Ali Salman is an economics consultant and managing partner of Development Pool, and has worked on several projects with CIPE-DC and CIPE Pakistan. He can be contacted at ali.salman@developmentpool.org
Trusting small enterprises and adapting laws to reflect social contracts for business transactions holds the answer to formalizing the informal sector; levying more taxes will only harm that cause.
One of the key policy objectives associated with the levy of a reformed general sales tax in Pakistan is to expand the tax net, or in other words to reduce the informal economy. The bulk of Pakistan’s economy is underground, or ‘extralegal’. The accounts are multiple, but most would identify the size of the extralegal economy within 30 to 50 percent of Pakistan’s economy or roughly 51 billion dollars in total economic activity.
Recently in Pakistan’s Express Tribune, I argued that a new high tax of 15 percent on revenues is a sure barrier for small businesses to disclose themselves. Such an imposition of a new reformed general sales tax is unlikely to bring new businesses on the register and is in fact more likely to reduce the overall collections.
People do not opt to live in the extralegal sphere out of a fear to pay taxes; they may end up paying far more than the legal taxes, as extralegal framework is not free. The instances of legal failure – not in the sense of implementation failure but in the sense of failure in updating laws according to current social norms – are many.
The Federal Board of Revenue faces the herculean task of expanding the tax base. For this, they must start with trust on the millions of small enterprises which are ready to pay taxes to get other benefits from documentation such as access to formal credit. A sales tax of even 15 percent after reform is simply too high to induce these millions of businesses to disclose them. An ideal tax rate will be much lower but its exact calculation should be best left to detailed economic research.
A tax structure must reward businesses for disclosure, not punish them.
Published Date: January 05, 2011