Report No. 50078-PK Pakistan Tax Policy Report Tapping Tax Bases for Development (In Two Volumes) Volume I: Summary Report July 2009 The World Bank The Government of Pakistan Federal Board of Revenue Georgia State University Document of the World Bank ACK OWLEDGEME TS This report is 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. The views, expressed in the report, are of the authors and not of the Government of Pakistan. The FBR team was headed by Mr. Ahmad Waqar, Secretary Revenue Division and Chairman FBR, and Mr. M. Abdullah Yusuf, former Chairman FBR, and included Mr. Mumtaz Haider Rizvi, Member Fiscal Research and Statistics, Dr. Ather Maqsood Ahmed, former Member Fiscal Research and Statistics, Mrs. Robina Ather Ahmed, Chief Fiscal Research and Statistics, Mr. Umar Wahid, Secretary Fiscal Research and Statistics, Mr. Mir Ahmed Khan, Second Secretary Fiscal Research and Statistics, and Mr. Naeem Ahmed, Second Secretary Fiscal Research and Statistics. The report was prepared by Kaspar Richter (World Bank), and Jorge Martinez-Vazquez (AYSPS). It is based on seven background studies (listed below), drafted by Robina Ather Ahmed, James Alm, Roy Bahl, Musharraf Cyan, Mir Ahmad Khan, Jorge Martinez-Vazquez, Geerten Michelse, Mark Rider, Wayne Thirsk, Umar Wahid and Sally Wallace. The tax revenue simulation results in the report are based on micro-simulation models developed by Mark Rider and Sally Wallace with Harini Kannan. The GST chapter draws extensively on a review of Pakistan's sales tax by Rebecca Millar and Christophe Waerzeggers from June 2008. The report also benefited from the Pakistan tax administration review by Carlos Silvani, Edmund Biber, William Crandall, Wyatt Grant, Orlando Reos and Geoff Seymour from September 2008. Peer reviewer comments from Kai-Alexander Kaiser, Senior Economist, World Bank; Michael Keen, Advisor, International Monetary Fund; Dr. Ahmad Khan, former Member FBR; Russell Krelove, Senior Economist, International Monetary Fund, and Eduardo Ley, Lead Economist, World Bank greatly enhanced the quality of the report. Dr. Ahmad Khan and Dr. A. R. Kemal reviewed the background studies, and Ehtisham Ahmad commented on the concept paper. Anjum Ahmad, Shamsuddin Admad, Mihaly Kopanyi, Hanid Mukhtar, and Saadia Refaqat from the World Bank provided useful feedback. Mirafe Marcos helped greatly by providing the draft chapter of the provincial background study. The team would like to thank Satu Kahkonen, Lead Economist, Miria Pigato, Sector Manager, Ijaz Nabi, former Sector Manager, Yusupha Crookes, Country Director, and Ernesto May, Sector Director, for continued support and guidance throughout all stages of this report. Muhammad Shafiq, Nimanthi Attapattu, and Irum Touqeer handled with great ease all arrangements for the missions and for the processing of the report. The team benefited enormously from the close collaboration of the Government of Pakistan ever since this work was launched in January 2007. The team is very grateful to Mr. M. Abdullah Yusuf, who conceived the idea for this report, and to Dr. Ather Maqsood Ahmed, who developed the framework and coordinated the inputs of the FBR team. The team is greatly indebted for the outstanding support and assistance of FBR's Fiscal Research and Statistics Wing. Its contribution is immense: it co-authored three background studies; provided comments, feedback, and guidance to the team throughout the analysis and report preparation; and facilitated the interaction with other departments, including the Budget Wing, Debt Office, and the Economic Affairs Division of the Ministry of Finance. Background Papers for the Pakistan Tax Policy Report 1. Ahmed, Robina Ather and Rider, Mark. Pakistan's Tax Gap: Estimates by Tax Calculation and Methodology. 2. Alm, James and Khan, Mir Ahmad. Assessing Enterprise Taxation and the Investment Climate in Pakistan. 3. Bahl, Roy, Wallace, Sally and Cyan, Musharraf. Pakistan: Provincial Government Taxation. 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 International Tax 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 EXECUTIVE SUMMARY Preface The Pakistan government has now taken on board the challenge of stepping up revenue mobilization. The One of the toughest questions that the Pakistan 2009 Poverty Reduction Strategy Paper (PRSP) lays government faces is what to do about taxes and how out the objective of increasing the tax-to-GDP (Gross to raise tax revenues. There can be no real progress Domestic Product) ratio by 3.2 percentage points of on education, health care, infrastructure or any major GDP over the next five years, lifting the tax-to-GDP economic issue without dealing with rising budget ratio from 10.4 percent of GDP in 2007-08 to 13.9 deficits and mounting debt. To restore the health of percent of GDP in 2012-13. This is encouraging, as the budget, let alone keep pledges for spending more in the past, similar targets were far more modest. For money on social safety nets and development, the example, the 2003 PRSP envisioned an increase in government will have to raise tax revenues. As the tax-to-GDP ratio of only 1 percentage point of Pakistan's economy recovers from its present GDP in five years. economic crisis, the overall tax effort has to be visibly enhanced. The effort must be fair, efficient Yet, it is by no means certain that fundamental tax and supportive of sustained economic growth. reform will succeed. Previous attempts at setting the system right over the last decades have delivered Tax revenue has continued to be a problem for the little in terms of more revenues and a more rational Pakistan government. In the past, tax payers have tax system. Comprehensive and fair tax reform will used anything from simple to sometimes complex face stiff opposition, as it has done in the past. While schemes to keep businesses and households outside the tax system has been bad for the country, it has the tax authority's reach. In response, the tax been good for those who were able to receive high administration has looked for short term solutions incomes largely shielded from the tax man. These and put together makeshift arrangements to save the interest groups will not want wider tax nets and more day. There were new withholding taxes, tax rate effective enforcement because their narrower increases, revisions of targets and the like. Attempts interests will supersede the broader ones of a to remove special treatments and exemptions went stabilized and growing economy. against powerful lobby groups and did not usually succeed. Whereas, all this improvisation may not This is why, it is feared that when the fiscal pressure have resulted in buoyant tax revenue collection, it will start to ease, the tax reform pushback will be in allowed the government to muddle through ­ until full swing. Even modest reform proposals to curb tax the arrival of the next crisis. exemptions and tax evasion will come under fire, and the government will be subjected to pressure to back There is broad consensus that Pakistan's tax system down and to return to business as usual. This would underperforms, as its tax base is very narrow. The leave the government with far too little revenue to government taxes only a limited number of sectors, cover its desired expenses. The result would be businesses and people. The low level and large unsustainable budget deficits or, alternatively, deep volatility of these tax revenues has greatly cuts in spending. which in turn would make it constrained the government's ability to make plans impossible to maintain social and infrastructure for development and poverty reduction, and respond spending at a level that is required for development. adequately to sudden economic crises. These Yet, the special-treatment lobbyists have little to say weaknesses are so grave that they can undermine the about how the government should close the budget confidence in Pakistan's economy as a