Research Folio 33

By M. Muneer Qureshi

DG (DOT)(DT)

T

he mobilization of tax revenue has a direct nexus with the number of taxpayers participating actively in the system set up to levy and collect taxes. In the case of Income Tax the number of persons filing periodic ‘Returns’ vis a vis the total population of the country, is a key indicator of the ‘Tax Base’ for the direct taxation of income earned by individuals and other entities including corporate entities recognized as ‘persons.’

Over the years Pakistan’s (Income) Tax Base has been more or less stable at 1% or less of the total population. In the United States, 72 million Returns of Income are filed annually with the I.R.S which, given a population of 300 million, translates into a tax base of just over 24%. In Malaysia, the tax base is about 20%. In Turkey, 5%. In India, 2%. The ‘tax to GDP’ ratio has a direct correlation with the tax base size and Pakistan’s poor tax base therefore means a poor tax to GDP ratio [ 10%] which ofcourse means poor tax revenues. In fact Pakistan is placed at the lower end of the ‘T2gdp’ spectrum whereas those at the higher end – typically, the Scandinavian countries led by Sweden and Denmark- score well over 40%.

What are the reasons for this dismal tax base picture?

To begin with, the largest single sector of the Pakistan economy, agriculture, generating 22% of GDP , occupied by 50% of the total population [ ie 80 million plus] and 42.5% of the total labor force [ ie 20 million] pays zero income tax to the federal exchequer because it is ‘exempt’ from payment of income tax under the statute ie the Income Tax Ordinance of 2001 – in fact this sector has been ‘exempt’ since 1947 and the Income Tax Ordinance of 2001 is the third income tax statute to ‘renew’ the exemption originally available for agriculture in 1947 when the Income Tax Act 0f 1922 was adopted as the Income tax Statute for Pakistan.

Secondly, Pakistan’s huge and burgeoning ‘Informal sector’ – also known as the ‘black economy’ and the ‘parallel economy’- appraised variously at 35 to 55% of formal GDP- and employing some 20 million out of the total labor force of 47 million. Thus between them, these two sectors, take away 110 million out of the total population of 165 million from the ‘tax net’ leaving barely 55 million to bear the burden of tax on income.

It is to be noted that in Pakistan there are some 24 million bank account holders. This means in effect that after accounting for the 1.7 million who do file Returns of Income annually, more than 22 million do not do so. Why? Is their ‘Income’ Exempt? Is is below the taxable limit? No body seems to know. The banks ofcourse have all the relevant data regarding these account holders but the department of Income Tax has no authority to demand these details ‘en masse.’ Nonetheless this data base is there and is a veritable treasure trove of information that could have a direct bearing on the income earned by the account holders.

Thirdly, inequalities in the distribution of Income. On the universally recognized ‘Gini Index,’ Pakistan scores a poor 41. This means that a very large segment of the population remains impoverished with income levels below the threshold of taxability.

If we are to succeed in augmenting income tax revenues significantly then we have to address the core reasons for the narrow tax base pointed out in the preceding paragraphs.

Strictly on merit it is neither fair nor logical to make a distinction between agricultural and non-agricultural incomes for purposes of taxation. A distinction so made arbitrarily amounts to creating a preference for one class of income over the other. Instead of creating such a preference for which there appears to be no economic justification, it is suggested by the counter exemption lobby that just as business and salary incomes below a certain level are exempted from income tax, the same principle should be extended to agricultural cultural income. This would take care of the subsistence farmers who would be automatically excluded.

Levy of income tax on agricultural income is also recommended to reduce the evasion of income tax in Pakistan which is by all accounts, considerable. The availability of statutory exemption for agricultural income has resulted in the systematic exploitation of this exemption by those enjoying non agricultural income. Through the simple expedient of attributing part of their income to agricultural activity they are able to secure substantial tax benefits. In reality of course such people are not actually significantly engaged in agriculture at all. However since they have purchased agricultural land-which may be marginal land or even wasteland (banjar) for all they care- it is not too difficult to hoodwink the federal tax authorities on the bonafides of the investments made by them and attributed to the earnings of their agricultural holdings.

