Bridging the tax gap

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The Federal Board of Revenue is under pressure to achieve the revenue target of Rs2.4 trillion for this fiscal year. It is said that the best way to raise taxes is through accelerated economic growth. However, the lacklustre growth due to a myriad of social, economic and political problems provides little space for raising additional tax revenue.

The apex tax authority, therefore, needs to focus on exploiting the existing tax gap for extra tax collection. The tax gap emanates from faulty tax policies and imperfect enforcement. And the tax policy gap arises from exemptions and tax amnesty schemes.

There is an enormous revenue loss due to exemptions, allowances and deductions from income tax, sales tax and customs duty, which was Rs887.5 billion or equal to 3.9pc of GDP in fiscal year 2012-13.

Generally, the tax incentives (exemptions) are provided to the investors to boost economic growth and create jobs. Nevertheless, slow GDP expansion over the last five years or so has demonstrated the ineffectiveness of tax incentives in accelerating the pace of growth.

Likewise, the tax amnesty schemes introduced from time to time frustrate the FBR’s efforts to curb tax evasion. The tax amnesty schemes adversely affect documentation, distort uniform collection of taxes and ensure horizontal and vertical equity, violating the two golden principles of good taxation.

Such schemes widen tax policy gap as they raise expectation of taxpayers for more such packages in the future. Furthermore, as the amnesties provide immunity from tax audit, this further hinders the process of tax compliance. There are more than one form of tax evasion such as none or under reporting of tax liability.

Inadequate staff, scarcity of physical and financial resources and/or poor working capacity of the tax officials may result in weak enforcement. And taxpayers might exploit weaknesses in the enforcement mechanism to evade taxes.

In order to improve revenue performance, it is necessary to bridge the tax policy gap as well as tax gap arising from weak enforcement. Minimal use of exemptions is needed to refine the existing taxes and to provide level playing field for all sectors of economy. At the same time, it is crucial to strengthen the current enforcement mechanism by enhancing administrative efficiency and capability as well as improving taxpayer compliance through taxpayer services and education.

In addition, regular and effective examination of records could be a deterrent against tax evasion and underreporting. At the same time, appropriate training of the relevant staff could improve recovery out of demand created from examination of records. The effective use of relevant information could help bridge the tax gap besides encouraging documentation.

Listening to public opinions and suggestions could improve mutual understanding and trust between taxpayers and tax officials, and this has to be addressed at each level of tax management.

Last but not the least, it is imperative to impose stipulated penalties on taxpayers who violate provisions of law. At the same time, strengthening the tax investigation system is fundamental in creating deterrence against tax evasion and bridging the tax gap.

The writer is a graduate in tax policy and management from Keio University, Japan

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