Pakistan: Provincial Government Taxation

Georgia State University Georgia State University

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ECON Publications Department of Economics

2008

Pakistan: Provincial Government Taxation Pakistan: Provincial Government Taxation

Roy W. Bahl

Georgia State University

, [email protected]

Sally Wallace

Georgia State University

, [email protected]

Musharraf Cyan

Georgia State University

, [email protected]

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International Studies Program

International

Studies

Program

Working Paper 08-07

December 2008

Pakistan: Provincial Government

Pakistan:

Provincial

Government

Taxation

Roy

Bahl

Roy

Bahl

Sally Wallace

Musharraf Cyan

International Studies Program

Andrew Young School of Policy Studies

Georgia State University

Atlanta, Georgia 30303

United States of America

Phone: (404) 651-1144

Fax: (404) 651-4449

Email: [email protected]

Internet: http://isp-aysps.gsu.edu

of the material protected by this copyright notice may be reproduced or utilized in any form or by

any means without prior written permission from the copyright owner.

International Studies Program

Working Paper 08-07

Pakistan: Provincial Government Taxation

Roy Bahl

Sally Wallace

Musharraf Cyan

December 2008

International Studies Program

Andrew Young School of Policy Studies

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ACKNOWLEDGEMENTS

These working papers are the reports that were a joint product of a team from the Federal Board

of Revenue (FBR), Government of Pakistan, the Andrew Young School of Public Policy

(AYSPS) at the Georgia State University, and the World Bank. The views, expressed in the

reports, are of the authors and not of the Government of Pakistan.

The FBR team was headed by Mr. Ahmad Waqar, Secretary Revenue Division and Chairman

FBR, and Mr. M. Abdullah Yusuf, former Chairman FBR, and included Mr. Mumtaz Haider

Rizvi, Member Fiscal Research and Statistics, Dr. Ather Maqsood Ahmed, former Member

Fiscal Research and Statistics, Mrs. Robina Ather Ahmed, Chief Fiscal Research and Statistics,

Mr. Umar Wahid, Secretary Fiscal Research and Statistics, Mr. Mir Ahmed Khan, Second

Secretary Fiscal Research and Statistics, and Mr. Naeem Ahmed, Second Secretary Fiscal

Research and Statistics.

The final report was prepared by Kaspar Richter (World Bank), and Jorge Martinez-Vazquez

(AYSPS). The background studies (listed below), were drafted by Robina Ather Ahmed, James

Alm, Roy Bahl, Musharraf Cyan, Mir Ahmad Khan, Jorge Martinez-Vazquez, Geerten Michelse,

Mark Rider, Wayne Thirsk, Umar Wahid and Sally Wallace. The tax revenue simulation results

in the report are based on micro-simulation models developed by Mark Rider and Sally Wallace

with Harini Kannan. The GST chapter draws extensively on a review of Pakistan’s sales tax by

Rebecca Millar and Christophe Waerzeggers from June 2008. The final report also benefited

from the Pakistan tax administration review by Carlos Silvani, Edmund Biber, William Crandall,

Wyatt Grant, Orlando Reos and Geoff Seymour from September 2008. Peer reviewer comments

from Kai-Alexander Kaiser, Senior Economist, World Bank; Michael Keen, Advisor,

International Monetary Fund; Dr. Ahmad Khan, former Member FBR; Russell Krelove, Senior

Economist, International Monetary Fund, and Eduardo Ley, Lead Economist, World Bank

greatly enhanced the quality of the report. Dr. Ahmad Khan and Dr. A. R. Kemal reviewed the

background studies, and Ehtisham Ahmad commented on the concept paper. Anjum Ahmad,

Shamsuddin Admad, Mihaly Kopanyi, Hanid Mukhtar, and Saadia Refaqat from the World Bank

provided useful feedback. Mirafe Marcos helped greatly by providing the draft chapter of the

provincial background study. The team would like to thank Satu Kahkonen, Lead Economist,

Miria Pigato, Sector Manager, Ijaz Nabi, former Sector Manager, Yusupha Crookes, Country

Director, and Ernesto May, Sector Director, for continued support and guidance throughout all

stages of this report. Muhammad Shafiq, Nimanthi Attapattu, and Irum Touqeer handled with

great ease all arrangements for the missions and for the processing of the report.