On another and more subtle plane, the "phantom" flow of funds from agricultural to non agricultural business contrived artificially through the creation of "ghost" liabilities, has provided legal cover to substantial investments funded by accumulations of untaxed "black" money. Had agricultural income been subjected to income tax then it would not have been so simple a matter to create such liabilities as the affairs of the agriculturist would have been as much subject to scrutiny as the person engaged in business. So far however, the income tax authorities have no direct record of the agricultural activities. Only sketchy information of dubious origin is relied upon to decide on the bonafides of a reported liability shown as owing to the agriculturist. Again, since bank accounts are as a rule not reported to the tax authorities - only those accounts are reported that "suit" the taxpayer, the cash flow of funds constitute an added impediment in this context as these cannot be monitored.

Thus if incomes generated through agriculture were made taxable, the "facilities" presently available through the "devices" mentioned above, for securing huge unwarranted tax benefits, would be effectively neutralized.

The feasibility of mobilizing revenues from the agricultural sector through direct taxation of income generated there is also apparent from the fact that the agricultural income tax would be more income elastic than land revenue. With a greater yield per acre, higher procurement prices and mechanization, incomes in the agricultural sector have risen considerably, but yield, in terms of direct taxes on agriculture, has lagged behind appreciably. To illustrate the point, it is pointed out that between 1972 -73 and 1978 -79, the yield from the direct taxation of agriculture (land revenue and irrigation charges) increased by 78%, while value added in agriculture, at current factor cost, increased by 157%. There is every reason to say that this trend continues to this day.

That the taxable capacity of the larger farmers (who constitute the rural elite) has improved over time is evident from the considerable increase in consumption expenditure of the rich farmers. According to Alavi, even when there are adverse changes in the terms of trade for agriculture, the rural elite enjoy considerably enhanced real incomes.

The conspicuous consumption of the rural elite is not only an indication of the steadily increasing affluence of the rich farmer but it is also a pointer to another evil - that of accentuating differences in income distribution in the agrarian sector. Progressive rates of income tax, if applied to the income of this rural elite, could, over time, alleviate this malady, the persistence of which can only bode ill for the social stability of agraria and for the politico economic well being of the country in general.

However one looks at it, there appears to be little justification for a blanket exemption for agricultural income. There is no denying that the small farmer with a limited landholding may not be able to bear the burden of additional taxation.

However barring such exceptions, levy of an income tax would appear to be fully justified - and even necessary if the negative perception in the other sectors of the economy of such blanket exemption from levy of income tax for the agriculture sector is to be corrected. It is now acknowledged that one of the important reasons for tax evasion in Pakistan in the other sectors of the economy is this ‘unjust preference’ for agricultural income which provides a justification for tax payers enjoying non agricultural income to justify and rationalize tax evasion on their part.

In a historical context too, in the case of post Meiji era Japan in the 1880’s when the drive to modernize the country was launched aggressively, taxation of agricultural income was the principal source of revenue to fund the industrialization drive. Paradoxically, the taxation of agricultural income in Japan did not ‘ruin’ Japanese agriculture as many had predicted. Rather, once the agriculturist realized that agricultural income would ‘have’ to suffer tax, the agriculturist made concerted efforts to increase agricultural productivity by systematic use of natural and chemical fertilizers, use of insecticides and pesticides, better crop rotation, use of improved quality seed , improved water management, use of machinery – the tractor and harvester- , all of which resulted in greatly increased productivity and consequentially, sharply increased income for the farmer which increase made it possible for him not only to pay tax but also left him with a healthy surplus. Part of this surplus was then used to improve the farmers standard of living and quality of life.

