S. Masoud Ali Naqvi Senior Partner KPMG Taseer Hadi & Co. 17 March 2006 GLOBAL SERVICE/ INDUSTRY AUDIT / TAX / ADVISORY / LINE OF BUSINESS Asia Pacific

S. Masoud Ali NaqviSenior Partner

KPMG Taseer Hadi & Co.17 March 2006

S. Masoud Ali NaqviSenior Partner

KPMG Taseer Hadi & Co.17 March 2006

GLOBAL SERVICE/ INDUSTRY

AUDIT / TAX / ADVISORY / LINE OF BUSINESS

Asia Pacific Tax Conference – 2006

Tax Incidence - Equity & Distortion

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Tax Incidence – Equity & DistortionTax Incidence – Equity & Distortion

Revenue sources for a Government Revenue sources for a Government

Taxation Taxation

Borrowing Borrowing

Money Creation Money Creation

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Basic Principles of Taxation Basic Principles of Taxation

Fairness Fairness

Efficiency Efficiency

Effectiveness – sufficientEffectiveness – sufficient

Simple – Convenient Simple – Convenient

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Standards for a good tax systemStandards for a good tax system

Sufficient to raise necessary government revenuesSufficient to raise necessary government revenues

Convenient to administer and to payConvenient to administer and to pay

Efficient in economic termsEfficient in economic terms

Fair to taxpayersFair to taxpayers

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Tax IncidenceTax Incidence

Who actually bears the final burden of a particular tax Who actually bears the final burden of a particular tax or set of Taxes.or set of Taxes.

The final burden is distinguished from the initial The final burden is distinguished from the initial burden.burden.

The initial burden is borne by those who makes the The initial burden is borne by those who makes the payment to the tax authoritypayment to the tax authority

The final burden is borne by those whose real income The final burden is borne by those whose real income is reduced as a result of itis reduced as a result of it

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Progressive Tax IncidenceProgressive Tax Incidence

A tax is progressive if final tax burden is higher for high A tax is progressive if final tax burden is higher for high income households relative to low income householdsincome households relative to low income households

Regressive Tax IncidenceRegressive Tax Incidence

A tax is regressive if its burden is higher for low income A tax is regressive if its burden is higher for low income households relative to high income householdshouseholds relative to high income households

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Direct TaxDirect Tax

The initial and final burden are the sameThe initial and final burden are the same

Indirect TaxIndirect Tax

When the initial burden can be passed on as a final When the initial burden can be passed on as a final burden to others.burden to others.

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Incidence of TaxIncidence of Tax

SPDC Study Conclusions:SPDC Study Conclusions:

Indirect taxes are regressive and neutralizing their Indirect taxes are regressive and neutralizing their regressivity appears to be difficultregressivity appears to be difficult

Direct taxes are progressive although their Direct taxes are progressive although their progressivity has declined over timeprogressivity has declined over time

The regressivity of direct and indirect taxes combined The regressivity of direct and indirect taxes combined is reduced relative to the regressivity of indirect taxesis reduced relative to the regressivity of indirect taxes

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Incidence of Tax …. (Contd.)Incidence of Tax …. (Contd.)

Implication is that enhancing the weight of direct taxes by styling Implication is that enhancing the weight of direct taxes by styling the primary ones of revenue generation from indirect to direct is the primary ones of revenue generation from indirect to direct is likely to render the incidence of the tax regime proportional and likely to render the incidence of the tax regime proportional and progressiveprogressive

Expenditure regimes is also regressive resulting in overall Expenditure regimes is also regressive resulting in overall regressive fiscal structure as the greater burden of taxation falls regressive fiscal structure as the greater burden of taxation falls on poor and they do not appear to be primary beneficiary of on poor and they do not appear to be primary beneficiary of public expenditurepublic expenditure

The above has resulted in transfer of resources from the The above has resulted in transfer of resources from the relatively lower income group to relative higher income group relatively lower income group to relative higher income group which has compounded inequality and poverty which has compounded inequality and poverty

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Concept of equity / fairnessConcept of equity / fairness

Reflects each taxpayers’ ability to pay and enhance Reflects each taxpayers’ ability to pay and enhance horizontal and vertical equityhorizontal and vertical equity

Ability to pay is measured by :Ability to pay is measured by :

IncomeIncome

WealthWealth

Standard of living Standard of living

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Horizontal equity Horizontal equity

That persons with the same ability to pay the tax That persons with the same ability to pay the tax should owe the same amount of tax.should owe the same amount of tax.

