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RR RUEHLH RUEHPW
DE RUEHIL #2554/01 2110347
ZNR UUUUU ZZH
R 290347Z JUL 08
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 8087
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHRC/DEPT OF AGRICULTURE WASHDC
RUEHNE/AMEMBASSY NEW DELHI 3585
RUEHLO/AMEMBASSY LONDON 8386
RUEHML/AMEMBASSY MANILA 3006
RUEHBUL/AMEMBASSY KABUL 8940
RUEHKP/AMCONSUL KARACHI 0102
RUEHLH/AMCONSUL LAHORE 5847
RUEHPW/AMCONSUL PESHAWAR 4629

UNCLAS SECTION 01 OF 02 ISLAMABAD 002554 
 
SENSITIVE 
SIPDIS 
 
E.O.  12958:  N/A 
TAGS: EFIN ECON EINV ETRD EAID PREL PK
SUBJECT: WANTED: TAX REFORM AND TAX PAYERS 
 
Summary 
- - - - - 
 
¶1. (U) Non-payment of taxes by Pakistan's numerous small businesses, 
large agricultural sector, and informal economy continue to 
constrain GOP taxation efforts.  The tax base has not been able to 
keep pace with economic growth spurred on by the services and 
industrial sectors, and GOP efforts at tariff rationalization and 
broadening of the tax base have not resulted in significant 
increases in collection.  Most tax collection is done by the federal 
government.  Provincial tax collection efforts are weak, with low 
compliance, numerous exemptions, and special treatment regimes, 
creating a gap between potential and actual tax revenue.  Despite 
recommendations from multilateral institutions, the GOP has been 
unable to tax agricultural and service income effectively due to 
powerful lobbies, undocumented workers, and the fact that such 
taxation falls under the purview of provincial governments. 
 
¶2. (U) Summary Continued:  The World Bank and the Andrew Young 
School of Policy Studies at Georgia State University have assisted 
the GOP Federal Board of Revenue in developing tax reform options 
and building capacity, and the World Bank continues to assist 
through a $100 million tax reform program that will conclude in 
¶2009.  Sustained increases in revenue will require a stronger effort 
by both the federal government and provincial governments if the GOP 
is to reach its goals of poverty reduction and devolution of 
political power.  Provincial spending must be matched by increases 
in provincial revenue collection, which will require reform of both 
tax policy and administration.  End Summary. 
 
Details of the Taxation Regime 
- - - - - - - - - - - - - - 
 
¶3. (U) Pakistan has a low tax-to-GDP ratio and narrow tax base that 
has not kept pace with economic growth.  An inadequate audit system, 
misuse of self-assessment schemes, undocumented economic activity, 
and refund claims contribute to the low tax-to-GDP ratio.  The 
income tax base is narrow, with only 2 percent of the population 
paying income tax.  Taxation is heavily skewed towards indirect 
taxes, which include sales taxes, federal excise duties, and customs 
duties.  Sales tax is the leading source of federal tax receipts and 
contributed some 38 percent to total revenue collection during the 
first nine months of FY2007-08. 
 
Lack of Diversification 
- - - - - - - - - - - - 
 
¶4. (U) Indirect taxes lack diversification.  Customs duties make up 
15 percent of total tax revenue, but 79 percent of customs duties 
collected come from only 15 commodity groups. (These commodity 
groups are: petroleum products, telecom equipment, automobiles, 
edible oil, cigarettes, machinery, iron and steel, chemicals, 
plastic and plastic products, paper and paper board, carbonated 
beverages, coffee and tea, textiles and apparel, electrical goods, 
and rubber products.) Another example of a lack of diversification 
can be seen in the fact that these same 15 commodities plus 
utilities, which represent a little less than 5 percent of the 
revenue to GDP ratio, make up approximately three quarters of total 
indirect tax revenue. 
 
Increasing Tax Collection in Some Sectors 
- - - - - - - - - - - - - - - - - - - - - - 
 
¶5. (U) Sales tax collection from services saw healthy growth in 
FY2007-08.  This can be attributed to improved performance by 
airlines, media, and courier services.  Sale of petroleum products 
and telecom services are also bright spots.  Tax collection on 
petroleum products has increased 47 percent and tax collection on 
telecom services has grown some 25 percent over the previous fiscal 
year.  The greatest contributors to federal excise duty are 
cigarettes, cement, carbonated beverages, natural gas, and petroleum 
products and services.  The FY2005-06 introduction of a federal 
excise duty on services such as international air travel and 
insurance has helped to enhance federal excise revenues 
substantially.  The corporate tax rate of 35 percent in the 
FY2008-09 budget is unchanged from FY2007-08. 
 