The team benefited enormously from the close collaboration of the Government of Pakistan ever

since this work was launched in January 2007. The team is very grateful to Mr. M. Abdullah

Yusuf, who conceived the idea for this report, and to Dr. Ather Maqsood Ahmed, who developed

the framework and coordinated the inputs of the FBR team. The team is greatly indebted for the

outstanding support and assistance of FBR’s Fiscal Research and Statistics Wing. Its

contribution is immense: it co-authored three background studies; provided comments, feedback,

and guidance to the team throughout the analysis and report preparation; and facilitated the

interaction with other departments, including the Budget Wing, Debt Office, and the Economic

Affairs Division of the Ministry of Finance.

Background Papers for the Pakistan Tax Policy Report

08-07 Bahl, Roy, Wallace, Sally and Cyan, Musharraf. Pakistan: Provincial Government Taxation.

08-08 Thirsk, Wayne. Tax Policy in Pakistan: An Assessment of Major Taxes and Options for Reform.

08-09 Michelse, Geerten. Pakistan – a Globalized Tax World – An Analysis of its International Tax Practice.

08-10 Alm, James and Khan, Mir Ahmad.

Assessing Enterprise Taxation and the Investment Climate in

Pakistan.

8-11 Ahmed, Robina Ather and Rider, Mark. Pakistan’s

Tax Gap: Estimates by Tax Calculation and

Methodology.

08-12 Sally Wallace and Harini Khan. Pakistan: Comprehensive Individual Tax Reform: Round 2

08-13 Wahid, Umar and Wallace, Sally. Incidence of Taxes in Pakistan: Primer and Estimates

Pakistan:

Provincial Government Taxation

Roy Bahl, Sally Wallace and Musharraf Cyan

International Studies Program, Andrew Young School of Policy Studies, Georgia State University

TABLE OF CONTENTS

EXECUTIVE SUMMARY ............................................................................................ vii

The Provincial Economies .................................................................................................3

Deficits and Fiscal Weakness ............................................................................................5

Budgetary Position: Punjab..................................................................................... 5

Budgetary Position: NWFP ..................................................................................... 9

Fiscal Profile .....................................................................................................................12

Revenue Assignment and Structure ...............................................................................14

Revenue Mobilization ......................................................................................................18

Intergovernmental Transfers ..........................................................................................23

Urban Immovable Property Tax: Punjab .....................................................................27

Revenue Performance ........................................................................................... 28

Rent and Base ....................................................................................................... 30

Valuation ............................................................................................................... 31

Determination of Tax Liability ............................................................................. 32

Appeals and Collections ....................................................................................... 32

Intergovernmental Dimensions ............................................................................. 33

Issues and Problems .............................................................................................. 34

The Tax base. .............................................................................................35

Tax rate. .....................................................................................................37

Low revenues. ............................................................................................37

Undervaluation. .........................................................................................38

Revenue growth. .........................................................................................41

Tax preferences. .........................................................................................43

Sticky Nominal tax rates. ...........................................................................44

Incentives for Inefficient Land Use. ...........................................................44

Administration............................................................................................44

Intergovernmental Issues. ..........................................................................46

Reform Options ..................................................................................................... 47

Revenue Target. .........................................................................................48

Valuation, revaluation and indexing..........................................................49

Base Broadening Measures. ......................................................................49

Indexation. .................................................................................................53

Rate Adjustments. .......................................................................................56

Organizational Issues ............................................................................................ 57

Urban Immovable Property Tax: NWFP ......................................................................58

Revenue Performance ........................................................................................... 58

Base for Taxation .................................................................................................. 59

Tax Rates and Valuation ....................................................................................... 60

Exemptions and Concessions ................................................................................ 61

Effective tax rates ................................................................................................. 61

