Tax-to-GDP Ratio: A Key Benchmark to Measure a Country's Financial Health
Tax-to-GDP ratio is one of the key benchmarks to measure the financial health of any country and it represents the tax revenue collected by the Government plus the Gross Domestic Product (GDP) of the country. The Tax revenue comprises of all compulsory payments made to the Government such as income tax, withholding tax, sales tax, GST, custom duty, excise etc. whereas the 'GDP is defined as the market value of all final goods and services produced in a given period of time by all the people and companies in the country. The tax-to-GDP ratio is a key measure of the degree to which a government controls a country's resources and it gives policymakers a measure to compare tax receipts from year to year. Slowing economic growth will mean lower GDP growth and also lower tax collection. On the other hand, increasing economic growth indicate higher GDP growth and more tax collection & the jurisdictions have higher tax-to-GDP ratio also signify heaviest tax burden countries. As can be seen from the given Chart, the tax collections as a percentage of GDP in OECD countries is increasing and in 2016, it averaged 34.3 percent Denmark leads the other OECD countries with 45.9% tax to GDP ratio whereas USA stands at 12th position in the list with only 25.5% ratio.
Tax-to-GDP ratio in Pakistan
As per the Economic Survey of Pakistan for2017-18, the tax-to-GDP ratio remained within the narrow range of 9.1 percent to 10.2 percent of GDP between FY2008 and FY2012 largely due to structural weaknesses in the tax system. Since 2013, the tax-to-GDP and revenue-to-GDP ratios have witnessed a marked improvement. The present government has taken a number of policy and administrative reforms in order to tackle the low tax revenues with objective to improve the effectiveness and fairness of tax administration, promote compliance and broadening the tax base. It is expected that the dividends of these measures will be seen in the near future in shape of improved tax revenue in terms of GDP. As can be seen from the above table, the overall tax-to-GDP ratio has increased from 9.8%in 2013 to 12.6% in FY 2016, however it went down to 12.4% in FY 2017 on account of relief measures and tax incentives introduced through the Federal Budget 2017. As per State Bank of Pakistan Report, the growth in direct and indirect tax collection by FBR decelerated to 10.3%t and 6.5% in FY 2017 as compared to respective growth rates of 17.8% and 21.8% in FY 2016. The slower growth in tax collection was due mainly to tax incentives provided to support exporting industries, agriculture and investment in the economy. As a consequence, tax to GDP ratio declined to 12.4% after rising consistently to 12.6% by FY16 from the low of 9.3% in FY2011. The tax to GDP ratio in FY17 was also significantly lower compared to 12.9percent target for the year.
Reasons for Low Tax-to-GDP ratio
There are many potential reasons for comparatively low tax-to-GDP ratio in Pakistan as compared to other countries which adversely impacts tax collections. Some of these reasons are summarized below:
- Low per Capita income
- Low direct tax base
- Less equitable distribution of national income
- Parallel and underground economy
- Vast unorganized sector
- Tendency for Tax evasion and payment
- Tax exemptions and subsidies to different sectors
- Tax amnesty schemes
- Corruption
- Sales tax frauds e.g. flying invoices, fake import declarations etc.
- Non-availability of robust IT infrastructure
- Inconsistency in economic policies
The tax revenues are highly skewed towards indirect taxes which account for about two thirds of tax revenue. The share of direct taxes has increased to about 3 8 04, in recent years from a meager 18.5% during the first half of 1990s but it is still unfavorable compared to other developing countries. The low level of direct tax mobilization is due to weak compliance and enforcement and abundant tax exemptions. Provincial tax revenues also remain small as agriculture, services and real estate sectors remain significantly under-taxed.
Measures needed for improving low Tax-to-GDP ratio
According to latest Tax Directory, only one third of companies registered with the SECP file income tax returns. It clearly provides evidence of significant tax evasion in the organized sector. The Pakistan Vision 2025 also include increasing tax-to-GDP ratio as one of the goals related to external sector, in addition to FDI, exports, ease of doing business, ranking and global competitiveness index ranking, Diaspora investment, remittances and per capita income. FBR has initiated different administrative and enforcement measures to broaden tax base and increase tax-to-GDP ratio, in addition to introducing a simple mechanism for bringing new taxpayers into the tax net. However, a lot more is to be done by FBR and government to bring structure reforms to broaden tax base and create more avenues for revenue collection and simplifying the complex tax system. FBR need to take concrete measures to bring the undocumented and under-taxed sectors into the tax net, especially the affluent class for reducing tax burden on low income groups. There is need for bridging the tax policy gap as well as tax gap arising from weak enforcement. Minimal use of tax 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 this context, it is important to strengthen the tax investigation system to create deterrence against tax evasion and bridging the tax gap.
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