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UNCLAS SECTION 01 OF 03 ISLAMABAD 001137 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV PGOV PK
SUBJECT: TAX COLLECTION MISSES TARGETS; TOP OF TARIN'S AGENDA FOR 
NEW BUDGET 
 
¶1.  (SBU)  Summary:  Reforming tax policy and improving revenue 
collection have become a policy focus of the current government. 
Finance Advisor Shaukat Tarin has made broadening the tax base a 
lynch pin of his economic strategy for the coming fiscal year.  In 
spite of stepping up collection efforts for the year ending June 30, 
however, the GOP is not expected to meet IMF targets due to a 
slowdown in manufacturing, which is responsible for over 60 percent 
of direct taxes, and a decline in imports, which causes a resulting 
decrease in customs duties and sales taxes.  In the new budget, the 
GOP plans to introduce a value added tax (VAT) and to widen the tax 
net to cover sectors that have been historically under-taxed, 
possibly including agriculture, which has largely been tax-exempt 
due to the political influence of large landowners.  This new 
emphasis on revenue collection has not gone over well with some 
multinational companies, which feel that they are being unfairly 
squeezed, primarily because they have always paid up in the past. 
End Summary. 
 
¶2.  (SBU)  All Sectors Do Not Contribute Equitably:  Agriculture 
accounts for almost 20 percent of GDP and only one percent of direct 
tax revenues; industry contributes 21 percent of GDP and 62 percent 
of the tax base; services contribute over 50 percent to GDP, and 26 
percent of the direct tax base.  Customs duties account for 40 
percent of indirect taxes.  The tax base is also very narrow, with 
70-80 percent of indirect taxes coming from only 11 items.  The 
petroleum sector is responsible for 20 percent of tax revenues, 
IT/telecom for 17-18 percent, while the banking sector contributes 
10-12 percent.  According to Malik Tiwana, Secretary of Tax Reforms 
and Policy, 70 percent of direct tax revenue comes from 200 large 
corporations (refineries, banks, telecoms).  Although tax collection 
has increased in nominal terms by over 300 percent in the past ten 
years, the tax to GDP ratio has remained stagnant or even declined. 
 
 
¶3.  (SBU)  At the heart of this imbalance is the agricultural 
sector.  Agricultural inputs such as fertilizer are heavily 
subsidized by the government (we have been told that the GOP 
supplies domestic gas to urea factories at one-fifth the cost it is 
provided to power plants, for example, despite the desperate power 
shortage), while at the present time the GOP's support price for 
wheat is higher than international prices (one reason why inflation 
remains stubbornly high).  In spite of the fact that substantial 
agricultural profits are almost guaranteed, not only are large 
farmers exempt from income tax, but many routinely avoid taxes on 
other sources of income by incorrectly claiming them as 
agricultural. 
 
¶4.  (SBU)  There are also enormous leakages from the existing tax 
base.  The GOP has a self-assessment scheme which is not backed by a 
strong audit system, resulting in massive under-filing.  One finance 
official estimates the revenue lost through under-reporting to be in 
neighborhood of $2.5 to 3.1 billion annually.  Another source at FBR 
noted that tax payers can file petitions against the audit process 
which can take years to be decided in court. 
 
¶5.  (SBU) Tarin Committed to Improving Tax Performance:  At the 
first International Monetary Fund (IMF) review of Pakistan's 
performance under the standby arrangement in February,  Fund 
officials gave the GOP the option of reducing its revenue target 
from $17 billion to $15.6 billion, due to slower than expected GDP 
growth.  But Finance Advisor Shaukat Tarin insisted that the higher 
figures be maintained, as this would give the GOP extra incentive to 
improve the tax to GDP ratio.  Tarin has told us repeatedly that 
broadening the tax net and stepping up collections are among his 
highest priorities.  He said that he visits the Federal Bureau of 
Revenue (FBR) every morning and drinks tea with the collectors to 
discuss strategy with them.  He is keen to change the current 
mindset of simply targeting those who already are compliant (e.g., 
large international corporations) to focusing on those entities 
which routinely evade their obligations.  In the past several 
months, the FBR has stepped up its collection efforts, posting 
undercover agents at restaurants and other establishments that 
conduct much of their business on a cash basis.  However, Tarin 
recently briefed the G-8 ambassadors that the IMF tax targets were 
 
ISLAMABAD 00001137  002 OF 003 
 
 
unlikely to be met, and that the tax to GDP ratio remains extremely 
low, in spite of these efforts.  (Note:  According to FBR officials, 
the tax to GDP ratio currently is 9.6 percent - the target is 10.2 
percent this year, 11 to 12 percent by FY 2010-2011.  End Note) 
Tarin explained that the output of Pakistan's industrial base, which 
provides over sixty percent of the tax revenue, has shrunk 
significantly during the past year, and, since imports are down as 
well, customs revenues have also suffered. 
 
