Abolishing the present – income tax system – II
(This is the SECOND article in a series on the subject).
No government can function without revenues, it goes without saying that the collection system must be efficient and honest. We have discovered through painful experience the futility of relying on our Income Tax Department to do either of the needful. While perfunctory threats have been hurled at tax evaders and their partners among income tax bureaucrats by successive finance ministers the successful and efficient have teamed up effectively with the corrupt to defraud the government exchequer at will and with abandon. In an unfair system the maximum burden has fallen on the limited earnings of the salaried class, thus the majority of the population of Pakistan depend upon their government to function on the narrow base of taxes collected from the very meagre minority of the successful and/or salaried few. It is a wonder that the salaried class has not rebelled, in effect an impoverished “Atlas” has not shrugged.
When faced with impossible situations one must come up with radical solutions meriting full analysis before implementation. In any case the present income tax levy defies adequate explanation or implementation. Let us find out alternate means of raising revenue, let us completely do away with the present failed system of taxing income. On the other hand, since government revenue needs are to be fulfilled, we can turn to a more indirect form of revenue collection, one that does not need the income tax department but changes the philosophy of taxation away from ability to pay to that of taxing “credit”.
A more equitable principle to serve as a basis of taxation would be that credit utilised would be treated as the capacity to pay. Any person or business obtaining bank advances believes in the ability to return that credit through future anticipated earnings. Projection of at least 15% earnings are made to justify that loan or facility, that projection should be the basis of flat rate of calculation. In essence this would mean that we will tax the ability to earn and not give relief for inefficient use or more importantly even the abuse of “credit” fairly which is widespread at this time.
The quantum of charge can be varied for the different types of credit, whether for business purposes or individual use, and the class of borrowers based on the national policy guidelines and objectives whether they are formulated towards (a) encouraging or discouraging various types of credit and (b) the revenues collection target. In a scenario using the present income tax slabs where a business has been leveraged normally as per the business average of 60:40 debt equity ratio with a 15% rate of return on equity, the taxable profit works out to 12% and thus the income tax to 6%, if we were to have a business of Rs 100,000 with debt being Rs 60,000 and equity being Rs 40,000 the taxable profit would be Rs 12,000 and the income tax Rs 6,000. The tax amounts to 10% of the original debt of Rs 60,000 and takes into account depreciation and interest. In layman’s language the average collection on fund based advances would be a FLAT 10% of the ADVANCE. So if a bank or any other lending institution were to lend an amount to any client, it would deduct 10% of the debt advanced at source in the bank. This could be fine tuned to fit a couple of alternatives, but that is the only refinement necessary.
For 1989-90 income tax revenues have been targeted in Pakistan at Rs 15 billion, an ambitious figure which most likely will not be accomplished despite the best predictions of the Central Board of Revenue. On the other hand the fund based advances of the scheduled banks has been Rs 150 billion for the past year. By using our all-encompassing formula, the gross potential collection comes to Rs 15 billion WITHOUT using the Income Tax Department at all, at the same time collection would be on other forms of bank credit such as letters of credit guarantees, etc which would be an additional amount of about 1% or Rs 1.5 billion extra, thereby coming to a mind boggling Rs 16.5 billion when even based on past figures. By reducing the size of the revenue collection machinery, a dramatic savings on government expenditure will be achieved. In fact the whole collection system will have become extremely simplified and eminently verifiable as the financial institutions would collect the revenue at source and pass it onto the government machinery without the hassle of an intermediate branch of public office with potential for chicanery. Adequate monitoring may be required but on the other hand, this monitoring units can be computerised and report/return oriented many times less cumbersome or personnel-heavy than the present, with much lesser chances for malfeasance.
