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Research Project On


Chapter # 1
INTRODUCTION The word Tax means a compulsory contribution towards the government, while the word Reform means to remove the evils, to remove the defects and to correct. So the tax reform means to remove the economic evils by correcting the tax structure so that the tax to GDP ratio increased and the economy move on the path of economic development. Pakistans system is characterized by a number of structural problems despite these problems, which have been manifested for a long time Pakistan path of tax reforms. In the 80s, higher fiscal effort was substituted for by large bank and nonbank borrowings. However, the extremely rapid growth in debt servicing clearly indicated that the task of resource mobilization from taxes could not be postponed indefinitely. The commencement of the decade of the 90s coincided with the induction of a newly elected (IJI) government, strongly committed to the process of Privatization and Deregulation and a return to the economy. Also, the Gulf War led to the largest budget deficits (almost a percent of GDP) in the history of Pakistan and a major surge in the rate of inflation. Given its commitment to change and the adverse turn of events the new government was compelled to embark on the process tax reforms. Within three months of the formulation of the government of a high powered Tax Reforms Committee (TRC) was constituted 1 Abasyn University of Science and Information Technology Peshawar


followed by the establishment in 1991 of a full fledged resource mobilization and tax reforms commission (RMTRC). Therefore, the year, 1990-91, can be said to mark the beginning of the process of major reforms in the taxation system of Pakistan, which is still going on. Source: Pasha (1995) In 1993, Pakistan signed the agreement for Structural Adjustment Facility (SAF) with the IMF, which envisage further reforms inducing a major calling down of tariffs and broad basing of sales and income taxes. The thrust of tax reform programme is to achieve a significant enhancement of the revenue effort, while promoting a more equitable distribution of the tax burden and greater documentation of the economy. Progress has been made over the last two years in reforming the General Sales Tax (GST), but difficulties were encountered in 1997-98 with respect to a number of important elements. In response to these problems, government conducted a comprehensive review of ways to broaden the GST base. The government remained fully committed to the implementation of meaningful agricultural income taxation. The imposition of this tax will meet the dual objectives of promoting equitable sharing of the tax burden across different sectors as well as tapping a potentially significant additional source of revenue for the provinces. In the last decade income tax has become one of the principal sources of revenue for the federal government. Its contribution to the total revenue stands at 28 percent, and its share in GDP has increased from less than 2 percent in the early 1990s to 3.6 percent by the end of decade. However, 70 percent of these taxes are withholding taxes settlement of taxes liability. Many of these presumptive taxes are taxes on transaction and can not qualify as income tax. (Task force, 2005) During the nineties, despite many changes in the tax regime and introduction of withholding and presumptive taxes, federal government tax to GDP ratio has 2 Abasyn University of Science and Information Technology Peshawar


varied narrowly around eleven percent. The tax base has grown but still remains narrow and skewed. The number of income tax filers was around one million. The tax to GDP ratio, which reflects the efficiency of a tax system, had remained stagnant over the years reflecting the inelasticity of the tax system, this tax ratio is around 40 percent for high income countries, 25 percent for middle income countries and above 18 percent in low income countries.(Task Force, 2005) The low tax to GDP ratio for Pakistan not only reflects inefficiently, but also indicates the inequities of our tax system, as many sectors of the economy do not bear the proportionate burden in revenue generation. Prominent examples of these are agriculture and the service sectors. (SBP, 2005) In the income tax regime, the GDP between the NTN holder and those actually filing return has substantially widened in the last four years. It must be remembered that the number of registered taxpayers is already low in Pakistan; amounting to approximately 1.5 percent of the population these problems exacerbated by the rising trend of non filing of return, throughout the period of tax administration reforms. (SBP, 2005) The fall in the tax revenue is due to the fiscal discipline. The low buoyancy in revenues strummed entirely from tax revenues, which rose only 8.4 percent in FY05, slower than FY04, which was 9.5 percent, especially, not only did the growth of Centre Board of Revenue taxes fail to keep pace with the growth in the economy, the collection of surcharges witnessed a decline (reflecting the governments decision not to raise the domestic price of many oil production in proportion to the rise in their international prices. As a result the tax to GDP ratio dropped. Source: SBp Annual Report (2005) The fiscal developments have exposed weakness in the tax system that need to be addressed of the improvement in fiscal indicators in the current decade is to be sustained. In particular, the importance of rising revenues from sectors that have 3 Abasyn University of Science and Information Technology Peshawar


traditionally remained under taxed cannot be overstressed. Moreover, the responsibility for this cannot lie solely with the CRB or, indeed the federal government. Provinces enjoy constitutional authority in respect of agriculture income tax and sales tax on services these two sectors contribute over 75 percent of GDP, but their share in total revenues remains negligible. The taxation of agricultural income has already received considerable attention at the policy level, but the tax yield remained low. More surprisingly however, there has been little debate on the poor growth in the services sector taxes. As highlighted in the subsequent sections, sustainable growth will depend heavily on tapping resources from all economic activities equitably, and the efficient usage of there resources. The provinces will have to significantly enhance there tax collecting capacity to meet their financing requirements. Such efforts will greatly improve the tax to GDP ratios, and will also meet the objective of fiscal decentralization. The constitutions empower the federal government to collect axes on income other than agricultural income taxes, on capital value, customs, excise duties and sales taxes. The central Bureau of revenue (CBR) and its subordinate departments administrator the tax system. Pakistan fiscal crisis is deep and can not be easily resolved. Taxes are in sufficient for debt service and defense. If the tax to GDP ratio does not increase significantly, Pakistan can not be governed effectively, essential public services cannot be delivered and high inflation is inevitable. Reform of tax administration is the single most important economic task for the government. Each of the three taxes has different history and different set of issues. The task force has tailored its approach to the more important aspects of each tax. For a large number of income tax payers the core of the business process is pre audit and assessment by a tax official. 4 Abasyn University of Science and Information Technology Peshawar


The current management of Central Bureau of Revenue has taken creditable initiatives on process and reform. However, much more is needed and on a sustained and comprehensive basis. The task forces recommendations for tax administration go far beyond what can be done for the rest of the civil administration. Yet, improvement in the collection of taxes is so crucial that government can not wait, nor will half measures do. Any attempt at this stage to qualify the costs and benefits of the suggested changes would have insufficient basis and will depend on the extent and speed of reform. The measures suggested will substantially reduce the adversarial relationship between tax payers and tax collectors improve the efficiency and morale of the tax administration. There is a high probability that these measures will increase tax compliance and reduce leakage there should be significant increase in the tax to GDP ratio. (Task Force, 2005) The Tax Administration Reform project (TARP) seeks to support the reforms initiated by the government for improving tax administration. The overriding objective is to raise tax revenue through improved compliance with tax rate and broadening of the tax base, improving effectiveness, responsiveness and efficiency of tax administration through institutional and procedural reforms improving collection through transparent and high quality tax services, and strengthening audit and enforcement procedures. The development objective of the project is to fundamentally reform the Central Board of Revenue (CBR) for a more efficient and effective revenue administration system. The project aims to facilitate and promote voluntary compliance, increase the overall collection result and guarantee fairer and more equitable application of tax laws. Additionally, the new human resource policy framework, and management system combined with modernized procedures and increase in transparency and integrity of the tax administration operations.

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In shot the Major Tax Reforms program in Pakistan started in 1990-91, so it called the beginning of the Major Tax Reforms in Pakistan, so great efforts were made in order to create a best environment between the taxpayers and the governments in order to increase revenue or to balance revenue to increasing expenditure.

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1.2 1.

OBJECTIVES OF THE STUDY To analyze the efforts, implementation and progress for and in Tax Reforms of Pakistan. 2. To study the resource mobilization tax buoyancy, enforcement and compliance. 3. To examine the impact of the tax reforms on revenue collection. HYPOTHESIS 1. 2. The tax reforms have a positive impact on revenue collection. The various tax reforms do not hit the estimated target of the fiscal years.




Under this section, the first chapter of this research includes introduction, second review of literature, third tax reforms in Pakistan, fourth tax reforms and revenue collection in Pakistan, fifth Summary, Main findings, suggestions and Conclusions at the end references has been mentioned.

In this research we use entirely the secondary data of CBR. We made analysis of this data in order to show the impact of tax reforms in revenue collection and no primary data is used in this research, used only the CBR data in order to highlight the impact of tax reforms on revenue collection in Pakistan.

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Saeed (2005) mentioned the efforts of tax administration in Pakistan. He found that the efforts to improve tax administration will be intensified over the next two years. The governments program aims to improve tax payer compliance, reduced compliance costs, and broaden the tax base in order to achieve a sustained growth of tax revenues. The central board of revenue (CBR) will be converted into an independent and autonomous body, the Pakistan Revenue Service (PRS). Another important step in strengthening tax administration will be the introduction of a unique tax identifier number (TIN) that will replace all previous numbering system in use in the tax and customs administration. Atkinson (2000) identified that the direct tax schedule became less progressive in (OEDC) countries although this was offset in part by broadening the tax base in three of them a comprehensive study of tax reforms since the mid 1970 for developing countries. Chu, Davoodi and Gupta (2000) pointed to an average drop of one percentage point in the 1990s (as apposed to a rise of 1.6 percentage points between the 1970s and 1980s), a decline in the share of direct taxes and a fall in overall tax progressiveness, all of which correlated with rising inequality. Morley (2000) noted that tax changes shifted the burden of taxation away from the wealthy of the middle and lower classes. Similar evidence is available for Pakistan, where following tax reforms the tax burden on the poor increased by 8 Abasyn University of Science and Information Technology Peshawar


7.4 percept between 1987-1998 and 1997-1998, while the burden on the richest households declined by 15.9 percent. Friedman (1972-1978) supported the view that increasing taxes means that one would have just as large deficit but at a higher level of government expenditures. To him, the direction of causality is from tax revenues to government spending. Buchnan and Wagner (1977) also substantiate these results. In their view, the budget deficit is a primary view; the budget deficit is a primary cause of increase government expenditures. If the government is to finance this deficit entirely through direct taxes, demand for restraining the expenditures would be called for by the society. Blackly (1986) also showed that increasing revenue leads to increased expenditure thus the smaller deficit is reeled out. Manage and Marlow (1986) found the unidirectional causality running from federal receipts to expenditures. However, they criticized the Reagan administration; deficit reduction packages were designed to reallocate the various revenues sources without concentrating on aggregate spending levels, Marlow and manage (1987) also studied this. Barro (1974) peacock and Wise-man (1979) supported the other view that increased taxes and borrowings are due to increased government expenditures. Developing countries such as Pakistan apparently face this situation. Mahmood (2005) mentioned that tax reforms introduced in Pakistan a few years ago have given impressive boost to the tax revenue collection and also changed the tax culture in the country. Pakistan times (Sunday, June 13, 2004) mentioned that the tax reforms have a positive effect on revenue collection. The CBR has set Rs.174.326/- billion 2004-05 target for tax on income while previous year it has collected Rs.154.638/billion tax on income Rs.181. 900/- billion target for year 2004-05 for the direct taxes. The CBR set Rs.103.200/- billion for the custom and Rs.249.200/- for sale 9 Abasyn University of Science and Information Technology Peshawar


tax while federal excise duty target is Rs.398.100/- billion for the next fiscal year. So this shows the impact on revenue for the government due to tax reforms. Hoff (1991) and skinner (1991a, 1991b) discussed some of the economic, political and administrative considerations for not extending the standard income tax to the agricultural sector. A uniform application of the income tax, in Pakistan, is also constrained by the nature of Pakistans constitutional structure. Under the constitution, taxation of agricultural income is the juries direction of the provincial governments, while taxation of incomes on profit from non agricultural sources is the sole responsibility of the federal government. The provincial governments have not taken the initiation in imposing on agricultural income tax in Pakistan. GOP (2005) pointed out that a number of positive steps have been taken to provide a taxpayer friendly environment in the country. With the ultimate view to promote voluntary compliance and enhance resource base in the country. The outlives of such measures are the simplification of tax laws through promulgation of income tax ordinance 2001 the universal self assessment introduced in income tax regime, the minimum interface between the tax official and taxpayers, the restrutting of CBR on functional lines. The automation of assessments and refunds, the establishment of large tax payers unit (LTU) medium taxpayers unit (CMU) tax facilitation centers (TFCS), the integration of income tax and sales tax functions, the effective dispute resolution systems and customs administration reform (CARE) to reduce the cost of doing business. CBR (2003) analyzed the performance of sales tax in 2002-03. According to the CBR the financial year 2002-03 has been a year of substantial growth in revenue collection, payments of sales tax refunds and expansion in the tax base. The gross sales tax collection has rise by 17.8% from the preceding year.

