From GST to RGST: a raucous ride.
Ahmed, Ather Maqsood
The transition from General Sales Tax (GST) to Reformed General
Sales Tax (RGST) has become an intricate and controversial topic for no
particular reason. Let me start the discussion by acknowledging that
RGST is not a new tax as generally perceived, rather it is the old GST
which when fully implemented would be a sufficiently broadened and
extended version of the existing GST. The changes in the existing GST
would include withdrawal of many of the exemptions and concessions that
have been granted over time, gradual abolition of the zero-rating of
domestic sales while maintaining zero-rating of the export sector, and
extension of the existing GST to services that are currently outside the
tax net. Thus, those who are opposing RGST believing it to be a new tax
are required to be properly educated by the Sales Tax and the
Taxpayers' Education and Facilitation wings of the Federal Board of
Revenue (FBR).
In order to understand the possible challenges and opportunities
that could be encountered while implementing RGST let us go back in
history and remind ourselves that the transition from sales tax (ST) to
GST in early 1990s was not smooth and trouble-free and we should not
expect anything different when progressing from GST to RGST. Despite
initial hiccups due to operational difficulties and resistance from the
business community we know that sanity did prevail and the first phase
of GST was levied. The policy decision that there will be
substitutability between indirect taxes was one of the motivational
factors for the acceptance of GST. The stakeholders were informed that
the new tax called GST would replace most of the existing excise duties along with substantial reduction and rationalisation of customs duties.
Thus, the additional burden of the tax will be substantially less than
what was being anticipated at that time. However, despite this
assurance, the speed of implementation of GST was unfortunately fairly
slow as compared to the speed at which tariffs were reduced and
rationalised and excise duties were removed. Consequently, there was a
revenue loss for the revenue authority equivalent to one and a half to
two percent of GDP while the benefits were not passed on to the final
consumers. This clearly indicates that without due care there is an
initial cost of reform initiative in fiscal domain.
It is also relevant to discuss at the outset the rate structure of
GST. As we all know that the experimentation of sales tax rate started
with the adoption of 12.5 percent rate that was quickly raised to 18
percent in subsequent years. It was reverted back to 15 percent only to
be increased again to 16 and then to 17 percent. Higher and multiple
rates also prevailed for the non-documented sectors. Realise that all
these changes were introduced within a short span of 15 to 20 years
which is an obvious indication of inconsistency and indecisiveness.
While the revenue authority did gain in terms of tax collection, there
was an obvious cost of this topsy-turvy behaviour for the taxpayers. The
transition from GST to RGST has been analysed within this backdrop while
acknowledging the fact that now we are moving from easy to tax, i.e.,
taxation of commodities, to relatively difficult to tax areas, i.e.,
taxation of services, while gaining some of the turf that was lost to
powerful players in the shape of concessions and exemptions.
What could have been the challenges and gains if the Government
decides to levy RGST from January 2011? To answer this critical
question, let me concentrate on four areas. The first one naturally
relates to possible revenue gains from RGST. One needs to have fair idea
of how much additional revenue could be collected when the tax base is
broadened by bringing additional services into the tax net. (1) The
second and third issues concern with macroeconomic and distributional
consequences of GST. Finally GST has serious issues with regard to tax
administration, especially related to tax fraud and the operational
readiness of FBR. One has to evaluate whether or not the tax
administration is ready for this ambitious undertaking.
Using Sales Tax Forecasting model, an initial exercise was
undertaken to determine the revenue gains of bringing additional
services in the tax net. The assumptions to start calculations included
use of 15 percent rate for such services as construction and land
development, wholesale and retail trade, banking and insurance, real
estate, ownership of dwellings, personal and household services, social
and cultural services, and business services. To start with health and
education services are assumed to have been exempted from tax on the
grounds that the country is already deficient as far as human capital
development is concerned. A very low compliance rate of 20 percent has
been assumed for the simple reason that the overall compliance rate,
especially at the wholesale and retail level, was quite low before the
introduction of e-filing in GST.
Using this information, it was found that RGST could fetch an
additional sum of Rs 35 billion on account of new services. As of today
when half of the year has already passed, if the tax is levied from
January 1st, we should expect no more than Rs 17 to 18 billion of
additional revenue in the remaining six months. On the other hand,
learning from international experience, if we start with a lower tax
rate of 10 percent rather than 15 percent then the amount of additional
taxation will reduce to Rs 10-12 billion only. Simultaneously, since the
tax authorities are contemplating on reducing the existing standard tax
rate by at least one percentage point and are also planning to do away
with higher tax rates, we expect that the cost of these measures would
be around 10 to 12 billion rupees. Thus, taken together, it essentially
reduces to a zero sum game. Under these circumstances when initial
revenue gains are negligible, the natural question is should the
authorities pursue an extended version of GST which would be much closer
to VAT? Notwithstanding this less than optimistic scenario, I strongly
favour reformed GST over the existing GST for the simple reason that a
broad-based tax on consumption (GST or RGST or VAT, the name really does
not matter) is a money machine. There is enough evidence in the
literature to prove that countries which have opted for a comprehensive
VAT have generated so much of revenue that they were able to increase
the size of the government on the one hand and spare enough resources
for productive investment leading to employment and growth on the other,
(2) Since Pakistan is in dire need of additional resources, we need to
revamp GST as early as possible.
