Public Disclosure Authorized

Report No. 50078-PK

Pakistan
Tax Policy Report
Tapping Tax Bases for Development
(In Two Volumes) Volume I: Summary Report

July 2009

Public Disclosure Authorized

The World Bank The Government of Pakistan Federal Board of Revenue Georgia State University

Public Disclosure Authorized

Public Disclosure Authorized
Document of the World Bank
 ACK1OWLEDGEME1TS
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 1ational 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: 1ational 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: 1avigational 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