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Mughal (2006) found that the landmark achievement has become possible through application of tax reforms and restructure g of CBR under the able guidance of a professional of par excellence and an outstanding administrator, the chairman of the Board, who sincere efforts, deep interest and constant vigilance in the system and affairs of the Board has not only improved the working environment but fully activated the entire tax machinery. This reforms process is to take few more years to complete but, it has already paying dividends. He also analyzed the reforms in their true perspective; it would be appropriate to recall the situation exited prior to the launching of these structural reforms. At that time, the general perception was that the countrys tax administration is inefficient, vexation and corrupts. So, a dire need was felt to improve the tax system of the country. For this purpose, a task force was appointed in 2001 which had adopted a two pronged approach aimed at policy reforms and the administered reforms with the main objectives to simplify tax laws, facilitate tax payers, eliminate discretion of tax functionaries, automate tax administration and the last but not the least to expand the tax base. Pasha (1995) found that a government can meet with exceptional sources in some areas it can fail in others, depending primarily on the governance capacity displayed in implementing each reform. For example, the Nawaz Sharif governments achieved notable successes in extending the network of withholding system because number of favorable factors of governance came together. There included the projection of the particularly reforms as an integral part of its vision of change, demonstration of superiority of the reforms over the available actions etc and initial success of the reforms. He also described the problems. First, the over level of fiscal efforts is low and the tax to GDP ratio remained, more or less, stagnant at between 12 to 13 percent. Second, there is over dependence on indirect taxes, which until recently accounted for a share in revenues of over 80 percent. 11 Abasyn University of Science and Information Technology Peshawar


Third, within indirect taxes there is domination of taxes on international trade, which has promoted inefficiency, distorted the allocation of resources and encouraged illicit trade. Fourth, the effective tax bases most taxes is narrow due to wide ranging exemption and concessions and rampant tax evasion. Fifth, the tax administration is characterized by primitive and out moded procedures, complex laws and considerable arbitrations and discretion. Haq (2005) mentioned that Pakistan for the last few years has been grappling with the problems of raising revenue to service as viable economic entity. The everincreasing fiscal deficit, coupled with mounting debt servicing, is posing a serious threat to the countrys economic revival while the economic managers have failed miserably to increase revenues. Pakistan also needs to learn from the experience of many developing countries of the world that managed to raise revenue by improving tax administration. In 1992, Richard M. Bird and Mika Casanegra de Jangscller presented a marvelous book improving tax administrations in Developing Countries. Since 1992 there has been a growing awareness that more efforts are required to improve existing administration of a developing country is keen to explore new sources of revenue. The old saying Tax Policy is only good as its administration is outdated. Todays consensus is that Tax Administration is tax policy. Anyone who has worked in a tax administration of a developing country can vouch for that. Many well international laws have been laid to rest by inefficient corrupt and incomplete tax administration. Pakistan is a classical example of it. Daily Dawn (April 29, 2002) conducted that Pakistan has launched a major $ 149 million reforms plan funded by the World Bank. The administrative shake-up, being implemented over the next five years, is aimed at increasing revenues in a country where only 1.1 percent of the total 150 million populations pay income 12 Abasyn University of Science and Information Technology Peshawar


tax. It will involve encouraging taxpayers to access themselves instead of relying on a national instead of relying on a national inspection system that many Pakistanis regard as corruption as well as increasing automation, It would increase the revenue and the base of taxpayers, improve efficiency and make the tax regime friendly for the payers, the World Bank is providing $23 million and the Pakistan government has given $23.1 million. The reform plan is due to be completed by June 2009. The agency said on its website that the reforms were the single most important economic task for the government as it tackles Pakistans deep fiscal crisis. Malik (1999) discussed that the introduction of universal self-assessment scheme (USACS) and the development tax, exemption of small traders from income tax for the current financial year accompanied by drastic cut in the rates of income tax are the massive reforms in the tax regime and the efforts for creating a tax Culture in Pakistan. There is a hope that the taxpayers would voluntarily come forward to make it success currently.

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SECTION: -3 Chapter # 3
3.1 INTRODUCTION Pakistans tax system is characterized by a number of structural problems. Despite the problems, which have been manifested for a long time, Pakistan has been slow to embark on the path of tax reforms. In the 80s, higher fiscal effort was substituted for by large and non-bank borrowings. However, the extremely rapid growth in debt servicing clearly indicated that the task of resource mobilization indicated that the task of resource mobilization from taxes could not be postponed indefinitely. The commencement of the decade of the 90s coincided with the induction of a government, strongly committed to the process of privatization and deregulation and a return to the market economy. Also, the Gulf War led to one the largest budget deficit (almost 9 percent of GDP) in the history of Pakistan and a major surge in the rate of inflation. Give its commitment to change and the adverse turn of events the new government was compelled to embark on the process of tax reforms. Within three months of the formulation of the government a high powered tax reforms committee (TRC) was constituted followed by the establishment in 1991 of a full-fledged resource Mobilization and Tax Reforms Commissions (RMTRC). Therefore the year, 1990-91, can be said to mark the beginning of the process of major reforms in the taxation system of Pakistan, which is still going on. In 1993 Pakistan signed the agreement for structural adjustment facility (SAF) with the IMF, which envisages further reforms including a major scaling down of tariffs and broad basing of sales and income taxes. 14 Abasyn University of Science and Information Technology Peshawar





INTRODUCTION OF WITH HOLDING AND PRESUMPTIVE TAXES During the decade of the 90s the focus of tax reforms in Pakistan has been on the broad basing of direct taxes through extension of withholding and presumptive taxes with the objective of reducing the quantum of tax evasion, especially in the declaration of capital income, generation of revenues from hard-to-tax sectors and minimizing compliance costs of tax payers.


PROGRESS IN IMPLEMENTATION Withholding taxes have traditionally represented, more or less, adhoc deductions at source at the point of accrual of income with subsequent adjustment following assessment by the tax department of the statement filed of income from all sources. In this sense they have the obvious merit of preventing the leakage of income from the tax net. Withholding and fixed taxes have primarily been used to extend the coverage of income tax to various forms of capital/unearned income traditionally; section 50 of the income tax ordinance (ITO), which covers such taxes, was restricted largely to salary income with deduction at source on a monthly basis by employers. In the 80s this was extended to cover other form of income like interest income of financial institutions from government securities, the income of nonresident, the income of contractors, suppliers and importers. Forms 1991 on wards there have been significant developments in the withholding/fixed tax regime. In the finance was expanded, a fixed tax at 15

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the flat rate of 10 percent was levied on interest income from financial institutions and on dividends and at percent on rental income above Rs 10,000. This was followed in the finance bill of 1992 by the extension of a fixed tax (at 0.5 percent to 1 percent of value) on exporters to be collected by the state Bank of Pakistan at the time of realization of foreign exchange proceeds. (Pasha, 1995) Use of withholding/fixed taxes has not remained restricted only to deductions at source in Pakistan. Increasingly, these taxes have been levied at points where it is possible to get a proxy of the income of a taxpayer. This innovation in the tax system is largely attributed to the desire to detect tax evasion. For the first time a withholding tax was levied on commercial and industrial consumers of electricity in the Finance Bill of 1992. The objective was to bring a large number of small to medium sized taxpayers into the income tax net on the assumption that there is a relationship between elasticity consumption and income. The magnitude of the withholding tax was linked progressively to the value of the electricity bill, with collection responsibility resting with the power utilities. A similar concept has been applied to justify the imposition of withholding tax in 1992 at the time of granting/updating registration of private motor vehicles, in 1993 at the rate of 5 percent at the time of issue of foreign exchange for travel (withdrawn in 1994) and at the rate of 2 percent of estimated cost at the stages of approval of building plans and issue of completion certificate to developers. Altogether there has been considerable success in reducing evasion by extending the network of withholding and presumptive taxes. Total revenues under 50 of the ITO have grown very rapidly during the last two years with a cumulative increase of almost 150 percent in 1991-92 and 1992-93. 16 Abasyn University of Science and Information Technology Peshawar


The extension of presumptive/withholding taxes has not only contributed to a rapid growth in revenues but it has also probably implied in revenues but it has also probably implied greater equity in the tax system. The share of greater equity in the tax system. The share of direct taxes has increased dramatically and there has been more effective taxation of capital income like interest, dividends, rent, etc. Which accrue largely to upper income households. In addition the change in tax regime has meant greater elasticity of income revenues which are now linked to fast. Growing income streams like interest income from back deposits, interest on government securities (due to rapid growth in government borrowing), income from the rendering of professional service etc. (Pasha, 1995)



REDUCTIONS IN INCOME TAX: One of the major elements of the strategy of tax reforms is to broaden the base of taxes (especially direct taxes) and simultaneously bring down tax rates. This will not only protect (and perhaps even increase) revenues by reducing the incentive for evasion but will also lead to a more neutral and efficient tax structure with less distortion impacts on the economy. We study in this section the success Pakistan has had in achieving this component of the tax reforms. Broadening the base, through withdrawal of major exemptions, is an excellent case study in highlighting the political economy of tax reforms. (Pasha, 1995)


PROGRESS IN IMPLEMENTATION: The income tax system of Pakistan is characterized by a large number of exemptions, tax credits, rebates concessions, etc., which have led to substantial revenue losses. The estimated magnitude of tax expenditures 17

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(revenue cost of the differential tax treatment) is colossal and in excess of revenues actually collected. Major tax expenditures include the statutory exemption of major public corporations (like Water and Power Development Authority (WAPDA) and Pakistan Telecommunications Corporation (PTCL). Interest income from government savings instruments, agricultural income and wealth, capital gains on financial assets, tax holidays) salary perquisites in cash and in kind, export income, accelerated depreciation allowances, owner occupied properties, etc. the total revenues forgone due to these exemptions/concessions is over 2 percent of the GDP. This is one major explanation why the direct tax-toGDP ratio is low at less than 3 percent of the GDP as compared to over 7 percent for developing countries at a comparable stage of development as Pakistan (see burgress and stern (1989). The sequencing of tax reforms pursued in Pakistan appears to have been an upfront announcement of reduction in tax rates without any link necessarily with a simultaneous removal of exemptions. In this sense, the approach of bargaining with particular social groups has not been adopted. This had made it politically more difficult to subsequently withdrawn concessions. In the financial bill of 1991 the government announced an immediate slashing down of personal income tax rates, with the maximum marginal tax rate falling to 35 percent. For the corporate sector, it was proposed to bring down rates substantially over a five year starting from fiscal year, 1992-1993. The decline envisaged by 1997-98 is form 66 percent to 55 percent in the case of banking companies, from 44 percent to 30 percent for public companies (other than banking companies) and 55 percent to 40 percent for other companies. In addition, the super tax or surcharges on companies was withdrawn. This measure is likely to have contributed greatly to reduction in uncertainty about future tax rates and facilitated better investment planning. (Source: Pasha 1995) 18 Abasyn University of Science and Information Technology Peshawar


However up to the budget for the current fiscal year, no major success appears to have been achieved in the rationalization of the major exemptions and concessions is direct taxes mentioned above1 the last caretaker government (form July to October 1993) had made an attempt at introducing both income and wealth taxation in the agricultural sector by promulgation of ordinances. There were proposed as scheduler, presumptive (link to produce index units of land) taxes in order to simplify the process of administration. Tax rates were deliberately kept low so at to minimize resistance. However, the elected government has allowed the agricultural income tax ordinance to laps (except in the NWFP) while the wealth tax proposal was accepted and embodied into law, but in the 1994 finance bill the special exemption to wealth in the form of agricultural land has been increased ten times, form Rs 100,000 to Rs 1,000,000. this implies that although agricultural land is part of the wealth tax net very few landowners will actually end up playing this tax.



