POLITICAL ECONOMY OF TAX REFORMS IN PAKISTAN* By Prof. Dr. Khalida Ghaus**

1. POLITICAL ECONOMY OF TAX REFORMS IN PAKISTAN* By Prof. Dr. Khalida Ghaus** * Prepared for the Workshop on South Asia Tax Systems, 8-9 August 2010, Singapore. ** Dr. Ghaus is Managing Director of Social Policy and Development Centre (SPDC), Pakistan

2. Taxation System in Pakistan Highly centralized taxation system; over 95 % of tax revenue is collected by federal government Overall level of fiscal effort is low; tax-to-GDP ratio remained more or less stagnant at 10 to11 % during this decade More reliance on indirect taxes where 63% revenue is generated from indirect taxes while 37% of revenue is generated from direct taxes Effective tax base remains narrow due to exemptions, concessions and tax evasion (for example, agricultural income is exempt from tax)

3. The Reforms Major taxation reforms initiated in early 1990’s (and are on-going) Introduction of withholding and presumptive tax regime Reduction in income and corporate tax rates Broad-basing of General Sales Tax (GST) Initial attempts to convert GST into VAT Tariff reforms (bringing down tariff rates) Outcomes Share of direct taxes in total tax revenue increased (from 15% in 1990 to over 30% in 2000); currently it is 37% Within indirect taxes, share of GST increased while that of Custom Duties decreased Overall, tax-to-GDP ratio did not improve much

4. Continued. In nineties success was achieved by the government in extending the network of withholding /presumptive taxes by including, for example, interest income, from financial institutions, dividends, exports, electricity bills, etc. The government, however, could not succeed in eliminating concessions and exemptions enjoyed as a privilege by power groups such as agriculturists and business community Similarly, GST could not be implemented in true VAT mode and was not extended to wholesale and retail trade and services Influence of various interest groups still remains effective

5. Role of Lobbies There are a number of formal and informal lobbies in Pakistan, which influence policy formulation including tax reforms. Some of the most influential lobbies include: Agriculturists (large land holders, strong presence in parliament) Business Lobby (Chambers of Commerce and Industries, All Pakistan Textile Mills Association, Overseas Chamber of Commerce, Associations of wholesale and retail traders) Banking sector Stock Markets Some examples of the influence on tax policy:

6. Continued. Agricultural income continues to remains exempted from tax though provinces have levied agricultural income tax but the collection is negligible and the tax is mainly based on land holding not on agricultural income Several efforts from government for greater documentation of economy have failed due to strong resistance from business lobby. For example, survey for the documentation of economy launched by the government in 2000 was strongly opposed and resisted by the business sector Banking sector made huge profits during last decade while tax rate for banking companies were brought down from 50% in 2002 to 35% in 2007

7. Continued. The Stock Exchange lobby resisted successfully to avoid taxation on capital gains until 2010-11. Capital Gains Tax could not be levied at the time when stock markets were flourishing. Capital Gains Tax on real estate could not be levied due to strong resistance from the concerned interest groups GST could not be implemented in true VAT mode. It was not extended to wholesale trade and services due to strong resistance from trading community Recently, government planned to introduce new system of VAT (including removal of exemptions) in the budget 2010-11, which would replace current GST. However, introduction of VAT was delayed till October 2011 due to strong opposition from business community as well as from political parties