Such a simplified system is not without inherent drawbacks and these have to be closely analysed so that we do not shift from an on-going disaster into all consuming fire. The major problem is that on the face of it taxing credit at source i.e taking away part of the credit, and thus not making it available for utilisation has a depressive effect on the economy. On the other hand the fact that since black money is lent by loan sharks at exorbitant rates (@ between 3-5% per month) the fact that entrepreneurial activity is not being held back by the cost of credit is a major plus point negating the depressive pressures. At the same time assets are normally shown to be acquired at inflated value and bank credit for these as such obtained for higher amounts the inflated borrowing cost versus the true value of the assets acquired is much higher than it needs to be. By pro-rating the rate of charge to these sectors requiring encouragement/discouragement at universally proportional values the tax may act as a force multiplier/reducer as the case may be. However tax concessions cannot be made available to encourage or discourage consumption as this tax arrangement may be impractical and become grounds for tempting irregular practices. By reducing the base interest rate even in the face of inflationary trends and allowing domestic manufacturers reduction in tax rates one can achieve some element of credibility in making credit available to encourage consumption. Subsidised credit is always subject to abuse e.g the subsidised credit available for agriculture as well as the export finance made available by the State Bank of Pakistan have been misused in conservance with unscrupulous officials of nationalised banks. The other negative factor is the short-term Cost-Push Effect as Trade and Industry tend to recognize the tax on credit as an element of cost that is to be passed onto the consumer. Over the longer term the effect will be the reverse if the proposed system is introduced since the savings made on the existing system is mainly by evading taxes.
The system proposed has to be refined and computerised monitoring guidelines have to be established but the advantages are that it is (1) a more even basis for taxation as compared to taxing efficiency and success it has a more equitable relationship to enterprise (2) even small businesses and rural/agricultural economic activity are drawn into this scheme thereby making for a wider taxation base with least changes in the administrative system (3) lowers dramatically the cost of collection (4) the combination of wider base and more efficient collection reduces net taxation rates (5) corruption would be almost abolished on the part of tax payers and revenue collection agents (6) deterrent to over-invoicing by the taxing of higher credit, thereby reducing chances of illegal foreign exchange transactions and creation of black money (7) fundamental causes of black money creation will be reduced and more banks savings will be the result as hidden income does not need to be hidden anymore and can be drawn legitimately into investment opportunities (8) ridding the evils of tax evasion and related corruption will have a social impact on the national character (9) taxation on credit has a major anti-inflationary effect (10) there will be a greater incentive to plough back earnings and thus encourage capital formation instead of the present system of taxing income which rewards a highly leveraged business (11) reduce abuse of the availability of bank credit and make this available to those with genuine need (12) with removal of black money discourage profit making through hoarding and blackmarketing (13) reduce “tax deductible” wasteful expenditure and its socio-economic ill-effects (14) reduces artificial inflation (15) releases stagnant bank credit and salvages non-productive assets because by making them liable to pay taxes it makes them answerable and more liable to send sick industries into receivership thereby avoiding this burden on the economy (16) demands higher efficiency in management (i.e to pay back tax liability even in lean periods) (17) force the entrepreneur to take timely action to prevent industries/business from becoming sick by injecting fresh capital when needed (18) act as an incentive for foreign investment, in fact as a major attraction as a potential tax free haven for individuals and (19) by making saving returns tax free will act as a major promotion of savings, at present not being mobilised on optimum basis.
Two articles in a newspaper cannot serve as a complete all-embracing solution to revamp the entire system. All this needs refinement by more experienced minds but the suggestions aforementioned do provide for dealing with the main causes of our parallel black economy and related ills while drastically reducing the size and cost of the collection machinery. We must seriously study this proposal for taxing credit utilisation instead of taxing income and thus the hapless salaried class and the successful/efficient minority. We are a free democratic country of the Third World, there is no need for us to maintain imperialist tax collection philosophies, the system suggested is not to be used as an experiment, Pakistan must go in for outright overhaul of the present corrupt status of our tax collection machinery. People talk of innovation, let us make it into a fact by abolishing the tax system and replacing it with a simplified version for collecting government revenues.
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