The primary motivations for broad-basing the general sales tax, following

its conversion to a VAT type of tax in 1990-91 with tax invoicing features are, first, to compensate for revenue losses resulting form the on-going tariff reforms (discussed in the next section) second, to move the tax base towards consumption in order to encourage savings, third, to achieve a more neutral tax structure by taxation of a broad renege of items (excluding food and other necessities) and, fourth to bring about the process of greater documentation of economy as result of the incentives created for invoicing so as to claim tax refunds. 3.4.1 PROGRESS IN IMPLEMENTATION: The GST was levied on 59 additional industries between 1991 and 1993. However, many of there industries are small in terms of value and revenue 19 Abasyn University of Science and Information Technology Peshawar


gains have been marginal. In an attempt to cover small units, a nonindictable GST at the rate of 5 percent has also been introduced. Simultaneously, in the case of some industries a kind of forfeit (shoora-etashkeens) system has been introduced leading to negotiated fixed tax liabilities of all units within an industry. Some tentative attempts have been made to extend the GST to the wholesale and retail trade rector and thereby give it more of the character of a consumption tax. The government was reluctant to fundamentally extend the tax net to this sector because of a virtual absence of documentation of transactions and as the urban trading community constituted a major supports base for the government. In the budget of 1993-94, primarily out of considerations of revenue enhancements, the standard GST rate was raised 12 percent to 15 percent. The Finance Bill of 1994 represents major efforts of broad-basing of the GST. As additional 277 industries, excluding those producing food items have been brought into the tax net. Simultaneously, the fixed sales tax system has been abandoned on the grounds of inelasticity of revenues and low effective rates. However, this reform led to a nation wide strike by business and trading interests which compelled the government to temporarily suspend the with drawl of the fixed tax system and evaluate industries proposed to be brought in to the GST regime.


Pakistans taxation system is characterized by excessive dependence on

tax on international trade. Customs duties, surcharges, import license fee (equivalent to a tax levy) and sales tax on imports contributed revenue of over Rs 87 billion in 1992-93, equivalent to 6.4 percent of the GDP. Statutory tariff are high and while these were justified in the past on the basis of the infant industry 20 Abasyn University of Science and Information Technology Peshawar


argument their continuation has perpetuated excessively high levels of protection across the broad to a large number of industries including throe which are inefficient (either with negative value added at world prices or high domestic resource costs). This has led to a large-scale diversion of resources towards import substitution and created a strong ant export bias. High tariffs have also encouraged rampant smuggling (of over 5 percent of GDP according to PIDE 1993) which has not only eroded the tax base and adversely affected industrial production but has also implied all the social evils associated with the generation and use of illicit incomes. Technical flaw have also crept into the tariff structure. Adhoc tinkering with rates largely for revenue purposes has created fiscal anomalies. There is no rational cascading, of rates and average rates do not vary significantly by stage of processing. High statutory tariffs have led in many cases to the promulgation of statutory rules and orders (SROS) to grant exemptions or concessions by region, types of end use or nature of importer. This has greatly complicated customs administration and promoted corruption and rent seeking activity. In 1992-93, almost 40 percent of dutiable imports paid concessionary duties under the provisions of some SRO. Therefore, tariff reforms are required not only from the view point of influencing the future process of industrialization of the country in the desired directions but also for rationalizing the tax regime, making it simpler to administer the prime instrument for tackling the problem of smuggling. 3.5.1 PROGRESS OF IMPLEMENTATION: A gradual process of reforms in the trade regime has been on going in Pakistan for some times. In the first phase, quantitative restrictions on imports were largely removed and the negative list consists now largely of items which are prohibited for religious or other reasons. During the last few years, the maximum tariff rate (except for automobiles) has been brought down from 225 percent to 80 percent. However, efforts at reform 21 Abasyn University of Science and Information Technology Peshawar


have been piecemeal in character and no attempt has been made to bring about comprehensive changes which eliminate fiscal anomalies and provide well defined signals for allocation of domestic resources. Government constituted a Tariff Reforms Committee ((TRC) to develop a new tariff structure to be implemented over three years period. The committee made a large number of recommendations including first the abolition of Para tariff second, scaling down of the effective (inclusive of surcharges and license fee) maximum tariff from 92 percent to 50 percent over the three year period, third, cascading of tariffs with lowest rates for non competitive primary raw materials and highest for finished goods fourth, promotion of exports by duty free imports of raw material, intermediate goods and machinery for exports oriented sectors with phasing out simultaneously of the cumbersome and difficult to administer exports rebate scheme, fifth protection to existing and proposed deletion programs and locally fabricated machinery, sixth, duty free imports of food and other basic items, seventh, sizeable tariff reductions on items prone to smuggling, eight, large on items prone to smuggling, eight, large scale with drawl of SROs including removal of differential treatment between industrial and commercial importers and concussions to public sector entities and, ninth, introduction of minimum tariffs to reduce rate dispersion. Soon after presentation of the report of the committee, the newly inducted elected government included a major tariff reforms packages as of the Structural Adjustment Program with the International Monetary Fund (IMF). This package incorporates many of the principles of reform enunciated by the committee. However, it envisages a faster program of reduction of tariff, whereby the maximum tariff is to be brought down to 35 percent (rather than 50 percent as recommended by the tariff reforms 22 Abasyn University of Science and Information Technology Peshawar


committee) by beginning of fiscal year, 1996-97. The first phase of this reform package has already been implemented in the 1994. Finance Bill where by Para tariffs have been merged into the basis tariff structure, the maximum into the basis tariff structure, the maximum tariff has been brought down to 70 percent, the number of rate slabs has been reduced from nine to six, some SRO have been withdrawn including the distinction between commercial and industrial importers and drastic reductions have been announced in rates o items prone to smuggling. Neutrality of tax revenues has be, more or less, preserved by revenue gains due to consequential effects on sales tax collections arising from the merger of Para tariffs. However, there has been a sizeable revenue loss of over Rs.15 million due to the abolition of the import license fee. Impact of levels of protection is not very pronounced in the first year of reforms because of the merger of Para tariffs. While industries with competitive imports at the maximum tariffs rate have been experienced some decline, most industries have yet to receive the shock of downward adjustment in tariff on competitive imports. For the serve reasons, impact on the level of imports is unlikely to be significant. 3.5.2 CONCLUSION: It has adopted a political economy perspective to analysis of four major components of tax reform during the 90s in the Pakistani setting, one of which has been more or les, implemented and three are on going. It demonstrators that while a government can meet with exceptional success in some areas it can fail in others, depending primarily on the government capacity displayed in implementing each reform. For example, the Nawaz Sharif government achieved notable success in extending the network of withholding and presumptive taxes within the income tax system because a number of favorable factors of governance came together. There 23 Abasyn University of Science and Information Technology Peshawar


included the projection of the particular reform as an integral part of its vision of change, demonstration of superiority of the reform over the available actions, building of a strong and diversified coalition of support, strong leadership from the top, by passing of and credible threats to losers, lack of homogeneity of losers and spectacular initial success of the reforms. In contrast to this, elimination of tax concessions and exemptions to make, the income tax system more neutral and fair. Similarly, the partial retreat from implementation of reforms in the general sales tax this year reveals how an effective coalition of potential, commitment and preparedness for the reforms.



INTRODUCTION: To analyzing the reforms in their true perspective, it would be appropriate to recall the situation exited prior to the launching of these structural reforms. At that time, the general perception was that the countrys tax administration is in efficient, vexatious and corrupt. So, a dire need was felt to improve tax system of the country. For this purpose, a task force was appointed in 2001. Which had adopted a two pronged approach aimed at policy reforms and the administrative reforms with the main objectives to simplify tax laws, facilitate taxpayers, eliminate discretion of tax functionaries, automate tax administration and the last but not the least to expand the tax bore. Major initiatives taken under tax administration reforms program included organizational destructing of CBR, universal self assessment, minimizing interaction between taxpayers and tax collectors, simplification of 24

Abasyn University of Science and Information Technology Peshawar


procedure and processes, revised terms and conditions for employment in CBR and use of latest information technology skills. 3.6.2 MILESTONES IN THE REFORMS PROGRAM HAVE BEEN ACHIEVED: Establishment of Large Taxpayer Unit (LTU) at Karachi and Lahore. In its reform project CBR from July 01-2002, established a pilot Large Tax Payer Unit (LTU) at Karachi. The unit is bard on functional organization encompassing all the three domestic taxes i.e. sales tax, central excise duty and income tax. It has an open floor layout with a large reception and facilitation area for the taxpayers. The unit has revenue target which is approximately 20% of the total federal tax revenues, to be collected from around 600 Karachi based large taxpayers. The successful experience of establishment of LTU at Karachi and the position feedback from the community of large tax payers convinced CBR to move ahead wit the establishment of another LTU at Lahore, which has already started functioning and will be formally inaugurated this month. It is planned to inaugurate the third LTU in the federal capital the next financial year. 3.6.3 ESTABLISHMENT OF MEDIUM TAXPAYERS UNITS (MTUs) A model medium taxpayers unit started working in Lahore from. October 01-2002. The unit was set up to test the re-engineered income tax system based on functional organizational structure. The total taxpayer population of this unit is around 120,000. The positive results experience in MTU, Lahore gave confidence to senior management in CBR to more ahead with the establishment of further MTUs across the country. The MTU at Lahore has successfully demonstrated the new income tax functional organizational structure for 25 Abasyn University of Science and Information Technology Peshawar


integrated unit catering to the specific needs of medium and small taxpayers. Moreover, it has also given a fair idea of the level of automation and communication infrastructure required for launching further MTU. Therefore, CBR has setup for more MTU at Karachi, Rawalpindi, Quetta and Peshawar. Another MTU at Faisalabad will become functional in the next month. In due course these MTU should be upgraded to form regional tax offices (RTOS) along with 7 more RTOs. These units will start functioning in the next financial year. The whole tax machinery of domestic taxes i.e. sales tax, income tax and central excise duty will be replaced by 12 RTOs located at all major cities of the country. It will facilitate taxpayers who will be served under one roof for the domestic taxes. 3.6.4 CUSTOM ADMINISTRATION REFORMS: The comber son customs manual clearing system involving 34 verifications and 62 steps, with an average dwell time of more than eight days has been replaced by a modern, fully automated system working on 24 hours a day seven days a week basis. It is a modern, fully automated system based on self-assessment and risk management. A pilot project covering 25% of countrys imports and exports has already started functioning at Karachi International Customs Terminal. After successful launch of the pilot project, which has been widely acclaimed by trade and industry, computerized customs clearance system is being rolled out al over the country. During the year, eight model customs collectorates will be established with the replication of the same computerized customs clearance systems. Currently, 60% goods declarations, filed by importers,

26 Abasyn University of Science and Information Technology Peshawar


are being processed in four hours in same day. CBR is planning to process 100% declarations within four hours by March next. 3.6.5 UNIVERSAL SELF-ASSESSMENT SYSTEM: The obsolete income tax system has been abandoned and replaced by Universal Self Assessment. The returns received are from July 01-2002. In the USAS all taxpayers automatically qualify for self-assessment. The returns relieved are not to be examined in detail at the time they are received. A certain percentage of cases are selected later for audit based on risk assessment for various classes of taxpayers. The USAS for income tax has already emerged as a successful policy change. It has helped to minimize direct contact between tax officers and taxpayers. It will enhance voluntary compliance. The system has been designed to apply stiff penalties for willful evasion. 3.6.6 TAXPAYERS FACILITATION CENTERS: With the more towards universal self assessment, introduction of large scale changes in tax laws and producer introduction of new forms and record keeping requirements and functional reorganization of income tax, the need for a dedicated tax payers facilitation and education setup has been realized. This will be user in a new era of productive cooperation between tax administration and tax payers for timely addressable of their inquires. At present these counters are functioning in the MTUs, however the function will be extended to 60-75 locations at together. Personnel bearing friendly disposition will staff these facilitation centers. 3.6.7 DISPUTE RESOLUTION COMPLEX KARACHI: This involves co-location of all indirect adjudication offices in single premise where the taxpayers and their law years are facilitated through 27 Abasyn University of Science and Information Technology Peshawar


improved facilities. The tax collectors also benefit from the consolidation of legal cases record and prompt access to them. This arrangement has facilitated the taxpayers and may of them have has already taken advantage of this system. 3.6.8 CAPACITY BUILDING OF TAX ADMINISTRATION: The defined vision and mission of CBR envisages skilled and properly trained personnel to perform their work on professional lines. A new history in the civil services has been created. The first batch of fifty eight officers selected through the competitive examinations are presently undergoing training at the Institute of Business Administration, Karachi for MBA in tax management program. Similar training program for in service officer are also being initiated. The knowledge of modern concepts related to trade and industry will bring cultural change in the organization, aimed at providing a higher quality of service to the taxpayers. MOUS have been signed with reputed educational/professional institutions like UMS, IBA, and NUST etc to import quality training to the personnel of he organization. 3.6.9 TAX ADMINISTRATION REFORMS PROGRAM (TARP): Formally inaugurated on 4th April, 2005 is expected to be fully implemented by 31st December, 2009 with a financial allocation of US $ 149 million which include IBRDs $ 78.5 million, UK DFID $ 23.0 million and Pakistan governments $ 23.10 million. The results so far achieved are very encouraging. Still lot more to be done establishment of 14 Regional Tax Offices of current calendar year would be another milestone towards facilitation of the taxpayers. These RTOs would deal al issues relating to income tax, sales tax and federal excise and appeal case less than one roof. It is hoped that TARP, once fully implement and 28 Abasyn University of Science and Information Technology Peshawar


institutional development, infrastructure up gradation, adopting responsive IT system, strengthen revenue services and promoting tax compliance culture.