Vertical equityVertical equity

That persons with greater ability to pay owe more That persons with greater ability to pay owe more than persons with a lesser ability to pay.than persons with a lesser ability to pay.

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EqualsEquals

Equals will be these having the same pre-tax income.Equals will be these having the same pre-tax income.

Equal treatment is equal post tax living standards for Equal treatment is equal post tax living standards for

pre-tax equals.pre-tax equals.

Equal average tax rule and equal taxes among equals.Equal average tax rule and equal taxes among equals.

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Tax Rate StructureTax Rate Structure

Regressive Rate StructureRegressive Rate Structure

Proportional Rate Structure (Flat Tax)Proportional Rate Structure (Flat Tax)

Progressive Rate StructureProgressive Rate Structure

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Tax Rate StructureTax Rate Structure

Average Tax RateAverage Tax Rate

The tax rate on income determined by dividing tax paid by an income The tax rate on income determined by dividing tax paid by an income

measure. Income measures selected are usually gross income or taxable measure. Income measures selected are usually gross income or taxable

incomeincome

Marginal Tax RateMarginal Tax Rate

The rate of tax applied to the next dollar of taxable income. In a The rate of tax applied to the next dollar of taxable income. In a

progressive rate structure this rate increases as income levels increase. progressive rate structure this rate increases as income levels increase.

In a proportionate rate structure average and marginal rates are the same.In a proportionate rate structure average and marginal rates are the same.

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Taxation Policy - Factors Hampering the Economic DevelopmentTaxation Policy - Factors Hampering the Economic Development

The Growth CrisisThe Growth Crisis

The Resources Mobilization CrisisThe Resources Mobilization Crisis

The Balance of Payment CrisisThe Balance of Payment Crisis

The External Debt CrisisThe External Debt Crisis

The Distributional CrisisThe Distributional Crisis

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DistortionsDistortions

Political disharmony between Centre and provincePolitical disharmony between Centre and province

Lack of equitable distribution of fiscal and powers Lack of equitable distribution of fiscal and powers

amongst Federal, Provincial and local Governmentsamongst Federal, Provincial and local Governments

Provincial Government generates only 5 percent of tax Provincial Government generates only 5 percent of tax

revenue as against 38 percent in Indiarevenue as against 38 percent in India

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Distortions (contd….)Distortions (contd….)

Exemptions/Exclusions from tax baseExemptions/Exclusions from tax base

Agriculture incomeAgriculture income

Capital gains on real estateCapital gains on real estate

Exemptions, allowances, tax credits, tax reduces and Exemptions, allowances, tax credits, tax reduces and

tax defends resulting in tax expenditurestax defends resulting in tax expenditures

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Tax Revenue GapTax Revenue GapTax actually payable and tax actually collectedTax actually payable and tax actually collected

Shadow EconomyShadow EconomySizeSize

Lack of tax ethics and social normsLack of tax ethics and social normsInconsistency in growth sectors versus tax incidence in Inconsistency in growth sectors versus tax incidence in these sectorsthese sectors

Network/Lobby cultureNetwork/Lobby culture

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Potential tax revenueminus

Actual budget collection

Tax revenue gap

Inadequate legal base

Institutionalinefficiency

Legal tax avoidance

Inadequate taxadministration

Tax avoidanceTax evasion

Unreported economicactivities

Shadoweconomy

Tax burden

Limited budgetresources

▪ Income▪ Traditions▪ Networks

Tax Revenue GapTax Revenue Gap

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Tax Gap – Pakistan Scenario Tax Gap – Pakistan Scenario

The tax to GDP ratio for a developing economy should The tax to GDP ratio for a developing economy should be around 15 percentbe around 15 percent

5 percent additional tax revenue =5 percent additional tax revenue = 300 m300 m1 percent additional tax revenue =1 percent additional tax revenue = 60 m 60 m

( on 2005 GDP ) ( on 2005 GDP )