It is clear that this improvement in agricultural productivity would not have been possible had there been no ‘slack’ in the agriculture sector. Prior to the modernization drive launched in Japan in the 1880’s, agriculture was entirely feudal in it’s organization and structure and absentee landlords owning vast tracts of land let out to harshly exploited tenant farmers had little impetus to increase agricultural productivity. All this changed dramatically once reforms were introduced and taxation levied on agricultural income.

In Pakistan, after almost sixty years of independence, there has been little ‘real’ change in the traditional, feudal complexion of our agriculture. True, land reforms have been introduced – but these have been largely cosmetic. The powerful feudal families owning much of the rural land have succeeded in making a mockery of the land reforms by resort to phoney land re-distribution on paper with the active connivance and collusion of the provincial revenue authorities whose parasitic dependence on the ‘largesse’ of the feudals has made them more than willing partners in this reactionary enterprise. As in pre Meiji era feudal Japan, these feudals have little interest in pressuring the tenant farmers to augment land productivity. All they want is their ‘ share’ and once they have received that they call it ‘quits’ and return to their comfortable lives. They know that they will suffer no tax on their income and this adds to the ‘surplus’ that is available to fuel a cycle of conspicuous consumption.

That there is a considerable ‘slack’ in the agricultural sector in Pakistan is quite evident from the available statistics [– Source: F.A.O ]. Thus, (in 2004) with a total land area of 0.9% under cultivation, Pakistan’s agricultural production index is pitched at 109 [base year 1989-91=100]. With an identical land area under cultivation, Brazil has a production index of 125. Egypt with 0.5% land area under cultivation has a production index of 109 – the same as Pakistan’s but with far less land under cultivation. Russia has just 0.1% of land area under cultivation and it’s agricultural production index is 114.

In the case of aggregate cereal production [wheat, rice, maize], Pakistan is ranked 18^th in the world [33 mill tons] while in yield it is ranked 87^th in the world [2423 kg per hectare]. Similarly, in the case of cotton production Pakistan is ranked 4^th in the world [6.6 mill tons] but in yield is ranked 27^th [1935 kg per hectare]. Again, in sugarcane production Pakistan is ranked 5^{th [57.4 mill tons]} and in productivity is ranked 58^th [49576 kg per hectare].

The above indices clearly show that there is considerable scope for improvement in agricultural productivity in Pakistan and relying on the historical experience of post Meiji era Japan, there is every reason to expect that the right set of policies – including taxation of agricultural income- will increase agricultural productivity significantly and will enable the farmer to not only pay tax on his significantly increased income but to also improve his own standard of life – as has admittedly happened in the case of Japan – one of the outstanding success stories of our times.

Coming now to the informal sector, compulsory (statutory) documentation of all economic transactions is probably the single most important step that can make a significant impact in reducing the size of this sector. A beginning has been made [after 60 years!] and the new income tax ordinance of 2001 now makes it mandatory for all businesses to maintain ‘prescribed’ accounts. However much more needs to be done especially in the case of the large ‘illegal segment’ of this sector where smuggling /hoarding /profiteering and widespread ‘underground manufacture’ and sale of spurious and counterfeit goods with brazen violation of copyright laws generate huge profits on which no tax is paid. A great deal of deterrence will have to be built into the tax code by enactment of appropriate punitive laws. High profile tax evaders need to be taken to task and prosecuted aggressively. Their successful incarceration in a State penitentiary for a protracted period is essential if the criminal elements in the informal sector are to be deterred effectively.

With regard to reducing inequalities in the distribution of income, the traditional reliance on the so called ‘progressive’ tax rate structure alone does not appear to have been very successful and much more needs to be done by re-introducing Wealth Taxation and also by direct state intervention to help and facilitate the disadvantaged and underprivileged members of society through better education facilities and healthcare and easier access to institutional credit so that they are able to compete and improve their economic standing.

We have to realize that economic prosperity must ‘trickle down’ to the under privileged sections of society and if the existing institutional arrangements and market forces do not facilitate such a ‘trickle down’ then the State must intervene and ensure that the fruits of prosperity do flow to all sections of society and do not remain concentrated in a few hands.