whole. gap their tax cuts would produce; the talk about fighting government waste and reforming The appropriate response to these challenges is to procurement procedures, however important, does embrace a structural reform of the tax system. The not add up to the required sums. goal is to put in place a system that is simple and predictable, encourages investment and rewards This report highlights design ingredients for a people for their hard work. At the same time, it comprehensive reform of tax policy in Pakistan. In delivers the funds for development spending. Such a the final analysis, the success of tax reform will comprehensive overhaul of the tax system is a crucial depend less on the mechanism of taxation and more step for securing Pakistan's sustainable development. on the politics of taxation. Beyond adequate administrative resources and an implementation i strategy, this will require a clear political recognition in 2004 in Asian and Pacific countries, it remained of the importance of the task and the willingness to roughly constant as a percent of GDP in Pakistan persist with tax reform over the long haul. since the early 2000s. However, increasing tax collection is so much more Tapping Tax Bases for Development difficult with anemic rather than strong economic growth. Indeed, on the back of the global economic Pakistan's tax collection has failed to improve since crisis, Pakistan's tax-to-GDP ratio is set to decline in the late 1990s. Structural problems, such as a narrow 2008-09 to 9.2 percent. tax base, tax evasion, distrust by the taxpayer of public institutions and administrative weaknesses, Structural weaknesses of Pakistan's tax system have all taken a toll on tax collection. The tax-to- heighten its vulnerability to the economic crisis. The GDP ratio increased from 9.6 percent in 1999-2000 revenue is raised in an inefficient way by favoring to 10.3 percent by 2007-08 (Figure 1). In order to certain sectors and economic activities over others. ensure adequate public funding for development This creates excess burden of taxation and can deter priorities while safeguarding macroeconomic people from investing in the most productive sectors stability, the government has endorsed the objective and earning more from the resources available. This to increase tax collection to 13.9 percent of GDP by ultimately gets in the way of economic growth. 2012-13. This commitment is reflected in Pakistan's Some sectors are more heavily taxed compared to 2009 PRSP. The rise in tax revenues, in addition to a their contribution in terms of GDP than others. decline in interest payments, will allow the Agriculture contributes about one fifth of GDP, yet government to reduce the fiscal deficit from 7.4 gives no more than 1 percent in Federal Bureau of percent of GDP in 2007-08 to 2.4 percent of GDP in Revenue (FBR) tax revenue. Services sector make 2012-13. up almost half of economic value added, but contribute only one quarter of central taxes due to the Figure 1: Turning Around the Tax-to-GDP Ratio low tax receipts from wholesale, retail and transport 14.0 Pakistan's Tax Revenues - Actual and Medium Term Framework (% of GDP) 14.0 sub-sectors. Given the shortfall in agriculture and PROJECTION 13.5 ACTUAL 13.5 services, industry carries the brunt of the tax burden 13.0 13.0 ­ its tax share is three-times as high as its GDP 12.5 12.5 share. In addition, there are question marks to what extent the tax system, through the way it treats 12.0 12.0 Tax Revenue with Tax Revenue PRSP-II different income classes of people differently, is 11.5 11.5 PDL & Surcharges sufficiently equitable. While some progress has been 11.0 11.0 made, Pakistan's tax system remains complicated and 10.5 10.5 most taxpayers have little knowledge of their 10.0 Tax Revenue 10.0 obligations. Finally, provincial taxes yield no more 9.5 9.5 than 0.4 percent of GDP, so that district and 9.0 1999/2000 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 9.0 2012/13 provincial governments depend on large fiscal transfers from the centre to meet their expenditure International experience shows that tax reform can responsibilities. deliver large increases in the tax-to-GDP ratio. Figure 2: Tax Collection in Pakistan and other Developing While there are other developing countries at Countries Pakistan's income level with similarly low tax-to- 13.5 Tax Revenue in South Asi an Countries (% of GDP), 2000/ 01 to 2006/ 07 GDP ratios, countries in the region set a different 13.1 example (Figure 2). The simple average of the tax- 13.0 to-GDP ratio in Bangladesh, India, Nepal and Sri 12.5 Lanka ­ countries with similar tax policies and 12.0 12.0 administration ­ is systematically higher than in 11.5 11.5 Pakistan, and the gap increased during the present decade. Furthermore, countries like Egypt, India, 11.0 Thailand, Turkey, and South Africa experienced 10.5 2006/07 rapid growth and rising tax ratios, while Pakistan saw 2000/ 01 2003/04 10.2 10.0 tax collection rising just in line with economic 9. 8 9.8 growth. While central government tax collection 9.5 Paki stan Simpl e Ave ra ge of Ba ngla desh, In dia, Nepa l and increased from 13.8 percent in 2000 to 16.5 percent Sri Lanka ii Meeting the Revenue Target (3.8 percent of GDP) ­ even allowing for the fact that a full elimination of the tax gap is not desirable, since It is important to take a thorough look at options for tax administration is costly. bringing in reforms in Pakistan's tax policy. The Figure 3: Raising Tax Revenues: Actual Collection, report shows that Pakistan has the potential to Additional Collection Target, Tax Policy Reform Impact, increase the tax-to-GDP ratio by around 3.5 and Tax Gap percentage points over the next five years. At the Actual (100%) same time, in order to ensure healthy long-run economic development, Pakistan needs to embrace substantial changes in its tax policy. These should be aimed at increasing the buoyancy of the tax system, broadening the tax base, reducing distortions and phasing out exemptions. From the perspective of efficiency, the primary role of taxation is in ensuring a level playing field for economic activities. From the equity side, it is in raising resources fairly to fund equitable public spending. Similarly, from the compliance side, it is in ensuring low costs of compliance (and large costs of non-compliance). For all three, administrative feasibility is vital. It might appear difficult to reform a tax system in a way that it meets the desired multiple objectives. Fortunately, the properties of efficiency, equity and ease of compliance lead, in large measure, to the same basic prescriptions for reforming the tax system for a given Additional Collection Target (35%) tax revenue target: · make the tax base as broad as possible; · keep tax rates as low as possible; and · make compliance simple and non-compliance expensive Pursuing the twin track reforms of tax policy and tax administration would put the government in good Tax Policy Reform (38%) stead to meet its medium-term revenue collection targets. Our simulations show that a fairly simple and comprehensive tax policy reform package could boost tax-to-GDP ratio by 3.5 percentage points of GDP to meet the 2012/13 tax collection target of 13.9 percent of GDP (Figure 3). However, two caveats are important. The simulations relate to the economic situation prior to the current economic Federal Tax Gap (72%) crisis. These simulations also assume no changes in enforcement and compliance relative to current levels. Tax compliance could increase with a more simplified and uniform tax system, but it could also fall due to the overall increase in the tax burden. This makes it so important to complement the reforms of tax policy with the reform of the tax administration. Enhancing tax enforcement would contribute to revenue increases through a reduction in the tax gap. After all, our estimates suggest that the revenue potential