The whys of low tax revenue Jamil Nasir Thursday, July 05, 2012 From Print Edition

The tax authorities are Rs47 billion short of the revenue target for the financial year 201112. The revenue collection reported in the media is Rs1,905 billion, which includes Rs25 billion collected by the Sindh Revenue Board (SRB) on services, against a target of Rs1,952 billion. The low economic growth due to power shortages and the poor law and order situation are being cited as the main culprits in the revenue target being missed. Some experts have also argued that the higher collection of taxes compared with last years is merely due to double-digit inflation and the hike in oil prices. Revenue collected through administrative measures is very low, and as such the tax authorities had little role in the realisation of Rs1,905 billion. To support their assertion, such tax experts argue that it is mainly through the broadening of the tax base that the tax authorities can enhance tax revenue, and on this front they have failed miserably. The role of the tax authorities or the reasons for missing the revenue target fixed for the financial year 2011-12 may be debated, discussed and disputed, but one point is clear: that revenue collected is far lower than our tax potential. Low tax base is one of the fundamental reasons for low tax revenues. The tax potential of the country cannot be exploited unless the tax base is broadened and tax evasion is controlled. The rampancy of tax evasion is due to multiple factors. A weak deterrent policy and low tax morale are perceived as primary reasons. The standard argument goes that if the probability of detection of tax evasion is low and punishment is not high, people will have every incentive for not paying taxes. However, a taxpayers behaviour towards paying taxes should not be viewed in isolation. If the majority of people having taxable incomes pay taxes, a citizen outside the tax net will also feel obligated to do so. On the other hand, if the perception is that everyone is cheating, the citizens who want to pay their taxes honestly will also have little motivation. So tax morale should not be seen as an isolated phenomenon. Tax morale depends on the degree of rampancy of tax evasion in society. A taxpayer is strongly influenced by his perception of other taxpayers (or potential taxpayers). If a taxpayer believes that tax evasion is high, tax morale decreases. On the other hand, it increases if he perceives others to be honest. This is what the literature on tax compliance says. In the context of weak deterrence and low tax morale, raising tax revenues becomes an exceedingly difficult task. In our country, the prevailing perception is, and it is absolutely correct, that the elite and the mighty do not pay taxes despite their being the main beneficiaries of the public goods provided by the state. For example, the majority of the political elite either do not pay taxes at all or just pay peanuts compared what they should be paying in terms of their incomes and wealth. But most of the security paraphernalia is deputed for their security. It is an open secret that the majority of the police force remains deputed for the security and protocol of such political elite. Maintenance of law and order is a public good which the state provides out of tax money but deputing security personnel for the security of such elite detracts from the very nature of the public good as such force is not being utilised for the security of the people at large. Deputing security personnel for the individuals is a private good in true economic sense. Paying for the upkeep of such security paraphernalia from the public kitty is not justified as tax money is supposed to provide public goods by the state.

It is not easy to boost the tax morale of the citizenry in a culture of protocols. The non-tax paying behaviour of the elite is despicable, not only in the sense that they are not contributing their due share to the public revenue but also to the point that such a behaviour weakens the tax morale of existing and potential taxpayers. In this context, the assumption that the tax base will be increased merely through the efforts of the tax authorities is patently a bad assumption. Empirical literature points to the complexity of the tax base phenomenon. According to empirics, three relationships are very important. The first is between tax base and inequality. Tax base has negative relationship with income inequality, which thereby means higher income inequality in society is responsible for low tax base. The relationship between the tax base and income inequality seems very appealing and logical. Ours is a very pertinent case. About 90 percent of people do not have the capacity to pay taxes and those who have it do not pay. So the 90 percent cannot associate themselves with the state and the remaining 10 percent do not want to associate themselves as they send their children to private schools (so education is not a public good for them). They visit private hospitals, inside or outside the country. It is thus very clear that high levels of inequality and low tax base have implications for state building. It is not possible to forge strong social contract between the state and the citizenry if inequality is high and tax base is low. The policy implication is simple and straightforward: take bold policy initiatives to reducing income inequality if you really wish to increase the tax base. The second relationship relates to the nexus between corruption and low tax base. The empirical evidence suggests that there is a negative relationship between corruption index (based on perceptions) and tax base. If corruption perceptions are high, the tax base will be low. Overall corruption prevalent in the country as well as corruption in the tax collection agency both matter. If people perceive that corruption is high, they will not be motivated to pay due taxes due to low tax morale. The perception will prevail that the tax money will be wasted on expenditures that are not directly related to their benefit. Simply ask a common citizen as to why he is not paying taxes. The tax money will not be spent on me will come as an instantaneous response. Further, if the tax machinery is corrupt, the tax base will not increase as the tax officials will be least bothered to bring the potential taxpayers and businesses into the tax net. Rather they will collude with the taxpayers for their personal gains. The third important relationship in the context of low tax base relates to quality of institutions. Empirical evidence suggests a deep relationship between the tax base and quality of institutions. Low quality institutions imply low tax base. How can this relationship be explained? Two plausible explanations come to mind. First, weak institutions mean poor public service delivery and provision of public goods, hence weak tax morale and low incentive to pay taxes. Second, weak revenue agency means weak enforcement and prismatic decisions due to differential implementation of tax laws and procedures. Based on abovementioned three relationships, a social contract that incorporates the elements of inequality, corruption and institutions is direly required to enhance the tax base. Going hard on tax evaders and potential taxpayers can be helpful in broadening tax base but to a limited extent. Low tax base cannot be changed overnight. Unless public perception about fairness of the system is changed, enhancing tax base will remain a distant dream. We need to fix the roof first. First of all, those in power should demonstrate their will to pay taxes. The citizenry should have access to the assets and income declarations of all the public office holders. Reprioritisation of public expenditure where curbs on unproductive spending is the primary objective is also a must. The writer is a graduate from Columbia University with a degree in economic policy management. Email: jamilnasir1969@gmail.com