Tax Administration ............................................................................................... 63

Intergovernmental Dimensions ............................................................................. 65

Problems with the Present System ........................................................................ 66

Reform Options ..................................................................................................... 67

Revaluation. ...............................................................................................68

Base Broadening. .......................................................................................69

Indexation. .................................................................................................69

Rate Adjustments. .......................................................................................70

Administration............................................................................................70

Comprehensive Structural Reform: UIPT ....................................................................71

Motor Vehicle Taxes ........................................................................................................75

Revenue Performance ........................................................................................... 75

The Registration Tax............................................................................................. 77

Annual (Token) Tax .............................................................................................. 78

Problems and Issues .............................................................................................. 79

Reform Options ..................................................................................................... 83

Piecemeal Reforms. ....................................................................................84

Comprehensive Reform of the Existing Structure. .....................................87

Motor fuel tax. ............................................................................................90

Tax on Professions, Trades, and Callings (“Profession Tax”) .....................................95

iii

Professions Tax Overview .................................................................................... 95

Tax Structure ......................................................................................................... 97

Administration ...................................................................................................... 99

Problems and Issues ............................................................................................ 100

Reform Options ................................................................................................... 102

Land Revenues: Land and Property Transfer Taxes .................................................105

Revenue Performance ......................................................................................... 106

Mutations and Registrations ............................................................................... 108

Tax Base: Rural Properties. ....................................................................109

Tax Base: Urban Properties. ...................................................................110

Tax Rates. .................................................................................................111

Land Records. ..........................................................................................111

Stamp Duty ......................................................................................................... 113

Other Land Taxes in NWFP ............................................................................... 114

Water Rates ......................................................................................................... 115

Problems and Issues ............................................................................................ 116

Are the Basic Tax Instruments Adequate? .......................................................... 118

Reform Options ................................................................................................... 120

Agricultural Income Tax (AIT) ....................................................................................127

Revenue Performance. ........................................................................................ 128

Valuation and Tax Base. ..................................................................................... 129

Tax Rates ............................................................................................................ 131

General Administration ....................................................................................... 133

Issues and Problems ............................................................................................ 135

Is the Agricultural Sector Undertaxed? ............................................................... 136

Reform Options ................................................................................................... 140

Structural and Administrative Changes. ..................................................141

Tax Base and Rate .............................................................................................. 146

Tax Administration ............................................................................................. 147

Revenue Performance ......................................................................................... 147

Problems and Issues ............................................................................................ 147

Revenue Potential. ...................................................................................148

Tax Administration. .................................................................................148

Encroachment. .........................................................................................150

Economic Incentives. ...............................................................................150

Reform Options ................................................................................................... 151

Tax Burdens. ............................................................................................158

Other Taxes ....................................................................................................................159

Entertainment Tax ............................................................................................... 159

Excise Duty ......................................................................................................... 160

Cotton and Tobacco levies .................................................................................. 160

Hotel Tax ............................................................................................................ 161

Electricity Duty ................................................................................................... 162

Problems and Reform Options ............................................................................ 163

Hydel Profits: NWFP .....................................................................................................164

Conclusions and Implementation .................................................................................166

Revenue Targets.................................................................................................. 167

Structural Reforms .............................................................................................. 171

Incentives ............................................................................................................ 174

An Incentive Model. .................................................................................175

Empirical Test: An Illustration. ...............................................................179

Implementation and Institutional change ............................................................ 180

Implementation: Timetable ................................................................................. 182

What to do Next? ................................................................................................ 184

Federal Blue Ribbon Commission on Fiscal Federalism. .......................184

Provincial Blue Ribbon Commissions on Taxation. ................................186

References .......................................................................................................................189

APPENDIX A .................................................................................................................194

APPENDIX B .................................................................................................................197

APPENDIX C .................................................................................................................199

APPENDIX D .................................................................................................................200

APPENDIX E .................................................................................................................203

APPENDIX F .................................................................................................................213

Glossary of Terms ..........................................................................................................216

