Economic Survey: VAT in Pakistan

The parliament has finally announced the budget for this year. Some analysts have already started calling it "the IMF-budget". Certainly, it can't be called the people's or the trader's budget. Even though it appears people-friendly (for example the 50% increase in the salaries of government employees) and has indicated increases in pensions, it does not bear any good news for a common man who may be a labourer or a farmer or working in a private institution. The failure of government to provide relief to masses has dwindled their confidence in system. 





WHAT DOES IMF (International Monetary Fund) HAVE TO DO WITH ALL THIS??

For 8 years, dictator rule remained imposed in Pakistan. But then our (not-so-smart) dictator fired the Chief Justice. Personally, I am against dictatorship, but I have to admit that dictatorship has some advantages, most important of which is the betterment of law and order, which in turn plays an important role in attracting foreign investors. These positive aspects heighten if the democratic setup in a country is not resilient and durable, one of the leading causes of which stays corruption. The Letter of Intent that the PPP government signed with the IMF last year acknowledged that 

"Pakistan attracted over $5 billion in foreign direct investment in the 2006-07 fiscal year, ten times the figure of 2000-01. The government's debt fell from 68% of GDP in 2003-04 to less than 55% in 2006-07, and its foreign-exchange reserves reached $16.4 billion as recently as in October (2008)." -chowk.com

The protests and the political turmoil that followed Chief Justice's firing and the NRO (another act of Musharraf) led to a sharp decline in investment and paved way for the economic crisis in 2008.
And then came the global recession. 

Conditions worsened significantly in mid-2008 with the sharp increase in international food and fuel prices and the deterioration in the security situation. The widening fiscal deficit, due in large part to rising energy subsidies, was financed by credit from the central bank. As a result, the rupee depreciated and foreign currency reserves fell sharply. Inflation reached 25 percent in mid-2008, causing harm to vulnerable social groups. -IMF.ORG

And then, as usual, our government went to the IMF. 
As a response, IMF programme was started. Under this programme, Pak gov was required to submit a VAT law to parliament by the end of last December, and implement it by July 1, 2010. Pakistan is required to impose this tax in order to increase its revenues. It will increase its revenues, no doubt, through VAT, but it will have a disastrous effect on a common man. From July, 16% tax will be imposed on all purchases. Inflation, till then, will be bad. From July, it will only get worse.

SO, WHAT IS VAT?

According to Wikipedia: 


It is a tax on the estimated market value added to a [product or material] at each stage of its manufacture or distribution, ultimately passed on to the consumer.
A conventional or retail sales tax (aka General Sales Tax) is charged only on the sale of an item to its final end user. 
To achieve this, a purchaser who is not an end user is usually required to provide the seller with a "resale certificate," which states that the seller is purchasing an item to resell it. The tax is charged on each item sold to purchasers who do not provide such a certificate.



COMPARISON OF GST AND VAT WITH AN EXAMPLE
Consider the manufacture and sale of any item, which in this case we will call a widget. In what follows, the term "gross margin" is used rather than "profit". Profit is only what is left after paying other costs, such as rent and personnel.
Without any tax

• A widget manufacturer spends Rs. 100 on raw materials and uses them to make a widget.
• The widget is sold wholesale to a widget retailer for Rs. 120, making a gross margin of Rs. 20.
• The widget retailer then sells the widget to a widget consumer for Rs. 150, making a gross margin of Rs.30.

With a 10% sales tax

• The manufacturer pays Rs. 100 for the raw materials, certifying it is not a final consumer.
• The manufacturer charges the retailer Rs. 120, checking that the retailer is not a consumer, leaving the same gross margin of Rs. 20.
• The retailer charges the consumer Rs. 165 (Rs. 150 + (Rs. 150 x 10%)) and pays the government Rs. 15, leaving the gross margin of Rs. 30.

So the consumer has paid 10% (Rs. 15) extra, compared to the no taxation scheme, and the government has collected this amount in taxation. The retailers have not paid any tax directly (it is the consumer who has paid the tax), but the retailer has to do the paperwork in order to correctly pass on to the government the sales tax it has collected. 


With a 10% VAT

• The manufacturer pays Rs. 110 (Rs. 100 + (Rs. 100 x 10%)) for the raw materials, and the seller of the raw materials pays the government Rs. 10.
• The manufacturer charges the retailer Rs. 132 (Rs. 120 + (Rs. 120 x 10%)) and pays the government Rs. 2 (Rs. 12 minus Rs. 10), leaving the same gross margin of Rs. 20. (Rs. 132 - Rs. 2 - Rs. 10 = Rs. 20)
• The retailer charges the consumer Rs. 165 (Rs. 150 + (Rs. 150 x 10%)) and pays the government Rs. 3 (Rs. 15 minus Rs. 12), leaving the same gross margin of Rs. 30 (Rs. 165 - Rs. 3 - Rs. 132 = Rs. 30).

With VAT, the consumer has paid, and the government received, the same as with sales tax. The businesses have not incurred any tax themselves. Their obligation is limited to assuming the necessary paperwork in order to pass on to the government the difference between what they collect in VAT (output tax, an 11th of their sales) and what they spend in VAT (input VAT, an 11th of their expenditure on goods and services subject to VAT). However they are freed from any obligation to request certifications (resale certificates) from purchasers who are not end users, and of providing such certifications to their suppliers. The advantage of the VAT system over the sales tax system is that under sales tax, the seller has no incentive to disbelieve a purchaser who says it is not a final user. 

              In the above example, it is assumed that the same number of widgets were made and sold both before and after the introduction of the tax. This is not true in real life. 

           The fundamentals of supply and demand suggest that any tax raises the cost of transaction for someone, whether it is the seller or purchaser. Consequently, the quantity of a good purchased decreases, and/or the price for which it is sold increases.

The "value-added tax" has been criticized as the burden of it relies on personal end-consumers of products.

PROBLEMS WITH VAT IN PAKISTAN

• For subnational governments (in provinces or other administration units), VAT leads to an overall reduction in the revenue they collect as well as a loss of some autonomy. VAT law has been introduced in the parliament but not yet approved due to the differences between the provincial and the federal governments especially on the mechanism for collection of VAT, and they have yet to be resolved.
• In addition to the differences between the federal and provincial governments, the technical and administrative apparatus for implementing the VAT is not ready.
• And last but certainly not the least: imposition of VAT would result in price hike of minimum 200 essentials by 15-20 per cent, which will be a blow to masses reeling under inflation. 

ETHICAL PROBLEM

                     The major problem, which completely overshadows other obstacles, is dishonesty on the part of taxpayer and tax collector. The ethics and morality: rare but often spoken of; such is the condition of our society. So whether it's GST or VAT, the gov simply can't collect revenues when only 1% of the total population is paying taxes!!

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                            Overall, the current government appears to have failed to uplift Pakistan's economy. Instead of adopting an attitude of self reliance, the gov is turning this country dependent on foreign aid. Maybe, they should learn from the Musharraf government who like them didn't knock on IMF's door, but still improved Pakistan's economic condition. For progress and prosperity, it is important that we replace an "I need help" attitude with an "I can do it myself" attitude. 

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