Weak Provincial Tax Collection 
- - - - - - - - - - - - - - - - 
 
¶6. (U) The federal government collects most taxes. While some 
provinces have experienced a degree of success, overall, provincial 
 
ISLAMABAD 00002554  002 OF 002 
 
 
revenue collection remains weak due to inadequate tax policies and 
lack of capacity.   Agricultural income, capital gains on physical 
assets, consumption of services, and taxation of urban property are 
constitutionally mandated to be within the provincial purview, yet 
regional governments have been unable to acquire significant revenue 
from either transport services, or wholesale and retail sales. 
While wholesale and retail trade constitute 16 percent of GDP, 
taxation of wholesale and retail items represent only 2.4 percent of 
national tax revenue. 
 
Rampant Tax Evasion 
- - - - - - - - - - - 
 
¶7. (U) Of the more than 39 million people who are a part of 
Pakistan's official labor force, less than 4 percent (1.5 million) 
pay income tax.  Pakistan's tax base remains narrow and tax evasion 
is rampant due to: 1) a large proportion of the labor force being 
employed in small-scale agriculture and the informal economy; (2) 
numerous exemptions; and, 3) the high frequency of undocumented cash 
transactions.  Furthermore, due to the lack of government efforts to 
curb abuse of the self-assessment scheme and a lack of speedy and 
transparent audits, many taxpayers, particularly Pakistan's rich, 
continue to underpay. 
 
World Bank Tax Reform Assistance 
- - - - - - - - - - - - - - - - - 
 
¶8. (U) In January 2006, the GOP requested World Bank assistance on 
comprehensive tax reform, and the Bank funded a review of Pakistan's 
federal tax system that was done by the Andrew Young School of 
Policy Studies at Georgia State University (which specializes in tax 
policy in developing countries).  This was completed in June 2006. 
Pakistan began its 22-month Tax Policy Program (TAP) in March 2007. 
The objectives of TAP are to provide a comprehensive assessment of 
Pakistan's tax system, learn lessons from other countries' 
experiences with tax reform, develop tax reform options for 
Pakistan, and build the capacity of the Federal Board of Revenue. 
The World Bank continues to assist Pakistan with tax administration 
and policy reform by funding a USD 100 million program that will 
conclude in 2009. 
 
World Bank/Andrew Young School of Policy Studies Report Findings 
- - - - - - - - - - - - - - - - - - - - - - - - - - 
 
¶9. (U) The World Bank/Andrew Young School of Policy Studies report 
offered some short-term options to expand the direct and indirect 
tax bases.  Regarding indirect taxation, the report recommended: 
imposing excise tax fees and commissions on banks and companies 
providing certain services (such as non-fund services, advisory 
services, etc.); withdrawal of the sales tax exemption on some duty 
free imports; and lowering of the sales tax threshold for retailers 
(currently at 5 million rupees).  The 2007-08 GOP budget imposed a 5 
percent excise tax on banking sector non-fund services (such as bank 
drafts and letters of credit) which increased to 10 percent in the 
2008-09 budget.  In regard to direct taxes, the report suggested 
elimination of the exemption on short-term capital gains, taxation 
of pension income, and taxation of employee benefits at market 
value. 
 
Comment 
- - - - - 
 
¶10. (U) Provincial revenues have dropped steadily in recent years 
and are currently only 0.5 percent of GDP.  Sustained increases in 
revenue will require a stronger effort, not only by the federal 
government, but also by provincial governments.  In order to reach 
the GOP's goals of poverty reduction and devolution of political 
power, provincial spending, particularly in education and health as 
well as on infrastructure, must be matched by an increase in 
provincial revenue collection.  This will require reform of both tax 
policy and capacity building for tax officials.  Possible areas of 
tax reform might be in the areas of capital gains and the sale of 
real estate, as well as in the services and agricultural sectors. 
The GOP must expand their tax base to generate much needed funding 
for the plethora of policies which are publicly announced but rarely 
funded and fail to make a difference for the average Pakistani 
living on less than two dollars a day. End Comment. 
 
PATTERSON