FIGURES

Figure 1a. Revenue Growth by Source in Punjab ....................................................... 22

Figure 1b. Revenue Growth by Source of NWFP ........................................................ 22

BOXES

Box 1. Inter-Provincial Coordination Committee ........................................................ 16

Box 2. International Practices in Property Taxation ................................................... 29

Box 3. An Example of Undervaluation ......................................................................... 40

Box 4. Taxing Land and Structures .............................................................................. 45

Box 5. Growth of Motor Vehicle ownership in Pakistan ............................................. 77

Box 6. Subnational Government Taxation of Motor Fuels in ..................................... 92

Box 7. Mutations and Registrations ............................................................................ 108

Box 8. The Patwari ........................................................................................................ 112

Box 9. A Capital Gains Tax or a VAT on Property Transfers? ............................... 126

Box 10. Changes in Protection and Taxation of Agriculture Sector ........................ 139

Box 11. Who should Administer the Sales Tax on Services? .................................... 154

TABLES

Table 1. Disparities in Economic Condition ............................................................... 218

Table 2. Budgetary Position Punjab 2006-07 ............................................................. 219

Table 3. Budgetary Position Punjab 2006-07 ............................................................. 220

Table 4. Budgetary Position NWFP 2006-07 .............................................................. 221

Table 5. Budgetary Position NWFP 2006-07 .............................................................. 222

Table 6. Intergovernmental Fiscal Profile of the Four Provinces ............................ 223

Table 7. Fiscal Comparisons: Provincial Level Governments .................................. 224

Table 8. Revenue Structure of Provincial Governments in 2005-2006 .................... 225

Table 9. Revenue Mobilization in Punjab and NWFP, 2002-2006 ........................... 226

Table 10. The Changing Reliance on Intergovernmental Transfers

by Provincial Governments .......................................................................................... 227

Table 11. The Growth in Federal Transfers ............................................................... 228

Table 12. Revenue Performance of the Urban Immovable Property Tax ............... 229

Table 13. International Comparison of Property Tax Revenues: Selected Countries

......................................................................................................................................... 230



Table 14. Revenue Impact of Removing Preferential Property Tax Treatment in

Punjab ............................................................................................................................ 231



Table 15. Illustrative Property Tax Reform Program for Punjab ........................... 232

Table 16. Simulation of the Effects on Indexing the Property Tax in Punjab ........ 233

Table 17. The Tax Rate Structure in NWFP .............................................................. 234

Table 18. Revenue Impact of Removing Preferential Property Tax Treatment in

NWFP ............................................................................................................................. 235



Table 19. Illustrative Property Tax Reform Program for NWFP ............................ 236

Table 20. Simulation of the Effects on Indexing the Property Tax in NWFP ......... 237

Table 21. Revenue Performance of Motor Vehicle Tax ............................................ 238

Table 22. Growth in Motor Vehicles and Population in Punjab .............................. 239

Table 23. Implied Tax Burden on a Standard Motor Car in NWFP ....................... 240

Table 24. Implied Tax Burden on a Standard Motor Car in Punjab ...................... 241

Table 25. Proposed Reform in Motor Vehicle Taxes: Punjab .................................. 242

Table 26. Proposed Reform in Motor Vehicle Taxes: NWFP ................................... 243

Table 27. Indexation of the Token Tax ....................................................................... 244

Table 28. Revenue Potential of a Motor Fuel Tax ..................................................... 245

Table 29. Distribution of Consumer Expenditures for .............................................. 246

Table 30. Distribution of Consumer Expenditure for ............................................... 247

Table 31. Revenue Performance of the Professions, Trade and Callings Tax ........ 248

Table 32. Taxes on Professions and Callings .............................................................. 249

Table 33. Revenue Potential: Tax on Professions (2005) ........................................... 250

Table 34. Total Revenue Collections of Land Taxes: By Component ...................... 251

Table 35. Revenue Performance of Land and Property Transfer Taxes ................. 252

Table 36. Disaggregation of Provincial Government Land Taxes by Component for

Punjab (2005-06) ........................................................................................................... 254