Pakistan's economy is on the path of sustained growth. The revised assessment brightly indicates that the real GDP growth may exceed 7% mark during FY 0405. A number of factors have contributed towards this robust escalation. The strong domestic demand has been generated by the buoyant industrial sector, unprecedented mercantile and business activities, and a big-awaited exceptional performance of the agriculture sector. Furthermore, there has been a sharp turn around in some of the leading services including the telecom and banking sectors. It is encouraging to observe that the manufacturing sector has registered a significant growth of 10.2% during the first three quarters of current fiscal year (CFY). More importantly, within the manufacturing sector, the large-scale manufacturing has recorded a substantial growth of 16.1%. Thanks to the kindness of the Mother Nature, the timely rains have not only contributed towards bumper cotton and wheat crops thereby raising the prosperity level of the agrarian population, but the shortage of water availability has also been reduced considerably. Notwithstanding the 'shiny' side of the economy, there are few disturbing features also that must not be overlooked. One of the major concerns among policy planners has been the significant rise in prices over the last three quarters. After enjoying a rather low rate of inflation of less than 4% between FY 00-01 and FY 29 Abasyn University of Science and Information Technology Peshawar


02-03, prices of essential food items, property rents, and transport and energy (oil) have begun to soar due to multiple factors including supply-side constraints and rising international fuel prices. The overall inflation rate has now reached a level that requires immediate correction.1 Needless to say that inflation is one of the major macroeconomic instabilities, which if allowed to persist, certainly leads to further deterioration in key economic fundamentals. Similarly, taking cue from the 'Development Economists', it is safe to argue that growth alone is only a necessary condition for transition from low-income to middle-income economy. The sufficient condition requires that the growth process be accompanied with equitable distribution of resources to avoid interpersonal and inter regional disparities. It was pointed out in one of the earlier reviews of the economy that "to ensure equitable distribution ... it [should] not be left to the trickle down effect of the growth process. The problems of unemployment and poverty are far too serious to be left alone to the mercy of the market forces. 2 This assertion unfortunately remains valid even today. (CBR, 2005)



CBR has exceeded the revenue target of first nine months of CFY by about Rs. 5 billion. A double-digit growth in net collection has been recorded in direct taxes (14.4%), CED (19.3%), customs duties (27.4%), and sales tax at import stage (16%). The collection of sales tax (domestic) has been adversely affected by a number of budgetary policy initiatives including the zero-rating of ginned cotton, and the introduction of uniformity in the sales tax rate by abolishing further tax @ 3% and high withholding sales tax on the selected items @ 20%. Whereas the timing issue in the case of ginned cotton has started to take positive effect as the

The recent reversal in trend is partly due to easing of supply constraint as the harvesting of new crop of wheat is near completion, and partly due to somewhat stability in the international price of oil. Thus, the correction through monetary policy is required only lo the extent that inflation is a 'monetary phenomenon.

The CBR Quarterly Review, Vol. 3, No. 4, April-June 2004.

30 Abasyn University of Science and Information Technology Peshawar


processing of cotton is moving from ginning to spinning, weaving and higher stages, it is anticipated that the situation will improve in the remaining three months, as less and less refunds will be generated, A turn around in collection has already been recorded in March. Contrary to -7.7% growth during July-March period, the net domestic sales tax collection has been higher by 39.5% in March due to 15.4% less refunds than March 2004. With this pattern persisting in the 4lh quarter of CFY, the chance of accomplishing the overall revenue target remains fair. (CBR, 2005) 4.3 OVERALL COLLECTION AND REFUNDS

Using the stock market phrase, CBR has crossed the psychological barrier of Rs. 400 billion by collecting net revenue receipts of Rs. 401.3 billion at the close of the third quarter of the CFY. When compared with last year's collection of the corresponding period, this collection indicates a healthy growth of 13.5%. Whereas the (provisional) gross collection has increased by 14.9% -- raising the collection from Rs. 414.9 billion to Rs. 476.8 billion, an increase of Rs. 62 billion, the net collection has jumped from Rs. 353.4 billion to Rs. 401.3 billion indicating a difference of Rs. 47.9 billion. The overall refund/ rebate payments during first three quarters of CFY have been Rs. 75.6 billion, registering a growth of 23% (Table 4.1). Taking note of various budgetary measures and freezing of oil prices during first half of CFY, the overall growth of federal taxes has been consistent with the performance of the economy, especially the growth of GDP, domestic industrial production and sales, and the level of total and dutiable imports. In fact, the growth in tax collection exceeds the nominal GDP growth if due adjustment is made for the changes just mentioned. Thus, the undue concern about falling tax/GDP ratio appears to be unwarranted. The entire resource mobilization effort needs to be carefully viewed within the broader framework of tax facilitation to promote investment by lowering rates of capital goods, reduction in cost of doing 31 Abasyn University of Science and Information Technology Peshawar


business, discouraging smuggling by reducing tax rates of smuggling-prone items, abolishing distortions in the sales tax regime, continuous reduction in corporate rates, and promoting hassle-free environment for the taxpayers. Furthermore, it is important to realize that tax collection cannot exceed the taxpaying capacity of the sectors that are liable to pay taxes under the existing legal framework. This is unfortunate that some of the majors sectors of the economy are outside the tax net for one reason or the other. Presently, the sectoral composition of taxes is not consistent with the sectoral composition of GDP. Given the present lop-sided structure of taxes whereby the manufacturing sector is over-burdened and the services sector that generates nearly 50% of GDP is lightly taxed besides agriculture sector being totally tax exempt; the requirement that tax/GDP ratio should also improve with growth in the economy, reduces to a theoretical discussion with no practical importance. A significant change in the tax/GDP ratio beyond the existing cosmetic improvement requires bold initiatives to be taken to bring ail those sectors that are generating taxable income to the tax net. Source: CBR Quarterly Review, Vol 4.

32 Abasyn University of Science and Information Technology Peshawar


Table 4.1 Federal Gross and Net Revenue Receipts: A Comparison (Revenue Receipts in fee. Billion)
FY 03-04 Gross July August September October November December January February March 31.0 36.1 45.8 47.9 39.8 66.9 52.0 46.7 48.7 Net 23.4 30.1 40.6 42.0 33.8 60.6 43.7 39.3 40.0 FY 04-05 Gross 38.4 41.4 68.5 48.0 46.4 66.5 50.4 45.5 71.6 Net 30.7 34.2 60.8 40.9 38.5 57.4 41.3 37.2 60.3 Growth (%) Gross 23.8 14.7 49.4 0.4 16.8 -0.6 -3.1 -2.4 47.1 Net 31.3 13.5 50.0 -2.5 14.0 -5.4 -5.7 -5.1 50.9

July -March






13.5 33

Abasyn University of Science and Information Technology Peshawar


Source: CBR Quarterly Review, Vol 4, 2005 Note: (1) Figures are rounded to one decimal place



On the whole, the collection of direct taxes has been better than last year on cumulative basis. Even though the month-to-month comparison remains invalid due to change in the advance tax regime, the quarterly figures are reported in Table 4.2. It is evident that the gross collection has registered a robust growth of 20.1% --an increase from Rs. 116 billion during first three quarters of PFY to Rs. 139.3 billion during the comparable period of CFY. However, due to higher refund payments by 71%, the growth in net collection has been 14.4%, i.e., rising from Rs. 104.4 billion to Rs. 119.5 billion during the period under review. Table 4.2 Gross and Net Revenue Receipts of Direct Taxes: A Comparison (Revenue Receipts in Rs, Billion)
FY 03-04 Gross Quarter- 1 Quarter- II H1: 04-05 Quarter III July-March 27.4 47.5 74.9 41.1 116.0 . Net 25.6 44.4 70.0 34.4 104.4 FY 04-05 Gross 45.0 43.9 88,9 50.4 139.3 Net 41.7 36.7 78.4 41.1 119.5. Growth (%) Gross 64.4 -7.7 18.6 22.7 20.1 Net 63.2 -17.5 12.0 19.4 14.4

34 Abasyn University of Science and Information Technology Peshawar


Source: CBR Quarterly Review, Vol 4, 2005 Note: (I) Figures are rounded

It is interesting to observe that nearly 66% of gross collection originates from the corporate sector. Of this, 41.3% is realized in the shape of advance taxes. Within the corporate sector, the share of public sector companies, as defined under the Income Tax Ordinance 2001, has been the highest (52%) followed by private and banking companies. Detailed Analysis of the Components of Direct Taxes: Based on the currently available aggregated data for July-March 2004-05 and using the corresponding data of PFY, the following features of direct tax receipts have been observed. 4.5 VOLUNTARY PAYMENTS (VP)

Voluntary compliance is one of the important components of direct taxes for two reasons. Firstly, it highlights taxpayers' confidence, and secondly, an increasing share of VP is vital for maintaining the overall equity in the taxation system. It is important to observe that both the components of VP, i.e., payments with returns and advance tax, have shown an extraordinary change during July-March period. The number of returns has increased from 1.03 million during the first three quarters of PFY to 1.17 million during the same period of CFY, indicating a growth of 13.6%. Similarly, the payments with returns have increased from Rs. 9.8 billion during PFY to Rs. 13.5 billion during CFY, yielding a healthy growth of 38.7%. Similarly, the collection of advanced taxes has also registered a strong growth of 27%. In fact, the three-quarter collection of CFY under advance tax has already exceeded the reported collection of Rs. 37 billion until May last year. Source: CBR Quarterly Review, Vol 4.



35 Abasyn University of Science and Information Technology Peshawar


Contrary to voluntary compliance, the collection on account of demand creation has declined during the first nine months by 8.2%. The decline has occurred due to the successful implementation of the USAS wherein the declared income in returns is treated as final liability. Of the two components of CoD, the collection under arrear demand has significantly increased by 19.4% over the PFY. This growth is mainly due to disposal of the 'Brought Forward' cases lying pending with the Regions. The second component may also receive a boost during the 4th quarter of the year when initial assessment of the returns will be completed and cases will be ripe for audit assessment through random selection criteria.3 Source:
CBR Quarterly Review, Vol 4.



WHT continues to remain the leading component of direct tax receipts in view of the large informal sector of the economy. The WHT collection during July-Mar 2004-05 has been Rs. 73.3 billion against Rs. 62.7 billion during PFY, yielding a healthy growth of 16.9%, The six major withholding taxes constituting 81.3% of total WHT collection are: contracts, imports, salary, exports, electricity, and line/ mobile phones. The share of contracts (27.7%) remains at the top, followed by imports (24.5%), salary (11.7%), exports (7.7%) electricity (4,7) and telephones (4.6%). However, notwithstanding the share, the highest growth in WHT collection has been from telecom services (54.2%), followed by contracts (25.1%). This outcome reinforces the existing evidence of related economic indicators that the commercial activities are booming and higher government spending on infrastructure development programs is generating further growth. The exceptional international trade activities duly captured by international trade taxes have also been instrumental in raising the WHT receipts. The WHT deductions on

The task of computerization of the Returns submitted during CFY has already been completed.