¶6.  (SBU) New Budget Will Contain Signficant Tax Reforms: 
Tarin told the G-8 Ambassadors May 18 that addressing the tax 
collection issue was the single most important item in the upcoming 
budget.  It is unclear, however, whether the agricultural sector 
will be brought into the tax net in the upcoming fiscal year.  But 
Tarin claimed that the new budget will introduce a carbon tax and 
will eliminate "two of the four untaxed areas."  Afzal nau Bahar, 
Member, Tax Policy and Reform at the FBR, described how the GOP has 
been working with the World Bank and DFID through a five-year 
program to reform the tax collection structure and modernize its 
infrastructure.  The FBR is tightening up on sales tax evasion by 
posting officials in prominent hotels and restaurants, establishing 
a high powered tax policy board, and tightening audit standards. 
The GOP, which initiated a value added tax in the early nineties, 
but quickly rescinded it when it was unable to implement the tax 
efficiently, plans to re-introduce the VAT in the coming fiscal 
year.  Bahar emphasized that the GOP wants a broad-based, 
comprehensive VAT law.  The proposed law will be introduced during 
the 2009-10 fiscal year and be debated in Parliament.  It has yet to 
be decided whether the VAT would be managed at the provincial or 
federal level.  The second focus of tax reform will be removing some 
of the exemptions under the income tax and sales tax laws. 
 
¶7.  (SBU)  Multinationals Feel the Heat:  There appears to be 
growing dissatisfaction among those multinational businesses, which 
in general have an excellent record of tax compliance (e.g., U.S. 
companies paid $500 million in direct and indirect taxes to the GOP 
last year), with the increased pressure tactics the GOP is bringing 
to bear.  Officials of a large U.S. company with significant 
investments in Pakistan told the Ambassador that its factories had 
been shut down twice in the past two months as a result of dispute 
over a relatively small amount of tax, which the company was 
contesting in court.  The resulting loss of tax revenue due to the 
closure was much greater than the originally contested amount.  The 
officials also noted that they had been waiting for years for a much 
larger tax refund owed to them by the GOP. 
 
¶8.  (SBU)  The Karachi Chamber of Commerce and Industry, in its 
pre-budget proposals to the GOP, suggested that services and 
agriculture be brought into the tax net, as well as any individual 
with an annual income over $3,750.  They recommended that the 
maximum corporate tax rate be reduced from 35 to 25 percent for 
manufacturing and 30 percent for non-manufacturing business.  When a 
two percent workers' welfare fund levy and a five percent workers' 
profit participation fund are added into the mix, the corporate tax 
rate approaches 42 percent, which makes Pakistan a relatively 
unattractive investment destination compared to its regional 
neighbors.  The Overseas Investors' Chamber of Commerce and Industry 
recommended mandatory documentation of all sectors of the economy, 
including real estate, agriculture, capital markets and 
manufacturing.  In April 8 meetings of the President's Task Force on 
Private Sector Development, business leaders noted the impact of 
tax-avoiding firms on the development of national industry.  They 
asserted that "big" business in Pakistan is not big by international 
standards and needs to expand domestically to attain economies of 
scale.  Competitors in the gray market have a substantial cost 
advantage from tax avoidance, resulting in stunted growth of formal 
firms.  More consistent application of the tax burden, the Task 
Force members asserted, would create a more dynamic industrial 
sector. 
 
¶9.  (SBU)  Comment:  Although Tarin has told us that he intends to 
tax agriculture, this issue has long been extremely difficult to 
address due to the feudal nature of Pakistan's agricultural economy 
and the fact that many influential politicians are also large 
 
ISLAMABAD 00001137  003 OF 003 
 
 
landowners.  Even if agricultural income remains outside the tax 
net, however, there is scope for greatly improving tax collection 
rates by improving the audit function and the appeals procedure, as 
well as stepping up enforcement measures to ensure those who are 
required to pay under the current policy actually do so.  Tarin's 
emphasis on moving away from the "traditional" targets, i.e., large 
corporations which are already shouldering a disproportionate share 
of the tax burden, is also a good sign. 
 
PATTERSON