Given greater sectoral equity with regard to levy of tax on income, meaningful reduction in the size of the informal sector and reduction in income inequalities in the distribution of income, there is no reason why the tax base should not be greatly enlarged in size and scope so that we have not only many more taxpayers who file Returns of Income regularly but also declare significantly higher levels of income and eventually when all is said and done, it is these two aspects that will bring about the quantum jump in revenues that is presently, only a distant dream.

According to researchers and government statistics, in Pakistan 40% of the richest landowners own 70% of the arable land

1-AGRICULTURAL PRODUCTION DENSITY (PERSONS PER SQ KM)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2001)

Rank	Country	Value
1	Singapore	1,063,967
2	Djibouti	166,795
3	Kuwait	34,032
4	Bahrain	28,145
5	Andorra	23,310
6	Brunei	12,396
7	Iceland	10,396
8	Malta	10,153
9	Maldives	8,632
10	Oman	8,384
13	Japan	6,879
16	Egypt	5,361
18	Bangladesh	4,284
33	United Kingdom	2,714
41	China	2,168
61	Pakistan	1,694
71	India	1,562
76	Saudi Arabia	1,435
83	Italy	1,357
99	Iran	1,116
111	Mexico	953
128	Malaysia	772
135	Afghanistan	723
141	Brazil	673
142	Turkey	666
169	Sudan	495
176	United States	417
182	Russia	298
186	Canada	176
187	Australia	98

. 2-AGRICULTURAL PRODUCTION INDEX (INDEX 1989-91=100)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value
1	Qatar	144
2	Benin	133
3	Brunei	133
4	Burkina Faso	132
5	Tajikistan	131
6	Brazil	125
7	Romania	125
8	Kuwait	125
9	Nicaragua	124
10	Morocco	122
18	China	118
25	Sudan	115
26	Indonesia	115
30	Russia	114
31	New Zealand	114
40	Iran	111
52	Pakistan	109
55	Egypt	109
59	Saudi Arabia	108
62	Mexico	108
74	United States	107
89	India	105
93	Bangladesh	105
95	Turkey	105
117	Canada	102
136	France	100
146	United Kingdom	98
153	Sri Lanka	97
159	Italy	95

3-ARABLE LAND PER 1000 PEOPLE (HECTRES PER 1000 PEOPLE)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2001)

Rank	Country	Value
1	Australia	2,598.7
2	Canada	1,454.2
3	Kazakhstan	1,287.1
4	Argentina	901.4
5	Russia	851.4
6	Lithuania	811.5
7	Latvia	771.8
8	Guyana	688.5
9	Ukraine	667.8
10	United States	630.1
35	Turkey	358.0
39	Brazil	337.4
46	France	309.8
51	Afghanistan	295.0
65	Iraq	246.4
66	Mexico	243.4
76	Iran	215.8
99	Saudi Arabia	158.2
100	India	157.0
105	Pakistan	148.6
109	Italy	141.7
127	China	112.3
133	United Kingdom	99.2
137	Indonesia	89.7
144	Malaysia	81.0
151	Bangladesh	61.6
160	Sri Lanka	46.2
164	Egypt	41.1
187	Singapore	0.2

4-AREA, TOTAL (INCLUDES INLAND WATER AREA)

(Source: INDIVIDUAL COUNTRY STATISTICS BUREAUS)