from eliminating the federal tax gap alone (7.2 percent of GDP) is even larger than from implementing the national tax policy reform package iii Closing the Tax Gap the self-employed have all year to decide if, and how much, he will pay. It is not that the average self- The tax gap provides a useful measure of the extent employed worker is less honest than the average of tax evasion in a country. People and firms fail to wage earner. Instead, the self-employed knows that comply with tax laws for many reasons, such as the only chance the IRS has of learning his true illness, distractions, ignorance, sloth and greed. income and expenditures is to audit him. But since There is a difference between tax avoidance and tax the IRS audit rate is so low -- the agency conducts evasion. Tax avoidance refers to the use of the tax face-to-face audits with no more than 0.20 percent of law to minimize tax liabilities, which is perfectly all individual taxpayers -- he can be pretty confident legal. Tax evasion, or non-compliance with the tax to go ahead and not disclose his actual income. The law, refers to the non-payment of lawful tax liabilities stark differences in compliance rates across taxable and is illegal. The tax gap does not arise from tax items that line up closely with detection rates suggest avoidance, but rather from evasion, whatever the strongly that many people pay their taxes not so underlying motivation. Given this definition, the tax much because it is the right thing to do, but because gap becomes zero when everyone fully complies with they fear getting caught if they do not. A a country's tax system. As tax evasion increases, the combination of good technology (employer reporting country's tax gap increases. Thus, the size of a and withholding) and poor logic (most tax-payers country's tax gap is directly related to the extent of overestimate their chances of being audited) makes tax evasion in the country. A large tax gap suggests the system work. So the compliant taxpayer should that a tax system is likely to underperform in terms of dislike FBR not because it is too vigilant, but because revenues, efficiency, equity and tax administration. it is not nearly vigilant enough. FBR requires, among As mentioned earlier, the estimated federal tax gap in others, a comprehensive risk-based compliance Pakistan for 2007-08 is about 79 percent of actual tax strategy, including reliable data, field audits, and receipts. This sum amounts to over Rs. 796 billion, penalties to enforce timely and accurate filing of or some Rs. 4,800 worth of tax evasion by every returns.. man, woman and child in Pakistan. Apart from better enforcement of laws, boosting tax What measures can the government take to reduce morale might be another way to increase tax the tax gap? International evidence suggests that tax compliance. In some countries, people appear to be evasion depends crucially on enforcement strategies. far more compliant than the low audit rates would It is a fair guess that the FBR is disliked by many suggest. One explanation is that tax compliance is Pakistani businessmen, professionals and workers. voluntary due the intrinsic motivation of citizens to But many people who dislike the FBR probably do so pay taxes. Such tax morale depends on their attitudes for the wrong reasons. They may think it is a harsh toward the state. If the general population feels that and cruel agency, but in fact it is not nearly as the tax system treats them fairly and that they are vigilant as it should be. At least, this is an important getting good value for their taxes, their willingness to lesson from the US Internal Revenue Service's (IRS) pay tax increases, and vice versa. Given this view,, National Research Program. In its three-year study, increasing tax morale should increase voluntary tax some 46,000 randomly selected tax returns from compliance. However, increasing the transparency 2001 were intensively reviewed, and a tax gap of and accountability of the government is likely to nearly one-fifth of all taxes (collected by the IRS) work only over the long-term. In the meantime, there was identified. While this tax gap is sizable, most is little alternative to an efficient, even-handed and people are compliant, and some people evade far stringent tax administration. more than others. In the "wages, salaries and tips" category, taxpayers underreport no more than only 1 One important issue is how many resources to devote percent of the actual income. Yet, in the "nonfarm to enforcing the tax laws. Just as it is not optimal to proprietor income" category, 57 percent of the station a police officer at each street corner to income goes unreported. The reason for such a large eliminate robbery, it is not optimal to completely difference between the wage earner and the self- eliminate tax evasion. The tax gap estimates are not employed is that the only person reporting the self- measures of the potential for additional enforcement employed's income to IRS is the self-employed yields because some would not be cost-effective to himself, whereas, for the wage earner, his employer collect. Nevertheless, the size of the tax gap suggests is filling in a form to let the IRS know exactly how that Pakistan's enforcement measures to date are much he has been paid. The wage earner's taxes are vastly inadequate. automatically withheld from his every check, while iv Raising Revenues from Tax Policy Reform could not be calibrated. In particular, the losses in corporate income tax revenue from the reduction in The structural tax policy reforms outlined in this the rate would be at least in part compensated by a report could produce substantial revenue increases. broadening of the tax base. In 2007-08, total tax revenue collections stood at Rs. 1.1 trillion or 10.3 percent of GDP. The World Bank While the revenue impact of the suggested reforms (WB) estimates that the proposed tax policy reforms remains to some degree uncertain, nevertheless, these could raise tax revenues by around Rs. 400 billion, structural reforms are in line with international equal to 38 percent of 2007-08 national tax principles of good tax policy and provide benefits collection, or 3.8 percent of GDP (Figure 4). Among other than just higher tax collection. First, while the the six taxes, there are four revenue gainers and two reforms would increase tax burden for all income revenue losers: groups, the proportional increase is the largest for the · By far the most important revenue impact would seventh to the ninth household deciles ( come from General Sales Tax (GST) reform. The Figure 5). Thus, the overall distribution of tax adoption of a broad-based GST on goods and burden in Pakistan would remain progressive. services in agreement between the federal and Second, the new tax system would yield a more provincial governments is, therefore, the central tax horizontally equitable distribution of tax burden due policy reform component. This reform would to the removal of many exemptions and other produce an increase in revenues of Rs. 408 billion, preferential tax treatments. This would also improve assuming exemptions for seven sectors. This is the overall investment climate in the country, as the slightly larger than the overall revenue impact of equalization and general lowering of the marginal the national tax policy reforms. effective tax rates across sectors would reduce the · Provincial tax reforms would contribute around excess burden of taxation on the economy. The Rs. 45 billion, or 11 percent of the overall revenue reformed tax structure would also be easier to increase. administer, which would lead to improved · Introducing a two-tier structure for individual enforcement and compliance, and therefore more income tax and imposing a 10 percent rate on horizontal equity, and in turn more certain revenue withholding taxes would raise tax collection by Rs. flows. 