."

y "Fourth, policy positions and compliance proposals should be sensitive to taxpayer rights andmaintain an appropriate balance between enforcement activity and imposition of taxpayer

burden."

The yawning tax gap in Pakistan Report by Dawn:

Published on February 14, 2011

THE tax gap the difference between sum of tax owed and amount of tax paid voluntarily

and on time stands at 79 per cent of the actual tax receipts in Pakistan, according to

Federal Board of Revenue Chairman Salman Siddique.

This compares with the tax gap of nine per cent in the UK and 22 per cent in the US, he told the

Supreme Court last month during the hearing of a case about pilferage of containers entering

Pakistans territory under the Afghanistan-Pakistan Transit Trade Agreement.

Mr. Siddiques tax gap estimate is based on a study detailing the extent of tax non-complianceduring the financial year 2007/08 and released by the World Bank in September 2009. The report

Pakistan Tax Policy Report 2009: Tapping Tax Base for Development pointed out that

the total tax evaded in 2007/08 stood at Rs. 796 billion against a collection of just over Rs. 1.1

trillion.

Dr. Ikram ul Haq, a tax Expert, told, Only 2.4 million people (out of a population of 180

million) file their tax returns. This is shameful.

He further contended, The tax gap which arises from tax evasion, avoidance and exemptions

(given to certain groups like rural land owners and urban property holders at the cost of theothers) underscores collection inefficiencies and defective and inequitable tax policy,

The World Bank report, too, emphasized the same, saying, There is a broader consensus that

the countrys tax system under performed as it has a narrow base, with taxes being levied

on a limited number of sectors, businesses and individuals. A large tax gap suggests that

the tax system is likely to under perform in terms of revenue, efficiency, equity and

administration.

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Rampant tax pilferage explains the main reason for the countrys tax-to-GDP (gross domestic

product) ratio of less than nine per cent, one of the lowest in the world. Only a fraction of taxes

illegally evaded or legally avoided (in the form of exemptions) can be recovered through

initiation of legal proceedings against the tax cheaters.

This involves a cumbersome legal process and we are rarely able to recover the exact unpaidamount of taxes after delays of months and years because of lacunas in the laws, social and

political pressures and widespread corruption (in the FBR),. It is difficult to state the exact size

of tax pilferage. Further, any increase in the collection of tax revenues in absolute terms did not

signify actual reduction in the tax gap. It simply means that the government might have imposed

more indirect taxes to push its collection and protect the affluent segments of society. Indirect

taxes are bad for the people because it forces many to pay taxes even though they shouldnt be

paying any. These also have implications for the economy and may retard growth.

Tax experts say, the reasons for tax pilferage are numerous. While some may evade taxes

because of personal greed, others escape paying their share because of a lack of documentationof the economy and the fear of accountability/punishment. Some may under report their incomes

because of high tax rates and absence of incentives for honest taxpayers. Lack of political will

for stricter enforcement of tax laws, departmental corruption and inefficient collection machinery

also contribute significantly to the anti-tax culture.

The implications of tax pilferage for the economy and society can be serious and far-reaching. It

leads to huge losses to the government revenues, which are crucial for meeting its development

and non-development expenditure requirements, and encourages black economy. Additionally,

say the experts, it causes accumulation of wealth in fewer hands and promotes wasteful

consumption.

More importantly, Dr. Ikram ul Haq argued, the tax pilferage and exemptions were an incentive

for speculative investments. The taxes are not merely a tool for revenue generation for the

government alone. These are also an important tool for discouraging certain activities in the

economy and encouraging the others. In Pakistan the taxes discourage productive investments

and encourage unproductive and speculative investments in property, etc. Who would want to

work hard and invest in the industry or other productive sectors if he can earn tax-free income

through speculative investment in property? he asked.

He was of the view that the inequitable tax exemptions, particularly on property transactions and

rental income, led to unproductive investments and imposition of inequitable taxes on productive

economic sectors as well as on people who should be getting tax subsidies.

We cannot measure exact tax gap because we are unaware of the countrys tax potential. But we

can say with certainty that the tax gap is created to benefit the wealthy and the powerful.

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