It is unfortunate that the tax has been made controversial without
analysing the macroeconomic and distributional consequences of a
broad-based GST. There is a widespread fear that RGST will be highly
inflationary. In this regard it is important to note that to the extent
that certain exemptions will be withdrawn and additional services will
be liable to taxation there will be a difference in producer and
consumer prices. Hence some prices would go up. On the other hand, since
the standard rate will be reduced and higher rate structure will be
abolished, this should result in lowering of prices of a large number of
commodities. It is anticipated that the net effect will be only a
marginal increase in prices not because of additional taxation rather
due to downward rigidity of prices as businesses seldom reduce their
prices. Besides this, inflationary consequences would also depend on how
monetary policy is coordinated with the fiscal policy. An accommodating
monetary policy would mean that prices will rise by the amount of tax,
whereas a tight monetary stance would imply reduction in factor payments
and therefore there will be limited consequences for inflation.
Regarding trade balance and investment, the impact of tax on trade
balance is expected to be neutral. While imports will be discouraged
because of tax and exports are already zero-rated, we should not expect
trade balance to deteriorate. Similarly, the tax will not be
anti-investment as such provisions as input adjustment and refund on
input tax will continue to be available on raw material and machinery
and equipment.
Regarding distributional consequences, contrary to available
evidence it is quite common to hear that the burden of tax is going to
be shifted to lower segments of the society and hence it will
regressive. At least three recent studies are available in the
literature where incidence of GST has been quantified using Household
Income and Expenditure Survey (HIES) data. All of them have concluded
that GST tax is mildly progressive. If indeed this outcome is true then
we should actually be looking forward to this tax rather than blocking
it. Another critical factor to be considered is what is the alternative
to GST? Historically the alternatives to GST are customs and excise duties, which incidentally are more regressive than GST.
Let me make my final comment on matters pertaining to tax
administration. The two issues that are of immediate concern are:
possibility of tax fraud and operational readiness of tax authority in
extending the tax base to hard-to-tax areas. The tax fraud originates
from zero-rating of exports, allowance for input adjustment, carry
forward, refund claim on inputs and similar provisions. Many developed
economies, where systems and procedures are firmly in place, are
continuously being haunted by the menace of tax fraud. The developing
countries are relatively more vulnerable to this. Pakistan too has
serious problem with authenticity of refund claims and their timely
disbursement. The authorities tackled the issue by zero-rating of five
export-oriented industries and later on the concession was extended to
some other industries. It was well understood that zero-rating would
seriously jeopardise VAT spirit, but there was limited choice.
Technology through computerisation of taxpayer records was supposed to
help in finding out the true extent of refunds and rebates while
squashing the use of flying and fake invoices, but it has failed FBR for
one reason or the other. How to get around this problem so that the true
spirit of VAT is preserved and tax fraud is minimised remains a critical
concern. Even though some progress has been made in this regard, but the
problem is expected to aggravate when an extended version of GST will be
in operation.
Similar is my concern on operational readiness before embarking
upon RGST. Currently the tax base is very narrow both in terms of
commodities as well as taxpayers. There are only five commodities that
generate nearly 80 percent of domestic sales tax receipts and less than
1500 taxpayers contribute nearly 90 percent of domestic sales tax in
this country. We are all aware of the fact there are large number of
cities in all provinces producing specialist goods but unfortunately the
tax collection is very low because the business activities are largely
un-documented. (3) Has the tax department prepared itself to exploit the
tax potential of this largely informal sector? Has the process of
business registration and documentation started? If the answer to these
questions is no, then obviously or we have already given up the hope. We
have, therefore, indirectly accepted that the possibility of broadening
the base is very limited in the informal sector? In this case the
implementation of RGST is too far off from reality and we should forget
about deadlines. Thank you very much.
(1) It is important to point out that some of the services having
significant tax contribution, like telecom and financial services, are
already in the tax net. albeit indirectly.
(2) In Pakistan also GST is a leading revenue spinner--the
contribution of GST in federal tax receipts is nearly 40 percent.
(3) For example Sialkot is producing sports goods, Wazirabad
cutlery, Gujrat fans, Okara furniture, Kasur leather goods and so on.
Ather Maqsood Ahmed is currently Professor of Economics at NUST Business School of National University of Science and Technology,
Islamabad.