34 billion, or 9 percent of the overall revenue Figure 4: Revenue Impact of ational Tax Policy Reform increase. 2007/08 Revenue Impact of National Tax Reform · Reforming the federal excise taxation on tobacco 40 400 35 would lift tax revenues by Rs. 14 billion, or 4 350 percent of the overall revenue increase. 300 30 · The reduction in the corporate income tax rate to 250 25 30 percent would reduce tax revenue by Rs. 38 200 20 billion, or 10 percent of the overall revenue 150 Rs. Billion 15 increase. 100 10 · A three-tier structure of customs duties would lead % of 2007/08 National Tax Collection 5 50 to a tax revenue loss of Rs. 65 billion, or 16 percent 0 0 of the overall revenue increase. -50 -5 GST PT IIT FED CIT CD -100 -10 These numbers are only indicative and rely on crucial Figure 5: ational Tax Reform and Vertical Equity assumptions. For example, the analysis is based on Incidence of National Taxation Pre- and Post-Reform by Household Consumption Deciles the economic situation of the last few years, where 45 Effective Tax Rate 20 economic growth was robust, inflation kept low, 40 (% of GDP) 18 businesses did well and there was increased 35 16 government spending. Today, Pakistan's economic 30 14 situation is different; growth is sluggish, inflation is 25 12 high, enterprise profits are dropping and government 20 10 spending is on the decline. In addition, the actual 8 15 PRE-REFORM POST-REFORM outcomes of tax policy reform would differ because 6 of the changes in the behavior of taxpayers and the 10 Share in Total Taxes (%) 4 economy in response to the changes in tax policy. 5 2 Finally, some components of the tax policy reform 0 Bottom 2 3 4 5 6 7 8 9 Highest 0 v Sequencing Tax Policy Reform which are easier to implement will be picked first and the more controversial reforms requiring a stronger Any successful reform has to take along three core determination, will be delayed, and ultimately stakeholders: the tax administration (FBR), the derailed. One way to guard against this is to separate taxpayer and the policy maker. First, meeting this the approval of the tax reform package, which could goal will not only be about bringing changes in tax be done upfront for the whole agenda, and the timing policy but also about changes in tax administration. of its implementation, which could be done In the past, reform initiatives failed because there was sequentially. This approach could also help in inadequate focus on ensuring that tax policy reforms overcoming resistance from particular groups, such could be well administered. Federal tax as sectors affected by the removal of tax preferences. administrators have made good progress in a number The overall gains from this whole reform effort of areas, but more efforts are needed to complete should be properly highlighted to increase FBR's modernization program over the next few stakeholder involvement. years. Similar efforts are needed to strengthen tax administration at the provincial level, such. Second, The right sequencing of tax policy measures will be although overall tax burdens in Pakistan are low, the important to sustain the reform program. If some of distribution of those tax burdens among households the expected outcomes of the reforms do not fully and among economic sectors is highly unbalanced. materialize, a backlash against change could stall its The taxpaying members of society who are to implementation. This highlights the importance of a compete in an increasingly globalized world are comprehensive analytical preparation (Table 3) and a likely to oppose reforms if they see them as further road-map for the successful reform of each major tax increasing their tax burden while doing little to tax component (Table 4). other individuals and businesses that pay little or no taxes. Third, the fiscal position of the government is Ensuring early gains should be part of the weak and could deteriorate further in view of the implementation strategy. The broadening of the tax economic slowdown. This will make policy makers base should have priority compared to rationalization reluctant to provide leadership on tax reforms that of taxes, and especially compared to tax rate may be considered uncertain in their revenue impact, reduction. Across taxes, GST reform should be the especially if they face opposition from interest first priority, followed by reforms of provincial taxes, groups. individual income tax and federal excise tax, while the reforms of custom duties and corporate income Because some of the ills afflicting Pakistan's tax tax should have the lowest priority ( system have been the outcome of past policy Table 1). For example, trade reform with a reduction measures, it will be important to spend time and and unification of the customs tariffs is desirable, but effort to generate broad consensus for the proposed it should be put on hold until it is certain that the reform package. Many tax incentives and revenue losses from trade liberalization would be preferential treatments that have been prevalent since offset by larger collections from domestic taxes, long, will be difficult to remove. The political especially the GST. When we combine tax by tax the economy of tax reforms in other countries suggests revenue potential from tax policy reform with the the importance of having a broad package that asks potential from tax gap elimination, corporate income for the sacrifices of many but also offers general tax and GST are the most important areas requiring advantages including simpler taxes and reduced tax reforms. rates. In the case of a gradual implementation of the reforms (Table 2), there is a risk that the reforms Table 1: Sequencing Tax Policy Reform Across Taxes and Issues Broadening of Tax Bases Rationalization of Taxes Reduction in Tax Rates FIRST PRIORITY THIRD PRIORITY GST PT, IIT, FED CD, CIT vi General Sales Tax Prior to the implementation of any legislative change, GST is arguably Pakistan's most important and yet a detailed economic analysis should be conducted to the weakest performing tax, and therefore has the determine the revenue implications of changing from largest reform potential. The performance of the current sales tax to a modern VAT-style tax. This Pakistan's Value Added Tax (VAT), the General study should provide recommendations on the Sales Tax (GST), has been disappointing. GST following issues: revenue increased from 3.1 percent of GDP during · extension of the tax base to services; 1999 to 2000 to 4.1 percent of GDP in 2002-03, but · the use of exemption and zero-rating, and the then declined to 3.5 percent of GDP in 2007-08 treatment of refunds; (Figure 6). Since 2006-07, the GST share in FBR · the threshold for registration and whether voluntary taxes has dropped below 40 percent and fallen behind registration should be allowed; and the share of direct taxes. International comparisons · the extent to which simplified schemes may be confirm that GST collections in Pakistan are weak. used to tax certain sectors or taxpayers more For example, India and Sri Lanka collect around 1.5 efficiently. to 2.5 percent of GDP more through GST than Pakistan. Ironically, the lower collection is not The administration of GST on a self-assessment basis because of lower rates. Until 2007-08, Pakistan should be an integral part of the new act. In line with charged a standard GST rate of 15 percent on sales FBR's experience on reforming income tax, this price inclusive of any FED and/or customs duty, the would require: same rate as in Sri Lanka and higher than the 12.5 · A review of all aspects of the administration of percent rate in India. Pakistan introduced GST rates sales tax; of 17.5 and 20 percent for some items during 2007- · Technical assistance to equip FBR personnel to 08, and increased the standard rate even to 16 percent effectively implement administration of sales tax during the current fiscal, in an effort to shore up the on a self-assessment