Pakistan Workshop on Reform of the General Sales Tax

On 23rd of June 2010, the International Growth Centre (IGC), Pakistan, organised a workshop on the “Reform of the General Sales Tax (GST)” at the Lahore University of Management Sciences. The purpose of this workshop was to encourage insightful debate on GST which has been given considerable coverage in the local press and vociferously debated in political circles.

Presentations by Dr. Ehtisham Ahmad

The first presentation by Dr. Ehtisham Ahmad introduced the participants to the basics of the GST, and how these relate to the experience in Pakistan. He made the case for the reform of the GST, including removal of distortions that have been introduced over the past ten years, particularly the extensive domestic zero-rating and exemptions that have been introduced, often as a result of pressures from lobbies. The domestic zero-rating is effectively an exemption, with attendant distortions. Removal of the distortions is shown to be efficiency-enhancing and in the interests of the producing and exporting sectors. This should also bring effective rates into line with nominal taxes, together with a slight downward adjustment in prices of goods consumed by the poor. Clearly expansion of the base also means that some relative price changes will occur, but this is largely for services consumed mainly by the rich—leading to a better distributional outcome. Changing relative prices is not inflationary—which is a monetary phenomenon. Indeed, failure to raise revenues through taxes and relying on deficit financing leads to an inflation tax that would be much more deleterious for the poor.

Dr. Ahmad also explained why the law needs to be rewritten and not just amended at the margin. This is largely based on an erosion of the base through the issue of SROs by FBR without reference to Parliament. Also, the old law was based on the European model of the 1980s that has some inherent shortcomings that have been addressed in more recent legislation, such as the GST in New Zealand and Australia.

There followed an extensive discussion on the need for an arms-length administration, to ensure that taxpayers are able to exercise self-assessment, and have minimal contact with FBR. Dr. Ahmad emphasized that international experience suggested the importance of risk-based audit, supplemented by random audits. Dr. Khwaja argued that announcing risk-based audit strategies may lead to modification of behavior by taxpayers and greater avoidance. Dr. Ahmad responded that some announced rules of the game are like traffic lights, or announced speed cameras, designed to modify behaviour and thus desirable. The risk of audit should increase for instance if a taxpayer has been delinquent, or is a stop-filer, or is claiming large refunds without a clear history of “clean” operations. Indeed, risk-based strategies do not have to be announced fully, and must be supplemented by random audits. While the audit capabilities of the FBR take time to augment, private sector auditors could be engaged to meet the gaps.

A concluding point was that it takes countries three to five years to set up tax administrations for the VAT. And provinces to do this for the VAT/GST on services, recognized to be the most complex and mobile part of a GST, would face the added complication of cross-border transactions. No province in Pakistan is capable of implementing in the short-run a proper GST on services at the present time—not Sindh and not even Punjab.

In the second presentation, Dr. Ahmad focused on alternative provincial sources of revenues. He argued that the assignment of the sales taxes on services to provinces was made before the advent of the GST, and poses significant problems. A cooperative solution would be for all provinces to agree to let an independent agency administer the tax on their behalf, and then agree on a distribution mechanism. If a province insists on implementing the tax itself, given the administrative capabilities in Pakistan, it would have to be in the form of a final point sales tax, without input credits or refunds. Perforce, the provincial administration would apply to only those services that are “stand-alone” in nature, and that do not require input credits or form inputs into other businesses or activities. If they do, then centralized administration, or a complex refunds and offsetting mechanism will be needed. This is shown to be unstable, and any one province can seriously affect the whole GST system, including the foundations of the GST on goods.

Dr. Ahmad finally presented a work plan for devising an alternate and more stable source of revenues for the provinces, and subsequently for lower levels of government. If work begins early enough, proposals could be developed for the next Finance Commission. Finally he brought up some key political economy issues in Pakistan relating to Reforms of GST and discussed potential solutions to these problems.

Discussion

There was a very lively debate on issues of tax administration, efficiency in collection, relations between the various levels of the government, audit frameworks and most importantly design and implementation of effective incentive mechanisms for tax reforms. Dr. Ehtisham Ahmad will prepare a policy paper based on his presentations and the discussion.

The discussion was followed by a media briefing session.

Note: The workshop was conducted by Dr. Ehtisham Ahmad of the London School of Economics and the University of Bonn who has also been advising the Federal and Provincial governments on the design and implementation of the revised GST/VAT. The session was attended by representatives from the Punjab Government, politicians from the Federal and Provincial Assemblies, academics and representatives from the private sector.