36 Abasyn University of Science and Information Technology Peshawar


exports and imports were higher by 17.6% and 6.6%, respectively during the first three quarters of CFY over PFY (Table 4.3). (CBR, 2005)

37 Abasyn University of Science and Information Technology Peshawar


Table 4.3 July-Mart h Data on Leading WHT Heads: A comparison of FY 04-05 & FY 03-04 Collection Collection Heads Contracts Ql Q2 Q3 July-March Imports Ql Q2 Q3 July-March Salary Ql Q2 Q3 July-March Electricity Ql O2 Q3 July-March Telephone Ql Q2 Q3 July-March Exports Ql Q2 Q3 July-March (Rs .Billion) FY: 04-05 F1 f: 03-04 6.1 6.4 7.8 20.3 6.3 6.0 5.8 18.2 2.8 2.7 3.0 8.6 1.0 1.2 0.9 3.1 1.0 1.1 1.4 3.5 1.7 1.9 1.9 5.6 4.6 5.9 5.8 16.2 5.8 6.0 5.2 17.0 2.0 2.8 2.9 7.7 1.0 1.2 0.9 3.1 0.6 0.8 0.8 2.3 1.5 1.6 1.6 4.7 Difference Absolute 1.6 0.6 2.0 4.1 0.5 0.0 0.6 1.1 0.9 0.0 0.1 0.9 0.1 0.0 0.0 0.1 0.4 0.3 0.6 1.2 0.2 0.3 0.4 0.8

Percent 34.5 9.4 34.8 25.1 8.4 0.1 12.3 6.6 43.0 -1.7 3.0 11.4 8.8 2.2 0.0 0.0 61.5 33.6 68.8 54.2 14.4 15.4 23.1 17.6 38

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a. Sub-Total Share (%) in

59.3 Total 13.96 73.38

51.0 81.5 11.58 62,71 51.1



WHT 81.0 b. Other WHT c. Total WHT Share (%) in Gross .Tax 51.4 Source:

2.38 10,7

20.5 17.0

CBR Quarterly Review, Vol 4, 2005

Apart from six major WHT contributors, the relatively minor components have recorded sizeable growth. For instance, WHT on non-residents grew by 42.2% during the first three quarters of CFY over the corresponding period of last year, dividends by 68.5% and commissions by 52.2%. On the other hand, the WHT collection from securities and bank interest has registered negative growth of 28.4% and 12.2% respectively due to declining bank rates that have started to rise recently but their impact is captured with lag.



The three components of indirect taxes are sales tax, central excise duties, and customs duties. The gross and net collection of indirect taxes has recorded a significant growth of 13% and 13.2%, respectively during the July-March period due to buoyancy in their respective tax bases. The gross receipts have increased from Rs. 298.9 billion during first three quarters of PFY to Rs. 337.6 billion during the comparable period of CFY. Similarly, the net collection has reached Rs. 281.8 billion during CFY from Rs. 249 billion during PFY. The difference between gross and net receipts reflects the higher amount of refund payments 39 Abasyn University of Science and Information Technology Peshawar


during the current year. The refund payments on account of indirect taxes have gone up by 11.8% during the period under consideration. Sales Tax: GST being one of the two major sources of federal tax receipts, has assumed great importance over the years. It has contributed 41.2% of the total net revenue collection during the July-March period of CFY. The gross and net sales tax collection has been Rs. 209.3 billion and Rs. 165.4 billion, respectively showing growth of 7.3% and 6.2% over the corresponding period of PFY. The refund payments have increased by 11.4% during this period, which have been paid out almost completely from domestic ST receipts. Of these two components of sales tax, the domestic sales tax collection decreased by 0.3% and 7.7% in gross and net terms respectively mainly due to zero-rating of ginned cotton and other budgetary measures. On the other hand, the growth in gross and net ST collection from imports has been around 16%, which is consistent with the growth in imports during CFY. Zero-rating of Ginned Cotton The Textile Sector has been one of the leading sectors of the economy. Since around 80% of its produce is exported, it was one of the major claimants of refunds and rebates because of the zero -rating of exports. In fact, Rs 37 billion out of Rs 52 billion (71%) sales tax refund payments during FY 03-04 were made to the Textile Sector. In the face of such a colossal amount of refunds, the ginned cotton was made zero-rated in the Budget FY:04-05, Besides claims for other inputs, the sales tax on ginned cotton amounting Rs. 14.4 billion was put forward for refund claims for its use at subsequent stages of production by the Textile Sector. The objective of this policy initiative was twofold: to reduce the amount of refund claims ~ thereby eliminate one of the major inlets, and secondly, to improve the cash flow situation of the producers who initially had to pay and then reclaim the amount with a lag of four to six months. Not only the economic 40 Abasyn University of Science and Information Technology Peshawar


activity was slowed down in this process, the later-stage producers also delayed the payments to ginners and growers. With the zero-rating of ginned cotton, a paltry sum of Rs. 642 million has been received as sales tax during the first 9 months of CFY, against Rx.12,6 billion during the corresponding period last year. Thus, the total loss in gross collection has been around Rx. 12 billion. So far a saving of Rs. 2.8 billion has been accrued in the shape of 'less' refund payments, and an amount of Rs 4 billion has been generated as additional gross collection from cotton yarn. The sales tax collection thus shows a loss of around Rx.5 billion, ignoring the growth factor, It is anticipated that further gains in the shape of less refunds will accrue in the 4dl quarter and the policy of zero -rating of ginned cotton will be revenue neutral, as envisaged at the time of budget. Domestic Sales Tax Collection and Major Revenue Spinners: The detailed analysis of domestic sales tax collection on the basis of data for July-March 2005 indicates that around 70% of gross collection (Rs. 73 billion out of Rs. 103.3 billion) has been generated by ten major revenue spinners that include: Services (essentially Telephone and Tele fax), POL Products, Electrical Energy, Natural Gas, Sugar, Cotton yarn, Cigarettes, Cement, Fertilizer, and Iron & Steel Products. However, with the exception of few of these commodities/ utilities, the rest of the major revenue spinners have recorded fairly low growth. Among the low-growth commodities are cigarettes and sugar and among those where the growth has been negative are cement, fertilizer, iron and steel products. The possible rationales for this apparently dismal performance have been as follows. The low collection from cigarettes has been due to the withdrawal of further tax that has provided a bonanza for the cigarette Distributors. The reduction in collection from cement despite a resounding growth in production and clearance has been due to various murky reasons. While some of the cement manufacturers have claimed huge input adjustment for import of coal, the others have sought 41 Abasyn University of Science and Information Technology Peshawar


adjustment for import of plants and machinery for enhancing their productive capacity in view of the increasing domestic demand and export potential. The paradoxical element in the whole scenario is that while their taxable sales have risen and also the retail price of cement has seen an upward trend, the tax receipts surprisingly have shrunken. A similar situation prevails for the sugar industry. Despite the availability of huge stocks, the retail price of sugar has also recorded an upward trend due to artificial supply constraints and the national exchequer is also not gaining anything out of this change. It appears that the cement and sugar cartels are getting stronger day by day! Finally, the reduction in sales tax collection from fertilizer has been due to the introduction of deemed price. Source: CBR Quarterly Review, Vol 4. On the brighter side, the highest positive growth of over 200 % has been recorded for Cotton Yarn mainly due to zero-rating of ginned cotton and higher prices of cotton during the harvest season. Similarly, nearly 55% increase in ST (D) collection from services confirms the significant improvement h economic activity and the widespread usage of mobile and telecom facilities (Table 4.4).

42 Abasyn University of Science and Information Technology Peshawar


Table 4.4 Sales Tax Collection from Ten Major Revenue Spinners (Domestic) for during FY 04-05 and FY 03-04 (Rs. In Million) S.No, Commodity Collection Collection Growth (%) Up to March 2004 1 2 3 Services (Including Telephone/Fax etc) POL Products (Including Petroleum, 4 5 Lubricating Oils) Electrical Energy Natural Gas Sugar (Including Baggase and 10636.4 15188.1 9429.6 7155.8 6009.1 Up to March 2005 16470.7 16267.2 10038.1 7888.7 6079.8 10.2 1.2 54.9 7.1 6.5

Molasses) 6 7 8 9 10 Cotton Yam Cigarettes Cement Fertilizers/Urea Iron & steel Products Sub Total Others 1852.0 3646.0 3096.7 2855,7 2088.5 61957.9 41691.1 5813.3 3727.4 2494.2 2411.1 1822.1 73012.6 30281.4 213.9 2.2 -19.5 -15.6 -12.8 16.5 -27.4

43 Abasyn University of Science and Information Technology Peshawar


G. Total Refunds Net GST Collection Source: CBR Quarterly Review, Vol 4, 2005 Sales Tax at Import Stage:

103649.0 39343.0 64306.0

103294,0 43908.0 59386.0

-0.3 11.6 -7.7

In terms of gross collection of sales tax, the contribution of Sales Imports [ST (M)] has been around 51% during the July-March of CFY. However, since all refund claims are entertained from the domestic collection of sales tax, the contribution of ST (M) in net sales tax collection has been 64%. Interestingly, the ST (M) is levied on import value inclusive of customs duties for commodities that are subjected to customs duties and on actual import value if they are duty free. Accordingly, slight variations in the effective rate of sales tax on imports vis--vis the standard rate are observed. Of all the commodity groups subjected to sales tax, the major five that have registered double-digit growth are: Iron & Steel, Vehicles, POL Products, Paper & Paper Board, and Rubber Products. The respective growth in these cases has been 66.5%, 51.8%, 39.7%, 23.8% and 23.1%. It is interesting to observe that the zero-rating of specific machinery belonging to Chapters 84 & 85 has boosted the overall imports of electrical and mechanical machinery tremendously. The collection of electrical machinery has grown by 9.8%, which reflects that substantial improvement in volume has taken place that has more than compensated the adverse impact of zero-rating. The policy change of reducing the up-front cost of plant, machinery, and equipment and thereby providing a competitive environment for investment has paid of. Similarly, the reduction of duty on smuggling-prone items, especially tea, has 44 Abasyn University of Science and Information Technology Peshawar


encouraged importers and as a consequence, the sales tax receipts have also increased. On the whole, the recent boost in imports has improved the sales tax collection at import stage by 16% (Table 4.5).

45 Abasyn University of Science and Information Technology Peshawar


Table 4.5 Major Revenue Spinners of Sales Tax at Import Stage (Growth and Effective Rates in percent) PCT Chapter TaritTDescription Growth in Imports (%) JM: 04- -IM: 27 87 29 72 39 85 POL Products Vehicles Organic Chemicals Iron and Steel Plastic Resins, etc, Electrical Machinery 84 Mechanical Machinery 38 Misc. Prod. 40 Rubber Products 39.0 1.8 1.5 23.1 46 Abasyn University of Science and Information Technology Peshawar Chemical 37.8 2.3 1.9 19.8 74.6 4.4 4.6 -5.2 41.6 65.0 28.2 113.6 47.6 104,8 05 10.3 8.7 7.3 7.1 5.6 4.8 03-04 7,4 5.7 6.9 4,3 5.2 4.4 Growth (%) 39.7 51.8 5.4 66.5 7.2 9.8 ST (M) Collection [Us. Billion



Paper Paperboard






9 32 54

Coffee and Tea etc. Dyes, Paints etc. Man-made Filaments

19.2 22.4 16.7

1.8 1.4 1.1

1.7 1.5 1.2

6.0 -8.8 -4.6


Articles of Iron & Steel






Edible Waxes










. 5&Q


Others Grand Total Source:

38.4 47.8

46.0 106.0

35.5 91,5

29,6 15,9

CBR Quarterly Review, Vol 4, 2005

Customs Duties: The gross and net collection from customs duties has exhibited remarkable growth during July-March 2004-05, by collecting Rs. 91.9 billion gross and Rs. 80.1 billion net collection, showing a sizeable growth of 25.5% and 27.4%, respectively over the comparable period of PFY. At the same time, Rs. 47 Abasyn University of Science and Information Technology Peshawar


11.8 billion have been paid back as refunds/ rebates during the CFY that are 13.5% higher as compared to the same period of PFY. The extraordinary growth in collection is attributable to a number of factors including the record level of international trade transactions, incentives to investors and traders, and the continuous improvement in customs business processes and efficiency gains. The information presented below indicates the performance of major revenue contributors of customs duties. The highest growth of 72% in customs duty has been recorded by vehicles listed in Chapter 87 of Pakistan Tariff, followed by 61% growth in electrical machinery (Chapter 85), machinery 55.5% (Chapter 84), and iron and steel with growth of 41.5% (Chapter 72). The growth of 15 major commodities reported in Table 6, has been 32% and the overall growth of all commodities is around 25%. With extensive revision in the duty structure within the existing slabs whereby duty has been reduced for capital goods and smuggling-prone items, the effective rate on dutiable imports for 15 major commodity groups has declined from 16.7% to 14.2% during July-March 2004-05 over the corresponding period of PFY. Similarly, the effective rate for all commodity groups has also declined from 17.5% to 15.1%. This reduction has been due to the changing composition of dutiable imports. Finally, it is also relevant to mention that the effective rate remains higher than the maximum statutory rate for only two commodities implying that the tariff structure is well within the specified limit. Thus, the tariff peaks have been reduced greatly.