basis with all the necessary GST collection. support for taxpayer education; · Establishment of an effective audit and There is an urgent need to reform GST in order to enforcement function; and strengthen the government's revenue position. The · Establishment of effective internal and external reforms will also help increase economic growth by appeal and review mechanisms. supporting businesses through a level playing field for GST and simplified compliance. The reform Strengthening the GST legislation would also require entails the broadening of the GST base via the curtailing FBR's administrative powers. This would inclusion of services and the elimination of include deleting the broad powers to effectively exemptions and special treatment of sectors. The legislate by an administrative order; and limiting rule induction of services sector into the GST net will making powers to deal with subsidiary matters only. require revenue sharing with provinces. Other GST Neither the government nor FBR should be reform components include simplification of the tax, empowered to effect substantive changes to the tax modernization of legislation, improvement in the use rules without parliamentary approval. of administrative resources, and transparent communication between authorities and businesses. Figure 6: Trends in GST Collection Pa kistan's Ta x Co llectio n of Genera l Sales Tax 4. 5 70 % of Indirect Taxes Pakistan needs to overhaul its existing sales tax 4. 0 % of GDP % of FBR Tax es 60 legislation along the lines of a modern and an 3. 5 international standard VAT system. The new GST 50 3. 0 law should replace the existing act while 40 incorporating relevant existing provisions, 2. 5 terminologies and concepts, where possible, and 2. 0 30 should aim to bring the existing GST in line with 1. 5 20 international best practices. The draft law could be 1. 0 released for public consultation well in advance of its 0. 5 10 introduction to parliament, so that relevant 0. 0 0 stakeholders can provide their recommendations. 1999/ 2000 2000/01 2001/ 02 2002/ 03 2003/04 2004/05 2005/06 2006/ 07 2007/ 08 This would require an agreement on a suitable time frame for implementation. vii Corporate Income Tax The second priority of tax policy reform is to rationalize the withholding tax system. The Following international trends, Pakistan's corporate extensive use of withholding taxes increases the income tax rates have come down markedly. In the effective tax rate on companies; creates opportunities early 1990s, banking, public and private companies for tax evasion schemes; masks serious compliance were taxed at the rate of 66 percent, 44 percent and issues; and, through the many special stipulations, 55 percent, respectively. By 2007, Pakistan adopted complicates the tax system. In many cases, a uniform corporate tax rate of 35 percent on taxable withholding taxes become final liabilities. As a profits for both public and private sector companies. result, many taxpayers are caught in the withholding In spite of the rate reductions, collections from the tax net, even though their incomes would put them in corporate income tax improved during this decade on the zero-rate bracket under the regular tax schedule. the back of the economic upturn. It increased from Some withholding taxes often resemble excise taxes 1.2 percent of GDP in 2000-01 to 2.5 percent in more than income taxes, as in the case of withholding 2007-08 (Figure 7). The share of the corporate on imports, exports and sales of goods and services. income tax jumped from one-half to two-thirds in As a general rule, whenever they are imposed on the gross direct taxes, and from one-seventh to one- formal economy, withholding taxes should be quarter in gross FBR taxes. Revenue collection considered an advance payment of the final tax improved sharply during 2006-07, primarily due to liability. Withholding taxes that generate trivial the doubling of nominal tax collection from the amounts of revenues could well be eliminated. financial sector, in addition to a significant Finally, clarifying FBR's rules for classifying performance from public and foreign owned withholding taxes into the different income tax heads companies from the oil and gas sector. However, the will improve the understanding of their impact of the ongoing slowdown in the economy poses a risk for system of direct taxation, and hence improve FBR's corporate income tax collection during the current ability to identify and implement good performance fiscal (2008-09). policies. The corporate income tax system requires change in With regard to international tax provisions, there are policy and administration, as well as the three areas requiring reforms. First, there is a need strengthening of international tax provisions. The for policy level guidance on new sectors, covering international trend is towards lower income tax rates residency, e-commerce, banking and financial as a means of increasing economic competitiveness. activities, turnkey projects, and the establishment of a Pakistan needs to respond to this challenge. Only reliable transfer price, in the 2002 Income Tax Rules. with a broader tax base is there room to cut income Second, a number of steps could help to limit the use tax rates and to enhance the attractiveness for of transfer pricing provisions to exclusively anti- international capital. Hence, the main priority should avoidance situations. Third, double taxation be to broaden tax base and lower tax rates. agreements should be provided with more detailed Specifically, the statutory tax rate of the corporate implementation rules. For example, the current income tax could be reduced. This would bring agreements provide no guidance on the interpretation Pakistan more in line with peer countries and will of terms like "center of vital interests" and "effective help to significantly reduce the distorting effects of place of management" or on the application of the corporate tax. At the same time, expanding the reduced withholding tax rates. base of the corporate income tax, mainly by reducing or rationalizing the use of tax incentives and Figure 7: Trends in Corporate Income Tax Collection Pakistan's Gross Tax Collection of Corporate Income Tax exemptions, could ensure that the reduction in the 3.0 % of FBR Gross Direct Taxes 80 % of FBR statutory rates does not lead to revenue loss, and 2.7 Gross Taxes 70 instead bolsters efficiency and equity. In this regard, 2.4 % of GDP 60 it would be important to undertake a complete 2.1 50 examination of the costs and benefits of tax 1.8 incentives and exemptions. In addition, the 1.5 40 thresholds for small businesses could be reexamined 1.2 30 in order to ensure that only truly small businesses 0.9 20 qualify. 