Table 37. Collection by Type of Provincial Government Property Transfer Tax .. 255

Table 38. Property Transfer Taxes on Real Estate: Selected Countries ................. 256

Table 39. Distribution of Cultivated Area by Farm Size, 2000 ................................ 257

Table 40. Potential AIT, Current Lax ......................................................................... 258

Table 41. Revenue Impact of Reducing the Exemption to 5 acres in Punjab, 2000 259

Table 42. Revenue Performance of the Sales Tax on Services 2005-2006 ............... 260

Table 43. Sales Tax Collection from Services (Provincial) ....................................... 261

Table 44. Sales Tax/Excise Duty (in VAT mode) in Services in Pakistan ................ 262

Table 45. Revenue Performance of Taxes as Percent of Total Revenues ................ 263

Table 46. Tax Revenue Targets and Reform Options Punjab .................................. 265

Table 47. Tax Revenue Targets and Reform Options NWFP .................................. 266

Table 48. Policy Reform Matrix .................................................................................. 267

Table 49. Distribution of NFC Transfers: Impact of an Incentive Scheme ............. 268

vii

EXECUTIVE SUMMARY

Pakistan’s intergovernmental fiscal system is out of balance. Provincial governments

account for 35 percent of all government expenditures but only 7 percent of all taxes. It

is doubtful that local residents see much connect between the level of taxes they pay to

provinces and the expenditure benefits they receive. This means that the government

misses out on one of the most important advantages of fiscal decentralization – taxpayers

holding their elected provincial officials accountable for the quality of services delivered.

A second dimension of fiscal imbalance is the mismatch between the weak tax

administration skills of the provincial governments and the hard-to-collect taxes that they

have been assigned. The latter include taxes on agriculture, professions, property and the

consumption of services. The result of this mismatch (and politics) is that the level of

taxes is equivalent to approximately 0.2 percent of regional GDP in each province by

comparison with about 10 percent at the federal level.

The purpose of this study is to review the status of revenue mobilization by sub-

national Governments in Pakistan, and to identify reform options that might lead to a

higher level of revenues and a better functioning fiscal decentralization. This analysis is

based on case studies of Punjab and NWFP provinces, and on data gathered in the course

of field work in the two provinces.

Revenue Targets and Comprehensive Reform

What level of taxation should the provinces seek to reach? The federal government

has suggested a target of one percent of GDP, which would call for increasing the level of

revenues by more than four times in both provinces. Both provinces are carrying

structural fiscal deficits that they finance by drawing from balances created by unfilled

positions and by slow disbursements of project funds. These deficits are not sustainable

in the long run. To eliminate them would require an increase of provincial taxes

equivalent to 300 percent in NWFP and 137 percent in Punjab. This would lead to a level

of taxes that would exceed one percent of GDP in both provinces. If an international

average for developing countries was used to set the revenue target, it would imply a 179

percent increase in taxes in NWFP and a 111 percent increase in Punjab, and both

provinces would reach the one percent of GDP target set by the federal government. The

important point to be made here is that any of these targets would call for a significant

restructuring of the tax system. So, this report focuses first on a comprehensive reform,

and then secondly on piecemeal adjustments to the present system.

Some might say that tax increases of this magnitude would introduce too much of a

shock to taxpayers to be feasible. One of the two answers to this concern is that the

increases might be phased in over a period of time in order to cushion the shock. The

other is that taxes are presently so low that there is now a window for complete

restructuring that may not open again. Moreover, this might be an opportune time to

build an administrative infrastructure that supports a more rational provincial tax system.

Arguably, the shock that comes with comprehensive reform is exactly what is needed.

viii

The economic, administrative and political constraints that have kept provincial tax

revenues so low in Pakistan will continue to inhibit revenue growth. These will need to

be addressed.

• Provincial taxable capacity is low, and much of the tax base (rural and a large

informal sector) is hard to reach.

• Tax administration is weak. Records are out of date, tax bases are

undervalued and incomplete, and skilled tax staff are in short supply.

