Envisioning Tax Reforms in Pakistan: Cultivating Clarity, Efficacy, and Adherence

An esteemed Arabic historian, Ibn Khaldun, widely regarded as the father of historiography, articulated in his seminal work ‘Al-Muqaddimah’ that “At the beginning of a dynasty, taxation yields a large revenue from small assessments. At the end of a dynasty, taxation yields a small revenue from large assessments.” He noted that a nascent dynasty typically brings stability, security, and economic growth, which foster increased economic activity and an expanding tax base. Consequently, even with lower tax rates, the government can generate substantial revenue. As a dynasty declines, so does its economic vitality. Corruption, political instability, and inefficiency erode the economic foundation, leading to a shrinking tax base. This compels the government to raise tax rates to maintain revenue, often resulting in diminishing returns. The essence of Ibn Khaldun’s observation is that during the flourishing phase of a dynasty, taxes are low, and the government provides substantial services. However, as the dynasty nears its end, taxes become exorbitant, and the quality of government services diminishes. This decline is attributed to ineffective governance, corruption, and political instability—issues that are currently evident in Pakistan’s government machinery.

To address the tax deficit created by non-filing citizens in Pakistan, the Federal Board of Revenue (FBR) has employed stringent measures. One notable and contentious step is the FBR’s recent decision to deactivate the mobile SIM cards of 506,671 individuals who failed to submit their tax returns for 2023. This punitive measure is likely to face legal challenges from telecom operators. Such actions exemplify the reliance on coercive tactics to widen the tax net and enhance tax collection, rather than implementing systemic reforms grounded in international best practices. These short-term measures are unlikely to yield sustainable results. The government must devise comprehensive strategies and adopt effective methods for tax collection, aiming to broaden Pakistan’s tax base and ensure long-term fiscal stability. This particular article thus suggests better alternatives that the government must adopt in order to tackle the problem at hand. 

On April 1, 2024, the FBR rolled out a compulsory tax registration program for retailers and wholesalers in six major cities, though significant commercial areas such as Faisalabad, Multan, and Sialkot were notably omitted. Despite the month-long registration window ending on April 30, less than 100 traders registered, out of an estimated three million across the country.

For many years, Pakistan has struggled to reform its tax system, but the tax-to-GDP ratio remains low. In contrast, other low-income developing nations have managed to boost their tax-to-GDP ratios by approximately 3.5 percentage points since the early 1990s, achieving an average of 13.8 percent by 2020. The World Bank has invested in Pakistan’s tax reforms with limited success. A $103 million tax administration reform project launched in 2004 was deemed unsatisfactory in a 2012 evaluation. Similarly, a $350 million program approved in December 2023 has yet to make any meaningful progress. These ongoing issues reflect the ineffectiveness of previous reform efforts and highlight the necessity for the government to implement more robust and effective strategies to expand the tax base and ensure Pakistan’s fiscal health.

This demonstrates that previous attempts to implement outdated reforms have been fruitless. Pakistan requires systematic, politically tailored reforms to address its unique challenges. A thriving private sector is the backbone of any country’s tax system. When the private sector flourishes, industrialists and business owners contribute significantly to tax revenues. Pakistan urgently needs a revitalized private business sector, driven by entrepreneurs with creative and innovative ideas. However, this also necessitates substantial cooperation from the government.

To foster new business ventures and stimulate economic growth, the government should implement tax abatement schemes as a strategic tool. There is a common misconception that tax abatements negatively impact national revenue. However, when implemented wisely, tax abatements can actually lead to increased tax revenue under specific conditions. By attracting new businesses or encouraging existing ones to expand, tax abatements can spur economic growth, leading to higher employment, increased incomes, and an expanded tax base, which ultimately boosts overall tax revenue. Additionally, tax abatements often target areas with redevelopment potential, leading to enhanced property values and a subsequent increase in the tax base even after the abatement period ends. Encouraging the private sector will create more jobs, leading to higher income tax revenue.