0.6 10 0.3 0.0 0 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 viii Individual Income Tax phasing out many exemptions would move it closer to a fully-fledged broad-based income tax. The tax The individual income tax is typically not popular credits could be reshaped so that the amount of among taxpayers, yet it needs to be part and parcel of targeted allowances remains unchanged, irrespective the tax system. As a direct tax on individuals, rather of the income level of the beneficiary taxpayer. than an indirect tax on transactions, it relies on the While most exemptions and credits are relatively tax administration taking a slice of a hard-earned minor, there is one noticeable exception. Imposing a money of workers and the business income of the modest tax on short-term stock market related capital self-employed. At the same time, the individual gains would seem attractive from multiple income tax is central to a society's notion of raising perspectives: it benefits the national exchequer by revenue in a fair and equitable way. By allowing the generating revenues over the medium term; it assessment of individual economic circumstances, improves efficiency by making companies more the income tax is naturally better suited for making a indifferent between retained earnings and paying out tax structure progressive rather than through indirect dividends; and it improves equity by making the tax taxes. system more progressive. Arguably, it would also be good politics, as it would be a symbol for a Pakistan's tax yield from individual income tax is government ready to tackle powerful lobbies for the inadequately low and has declined since the early national interest. Whatever is done with the capital 2000s. Partly due to a reduction in income tax rates, gains tax, there is every reason to tax the incomes of gross revenues from the individual income tax stockbrokers according to the regular schedule for declined from 1.5 percent of GDP in 2000-01 to 1.1 non-salaried taxpayers percent during 2007-08 (Figure 8). The individual income tax accounts for around 11 percent of overall Second, the tax design can be simplified. The FBR tax revenues and 29 percent of direct tax individual income tax operates with two basic revenues, which also include the corporate income schedules for recipients of wage and non-wage or tax, capital value tax and social security taxes. This business income. There are anywhere from fourteen level of revenue mobilization would seem to put to twenty different tax brackets, each having large but Pakistan somewhere in the middle rank among different zero rate brackets for men and women. The emerging market economies. However, Pakistan's high threshold level could be addressed over time by standing might actually be worse than what the keeping the zero-band constant in nominal terms in numbers suggest for three reasons. First, Pakistan's spite of inflation. The individual income tax applies individual income tax is measured in gross receipts, higher marginal tax rates to the total amount of a which include refunds. Second, there are two non-salaried taxpayer's income. This problem can categories of taxpayers liable to individual income result in punitively high effective rates of marginal tax in Pakistan: workers and salaried individuals; and taxation and create perverse incentives to accurately small unincorporated businesses and associations of report additional amounts of taxable income. The persons, including firms with a profit sharing marginal tax relief introduced in 2008-09, mitigates agreement. This may be in part due to a more this problem to some extent, but it further expansive definition of individual income tax than complicates the tax system and applies only for the ones used in other developing countries. Indeed, salaried taxpayers. FBR refers to the individual income tax as a non- Figure 8: Trends in Individual Income Tax Collection corporate income tax. Finally and most importantly, Pakistan 's Gross Ta x Co lle ctio n of Indi vidua l In come Ta x 1. 6 55 the individual income tax collection includes a share % of GDP A s % of FBR Gross Direct T ax es 50 of the funds mobilized through withholding taxes. 1. 4 A s % of FB R Gross Taxes 45 Some of the withholding taxes are presumptive, 1. 2 40 imposing a fixed charge on certain transactions. This 35 1. 0 arrangement, in many cases, turns such withholding 30 taxes effectively into indirect taxes. Since the heavy 0. 8 25 reliance on withholding taxes is unusual, this moves 0. 6 20 up Pakistan's rank in country comparisons on 0. 4 15 individual income tax collections. 10 0. 2 5 There are two priorities in the reform of the 0. 0 0 2000/01 2001/ 02 2002/03 2003/ 04 2004/05 2005/ 06 2006/07 2007/ 08 individual income tax. First, streamlining credits and ix Federal Excise Duties and Custom Duties term, proceeding prudently with any further reduction of customs tariffs is desirable. Tariff reduction leads Excise duties are taxes on the sale or use of specific to revenue losses as long as the government is not goods and services, such as tobacco and petrol. Their able to compensate these revenues from domestic tax design does not follow the standard prescription of a sources. While continuing with carefully paced tariff broad base and low rates. Instead, a good excise reductions, Pakistan could consider a sequence of system is invariably one that generates revenue from separate measures to avoid overall revenue losses. It a narrow base with relatively low administrative could initially eliminate existing tariff exemptions in costs. Federal excise taxes play an integral role in the system; then increase excise rates on excisable Pakistan's tax system (Figure 9). Among the major imports to balance out tariff reductions; and finally taxes, they contribute least in terms of revenue adjust the scope and rate of the GST to meet collection, and it is crucial to bolster the role of remaining revenue needs. excise taxes. They could serve well the traditional excise tax goals of raising revenue, discouraging Figure 10: Trends in Custom Duties' Collection Pakistan 's Ta x Coll ection of C ustom Du tie s undesirable types of consumption, pricing some 2.0 % of GDP 30 public services such as roads, and improving the 1.8 % of I ndirect Taxes overall progressiveness of taxation. Maintaining 1.6 25 % of FBR Tax es sizable excise taxes on petroleum products is justified 1.4 20 on efficiency grounds, as the use of petroleum is 1.2 harmful for the environment. Expanding the 1.0 15 coverage of excise by including services ­ and 0.8 possibly selected luxury goods ­ that have so far 10 0.6 escaped effective taxation could help to fix a major hole in the tax system and boost revenues along the 0.4 5 way. This arrangement should be confined only in 0.2 the interim until a fully fledged value added tax, 0.0 1999/2000 2000/ 01 2001/02 2002/ 03 2003/04 2004/05 2005/06 2006/07 2007/ 08 0 covering both goods and services, is put in place. In the long-term, FBR is set to focus on trade Figure 9: Trends in Federal Excise Duties' Collection Paki sta n's Tax Col lection o f Fe deral Excise Du ti es facilitation rather than on revenue generation, with 1. 5 30 1. 4 % of GDP the expectation that lower tariffs will spur economic 1. 3 25 growth and revenue gains elsewhere in the economy. 1. 2 % of Indirec t Taxes This policy will help reduce the differences in the 1. 1 1. 0 % of FB R Taxes 20 effective rates of protection of different sectors of the 0. 9 economy, reduce distortions in the allocation of 0. 8 0. 7 15 economic resources, and lead to increases in 0. 6 economic welfare. A progressive substitution of 0. 5 10 customs tariff collection with revenues from 0. 4 0. 3 domestic taxes could also make the tax system more 0. 2 5 progressive. One reform priority lies in further 0. 1 reducing tariff dispersion, by reducing the number of 0. 0 0 1999/ 2000 2000/01 2001/ 02 2002/ 03 2003/04 2004/05 2005/06 2006/ 07 2007/ 08 rates outside the regular tariff bands and eliminating special exemptions. For example, in 2007-08, some Additional areas of reform include modernizing the 471 tariff lines out of the overall 6,774 tariff lines legislative framework and bringing it in line with any were above 25 percent. Pakistan might also want to changes in the sales tax law; converting ad valorem make the tariff schedule more uniform. At present, rates to in rem rates for tobacco products; and lower rates apply to raw materials in general and simplifying the rate structure for petroleum products. higher rates on finished goods. Such an escalated Like for the other taxes, ensuring compliance with tariff structure leads to effective rates of tariff the federal excise taxes is crucial. protection that are much higher for finished goods than the nominal tariff rates indicate. Customs duties are levied on the dutiable value of goods imported into Pakistan. They raise revenue and provide some protection to domestic producers against foreign producers (Figure 10). In the short x Provincial Taxation form a substantially more revenue productive tax system than