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GST envisaged as full part of indirect tax system
September, 13th 2013

International Monetary Fund (IMF) has said that the elimination of exemptions/concessions under Statutory Regulatory Orders (SROs) and in the law, as well as withdrawal of power of the executive to grant preferential tax treatment through SROs would facilitate gradually moving the GST to a full-fledged integrated VAT-style modern indirect tax system.

According to the IMF country-report issued on Thursday, the additional fiscal adjustment in years two and three of the programme will be concentrated on efforts to broaden the tax base and to further reduce untargeted subsidies. On the revenue side, the authorities envisage measures yielding 3/4 percent of GDP in each of the subsequent years. The focus will be on eliminating exemptions and concessions embedded in the SROs and in the law, as well as on eliminating the power of the executive to grant preferential tax treatment through SROs.

These steps will facilitate gradually moving the GST to a full-fledged integrated VAT-style modern indirect tax system with few exemptions and to an integrated income tax by 2016/17.

Tax administration reforms will also be critical to this revenue effort. On the income tax side, the authorities will focus on 300,000 potential tax payers, through the national data warehouse. In addition to the 100,000 notifications for late return filing under section 114 envisaged for FY2013/2014, the authorities will pursue additional 100,000 in each of the following two years. If the tax payers fail to respond satisfactorily, these notifications will be followed by a provisional assessment of income under section 122-which will become final if the tax payer again fails to respond satisfactorily-and measures to collect the tax liability (including attachment of bank accounts), will be applied.

The authorities will also develop plans to strengthen the administration of Customs, sales and excise taxes (structural benchmark). Among the initiatives to widen the tax base we will finalise a comprehensive plan to separate existing SROs either by eliminating exemptions or concessions through SROs by end-December 2013. Pakistan will introduce the remaining to FY14/15 finance bill by end-June 2014.

The government has already stopped issuing any new tax concessions or exemptions (including Customs tariffs) through SROs except by an act of Parliament, and will also approve by end-December 2015 legislation to permanently prohibit the practice. We will also quantify the remaining tax expenditures and publish a detailed list in the budget in future years.

IMF said that the Pakistan's tax ratio for 2012/13 was 9.7 percent of GDP-significantly less than the 11.4 percent of GDP in 2002/3-so fiscal consolidation will have to rely heavily on tax policy changes to broadening the tax base. The implementation of a full Value Added Tax (VAT) remains the first-best option to raise tax revenue, but if this remains politically unfeasible, other permanent tax policy measures could be considered to come closer to it by wholesale reductions in exemptions and concessions, and by fully incorporating services into the tax net.

The administrative authority to grant tax exemptions via SROs should be eliminated to prevent further degradation of the tax net. Income tax should integrate income from all sources, concessions and exceptions should be eliminated, withholding tax should be adjustable, with the minimum tax on turnover remaining as a control for deductions.

In a country of nearly 180 million people, only 1.2 million individuals and firms file income tax returns, (of which half are corporate income tax filers). Some 118,000 entities are enrolled in the sales tax system but only 15,000 actually pay any tax, with 82 percent of total sales and federal excise revenue coming from only 100 companies. These low numbers reflect the long-standing failure of the Federal Board of Revenue (FBR) to efficiently administer the system and the inability of previous reform efforts to deliver sustained results.

The authorities need to develop and implement a strategy to strengthen tax administration, with the technical assistance of the Fund and the World Bank. While key elements of the strategy will need to be defined, these should include significantly stepping-up the FBR's enforcement activities and improving its legal authority (such as to facilitate asset seizures for tax evaders and to presumptively bill tax payers). The anti-money laundering framework will need to be fully applied in this effort.

Under the authorities' proposed programme, the fiscal deficit would be reduced to around 31/2 percent of GDP by FY2016/17. World Bank studies suggest that aggressively broadening the coverage of GST and key taxes (income taxes and import tariffs) could yield up to 41/2 percent of GDP over time, and increases in tax rates (such as GST or excises) could be considered, in addition to other potential measures.

On the expenditure side, current spending-mostly electricity subsidies-could be reduced by 11/2-2 percent of GDP over the programme period. Together, measures of this order of magnitude could deliver the desired deficit reduction while permitting increased spending on growth enhancing investment and social protection. Given the significant devolution of revenues to the provinces, the government will seek explicit agreement with the provinces to deliver the budgeted surpluses through saving additional revenue transfers, it said.

The IMF said that initial fiscal adjustment effort includes permanent deficit reduction measures of 2 percent of GDP, coming mainly from revenue increases and lower energy subsidies. Tax measures included in the 2013/14 budget-including a one point hike in the GST rate-are expected to yield 3/4 percent of GDP annually. Reduced energy subsidies will produce another 3/4 percent of GDP in savings. The remainder will come from lower current expenditures (0.15 percent of GDP), savings of the PSDP budget, and (in the second half of the fiscal year) a new levy on natural gas expected to yield about 0.4 percent of GDP on an annualized basis.

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