Table 4.6 48 Abasyn University of Science and Information Technology Peshawar


Major Revenue Spinners of Customs Duties and Effective Rates (Growth and Effective Rates m percent) July-March Growth Import Dutiable Customs Value Imports Duties 65.0 7.6 74.6 104.8 64.1 9.7 86.3 118.4 36.3 121.5 51.9 15.7 26.7 44.6 21.8 30.5 12.6 21.5 80.7 55.2 17.4 45.4 72.1 6.5 55.5 61.1 34.5 41.5 0.6 7.0 24.2 24.4 -30.9 9.0 31.8 -5.3 42.6 32.0 7.8 24.9 Effective Rates on Dutiable Imports Up to Up to March March 04 35.6 31.7 9.9 13.7 10.2 15.5 18.5 9.8 19.2 12.3 19.0 13.9 16.2 18.0 IX,5 76.7 19.9 n.6 05 37-3 30.7 8.3 10.1 10.1 9.9 12.2 i 9.1 18.8 10.6 10.8 11.6 18.9 14.1 14.6 14.2 18.2 15.1


Chapter S7 15 84 85 27 72 39 29 48 38 9 40 54 32 73

Tariff Description Vehicles oil and Waxes Machinery Electrical

Machinery POL Products 41.4 [Iron and Steel 113.6 Plastic Resins, 47.6 etc. Chemicals Paper 28.2 27.2 37.8 19.2 39.0 16.7 22.4 31.8 54.6 38.4 47.8


Paperboard misc. Chemical Prod. Coffee and Tea etc Rubber Products Vlan-made Filaments Dyes, Paints etc. Iron & Steel

Articles Sub total Others Grand Total

Source: CBR Quarterly Review, Vol 4, 2005 49 Abasyn University of Science and Information Technology Peshawar


Not-:. The Data pertains to Custom House, Karachi and Dry parts constituting nearly 96% of total CD Collect/inn.

50 Abasyn University of Science and Information Technology Peshawar


Central Excise: Unlike past many years when CED collection was constantly declining mainly due to continuous withdrawal of additional commodities from CED net and gradual shifting them to the GST net. The gross and net collection during CFY has been extraordinary. The net collection of CED during July-March 2005 has been Rs. 36.3 billion against Rs. 30.4 billion during the corresponding period of PFY, depicting a double-digit growth of 19.3 %. The vibrant performance of CED is mainly due to the healthy growth in the CED-base, particularly the exceptional growth of 16.1% in the large-scale manufacturing sector. The five major revenue spinners of CED have contributed 86.7% in total gross collection during the period under review. The highest growth of 21% has been registered in cigarettes mainly due to upward revision of CED duty and prices after the budget 2004-05. Incidentally, the production of cigarettes has also gone up by 10.5% during the first three quarters of CFY that has also been a contributing factor. Similarly, CED from cement has increased by 17.4% and this improvement is attributable to 15.3% growth in cement production in response to the booming construction activity in the country and export potential. The higher demand of cement has been accomplished partly by expansion in productive capacity and partly by improved capacity utilization of the existing units. Finally, the 12.2% growth in CED from Natural Gas, 11.2% from POL Products, and a nominal growth of 4.3% in beverages have all contributed towards overall CED growth (Table 4.7).

51 Abasyn University of Science and Information Technology Peshawar


Table 4.7 A Comparative Analysis of CED Collection (Rs. Million) FY:03-04 FY:04-05 Five Major Revenue Spinners Cigarettes Cement Natural Gas POL Products Beverages Sub Total All Commodities ->o S'hare in Gross 12129.7 6735.8 3639.0 2823.1 1644.5 26972.1 30512.0 88,4 14674.5 7906.2 4081.6 3138.7 1714.8 31515.8 36371.0 86,7 2544.8 1170.4 442.6 315.6 70.3 4543.7 5859.0 21.0 17.4 12.2 11.2 4.3 16.8 19.2 July- March Difference Absolute Percent

Source: CBR Quarterly Review, Vol 4, 2005



The CBR is well on its way to accomplishing the assigned target of collection for FY 04-05. It is heartening that all the four federal taxes are faring well. Various 52 Abasyn University of Science and Information Technology Peshawar


tax policy and administrative interventions are proving successful as far as revenue collection is concerned. The reduction of tariff and tax rates has provided the much-needed impetus to growth by reducing the cost of doing business. The zero-rating of ginned cotton has eased-up the liquidity situation that in turn has been instrumental in boosting economic activity in the country. It is anticipated that with further improvement in taxpaying capacity of the taxpayers, the tax revenue will also increase with the passage of time. 4.10 CBR TAX PERFORMANCE

CBR contributed around Rs 591.1 billion in total revenue collection against [lie revised target of Rs 590 billion during the year, showing a growth of 1 3,5 percent YoY, as compared to a growth of 1 3. 1 percent in the preceding year (see Table 4.8), but below the nominal GDP growth rate of 1 8.3 percent during the year. The causative factor seems to be the inflexibility in the tax system as the CBR tax buoyancy estimates are around 0.7 in FY05 as compared lo the 0.9 percent for the last year, depicting the resultant stagnancy in revenue mobilization efforts and a contracting tax base. Nonetheless, CBR with its tax reforms strategies is projecting to collect revenues of almost Rs 690 billion in FY06, improving the tax buoyancy to 1.1. Source: SBP Annual Report (2005).

Table 4.8 ACTUAL TAX COLLECTIONS (NET) BY CBR 53 Abasyn University of Science and Information Technology Peshawar


billion Rupees Collectio n FY04 165.1 Budgeted targets FY05 I8I.7 Revised Collectio targets n FY05 FY05 1827 183.1 Abs. Difference FY04 180 with Tareel 0.4 Targets Growth over FY06 FV04 215.4 10.9

Direct Taxes Indirect Taxes Sales Tax Central Excise Customs Total









319.2 45. 6

2492 46.9

239.5 52.8

240.0 52.9

20.8 7.3

0.5 0.1

294.0 59.4

9.5 16.0

91 0 520.8 Source:

1023 580.I

115.0 590.0

115.1 591.1

24.1 70.2

01 I.I

121.2 690.0

26.5 13.5

Central Board of Revenue, 2005

Assuming that the total revenue to GDP ratio should have matched at least the 14.9 percent achieved last year the decline of 1.4 percentage points in FY05 has to be assessed (see Table 4.9).



The slight variation in the tax related statistics in the chapter is due to the different source of data used

54 Abasyn University of Science and Information Technology Peshawar


Total Revenue

Total Tax Revenue

Total Non-Tax Revenue

Total Feder Provinci Total Feder Provinci Total Feder Provin al FYOO FY01 FY02 FY03 FY04 FY05 13.5 13.4 14.2 14.9 14.9 13.5 12.6 12.4 13,3 13.9 13.5 11.9 12.9 al 0.9 1,0 0.9 1.0 1.4 1.6 1.1 10.7 10,7 10.9 11,5 11.6 10.6 1 1.0 al 10.2 10.2 10.5 11,0 10.6 9.6 10.4 al 0.5 0.5 0,4 0.5 1.0 1.0 0.7 2.8 2.7 3.3 3.4 3.3 2.9 3.1 al 2.4 2.2 .2.8 2.9 2.9 2.3 2.6 cial 0,4 0.5 0.5 0.5 0.4 0.6 0,5

Average 14.1

Source; CBR Year Book 2004-05 Thus, the main causative factors behind the weaknesses in revenue collection are the lower Federal revenue collection, and that too in the tax and non-tax components. In the Federal tax component, the surcharges/GDP dropped by 0.6 percentage points due to a deliberate policy of reducing the Petroleum Development Levy to offset the cushion of higher international oil prices. The reduced CBR revenue-to-GDP ratio has arisen due to lower collection on account of direct taxes (3.0 to 2.8 percent of GDP) and sales tax (4.0 to 3.7 percent of GDP) (see Table 4.10). Table 4.10 55 Abasyn University of Science and Information Technology Peshawar


DECOMPOSITION OF TAX/GDP RATIO Percent Total Taxes Federal Taxes FYOO FYOI FY03 FY03 FY04 FY05 10.7 10.7 10.9 11.5 11.6 10.6 10.2 10.2 10.5 11.0 10.6 9.6 CBR Revenues 9.2 9.4 9.2 9.6 9.4 9.0 1 0.7 1.2 1.4 1.1 0.5 Surcharges Provincial Tax 0.5 0.5 0.4 0.5 0.5 0.5

Source; CBR Year Book 2004-2005


DIRECT TAXES With a growth of 10.9 percent YoY, direct taxes contributed around 31.0 percent of the FYO5 revenue collection as compared to 31.7 percent in FY04. As this was the first full year in which the impact of Universal Self Assessment Scheme can be gauged it would be useful to disaggregate the corporate and individual tax payer categories. Of Rs 172.5 billion collected under income tax (Rs 10.6 billion being other direct taxes), the corporate sector's share was Rs 110.4 billion (or 64 56 Abasyn University of Science and Information Technology Peshawar


percent) while that of individuals was Rs 61.1 billion (or 36 percent). This compares with Rs 102.6 billion paid by the corporate (an increase of 7.6 percent) and Rs 53.3 billon paid by the individuals (an increase of 14.2 percent) in FY04. The refunds under income tax jumped from Rs 19.8 billion to Rs 26.8 billion this year as the arbitrary advance tax regime was rationalized. A total number of 1.23 million returns were filled during FY05 showing an increase of 19.4 percent over the previous year but the number of income tax non-filers is also on rise. Source: SBP Annual Report (2005). With in the direct tax category, withholding taxes increased to Rs 109,6 billion in FY05, with a growth rate of 20.3 percent. Major heads contributing to this tremendous growth are contracts Rs 33.4 billion (30 percent), imports Rs 24.5 billion (22 percent), salaries Rs 13.3 billion (12 percent), and telephone & electricity Rs 9.8 billion (9 percent).

Figure 1: CBR Revenue Composition Over Time

57 Abasyn University of Science and Information Technology Peshawar


Fig: 4.6: CBR Revenue Composition Over Time

Series1 50 45 40 35 30 25 20 15 10 5 0
FY93 FY95 FY99 FY01 FY05 FY91 FY97 FY03




Figure 2: Distribution of GST Payers & Revenue Collection

Fig: 4.7: Distribution of GST Payers and Revenue Collection
Series1 160 140 120 100 80 60 40 20 0
FY98 FY99 FY01 FY02 FY05 FY97 FY00 FY03 FY04

percent of total

Series 2


Series 4

SALES TAX The sales tax has been a major contributor in revenue mobilization in recent years, but unexpectedly weak growth receipts meant that its share in total collections dropped in FY05 (see Figure 1); while the GST receipts of Rs 240 billion were slightly higher than the revised target of Rs 239.5 billion, these were significantly below the original FY05 target of Rs 249.2 billion. Of the FY05 receipts, Rs 9-4.6 billion were collected from domestic resources and the remaining were collected 58 Abasyn University of Science and Information Technology Peshawar

billion Rupees


on imports. The net collection from domestic sales tax grew by only 1.5 percent at the time when large scale manufacturing growth was 15.6 percent. Had it not been for 15.3 percent increase in sales tax on imports the overall outcome would have been even more dismal. Various policy measures, like deregistration of retailers/ manufacturers having annual turnover of less than Rs 5 million, zero-rating & exemption of duty on various products, contributed to the weak GST collections in FY05. However, the amendment in taxpayers slab drastically reduced the number of taxpayers on one hand, and decreased the sales (ax to GDP ratio from 4 percent during FY04 to 3.7 percent in FY05 on the other, lowering the buoyancy of tax collection (see Figure 2). Apart from these facts, a 5 percent growth in refunds (from Rs 52.2 billion in FY04 to Rs 54.9 billion in FY05) is observed, against an 8 percent increase in gross collection (from Rs 271.4 billion in FY04 to Rs 294.9 in FY05) during the year. CUSTOMS DUTY Customs duty collections demonstrated a relatively better performance, with a revenue collection of Rs 115.1 billion, registering a growth rate of 26.5 percent YoY in FY05 (see Table 4.8) as compared to a 32.3 percent rise in FY04. The increased receipts are principally the result of the sharp rise in imports during the year, which overshadowed the impact of a continuing decline in the effective tariff rate. Indeed, during FY05, duty relief over various commodities has led to a drastic increase in the import value of certain commodities5 like vehicles (up 70.5 percent), machinery and mechanical appliances (up 70 percent), electric

Duty on plant & machinery was reduced to 5 %, while agricultural equipment were exempted from any duty, duty rates on vehicles were also slashed in FY05, but even then vehicle remain major revenue spinner during the years

59 Abasyn University of Science and Information Technology Peshawar


machinery and equipment (up 117.5 percent), iron & Steel (up 102 percent), contributing not only to an acceleration in economic activity, but also higher customs duty collections. Source: SBP Annual Report (2005).