currently the case. The provincial taxes Weak mobilization of provincial taxes contributes to include property and property transfer taxes, motor the overall poor tax effort. At a time when federal vehicle taxes, sales tax on services and the agriculture government taxes are less than 10 percent of GDP, income tax. However, tax exemptions and there is a natural question whether the revenue preferences have narrowed existing tax bases, and collection of provincial governments is adequate. many taxes are subject to specific rates. Two considerations might suggest they are not. First, while the federal government carries out the bulk of There are good opportunities for reforming the the revenue collection, provincial governments system of provincial level taxation and fiscal deliver a large chunk of the public services. decentralization in Pakistan. This report proposes Provincial expenditures represent close to 30 percent structural reforms of provincial taxation that could of national government expenditures, yet provincial deliver increases of 115 percent and 143 percent in tax revenues contribute just 4 percent of national tax provincial tax collection in Punjab and NWFP, revenues (Figure 11). The gap is filled primarily by respectively. In view of the similarities of the federal transfers to the provinces based on the ratio economies, tax systems and tax policies, increases of agreed in the National Finance Commission (NFC) the same order would be achievable through similar Award. The large vertical imbalances between reforms in Balochistan and Sindh. Moreover, the federal and provincial government weaken financial reforms outlined here have other beneficial properties management and fiscal accountability to the public. in terms of improving the equity of the system, The provincial expenditure-revenue imbalance means reducing the administrative cost and rationalizing tax that the tax system violates the benefit principle, instruments. These policy changes cannot be realized which is one of two fundamental tax principles. without a significant upgrading of the tax assessment According to this principle, people should be taxed and collection efforts of the provincial governments. according to the benefit they receive from the A comprehensive reform will require involvement government services financed by the tax revenue from both federal and provincial governments. In the raised. Second, all provinces carry structural fiscal past, provincial governments in particular, have not deficits which they finance, among others, by shown much interest in revenue mobilization. There drawing from balances created by unfilled positions are three ways in which this reluctance might be and by slow disbursements of project funds. These overcome to reform the tax system. First, convince deficits are not sustainable in the long run and call for taxpayers that an outcome of the reform will be greater own-source revenue efforts. improved public services. Second, they should believe that a comprehensive reform will bring about The barriers to increasing revenue mobilization by a fairer tax system. It also can be argued that such a provincial governments are formidable. They range tax system will be friendly to economic development from structural problems with the present tax system, because of its fairness and because the higher rate of to administrative shortcomings and the absence of revenue mobilization could lead to infrastructure incentives for provincial governments to increase improvements. Lastly, offer financial incentives as their tax effort. There are also important part of the NFC Award to help provincial constitutional limitations for revenue assignments governments overcome their reluctance to increase amongst various levels of government. Revenues are taxes. assigned between the federal government and the provinces by specific constitutional provisions. The Figure 11: Trends in Provincial Tax Collection federal-provincial assignment is in general 0. 60 Provinci al Ta x Re ve nues (% of GDP and % of Nation al Ta x Re ve nue s) 6 P erc ent of GDP Percent of National Tax determined through the federal and concurrent lists. 0. 55 Rev enues Revenue sources that are mentioned in the federal list 0. 50 5 belong to the federation only; those in the concurrent 0. 45 0. 40 4 list are a shared base for which both the federation 0. 35 and the provinces can develop legal instruments to 0. 30 3 tax the base; and those neither mentioned in the 0. 25 federal or concurrent lists belong to the province 0. 20 2 only. While the constitution assigns the federal 0. 15 0. 10 1 government the more buoyant and easy-to-reach 0. 05 taxes, provincial taxes are sufficiently broad based to 0. 00 0 1999/2000 2000/ 01 2001/02 2002/03 2003/ 04 2004/05 2005/06 2006/07 2007/ 08 xi Scope and Process generously supported through the UK Department for International Development (DFID). The Pakistan Tax Policy Report provides a comprehensive assessment of Pakistan's tax policies This collaboration extended beyond the delivery of a and lays out options for its reform. It is based on report. Pakistan's capacity to undertake fiscal policy work commissioned for this report and on analysis is limited, despite some positives at FBR and contributions of other researchers in Pakistan and elsewhere. As part of a long-term remedy, initiatives elsewhere. The report has four parts (Figure 12). such as postgraduate training of FBR and MoF The first part, this chapter, argues from a personnel in fiscal policy, similarly expanding the macroeconomic perspective that there are no viable number of positions dedicated to tax policy analysis alternatives to mobilizing tax revenues for financing in those institutions, and offering more attractive government expenditures. The second part, Chapter salary and working conditions to draw and retain the 2, pulls together the main findings to lay out a right people are much needed. Such measures were roadmap for tax reform. It presents a comprehensive beyond the scope of this project. Nevertheless, other medium-term reform agenda for tapping tax bases forms of capacity building took place by the joint aimed at Pakistan's development. The third part, work of the AYSPS experts and government tax Chapter 3, subjects Pakistan's tax system to a basic policy analysis experts, ensuring that the process of health check and assesses with regard to the four preparing the report served as a "teaching tool" for properties of adequacy, efficiency, equity and capacity building and a "collaborative tool" to build compliance. The final part, covered in Chapter 4 to ownership. Many of these mechanisms also served Chapter 9, takes each major tax and discusses how it as dissemination tools to stimulate dialogue. The squares up with regard to the properties spelled out in report's primary audience is the federal and Chapter 3. provincial governments. The report is also written for policymakers and development practitioners in This report is the outcome of a partnership among Pakistan, as well as for governments and three parties: the FBR; the Andrew Young School of international donors that support tax policy reform in Policy Studies (AYSPS) at Georgia State University, other South Asian countries. The report is expected and the World Bank (WB). The Government of to generate debate and discussions among the civil Pakistan (GoP) attaches high priority to broadening society and research communities. the tax base in an efficient and equitable manner, and is aware of the need for further improvements in the The background studies for this report were existing tax system. Following the launch of a structured as a series of seven tax policy papers. The project of FBR and the WB on tax administration AYSPS teams visited Pakistan two times in the reform in 2005, the government wanted to start a course of the preparation of each policy paper. The parallel initiative on tax