Is indirect taxation the best means of raising revenue?

Announced last month, the federal budget – described as ambitious by some and austere by others – featured a number of heavy taxation measures, most prominently an increase in the standard rate of the general sales tax, from 16 to 17 per cent. According to some estimates, the measure put an additional burden of 55 billion rupees on consumers, prompting complaints that the new budget burdened ‘the common man’. The naysayers may have a point.

A direct tax – such as a tax on income – is collected directly by the government from the individuals or corporations on whom it is imposed, whereas an indirect tax is applied on goods and services. In that sense, the latter is a regressive tax: on a bar of soap worth a hundred rupees, for instance, the rich and the poor pay the same amount (at present, 17 rupees) in general sales tax, even though that sum of money may be valued differently by both economic groups. It is also generally inflationary, leading to an increase in the prices of goods and services. And, in some instances, it may lead to such a large increase that it risks deterring consumption, eventually leading to a decline in tax revenue.

More than half of Pakistan’s tax revenue was derived from indirect taxes during the past fiscal year, a trend which seems to have persisted for years. For a country with notoriously low rates of tax collection, and one which faced a daunting shortfall of 429 billion rupees in its collection targets, as of June 27, any extra money in the national coffers is a good thing. But as many commentators have pointed out, an increase in rates of indirect taxation still only targets those already under the tax net.

Pakistan’s real tax collection problem stems from those who pay – or rather do not pay – direct taxes. According to one report, only 768,000 individuals paid income tax last year, and even fewer – just 270,000 – paid something in each of the past three years. In other countries with comparable per capita incomes, tax collection rates are between 14 and 15 per cent of the total GDP; in Pakistan, for the past decade, tax as a proportion of the GDP has remained roughly 10 per cent. Total revenue could be significantly boosted if efforts are made to counter tax evasion — and no longer at the expense of the ‘common man’.