With expected Growth Targets on an average 1 percent With expected Growth Targets on an average 1 percent additional revenue to GDP should yield annually 75 m additional revenue to GDP should yield annually 75 m over next four yearsover next four years

Tax expenditure for 2004-2005 was estimated at Rs.25mTax expenditure for 2004-2005 was estimated at Rs.25m

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Summary of Tax ExpendituresSummary of Tax Expenditures

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Tax Reforms ModelTax Reforms Model

Optimal Tax ModelOptimal Tax Model

Harberger Tax ModelHarberger Tax Model

Supply side Tax ModelSupply side Tax Model

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Optimal Tax model (OT)Optimal Tax model (OT)

Design optimal tax system for tax efficiencyDesign optimal tax system for tax efficiency

Harberger Tax Model (HT)Harberger Tax Model (HT)

Design system that will minimize tax induced tax Design system that will minimize tax induced tax

distortions which may be administratively feasible and distortions which may be administratively feasible and

politically acceptable (Uniform Tariff / Broad Base VAT)politically acceptable (Uniform Tariff / Broad Base VAT)

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Supply-side Tax Model (SST)Supply-side Tax Model (SST)

Reduce role of stateReduce role of state

Reduce tax rates to minimize disincentive on work, Reduce tax rates to minimize disincentive on work,

saving and investmentsaving and investment

Minimize distortions in related pricesMinimize distortions in related prices

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Recent Trends – Combination of all these modelsRecent Trends – Combination of all these models

Enhance the revenue productivity of the tax systemEnhance the revenue productivity of the tax system

Minimize relative price distortionsMinimize relative price distortions

Tax system to be comprehensive, simple and Tax system to be comprehensive, simple and

transparenttransparent

Broaden tax baseBroaden tax base

Lower marginal ratesLower marginal rates

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Reforms InitiativeReforms Initiative

LTULTU

MTUMTU

Customs Administration Reforms (CARE) projectCustoms Administration Reforms (CARE) project

Installation of Scanners Installation of Scanners

Liquidation of RefundsLiquidation of Refunds

Sales Tax Project STARR / STREAMSSales Tax Project STARR / STREAMS

Effective Dispute Resolution Effective Dispute Resolution

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Broaden Tax BaseBroaden Tax Base

To ensure horizontal equity is desirable from the To ensure horizontal equity is desirable from the

political economy point of view as it reduces influence of political economy point of view as it reduces influence of

special interest group on tax policy and reduce special interest group on tax policy and reduce

administrative costsadministrative costs

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Tax Structure IssuesTax Structure Issues

Narrow baseNarrow base

Over dependence on import related taxesOver dependence on import related taxes

High tax rateHigh tax rate

Tax concessions and exemptionsTax concessions and exemptions

SRO cultureSRO culture

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Income Tax

2004-2005 2003-2004

NTN holders 2.28 million 2.11 million

Tax return filers (20%) 1.23 million 1.0 million

(growth over 2003-04)

Sales Tax

Registered persons 115,702 101,851

Growth percentage 14%

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Reforms imperativeReforms imperative

Institutional locks for credible commitmentInstitutional locks for credible commitment

TransparencyTransparency

Allocation to political sequencingAllocation to political sequencing

Incentive and compensationIncentive and compensation

Public Education and communicationPublic Education and communication

Encouraging participation in ReformsEncouraging participation in Reforms

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Customerised subsidies to investCustomerised subsidies to invest

Training expertise Training expertise

Pricing of land and utilitiesPricing of land and utilities

Large equity stake in some venturesLarge equity stake in some ventures

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Taxation Policy - Underground EconomyTaxation Policy - Underground Economy

Large number of economic activities outside reporting system Large number of economic activities outside reporting system and tax net.and tax net.

Constituents of underground economyConstituents of underground economy

Illegal activities, smuggling, narcotics, corruption etc.,Illegal activities, smuggling, narcotics, corruption etc.,Legitimate, but not reported to tax authorities.Legitimate, but not reported to tax authorities.

CausingCausing

Large fiscal lossesLarge fiscal losses

Distorts incentives structure and growth path of economic systemDistorts incentives structure and growth path of economic system

Loss of fiscal revenue and demand on public services a Loss of fiscal revenue and demand on public services a contributing factor for fiscal deficit.contributing factor for fiscal deficit.