Although this tax is being replaced with sales tax, and very few heads are left within the network of Central Excise Duty, the revenue collection showed an upward trend and surpassed its target of Rs 52.8 billion slightly with a collection of Rs 52.9 billion (see Table 4.8). Source: SBP Annual Report (2005).

60 Abasyn University of Science and Information Technology Peshawar


Table 4.11 Central Excise Duly Collection Billion Rupees Major commodities FY04 FY05 Absolute Percent Beverages Beverages concentrate Cigarettes & tobacco Cement Natural gases POL products Sub-total Others Local goods (gross) Imported goods (gross) Total (gross) Refund rebates 2,7 1.3 18.4 9.4 5.5 3.7 41.0 3.0 44.0 1.7 45.6 O.I 2.8 1.7 21.9 11.1 5.7 3.9 47.0 2.8 -19.8 3.1 52.9 O.I) 0.1 0.4 3.5 1.7 0.1 0.2 6.0 -0.2 5.8 1.4 7.3 0.0 5.3 29.4 18.9 17,7 2.3 5.6 14.6 -5.9 13.2 87 J J5.9 -31.2 VoY change

Source: Central Board of Revenue, 2005 A commodity wise breakup shows that the biggest contribution to this FY05 increase was from cigarettes & tobacco (that comprised 41 percent of the gross 61 Abasyn University of Science and Information Technology Peshawar


annual receipts), followed by that from cement (21 percent of the gross annual receipts). While the increase in receipts from the first was driven by growth in output (along with price and duty adjustments), the 17.7 percent rise in CED collections on cement reflect the corresponding rise in production following a strong recovery by the construction sector in FY05 and rising exports (see Table 4.11). 4.13 SURCHARGES

Surcharges are one of the most important sources of revenue for the government. In FY05, as against the target of Rs 65.3 billion, the collection could hardly reach Rs 26.8 billion, out of which Rs 16.2 billion were collected from gas, whereas Rs 10.6 billion were from the Petroleum Development Levy (PDL). The shortfall in surcharge from PDL is because of a hike in international oil prices that put the government with the difficult choice of passing on in full the higher prices to domestic consumers (and risking a sharp rise in inflation and slower growth) or reducing its fuel taxes (and worsening its fiscal position). The government chose the latter, and consequently, its PDL receipts of Rs 10.6 billion were well short of the Rs 47,4 billion budget target.6 (SBP, 2005) 4.14 NON-TAX REVENUES

Non-tax revenues surpassed the target of Rs 141.5 billion in FY05 with an outstanding collection of Rs 240.7 billion, representing a 70 percent rise over the budget estimates. Therefore, the non-tax to GDP ratio rose to 3.7 during FY05 from the 3.3 percent in FY04. This helped out in offsetting the high expenditure

In addition according to the OCAC, in order to subsidize consumers, and meet the cost of oil companies and oil refineries, it made some adjustments through PDC (Price Differential claimed), keeping PDC positive over MS87 RON and HOBC, and transferred this impact to the large group of consumer especially, HSD, by maintaining PDC negative over the time despite all these adjustments government has paid around Rs. 9.7 billion on account of PDC to OMCs and oil refineries in FY05. on the other had, governments collection through CED and customs duty showed a growth of 9% and 10% respectively, against the 10% growth in the consumption of POL products.

62 Abasyn University of Science and Information Technology Peshawar


during the year.5 Duty on plant & machinery was reduced lo 5 percent, while agricultural equipment were exempted from any duty, duty rates on vehicles were also slashed in H Y05, but even then vehicle remain major revenue spinner during the year, This remarkable growth in non-tax revenue is due mainly to (a) unexpectedly strong profits of the SBP, which allowed a transfer o("Rs 10 billion in FY05, compared with Rs 1 billion estimated for the year, (b) unexpectedly strong receipts in defense services, Rs 61.4 billion against the budgeted Rs 11.6 billion, (c) PTA receipts of Rs 17.7 billion against the projected Rs 6.2 billion, (d) and more than expected royalties on gas and oil - Rs 18.3 billion compared with budgeted figure of Rs 16.6 billion, and (e) receipts of Rs 10.4 billion from the United Nations against the estimated figure of Rs 5 billion.


4.15.1 INTRODUCTION: In an effort to promote tax compliance, CBR has embarked upon a liberal income tax regime based on the concept of universal self-assessment. The new regime has been designed to promote investment, encourage foreign direct investment and exports The rationale behind the new approach is that expansion of economic activity is prerequisite to higher tax collection. The purpose of this article is to evaluate the performance of the income and corporate tax structure in a broader framework. The analysis focuses on recently introduced reform measures that promise to remove the distortions in the existing system. In particular, it is essential to know how far the voluntary compliance has improved and what are the additional sources of strength. We start with a brief

Authors: Dr. Ather Maqsood Ahmad, Member and Mr. Umar Wahid, Secretary. Fiscal Research and Statistics, CBR

63 Abasyn University of Science and Information Technology Peshawar


review of the income tax system in Pakistan. Source: SBR Quarterly Review, Vol. 4


The income tax was imposed for the first time on agriculture in the Indian subcontinent in 1860. The original Income Tax Act was amended in 1866 that continued until 1922 when a progressive income tax scale was introduced. Pakistan on its creation adopted the Income Tax Act of 1922 and continued with it until the promulgation of Income Tax Ordinance, 1979. Currently the Income Tax Ordinance, 2001 is in vogue. The important components of direct taxes are: income and corporate taxes, capital value tax, workers' welfare fund and the wealth tax. The wealth tax is currently held in abeyance but the revenue is still trickling in, albeit insignificantly. Since the share of income and corporate taxes is around 96% in direct tax receipts, the present study concentrates on its components and base. Definitional, the Income Tax is levied on income-tax-chargeable incomes of individuals, association of persons, registered firms, and corporate entities. The three main components of income tax are voluntary payments (VP), collection of demand (CoD), and withholding taxes (WHT). The collection is dominated by WHT with 55% share in direct taxes. The collection is made through the withholding agents who are responsible for deducting the due amount of tax out of such disbursements that are taxable receipts in the hands of recipients of those disbursements. WHT as a mechanism of tax collection was first introduced in the late 1960s but later on its scope was enhanced to a number of additional activities. Presently, there are 19 activities subjected to WHT. 8

However, of these nineteen heads the contribution of six is around 80%.

64 Abasyn University of Science and Information Technology Peshawar


The second largest component of income tax is VP, which consists of payment with returns and advance tax. The taxpayers are required by law to submit annual returns to the income tax department as per time schedule fixed by the CBR. Similarly, the advance tax is also mandatory by law and it has to be deposited in four installments according to the timeframe prescribed by the CBR. The third component of the income tax is collection on demand (CoD). This component has assumed critical importance in an era of universal self-assessment (USAS). It allows the authorities to investigate the level of under or misreporting by the taxpayers. Under the USAS only a small percentage of returns are randomly selected on the basis of the pre-announced criteria. Recently, the primary objective of this component has been reduced to act as However, of these nineteen heads the contribution of six is around 80%. Deterrent against possible tax evasion rather than a source of revenue receipts. Thus, the tax collection notified as CoD includes the amount detected through audit, penalties imposed for failing to comply with the provisions of tax laws, and taxes recovered 6r failure to deposit tax within the prescribed limit of time. The direct taxation system, prima facie, continues to have a narrow base with 2.21 million taxpayers including around 0.6 million in fructuous cases. The share of taxpayers to total population is 1.5%. Which compares with 2.2% in India, 13.6% in Argentina, 53% in France and 82.5% in Canada.9 Often it is argued that on the basis of alternative estimates the income taxable population filing annual returns should range between 25 to 30 million. However, due care is required while interpreting the number of the existing base, as there is ample confusion between taxpayers filing returns and statements. The problem is compounded when one statement does not exactly match with one taxpayer. Source: SBR Quarterly Review, Vol. 4

See Report of the Task Forte on Reform of Tax Administration by Syed Shahid Hussain 2001 Reforms of Tax Administration in Pakistan Islamabad.

65 Abasyn University of Science and Information Technology Peshawar



The overall performance of direct taxes has been inconsistent when viewed in a historical perspective. A review of collection during past five years indicates that there has been significant variability in growth of tax receipts. This inconsistency not only makes mockery of tax effort, it also creates difficulties for management of the economy, as shortfall in revenue collection directly disturbs the execution of the national budget allocations. The excessive fluctuations in growth can be confirmed from the fact the net collection grew by 10.3% during FY 00-01, increased to 14.4% in the next year, but scaled down to only 6.6% in FY 02-03. A slight improvement has been seen in FY 03-04 when the growth was 8.8% (Table 4.12). Given this situation, it is relevant to know factors that cause these disturbances. Notwithstanding, these rather wild fluctuations in growth, the average share of direct taxes in the total collection has remained stagnant around 32 % during the last five years. Similarly, it is also disquieting that direct taxation in Pakistan accounts for only 3% of GDP whereas in other competing developing countries this ratio is as high as up to 7%.10 Source: SBR Quarterly Review, Vol. 4 Table 4.12 DIRECT TAXES COLLECTION AND SHARE (Rs. in billion) Years Net Collection Increase (%) Share in Total Federal Taxes (%) 1999- a) 113.0 32.6 3.0 Tax/GDP Ratio (%)


For instance, the income and corporate Tax to GDP ratio in Indonesia is 6.8%, Philippines 57%. Malaysia 7%, Thailand 6.3%, and India 3.7%. In the case of Bangladesh it is only 1.7% [Source: Information down loaded from Official Websites of respective countries).

66 Abasyn University of Science and Information Technology Peshawar


2000-01 2001-02 2002-03 2003-04

124.6 142.5 151.9 165.1

10.3 14.4 6.6 8.7

31.8 35.3 33.0 31.7

3.0 3.2 3.2 3.0 .

Source: CBR Quarterly Review, Vol 4. To gain further insight, the analysis of income tax by components during FY 9900 and FY 00-01 is presented in Table 4.13. We treat this to be the 'pre-reform' era, i.e., when the system was operating under the 1979 Act and the Universal Self-assessment Scheme (USAS) was also not offered. The historical data confirms that due to heavy reliance on WHT, having a significant proportion of presumptive taxes, the progressivity of the income tax structure to neutralize regressivity of indirect taxes has been compromised. The 27% share of voluntary compliance in FY 00-01 was low given the level of economic activity and the corporate structure in the country. At the same time, within VP, even though the share of advance taxes has increased overtime, but it was not a source of comfort, as it led to higher refund requirements in the future. Finally, despite the prevalent system of complete assessment of returns causing serious difficulties for the taxpayers, the resources generated through CoD were rather meager.

67 Abasyn University of Science and Information Technology Peshawar


Table 4.13 PERFORMANCE OF THE INCOME TAX BY COMPONENTS (Rs. in million) Revenue Heads Revenue Collection Growth Share in Collection {%) 1999-2000 2(11 MI01 Voluntary Payment With Returns Advance Tax Collection on Demand Arrear Demand Current Demand Withholding Tax Gross Income Tax 34,878 13,267 21,611 14,507 4.875 9,632 75,189 124,574 34,993 11,758 23,235 16,486 4,153 12,333 79,155 130,634 0.3 -11.4 7.5 13.6 -14.8 28 5.3 4.9 28.0 38.0 62.0 11.6 33.6 66.4 60.4 100.0 26.X 33.6 66.4 12.6 25.2 74.8 60.6 100.0 (%) 1999-2000 2000-01

Source: CBR Quarterly Review, Vol 4, 2005


68 Abasyn University of Science and Information Technology Peshawar


The reform process in the income tax system was started with the promulgation of Income Tax Ordinance, 2001 effective from 13th September 2001. The objective was to simplify the language of the Ordinance by removing ambiguities for ensuring uniformity in treatment for various categories of taxpayers, reduce dependence on withholding taxes, and encourage voluntary compliance backed by strong audit and minimum tax exemption. The introduction of USAS for all categories of taxpayers, without any conditionality has been a major break through. Under this system all the taxpayers automatically qualify for self-assessment. The concept of immunity from selection of cases for audit has been done away with. The returns received are no more examined (assessed) in detail at the time of receipt. However, a limited percentage of cases are selected for audit on risk assessment basis for various classes of taxpayers. One of the important features of the USAS has been the requirement of maintenance of accounts and related documents by the taxpayers for ensuring effective audit. Similarly, model large and medium taxpayers units, i.e., the LTUs and the MTUs have been established in major cities of the country with the objective to facilitate taxpayers. It has been observed such endeavors in other countries had been a success for the simple reason that only a limited fraction of taxpayers contribute a major chunk of revenues. Pakistan is not an exception to this rule. The second objective of these model units has been to reduce compliance cost for the taxpayers through integration of work processes. improvement in audit capacity and monitoring of arrears. Further gains are also envisioned through co-location of all domestic taxes, i.e., the direct taxes, sales tax, and central excise. There are signs that these changes have started to contribute positively. The voluntary compliance has improved significantly. From a negligible growth of 0.3% in FY 00-01, it has shoot up to 21% in FY 02-03. It increased further by 12.7% in FY 03-04. More importantly, the share of VP has jumped to 37.3% in 69 Abasyn University of Science and Information Technology Peshawar


FY 03-04 Similarly, another important development in the post-reform era has been the gradual reduction in dependence on the WHT. The share of WHT in the total income tax collection has declined from 61% to 54% during the CFY (Table 4.14).