Collection rates are low in both provinces.

• Tax exemptions and preferences have narrowed existing tax bases, and many

taxes are subject to specific rates.

• The federal government has indirectly slowed revenue growth by encroaching

on the provincial tax base in the areas of motor vehicle taxation and the sales

tax on services.

• Provincial politicians have felt pressure from strong interest groups (e.g.,

agriculture, property owners) to hold off on increasing taxes, and in a sense

they have been “protected” by growing allotments under the NFC.

Urban Immovable Property Tax (UIPT)

The UIPT is not yielding very much revenue, and probably has a negligible effect on

land markets. This suggests that it could be a good time to overhaul the entire structure

of the tax. In this analysis, a revenue “target’ is set that would bring both provinces to the

international average for developing countries (0.5 percent of GDP). A multi-year plan

to increase property tax revenues by ten times the present level would be required to

reach this target.

We would propose that these revenue increases be obtained from four measures.

First, bring in a new valuation roll, which assesses market rental value and puts the

correct relative values on properties. Such a new roll is ready for implementation in

Punjab, but has not yet been prepared in NWFP. Second, the numerous preferential

treatments in the present system should be eliminated, and property tax relief should be

limited to low valued properties. This would include eliminating both the 5 marla

exemption and the preferential treatment of owner occupiers. It also would require that

federal and provincial government properties make a payment in lieu of property tax for

services received. Vacant properties would be taxed, and industrial properties would be

moved to the commercial valuation table. Third, the property tax base could be indexed

during the period between valuations. Fourth, the statutory tax rate could be increased to

compensate for undervaluation. These four measures and administrative improvements

could raise enough revenue to nearly meet the revenue target in both provinces.

Motor Vehicle Taxes

Increased emphasis on the taxation of motor vehicles offers good opportunities for

increased revenue mobilization. A revenue target equivalent to the cost of provincial

roadway expenditures would imply a 90 percent increase in motor vehicles tax revenues

in NWFP, and a 50 percent increase in Punjab.

The comprehensive reform that is proposed here would replace the present system (a

one-time registration tax and an annual “token” tax) with a unified annual license tax

based on vehicle type (a rough proxy for engine capacity). All motor vehicles could be

grouped into three classes, and each would be subjected to a specific (indexed) rate. This

new structure would be more simple to administer and more revenue productive than the

present system, and would not heavily burden low income households.

Another element of a comprehensive reform would be the adoption of a provincial

motor fuel tax. While the token tax is meant to be a user charge for road use, it does not

reflect the amount of road use. A tax on motor fuels would better serve this objective,

and would mobilize significant revenues. The tax would be levied on an ad valorem

basis with the rate set by the province, and collection would be by the oil marketing

companies. Revenues would be returned to the provinces on a basis of origin of

collection. At a rate of approximately 2 percent of the cost of a litre of motor fuel in

Punjab and 1 percent in NWFP, the revenues would exceed the present yield of the

registration tax and the token tax in both provinces.

Tax on Professions, Trades, and Callings (“Professions Tax”)

The professions tax is levied at such low rates, and enforcement is so weak, that it is

almost guaranteed to fail on the revenue raising objective. The sheer number of

professionals would make an efficient administration of the tax a very costly proposition,

especially with the current complicated rate structure.

There would seem to be two routes to comprehensive reform of this tax. One is to

take the view that this tax is more a nuisance than a revenue productive levy, so it should

be abolished as a provincial tax. It would be better to invest the administrative resources

used in potentially more productive areas of revenue mobilization. Under this scenario,

the professions tax might be turned over to the local governments where some of the

administrative difficulties may be overcome by local knowledge of the tax base.

The other route is for the professions tax to be converted into a piggyback tax on the

federal individual income tax. Provincial governments could choose a piggyback rate

within a prescribed range and the federal government would collect the tax. A three

percent piggyback on collections for individuals and self employed in Punjab and NWFP

could yield substantially more than current collections from the professions tax in either

province.

