Tax Goods and Services Not Income

Taxation System
Federal taxes in Pakistan like most of the taxation systems in the world are classified into
two broad categories, viz., direct and indirect taxes. A broad description regarding the
nature of administration of these taxes is explained below:

Direct Taxes
Direct taxes primarily comprise income tax, along with supplementary role of wealth tax.
For the purpose of the charge of tax and the computation of total income, all income is
classified under the following heads:

1. Salaries
2. Interest on securities;
3. Income from property;
4. Income from business or professions
5. Capital gains; and
6. Income from other sources.

Taxation according to a person’s ability to pay is universally accepted principle, and

income is considered a satisfactory though not a sufficient index of such ability to pay.
Income Tax is, therefore, generally recognized as a highly equitable form of taxation. A
tax levied on income neither can nor normally is shifted to others and thus its incidence is
on those for whom it is intended. Since income tax is progressive in nature, it tends to
reduce economic disparity. Tax rates and method of calculating taxable income varies
with fiscal status of the tax payer. Following are the broad categories of taxpayers:-

• Companies
• Association of Persons (AOP)
• Non Salaried Individuals
• Salaried individuals
Indirect Tax: Sales Tax
· Sales Tax is levied at various stages of economic activity at the rate of 15 per cent on:
· all goods imported into Pakistan, payable by the importers;
· all supplies made in Pakistan by a registered person in the course of furtherance of any
business carried on by him;
· there is an in-built system of input tax adjustment and a registered person can make
adjustment of tax paid at earlier stages against the tax payable by him on his supplies.
Thus the tax paid at any stage does not exceed 15% of the total sales price of the supplies;

Taxation System of Pakistan

Tax policy is concerned with the design of a tax system that is capable of financing the
necessary level of public spending in the most efficient in the equitable way possible. An
efficient tax system should raise enough revenue to finance essential expenditures
without recourse to excessive public sector borrowing and raise the revenue in ways that
are equitable and that minimize its disincentive effects on economic activities. In
developing countries, including, Pakistan, the establishment of effective and efficient tax
system faces some formidable challenges. The first of these challenges is structure of
economy that makes it difficult to impose and collect certain taxes. Economy of Pakistan
is often characterized by a large share of agriculture in total output and employment, by
large informal sector activities and occupations by many small establishments by a small
share of wages in total national income and so on. All these characteristics reduce the
possibility of relying on certain taxes such as income tax and to a much lesser extent on
sales tax.
The structure of economy of Pakistan is such that association with low literacy and
human capital makes it difficult to develop a good tax administration. The staff of tax
administration is not well educated and well trained, resources to pay good salary and to
buy necessary equipment are limited, the tax payers have limited ability to keep accounts,
the use of modern communication network is limited, it is difficult to create an efficient
tax administration. The consequence of this situation is that Pakistan ; often end up with
too many small tax sources, too heavy reliance on foreign trade taxes and relatively
insignificant use personnel income taxes. The non-availability of reliable statistics from
the business makes it even more difficult for tax administration to assess the potential
taxes that need to be collected. Uneven income distribution is also a major constraint in
Pakistan's efficient tax system. To generate higher tax revenue, the top deciles are
supposed to be taxed significantly more proportionality than low deciles. But economic
and political powers are concentrated in the top deciles, which makes the task of tax
department rather more difficult to collect taxes from top deciles/rich people. This is one
major reason that the number of income tax payers in Pakistan is very low.

Composition and tax Efforts in Pakistan

Like many developing countries, Pakistan also has very low tax – GDP ratio and mostly
relies on consumption taxes. Large majority remain out of tax net because of overall low
average incomes. Low revenue collection then results in inflation tax as an alternative to
raise revenues. Various programs with IMF has special focus on tax reforms including
improved tax governance, increasing share of direct taxes, expanding the tax net,
imposition of sales tax on wider scales and improving the tax elasticity and buoyancy.
Tax reforms efforts since 1990s are quite visible from significant increase of the share of
direct tax in total tax revenues (17.3 percent in 1990-91 and 29.4 percent in 2005-06) and
share of sales tax in total tax revenues (15.4 percent in 1990-91 and 41.3 percent in 2005-
06). Despite visible changes in tax structure of Pakistan, total tax – GDP ratio is little
above 12 percent.
Share of indirect taxes in total tax revenues is more than direct taxes, however, since
1990-91 this trend is moving in opposite direction, i.e., share of indirect taxes in total tax
revenue was 82 percent in 1990-91 which is now reduced to 68.5 percent. Direct tax is
comprised of income tax mainly. Share of direct taxes in total tax revenues has been
substantially increasing from under 20 percent to 31.5 percent since 1990-91. The sole
contribution is through income taxes, i.e., 93 percent of the total direct taxes in 2005-06.
Indirect taxes are comprised of sales tax, custom duties and federal excise tax. After the
structural adjustment program in 1987-88 Pakistan has started reducing custom duties
(50.4 percent in 1987-88 and 19.4 percent in 2005-06). Custom duties were replaced by
sales tax, which increased from 11.6 percent of total tax revenues in 1987-99 to 41.3
percent of total tax revenues in 2005-06. Share of excise tax has also declined to 7.7
percent of total tax revenues in 2005-06 from 22.3 percent of total tax revenues in 1987-
88.
It is generally believe that sales tax is a regressive tax but a rigorous study by Sadia
Refaqat in 2005 published in Pakistan Development Review concluded that sales tax in
Pakistan is not clearly a regressive tax, however 1990s reforms are slightly welfare
reducing because sales tax on items such as vegetable ghee, sugar and basic fuels are
hurting poor. This is also stated in a study by Faiz Bilquees in 2004 published in the
Pakistan Development Review that introduction of sales tax on the petroleum products,
gas and electricity directly affects the consumption of poor because they lowered the
consumption of other goods. Contrary to this it is theoretically proved that sales tax is
difficult to avoid/evade thus to improve efficiency and equity sales tax/VAT is better tax
than other.