70 Abasyn University of Science and Information Technology Peshawar


Table 4.14 POST- REFORMS PERFORMANCE OF THE INCOME TAX (Rs. in million) Revenue Heads 01-02 02- (13 Growt 03-04 Growt h (%) h (%) 02- OIW 03 Voluntary Taxpayer a) With returns li) Advance lax 48,8% 59.070 20.8 13.267 11,758 -11.4 35.629 47.312 32.X 66,544 12.7 9,854 -16.2 M %AgiShare

34.8 37.3 27.1 1<).V 72.9 XO.l 15.1 11 1

56.690 19.8 19,884 -22.1

Collection on Demand 23,247 25.539 9.9 {cod) c) Arrear Demand d) Current Demand Withholding Tax. 4,355 4.530 4.0



18.7 17.7 81.3 82.3 50.1 5 1 .li


18,892 21.009 11.2 78.884 84,973 7.7

15,754 -25.0 92.018 8.3 178,44 5.2 6

Total Gross Income 151,02 169,58 12.3 Tax 7 2


Source: CBR Quarterly Review, Vol 4, 2005


71 Abasyn University of Science and Information Technology Peshawar


The corporate sector is the backbone of the economy. It is the largest contributor of direct tax receipts in the developed world. In an effort to understand its contribution in Pakistan, the income tax structure has been further evaluated separately for the corporate and noncorporate sectors. To refresh us the corporate sector consists of listed public and private companies, including banking companies. Currently 21,008 companies are registered with the tax department against over 40 thousands listed with the SECP. Even more unfortunate fact is that only 11,526 companies have filed corporate returns during FY 04-05. Of which 468 are public companies, only seven are registered as foreign companies and the remaining 11,051 belong to the private sector. The tax profile of the sector reveals that gross collection of Rs. 92.2 billion has been generated by the corporate sector. Its share in the total income tax gross collection has gone up to 66.2% during current fiscal year from 63.9 % during last year (Table 4.15). Probably, the differential in the corporate tax rate structure, i.e., 35% for the public limited companies and 39% for the private limited companies on the one hand and comparatively higher overall corporate rate on the other are the apparent reasons for low level of corporatization in the country. It may be added that the Income Tax Ordinance, 2001 provides for progressive reduction in these tax rates by 2% for the privately incorporated companies per annum for the next 5 years and 3% for the banking companies to achieve parity in rates at 35% by tax year 2007.

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Table 4.15 INCOME TAX COLLECTION BY SECTORS (Rs. in million) Collection up to March Growth Share (%) 04-05 Corporate sector (i+ii) i) Advance tax ii) Other collection Non-Corp sector (iii+iv) iii) Advance tax iv) Other collection Income tax collection 92,195.4 8, 102.3 54,093.1 47,072.6 777.6 46,295.0 139,268.0 03-04 74,118.2 29,693.9 44,424.3 41,872.8 918.0 40,954.8 115,991.0 (%) 24.4 28.3 21.8 12.4 -15.3 13.0 20.1 04-05 66.2 41.3 58.7 33.8 1.7 98.3 98.3 03-04 63.9 40.1 59.9 36.1 2.2 97.8 100.0

Source: CBR Quarterly Review, Vol 4, 2005 A further break down into public, private and banking companies presents an interesting picture. Currently the public companies despite their small number (468) are the major contributors in total gross collection. Their share has been around 52%. The private and banking companies on the other hand have contributed around 36% and 13%, respectively in gross receipts of Rs. 92.2 billion (Table 4.16). This outcome is against the conventional wisdom that the private sector is the mainstay of the economy. Thus, the future policy planning to encourage private investment in the country needs to be carefully assessed within the available information. Source: SBR Quarterly Review, Vol. 4

Table 4.16 73 Abasyn University of Science and Information Technology Peshawar


SHARE OF CORPORATE SECTOR IN TOTAL GROSS COLLECTION (Rs. in million) Type of Corporations Collection up to March 04-05 Public Private Banking Total 47,757.2 32,729.4 11708.8 92,195.4 03-04 36,985.0 27,127.3 10,005.9 74,118,2 29.1 20.7 17.0 24.4 Growth % 04-05 51.8 35.5 12.7 100.0 03-04 49.9 36.6 13.5 100.0 Share (%)

Source: CBR Quarterly Review, Vol 4, 2005


The promulgation of Income Tax Ordinance, 2001 has brought positive changes in the income tax system. However, there are a number of areas where more effort is desired. With increasing pressures of globalization of the world economy, continuous revisions are required in the corporate tax structure to attract FDl. Secondly, the WHT structure needs streamlining to minimize tax burden on final consumers. Thirdly, with the introduction of USAS the audit function has to be strengthened in the light of experience of those countries where audit has a high degree of success. Fourthly, serious effort is needed for broadening of tax base, as the existing tax base is too low by any standard. The corporate base is not only narrow but also largely dormant that needs to be activated. Finally, a much stronger linkage is required for information flows between headquarter and field offices for improving tax compliance and efficiency gains. (SBP, 2005) 74 Abasyn University of Science and Information Technology Peshawar


SECTION: -4 Chapter-5
5.1 SUMMARY In the past the taxation system in Pakistan was suffering from two major weaknesses, namely the difficulties arising out of complicated laws and procedures, and inefficiencies emerging due to administrative bottlenecks. In an effort to correct this situation, a reform agenda focusing on wide ranging revisions in tax laws and tariff structure as well as envisioned towards the second half of the 1990s and beginning of the new millennium. It required major shakeup in the whole system of taxation system through sequential and parallel actions. Using the experience of other countries, the reform program included establishment of additional support units for large and medium taxpayers. Even through many reform related activities were initiated over the past three years, the formal launching of the Tax Administration Reform Program (TARP) took place of 4th April 2005. In order to improve the tax machinery and its working, main focus has been placed on revenue operations, management services and policy and reforms. The overall strategy is to increase voluntary tax compliance through better management and facilitation of the tax payers. The old and primitive field structure in tax collection has equally contributed in the inefficiency of tax system. The experiment of establishing Large Tax Payer Units (LTUs) and Medium Tax Payers Units (MUTs) has been a success on the basis of a number of indicators, including revenue collection, joint audits by income and sales tax teams, enforcement provision of modern facilities, 75 Abasyn University of Science and Information Technology Peshawar


and facilitation of the taxpayers. It is anticipated that complete integration of domestic taxes will further improve the efficiency of the system. Enforcement is an important area of reform in view of the weak tax compliance. It is envisaged that the tax policy and administrative reforms should lead to better enforcement, as complete tax profiles of target population will be available to the tax administrators. So the major areas of reforms under (TARP) are the human resource development, audit, enforcement, appeals and dispute resolution, and tax payers education and facilitation. The enabling environment is to be provided through the extensive IT support. It is anticipated that there changes will help in transforming the taxation system on modern lines where the three principles of equity, efficiency, and transparency will be universally adhered. 5.2 FINDINGS AND SUGGESTIONS The main finding of the study has set the following hypothesis. Hypothesis-1: We accept the hypothesis that the tax reforms have a positive effect on revenue collection. Remarks: The tables and graphs in the chapter-4 clearly indicate that the tax reforms have a positive effect on revenue collection. If we look at the data given in chapter-4 there is increased in revenue from 2001-05. So these increases in revenue indicate that the tax reforms have positive effect to raise revenue collection. The tables and graphs are given in chapter-4 indicates that due to the provision intakes facilities and board base the net the CBR achieve greater 76 Abasyn University of Science and Information Technology Peshawar


revenue due to such efforts of CBR the revenue collections are increased so from the data given that in chapter-4 there is a positive effect of tax reforms on revenue collection. Hypothesis-2: Tax reform does not hit the estimated target of the fiscal years. Remarks: From the tables used in chapter-4 indicated that due to tax reforms the revenue collection increased but it failed to achieve the estimated target so this is because of the tax evasion, corruption and other weakness in the entire tax system of Pakistan. So due to such weaknesses in the tax system the govt. of Pakistan failed to raise revenue to the estimated target. OTHER FINDIGNS ARE: The continuation and extension of the tax reforms policies that major relief and facilitation measures have been announced like self assessment across all taxes, zero rating in five export oriented sectors etc, provision for alternative dispute resolution across all taxes special package for overseas Pakistanis, special incentives for more than sixteen important sectors like agriculture and: education, health and energy, exemption from all taxes for the import of agriculture machinery, plant and equipment, and sample user friendly income tax and sales tax forms. At this stage, let me assure that the wide ranging reforms initiated in the tax administration and the govts commitment for creating a compliance culture would not only benefit the govt: in the form of revenues but tax payers and in all the whole nation. Financial year 2002-05 has been a year of substantial growth in revenue collection, payment of sales tax refunds and expansion in tax base. The gross sales tax collection has risen to Rs.238.693 billion indicating a risen of 17.9% 77 Abasyn University of Science and Information Technology Peshawar


over the gross collection or Rs.202.519 billion in the preceding year. The share of sales tax collection in the total taxes collected by the CBR has also totaled from 41.9% to 44.18% so the tax to GDP ratio improved is for the year 2002-2003. The tax reforms introduced in Pakistan a few years ago have given an impressive boot to the tax revenue collection and also change the tax culture in the country. The overall level of fiscal effort in Pakistan is low and the tax to GDP ratio has remained, more or less, stagnant at b/w 12 to 13 percent. There is overdependence on indirect taxes, which until recently accounted for a share in revenues of over 80%. This has increased the regressively of the tax system and imposed a higher excess burden of taxation. The effective tax bases of most taxes are narrow due to wide ranging of exemptions and concessions and rampant tax evasion etc. Due to tax reforms, the revenue increased but not to the desire level this is because of lack of technical persons, officials and also the corruption and tax. The entire taxation system of Pakistan is not faire. Therefore, the tax revenue is inefficient and do not fulfill the expenditure gap.

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SUGGESTIONS Reforms can be successful only of simultaneous analysis is conducted of

the whole system, that it, tax structure, tax administration, state of economy, tax payers attitudes, revenue needs of the country and all other allied aspects. Measures that is necessary to make a tax system successful rate to: Devising and running an efficient and truly independent justice system. Provision of expert legal advice for crafting of laws, designing of tax forms and procedures, Improvements in management of tax department, a broad-based personal policy and Training of tax administrators. Educating taxpayers and making them realize their duty to pay tax. Development of work ethics, Provision of healthy working conditions. Efficient red ressal machinery for problems of workmen and tax payers. The tax system is simple and convenient. There is a friendly environment b/w the tax collectors and payers. The tax system should base on ability to pay system. The entire tax system should simple and known to every one. So that every body knows the fact that for what purpose I pay the tax to the government.

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CONCLUSIONS Tax culture that promotes voluntary compliance and inculcates tax payer

friendly environment is always assumed as a key success. However, it also needs to be a system of penalties and prosecution for tax evaders and dodgers, other wise, it is likely that the tax delinquents will betray the trust and confidence reposed on them by taking advantage of the self assessment scheme and automated refund system. Therefore, the tax policy in Pakistan needs strike a balance between there two important aspects. It is quite conceivable that in the initial stage of reforms there may be a temporary dip but as long as the structural things raise the threshold level of collection, the dip may be tolerable. But if the buoyancy, elasticity estimates do not improve and enforcement is not strengthened the dip may persist. The increase in tax revenues in recent years can not be attributed to the tax reform. On the contrary the data shows that the system of voluntary compliance has not been instrumental in yielding more resources at least in initial years of tax reform due to absence of effective audit, enforcement and penal actions.

80 Abasyn University of Science and Information Technology Peshawar