Property Transfer Taxes

Collections of rural land taxes and property transfer taxes account for less than one

percent of GDP in both provinces. In light of the fact that agriculture accounts for about

27 percent of provincial GDP in Punjab and 30 percent in NWFP, this is a surprisingly

low revenue share.

The underlying problem is that property transfers are not being taxed at their market

values. The only objective evidence used in the valuation process would appear to be the

average declared sales values computed by the Patwari for rural areas, but this is almost

certainly much below the true market value. Neither is there confidence that the urban

area valuation tables recognize full market value. Observers speculate that taxed values

are probably in the range of 25 – 50 percent of true values. Since sales ratio studies are

not carried out, the true coverage of the tax base is unknown. In addition, there is a

significant problem with record keeping. An updating of the “record of rights” is

required every fourth year, but is reported to be much more dated.

Comprehensive reform of the system of property transfer taxes must be led by

improved administration. Only then can restructuring be successful. The administrative

reform, which needs to be done whether there is a restructuring or not, would center on

developing an accurate and up-to-date census of all rural properties, their ownership and

their use. This survey would be accompanied by the development of a more modern

valuation method, regular sales ratio studies, and appropriate upgrades in staffing.

A comprehensive restructuring of the taxation of rural land might pull back from

taxing property transfers altogether. This regime could be replaced with an annual tax on

land in rural areas that would parallel the UIPT. This could be done by merging the

various taxes on property transfers into a single levy on land values in rural areas. The

revenue impacts of this package of administrative reforms are not easily estimated, but a

15 percent increase in taxable values, and tax collections would seem to be well within

the reach of provincial governments if they chose to make the necessary administrative

improvements. A capital gains tax on immovable property also should be considered.

Agricultural Income Tax (AIT)

The effective rate of agricultural income taxation is very low, despite the fact that

agriculture is one of the largest sectors in the provincial economies. The potential

revenue under current law is estimated to be more than 4 times the actual collections in

Punjab and more than 10 times the current level of collections in NWFP. The major

reasons for this poor revenue performance (in both provinces) is that the tax base has

been significantly eroded by exemptions, there is no allowance made for the different

profitability of the various crops, and the tax is not well administered.

There are a number of options for reforming the agricultural income tax.

Administrative reforms to be considered include, (a) Creating a withholding system for

the AIT, where tax is withheld on the purchase of agricultural inputs, with an exemption

limit for small farmers, (b) Creating a withholding system on the sale of cash crop

outputs, (c) Introduction of a self assessment scheme, (d) Expansion of the information

kept in the base records (Khasra Girdawari) to include the Produce Index Unit System

(estimates of costs of inputs and gross receipts by crops).

With respect to structural reform, the options include land-based (farm size) scenarios

with progressive rates by farm size, and a flat rate structure with different rates for

different crop types. A comprehensive income-based reform could involve taxing

presumptive net income based on crop yield and profitability, with an exemption of

100,000 rupees and progressive rates from 5 to 15 percent. Our simulations show that

under this income-based reform, revenues would increase by 20 percent in NWFP and 10

percent in Punjab. The revenue impact would be much greater if a more complete and

accurate tax roll was in place.

Sales Tax on Services

There are some significant challenges to ratcheting up revenues from the GST on

services. First, the provincial governments would need to be willing to expand their tax

base to include more services. Second, the service sector is not easily taxed because it is

composed of many small firms that are difficult to reach because of problems with

indentifying these firms and with accessing accurate records. In addition, there is a

“headquarter” problem, i.e., the tax may be paid at the headquarter location rather than at

the point of consumption. Finally, administration poses a constraint. Why should the

federal government aggressively pursue collections against a broader services base, when

98 percent of the revenues accrue to the provincial government? In fact, the ten services

now taxable as federal excises yield Rs 28.2 billion in federal revenues vs. Rs 4.2 billion

in collections under the provincial ordinances. About 98 percent of total national

collections are made in Punjab and Sindh.

