What the data from 2014 reveals about income tax, Part 1: Tax filers and non-filers

Anjum Nasim and Umbreen Fatima

The government of Pakistan collects income tax from both filers and non-filers of income tax returns.  In this article, we examine the share of tax collected from filers and non-filers in total federal income tax in tax year 2014 (TY2014).[1] We also comment on the limitations of withholding taxes if the burden of taxes is to be shared equitably across tax filers and non-filers.[2]

The income tax returns filed in TY2014 by companies, association of persons and individuals were in excess of 0.856 million.[3] Tax filers contributed about 63 percent to total federal income tax. The remaining 37 percent was collected from non-filers in the form of withholding taxes.[4]

How income tax revenue breaks down by mode of collection

In TY2014, gross federal income tax collection was Rs 919 billion, of which Rs 64 billion was refunded to taxpayers. Net income tax collection constituted 36 percent of federal tax revenue.

There are three principal modes of federal income tax collection in Pakistan: withholding taxes, voluntary payments by taxpayers and collection “out of demand”: taxes raised by the Federal Board of Revenue (FBR) on the basis of tax audits and from the recovery of outstanding payments.

As seen in the chart below, withholding taxes contributed the most to gross income tax collection (62 percent), followed by voluntary payments (29 percent), and collection “out of demand” (9 percent).[5] These ratios were 51.5 percent, 37.3 percent and 11.2 percent a decade earlier.

Distribution of income tax by mode of collection

(source: FBR Year Book 2014-2015)

Withholding taxes have been instrumental in increasing the share of income tax in total federal taxes from 14.4 percent in 1989/90 to 37.9 percent in 2014/15.[6] However, it is important to note that some withholding taxes may not be different from indirect taxes – such as customs and excises – thus exaggerating the share of income tax in total federal taxes.

The collection “out of demand” has been very erratic over the years. From 2001 to 2014, it was as low as 3.2 percent of gross income tax collection in 2006/07 and peaked at 17.6 percent in 2009/10, with considerable variation over the period.

The share of tax filers and non-filers in income tax

The total income tax declared, as listed in the TD2014, was Rs 491 billion.[7] If we assume that the taxes ‘out of demand’ (Rs 81 billion) and those listed under the category of ‘miscellaneous’ (Rs 4 billion) were raised exclusively from tax filers in 2014, then the tax paid by tax filers in TY2014 was Rs 575 billion. Since gross income tax collection was Rs 919 billion, it follows that Rs 344 billion of gross income tax collection, exclusively in the form of withholding taxes, is attributable to non-filers. The distribution of taxes paid between filers and non-filers is shown below.

Distribution of income tax between tax filers and non-filers

(Authors’ calculations)

We next consider withholding tax collection, the main component of gross income tax collection for TY2014. The total withholding income tax collection in TY2014 was Rs 572 billion. Subtracting our estimate of Rs 344 billion as withholding tax payment by non-filers, yields Rs 228 billion as withholding tax payment by tax filers. The figure below shows the relative distribution of withholding taxes between filers and non-filers:

Distribution of withholding income tax between tax filers and non-filers

(Authors’ calculations)

While the withholding tax paid by tax filers was Rs 228 billion, other components of their income tax were voluntary payments (Rs 263 billion), tax “out of demand” (Rs 81 billion) and miscellaneous payments (Rs 4 billion). The figure below depicts the distribution of income tax paid by tax filers between these components. On the aggregate, tax filers paid 39 percent of their income taxes in the form of withholding taxes. This ratio could, however, vary across different categories of tax filers (companies, association of persons, and individuals) and within the same category of tax filers. On the other hand, all non-filers pay 100 percent of their taxes in the form of withholding taxes.

Distribution of income tax for tax-filers

(Authors’ calculations)

Government efforts to increase the tax base

Although random audits of tax filers generated 7.4 percent of income tax collection in TY2014, FBR has not been very successful in recovering unpaid income taxes from non-filers. A project, ‘Broadening of the Tax Base’ that started at FBR in 2013, added 130,000 new tax filers, who filed only Rs 1.8 billion worth of tax returns. An additional tax demand by Rs 36 billion was raised but less than Rs 1 billion was collected as of 2016.[8]

Recently, the government has made it harder for non-filers to remain outside the tax net by imposing higher withholding tax rates. The cost of remaining outside the formal system can be increased further by expanding the withholding tax net and widening the difference in withholding tax rates between non-filers and filers. But even though this creates an incentive for non-filers to file their tax returns, it may not raise income tax collection if non-filers join the ranks of filers but declare their incomes to be below the threshold level of income required to impose an income tax. In this case, there would be no increase in taxes that are not withholding taxes, but the withholding tax revenue would decrease because lower rates would apply to previous non-filers turned filers.

The effort to broaden the tax base should also be intensified by recovering unpaid taxes. Identifying new tax filers and recovering tax from those who have assiduously avoided tax payment can be very challenging. It requires coordination and information sharing across ministries and departments at the federal and provincial levels, rigorous investigative work and data analysis at the FBR, and a robust legal team. Most importantly it requires strong political backing at the highest level of government to take on the economically powerful but rogue elements of society.

Without such a commitment, taxes will continue to be raised through greater indirect taxation or squeezing more taxes from existing tax filers. This will have even graver long-term consequences for social cohesion and the writ of the government.

[1] The analysis in this article is based on Tax Directory for 2014 (provisional edition) (TD2014) and the FBR yearbook 2014-15, both available on the FBR website.

[2] Withholding income taxes are taxes that are collected at source, e.g., by employers at the time of payment of wages and salaries or by companies at the time of payment of dividends. Some withholding taxes in Pakistan are presumptive income taxes, e.g., on electricity and phone bills, or on cash withdrawals from banks, or on imports and exports. Some withholding taxes are adjustable against final tax liability but others are un-adjustable.

[3] We calculated the number of tax filers from TD2014 to be 0.856 million. TD2014 clarifies that a “considerable number of manually filed Returns could not be entered in the system […] due to missing identifiers on the Returns”. If account is taken of the manually filed returns, which have not been entered, the number of tax filers will exceed 0.856 million.

[4] Since our estimates of the shares of tax filers and non-filers in income tax are based on TD2014, the omission of a number of manually filed returns in TD2014 may underestimate the tax share of tax filers and over-estimate the share of non-filers.

[5] Source: FBR Year Book 2014-15, Revenue Division, Ministry of Finance, Government of Pakistan (available at: http://download1.fbr.gov.pk/Docs/20166101364010551RevenueDivisionYearbook2014-15.pdf)

[6] Calculations based on data in ‘Table-1: Federal Tax Receipts’ in FBR Year Book 2014-15.

[7] While the FBR Year Book provides figures for gross income tax collection, the Tax Directory provides the list of all tax filers (companies, association of persons, and individuals) who file their tax returns, as well as the taxes paid by them i.e. the sum of their withholding taxes and voluntary payments.

[8] See Chapter 3 in Revenue Division Year Book 2015-16, FBR, Ministry of Finance.

Anjum Nasim is a senior research fellow at the Institute of Development and Economic Alternatives (IDEAS).

Umbreen Fatima is a research associate with IDEAS.