Rank	Country	Value (Sq. Miles)	Value (Sq.kms)
1	Russia	6,592,770	17,067,897
2	Canada	3,855,103	9,980,403
3	United States	3,794,083	9,822,429
4	China	3,695,500	9,567,210
5	Brazil	3,300,171	8,543,750
6	Australia	2,966,200	7,679,139
7	India	1,222,243	3,164,242
8	Argentina	1,073,518	2,779,210
9	Kazakhstan	1,049,200	2,716,254
10	Sudan	967,490	2,504,716
13	Saudi Arabia	864,900	2,239,123
14	Mexico	758,452	1,963,542
15	Indonesia	735,359	1,903,757
17	Iran	636,300	1,647,305
29	Egypt	385,229	997,312
35	Pakistan	307,374	795,755
36	Turkey	300,948	779,119
57	Iraq	169,235	438,129
66	Malaysia	127,320	329,616
70	Italy	116,341	301,193
77	United Kingdom	94,251	244,005
91	Bangladesh	56,977	147,507
192	Vatican City	0.17	0

5-CROPS, CEREAL PRODUCTION (TONS)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value
1	China	465,835,830
2	United States	427,032,700
3	India	249,486,120
4	Russia	82,083,611
5	France	76,804,642
6	Indonesia	71,054,053
7	Brazil	70,844,274
8	Germany	56,009,539
9	Canada	55,286,644
10	Ukraine	46,117,398
11	Bangladesh	43,245,877
13	Australia	38,859,229
14	Turkey	37,441,855
16	Mexico	33,345,896
18	Pakistan	32,681,325
24	Italy	24,653,192
25	United Kingdom	24,623,430
26	Iran	24,372,103
27	Egypt	22,134,251
44	Afghanistan	6,102,395
52	Iraq	4,506,800
69	Sri Lanka	2,801,381
73	Malaysia	2,489,746
77	Saudi Arabia	2,181,474

6-CROPS, CEREAL YIELD (OF ARABLE LAND)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value Oz/Acre	Value (Kgs/Hectre)
1	Belgium	121,049	8,480
2	Netherlands, The	118,871	8,327
3	France	107,006	7,496
4	Ireland	104,663	7,332
5	Egypt	103,367	7,241
6	United Kingdom	101,941	7,141
7	Germany	99,768	6,989
8	United States	97,367	6,821
9	New Zealand	93,562	6,554
10	Japan	90,084	6,311
18	Italy	75,690	5,302
19	China	74,021	5,185
27	Indonesia	60,915	4,267
50	Bangladesh	47,745	3,345
55	Malaysia	46,392	3,250
57	Sri Lanka	46,079	3,228
60	Brazil	45,197	3,166
67	Canada	41,693	2,921
72	Mexico	39,310	2,754
84	Iran	34,953	2,449
86	Turkey	34,644	2,427
87	Pakistan	34,591	2,423
89	India	33,669	2,359
104	Australia	27,932	1,957
106	Russia	27,315	1,913
112	Afghanistan	23,836	1,670
163	Iraq	8,718	611

7-CROPS, COTTON PRODUCTION (TONS)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value
1	China	19,841,603
2	United States	13,655,807
3	India	7,936,641
4	Pakistan	6,613,868
5	Brazil	3,993,872
6	Uzbekistan	3,891,159
7	Turkey	2,832,940
8	Turkmenistan	2,425,085
9	Australia	1,304,034
10	Greece	1,212,542
12	Egypt	826,733
24	Iran	341,717
29	Mexico	205,192
42	Afghanistan	61,178
47	Bangladesh	49,604
57	Iraq	21,605

8-CROPS, COTTON YIELD (OF ARABLE LAND)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value Oz/Acre	Value (Kgs/Hectre)
1	Israel	63,687	4,461
2	Syria	57,099	4,000
3	Turkmenistan	57,099	4,000
4	Australia	55,007	3,853
5	Spain	53,168	3,725
6	Turkey	50,602	3,545
7	Niger	47,582	3,333
8	China	45,079	3,158
9	Brazil	44,822	3,140
10	Greece	41,872	2,933
11	Mexico	41,725	2,923
13	Egypt	39,653	2,778
16	United States	33,046	2,315
18	Bangladesh	32,118	2,250
26	Iran	27,658	1,938
27	Pakistan	27,629	1,935
44	Iraq	17,844	1,250
63	Afghanistan	13,918	975
70	India	11,814	828