High and uncertain cost of doing business an important constraint High and uncertain cost of doing business an important constraint for the private sector led development strategy.for the private sector led development strategy.

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Taxation Policy - Areas Requiring Policy changes to Counter Underground EconomyTaxation Policy - Areas Requiring Policy changes to Counter Underground Economy

Economic liberalizationEconomic liberalization

Fiscal disciplineFiscal discipline

Enhanced space for private sectorEnhanced space for private sector

Tax reforms comprising of low rates and broad Tax reforms comprising of low rates and broad basebase

Transparent decision makingTransparent decision making

Severe punitive measures against the errant Severe punitive measures against the errant

Equitable and expeditious justiceEquitable and expeditious justice

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Taxation Policy - Major irritants in achieving Policy ObjectivesTaxation Policy - Major irritants in achieving Policy Objectives

UNEMPLOYMENT / POVERTY LEVELUNEMPLOYMENT / POVERTY LEVEL

Social netSocial net

Lack of basic amenities (Medical, clean water etc.)Lack of basic amenities (Medical, clean water etc.)

Taxes impact on savingsTaxes impact on savings

National Saving SchemesNational Saving Schemes

TAXATIONTAXATION

Multiplicity of taxes – Federal, Provincial, LocalMultiplicity of taxes – Federal, Provincial, Local

In-equity in allocation of taxes amongst provinces and local bodiesIn-equity in allocation of taxes amongst provinces and local bodies

Incentive for tax evasionIncentive for tax evasion

Complexity of tax lawsComplexity of tax laws

High incidences of taxesHigh incidences of taxes

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Taxation Policy – Unemployment / Poverty LevelTaxation Policy – Unemployment / Poverty Level

Engendering growthEngendering growth

Implementing broad based governance reformsImplementing broad based governance reforms

Improving income generating opportunitiesImproving income generating opportunities

Improving social sector outcomesImproving social sector outcomes

Reducing vulnerabilities to shocksReducing vulnerabilities to shocks

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Distributional Crisis Distributional Crisis

Key to inequalityKey to inequality

Equity content sharply erodedEquity content sharply eroded

Incidence of poverty is a function of economic growth Incidence of poverty is a function of economic growth and distributionand distribution

Inequality in holding of assetsInequality in holding of assets

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Distributional CrisisDistributional Crisis

Inequality measured by Gini coefficient that:Inequality measured by Gini coefficient that:

1 percent reduction in equality is likely to reduce poverty 1 percent reduction in equality is likely to reduce poverty by 8.5 percentby 8.5 percent

1 percent increase in per capita income is expected to 1 percent increase in per capita income is expected to reduce equality by only 3.6 percentreduce equality by only 3.6 percent

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Alternate Estimates of Poverty ElasticityAlternate Estimates of Poverty Elasticity

Table 3.6 Alternate Estimates of

Poverty Elasticity

With reference to

Inequality Measures Growth Inequality

Gini coefficient -3.6 8.5

Quintile dispertion ratio* -2.3 3.6

Extreme inequality represented by square of Gini -1.2 2.4

*share in national income of the highest 20 percent of population to the lowest 20 percent of population

Source: SPDC estimates

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Composition of Tax Revenue (%)Composition of Tax Revenue (%)

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Burden of Indirect Taxes by Income Group (%)Burden of Indirect Taxes by Income Group (%)

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Burden of GST Net of Tax on KeyAgricultural Inputs (%)Burden of GST Net of Tax on KeyAgricultural Inputs (%)

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Thank youThank you

43 © (year) KPMG (member firm name if applicable), the (jurisdiction) member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in (country).

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Presenter’s contact detailsPresenter’s contact details

Syed Masoud Ali NaqviSyed Masoud Ali Naqvi

Senior PartnerSenior Partner

KPMG Taseer Hadi & Co.KPMG Taseer Hadi & Co.

[email protected]@kpmg.com

www.kpmg.comwww.kpmg.com

Documents

S. Masoud Ali Naqvi Senior Partner KPMG Taseer Hadi & Co. 17 March 2006 GLOBAL SERVICE/ INDUSTRY AUDIT / TAX / ADVISORY / LINE OF BUSINESS Asia Pacific