However, to fully capitalize on the benefits of tax abatements and ensure that the economic growth they generate translates into sustained and robust tax revenue, Pakistan must modernize its taxation system. This modernization can be achieved through a collaborative effort with the National Database and Registration Authority (NADRA), a key player in integrating technology into the country’s tax infrastructure. NADRA’s comprehensive database, which includes detailed citizen information such as names, addresses, and biometric data, can play a crucial role in identifying potential taxpayers and verifying their identities. By cross-referencing NADRA’s data with other government records like property ownership, vehicle registration, and income tax returns, Pakistan can ensure that the economic activities spurred by tax abatements are accurately captured within the tax system.

Moreover, NADRA’s technological expertise and robust IT infrastructure can support the development of a sophisticated tax administration system. This includes the creation of digital tax systems for online filing, payment, and verification processes, which will not only enhance efficiency but also reduce the risk of fraud and identity theft. By leveraging NADRA’s capabilities, Pakistan can build a more effective and equitable tax system, ensuring that the economic growth fostered by tax abatements is sustained and contributes to the country’s long-term economic stability and growth.

Following the implementation of tax reforms integrated with NADRA, the next step to facilitate taxpayers and enhance government efficiency is to ensure a seamless and user-friendly system that encourages greater compliance. One effective measure would be to merge the National Tax Number (NTN) with the Computerized National Identity Card (CNIC). By doing so, a single, unique identifier would be created for every taxpayer, simplifying the identification and tracking process for tax purposes.

This merger would streamline the registration process, eliminating the need for individuals to separately register for an NTN. Since the CNIC is mandatory for most official transactions, it would automatically serve as the NTN, significantly reducing administrative burdens. Additionally, integrating these systems would enhance data matching and verification. The tax authorities and other government agencies could more easily match and verify data, helping to identify potential tax evaders and ensuring compliance. A unified database would also allow for more comprehensive data analysis, enabling tax authorities to identify trends, patterns, and areas for potential tax policy improvements.

The simplified registration process would save time for both taxpayers and the government. By linking tax obligations to the widely used CNIC, evading taxes would become more difficult. This integration would improve the accuracy of taxpayer data, reducing errors and inconsistencies, and ultimately making the tax system more efficient and reliable. In summary, merging the NTN with the CNIC would provide numerous benefits, including streamlined processes, enhanced data accuracy, improved compliance, and more effective tax policy development. These steps would significantly contribute to a more robust and equitable tax system in Pakistan.

Another crucial recommendation is to simplify Pakistan’s complex and often criticized taxation system. The current framework, governed by the Income Tax Ordinance of 2001, expects taxpayers to make accurate self-assessments. However, the intricate nature of tax laws poses challenges even for seasoned lawyers, let alone ordinary citizens with limited legal knowledge. Simplifying the tax system by consolidating similar taxes into single categories would alleviate confusion and encourage compliance. For instance, merging the Sales Tax and Federal Excise Duty into a single Value-Added Tax (VAT) would streamline the consumption tax process, as both taxes often apply to the same goods and services. Similarly, harmonizing Income Tax and Withholding Taxes, despite one being direct and the other deducted at the source, and reducing the number of withholding tax categories would simplify compliance. These examples illustrate the broader need for tax simplification. If the government aims to broaden the tax base, it must make it easier for ordinary citizens to understand and comply with tax laws. Small business owners, who often lack the resources to hire accountants or tax lawyers, are particularly disadvantaged by the current system. Simplifying the tax structure would motivate more citizens to fulfil their tax obligations. As Lord Thomas Bingham articulated in his explanation of the rule of law, “the law must be accessible and so far as possible, clear and predictable.” While ignorance of the law is no defence in court, it is the state’s responsibility to ensure that laws are comprehensible and straightforward to facilitate the proper implementation and uphold the rule of law. By making the tax system more accessible and less daunting, Pakistan can foster a culture of compliance and significantly enhance its tax revenues.