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9-CROPS, SUGARCANE PRODUCTION (TONS)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value
1	Brazil	453,060,950
2	India	269,845,810
3	China	102,735,410
4	Thailand	70,225,246
5	Pakistan	57,364,280
6	Mexico	49,743,451
7	Colombia	40,895,749
8	Australia	40,666,468
9	Philippines	30,864,716
10	United States	30,315,005
11	Indonesia	27,116,858
17	Egypt	18,006,255
20	Iran	7,165,024
21	Bangladesh	7,147,387
50	Malaysia	1,322,774
81	Iraq	71,650

10-CROPS, SUGARCANE YIELD (OF ARABLE LAND)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value Oz/Acre	Value (Kgs/Hectre)
1	St. Vincent and the Grenadines	5,286,989	370,369
2	Egypt	1,727,259	120,999
3	Senegal	1,588,079	111,249
4	Honduras	1,562,297	109,443
5	Swaziland	1,543,229	108,108
6	Zambia	1,511,458	105,882
7	Malawi	1,498,861	104,999
8	Zimbabwe	1,464,089	102,564
9	Chad	1,447,880	101,428
10	Burkina Faso	1,427,487	100,000
15	Iran	1,325,523	92,857
16	Australia	1,268,985	88,896
26	Brazil	1,075,523	75,343
27	Malaysia	1,070,615	75,000
32	China	1,010,956	70,820
33	United States	1,008,808	70,670
34	Mexico	1,008,003	70,613
46	India	852,314	59,707
58	Pakistan	707,692	49,576
70	Bangladesh	566,140	39,660
86	Iraq	309,289	21,667
88	Afghanistan	271,223	19,000

11-CROPS, WHEAT PRODUCTION (TONS)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value
1	China	100,674,380
2	India	79,432,552
3	United States	64,905,597
4	Russia	46,517,537
5	France	43,696,722
6	Germany	27,939,182
7	Canada	26,965,070
8	Australia	24,802,004
9	Turkey	23,148,537
10	Ukraine	22,279,585
11	Pakistan	21,789,387
12	United Kingdom	17,312,901
14	Iran	15,432,358
19	Egypt	7,912,231
21	Brazil	6,653,000
28	Afghanistan	4,807,180
35	Mexico	2,755,778
43	Saudi Arabia	1,763,698
48	Bangladesh	1,381,196

12-CROPS, RICE PRODUCTION (TONS)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value
1	China	205,834,590
2	India	137,127,530
3	Indonesia	58,532,845
4	Bangladesh	41,788,621
5	Vietnam	39,132,051
6	Thailand	27,778,245
7	Myanmar	25,353,160
8	Philippines	15,652,820
9	Brazil	14,722,800
10	Japan	12,566,349
11	United States	11,274,396
12	Pakistan	8,344,497
14	Egypt	6,613,868
18	Iran	3,747,858
22	Sri Lanka	2,766,581
24	Malaysia	2,407,073
38	Australia	589,737
41	Afghanistan	477,301
43	Turkey	440,925
55	Mexico	211,137
59	Iraq	165,347

13-CROPS, MAIZE PRODUCTION (TONS)

SOURCE: FOOD AND AGRICULTURAL ORGANIZATION OF UNITED NATIONS (Year 2004)

Rank	Country	Value
1	United States	328,745,710
2	China	145,350,770
3	Brazil	46,238,657
4	Mexico	22,046,226
5	France	17,353,687
6	India	15,432,358
7	Romania	14,584,714
8	Argentina	14,330,047
9	Indonesia	12,521,208
10	Italy	12,478,164
13	Canada	8,889,369
22	Turkey	3,306,934
32	Pakistan	1,984,160

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14-EMPLOYMENT IN AGRICULTURE AS SHARE OF TOTAL (PERCENT)

(Source: INTERNATIONAL LABOUR ORGANISATION – DIFFERENT YEARS)

Rank

Country

Value