policy. In response to the first mission gathered the basic information, held government's request, a partnership among the three detailed discussions with government staff and other parties was formed in January 2007. Additional stakeholders, and came to an agreement with the government counterparts included the Ministry of Pakistan authorities on the coverage of each tax Finance (MoF) and finance departments of Punjab policy study. The second mission presented the draft and Balochistan. The services of AYSPS were policy paper and collected comments and feedback for the final report of the study. Figure 12: avigational Aid for the Report CHAPTER I OBJECTIVE Tapping Tax Bases for Development CHAPTER II STRATEGY National Tax Policy Reform CHAPTER III PROPERTIES Adequacy Efficiency Equity Compliance CHAPTER IV CHAPTER V CHAPTER VI CHAPTER VII CHAPTER VIII CHAPTER IX TAXES General Sales Corporate Individual Federal Customs Provincial Tax Income Tax Income Tax Excise Duties Duties Taxes xii Table 2: Piecemeal and Comprehensive Tax Policy Matrix Reform Type Proposal Individual Income Tax · Introduce taxation of short-term stock market related capital gains · Tax stockbrokers' income according to the non-salaried income tax schedule · Broaden the tax base by reducing the zero-rate income thresholds in real terms · Replace the two basic schedules with single schedule accompanied by tax credits for earning labor income or fo r female labor force participation Piecemeal · Remove notch problem by reverting to conventional method of taxing personal incomes progressively · Reduce significantly the nu mber of tax brackets · Streamline system of personal tax credits (charity; pensions; purchases of new shares; purchases of housing) · Ensure that tax credits deliver the same amount of tax relief regardless of the taxpayer's taxable income Co mprehensive · Introduce broad-based two-tier indiv idual income tax Corporate Income Tax · Limit the use of tax exempt ions and tax incentives for industrial policy · Make withholding taxes adjustable for formal econo my · Limit favorable withholding tax rates for informal economy Piecemeal · Eliminate withholding taxes that generate only small revenues · Narro w definit ion for s mall businesses by reducing turnover threshold in real terms · Make small businesses withholding agents · Strengthen rules for international tax provisions Co mprehensive · Introduce corporate income tax with lower rate and wider tax base General Sales Tax · Redraft the sales tax act to convert general sales tax into modern VAT, designed as shared federal- Piecemeal and provincial tax covering both goods and services and under federal ad ministration Co mprehensive · Expand successively the base of the sales tax Federal Excise Duties · Bring federal excise leg islation in line with the sales tax law · Convert the existing ad valorem rates into in rem rates for tobacco products Piecemeal and Co mprehensive · Index in rem rates for inflat ion · Emp loy excise duties as green tax and simp lify the rates structure for petroleu m products · Bring additional lu xu ry goods and services under excise taxat ion Customs Duties · Co mbine tariff reductions with a sequence of separate measures to avoid overall revenue losses, including elimination of existing tariff exemptions (especially at the 6-8 d igit level), increases in Piecemeal excisable imports; and expansion of the yield fro m general sales tax · Reduce tariff d ispersion, especially at disaggregated level Co mprehensive · Introduce customs duties with three tariff rates for unprocessed, intermediate and processed goods. Provincial Taxes Piecemeal · Strengthen major provincial taxes selectively Co mprehensive · Strengthen consolidated system of provincial taxes and provide incentives for revenue effort xiii Table 3: Analytical Preparation of Tax Policy Reform All Taxes · Harmonize tax definitions and tax procedures for all domestic taxes and modernize the delegation framework for the revenue laws · Conduct economic analysis of specific proposals for tax policy changes, including expansion of the tax bases and adjustment in rates. This work includes the following: Individual Income Tax · Develop reformed system of tax credits · Develop transition plan from current system of multiple tax brackets to two-tier tax rates Corporate Income Tax · Establish clear attribution of withholding tax collection to salaried taxpayers, non-salaried taxpayers and corporations · Review each withholding tax with regard to its revenue impact, base, rate and adjustability · Evaluate treatment of debt and equity · Assess potential to widen corporate income tax base through the elimination of exemptions, investment incentives and special treatments General Sales Tax · Develop plan for widening successively the tax base · Develop revenue sharing formula between federal government and provincial governments Federal Excise Duties · Assess scope for increasing taxation of luxury goods and services · Develop reformed system of petroleum products Custom Duties · Assess scope for expanding the base of dutiable imports · Develop transition plan from current multiple duties rates structure to three-tier duty rate structure Provincial Taxes · Conduct provincial tax policy analyses for Balochistan and Sindh · Develop reform proposals for revised National Finance Commission Award that include incentives for provincial revenue effort xiv Table 4: Sequencing Tax Policy Reform for each Tax Time-Period Proposal Individual Income Tax · Tax stockbrokers' income according to the non-salaried income tax schedule · Broaden the tax base by reducing the zero-rate income thresholds in real terms Short-Term · Remove notch problem by reverting to conventional method of taxing personal incomes progressively · Introduce taxation of short-term stock market related capital gains · Replace the two basic schedules with single schedule accompanied by tax credits for earning labor income or for female labor force participation Medium-Term · Streamline system of personal tax credits · Ensure that tax credits deliver the same amount of tax relief regardless of the taxpayer's taxable income · Introduce broad-based two-tier individual income tax Corporate Income Tax · Limit the use of tax exemptions and tax incentives for industrial policy · Narrow definition for small businesses by reducing turnover threshold in real terms Short-Term · Make small businesses withholding agents · Eliminate withholding taxes that generate only small revenues · Make withholding taxes adjustable, especially for formal economy · Limit favorable withholding tax rates for informal economy Medium-Term · Strengthen rules for international tax provisions · Lower tax rate when tax base wide enough to ensure adequate revenues General Sales Tax · Redraft the sales tax act to convert general sales tax into modern VAT, designed as shared Short-Term federal-provincial tax covering both goods and services and under federal administration Medium-Term · Expand successively the base of the sales tax Federal Excise Duties · Convert the existing ad valorem rates into in rem rates for tobacco products · Index in rem rates for inflation Short-Term · Employ excise duties as green tax · Bring additional luxury goods and services under excise taxation · Simplify the rates structure for petroleum products Medium-Term · Bring federal excise legislation in line with the sales tax law Customs Duties · Eliminate tariff exemptions, especially at the 6-8 digit level Short-Term · Reduce tariff dispersion, especially at disaggregated level · Introduce customs duties with three tariff rates for unprocessed, intermediate and processed Medium-Term goods once tax base wide enough to ensure adequate revenues Provincial Taxes Short-Term · Strengthen major provincial taxes selectively Medium-Term · Strengthen consolidated system of provincial taxes and provide incentives for revenue effort xv