A comprehensive reform could take one of two broad paths. The most obvious

reform option is for the provincial government to expand its base by bringing more

services into tax. A disadvantage of this proposal is that the tax base could become more

complicated as additional services are added, and the central government may not be

willing to expand its administrative efforts so as to reach the hard-to-tax services area.

This disadvantage could be erased by transferring administrative responsibility to the

provincial government. It would however, be difficult to protect revenues during the

transition period while the province was learning to administer the tax. In the long run,

however, a provincially administered sales tax on services is a viable option in a federal

country such as Pakistan.

Another comprehensive reform option is to convert the GST on services to a shared

tax with a significantly broader base. Both the federal and the provincial governments

would tax the same services, with assessment and collection carried out by the federal

government. The services to be taxed would have to be the same under such a regime,

but the provincial tax rate could vary according to the decision of the provincial

government. Revenues would thus be shared between the two levels of government,

hence there would be more incentive for aggressive tax administration. The revenue

potential is considerable, but because of data limitations, we can only suggest indicative

amounts. The services sector now accounts for more than 10 percent of GDP in Punjab,

which suggests that a doubling of the present level of revenues should be easily

accomplished.

Other Taxes

The “other taxes” levied by the provinces do not generate much revenue, and are

poorly administered. The sum of hotel tax, entertainment tax, excises, and tobacco and

cotton levies and other agricultural cesses, yielded an amount equivalent to only 6.97

percent of total tax revenues in Punjab and 4.67 percent in NWFP. A reform program

might abolish the hotel tax and electricity duty in favor of their inclusion in the sales tax

on services. The agricultural cesses could be folded into the reformed agricultural

income tax. The entertainment tax might be passed down to the local governments, since

they are in a better position to administer the tax efficiently.

xii

Revenue Adequacy and Implementation

We estimate that this package of comprehensive administrative and structural reforms

can raise provincial taxes to one percent of GDP in Punjab. The same package will fall

short in NWFP, even though revenue mobilization would be significantly increased. This

suggests the need for more emphasis on equalization in the National Finance Commission

(NFC) awards.

This reform package does imply a very large increase in taxation in both provinces.

But, it also addresses both problems of fiscal balance that the government faces. On the

issue of vertical balance, the result would be that provincial governments in Pakistan

would now match a 35 percent expenditure share with an 11 percent tax revenue share

(vs. the present level of 7 percent). This would move the intergovernmental fiscal system

in the direction of more accountability at the provincial level, though the imbalance

would remain large. The tax administration mismatch would also be addressed. With tax

base revenue sharing under the sales tax on services and the professions tax, and with

significant administrative improvements in the land and property tax areas, the tax

administration mismatch would be addressed in a significant way.

Implementation of such a sweeping reform will be no easy matter, in terms of the

upgrades in administrative capacity needed to absorb the restructuring, the timeline for

bringing the reforms on stream, and managing the politics. The provincial governments

need to develop an implementation plan that takes all of this into account.

Improvements in the system of tax administration will be a difficult matter and will

take time to develop. The completion of an accurate survey of all lands in the province

and putting in place new methods of valuation will necessarily precede the complete

restructuring of property and land taxes. These administrative upgrades will be

expensive, but they are essential.

One administrative reform that can be moved on quickly is to create a unified tax

authority. The present bifurcation of responsibility for tax administration between the

Board of Revenue and the Excise Tax Department is not productive. The opportunities

for eliminating duplication in assessment, information sharing and for economies in

recordkeeping are missed in the present system. A unified tax administration would

create a much better umbrella for enforcement of the kind of tax system that is envisioned

here.

The reform program outlined here could only be implemented over a period of years.

One constraint is the need for some tax administration improvements to lead the way.

Other important considerations are gaining the necessary legislative approval, working

out the detail of the new laws and regulations, and navigating the politics of tax reform.

In the last analysis, though, the speed of the reform is dependent on the willingness of the

provincial government to push for changes in tax administration and tax structure and for

increased revenue mobilization. In fact, work on most of the restructuring could begin

immediately. The implementation timetable could be very fast on some items, including:

the introduction of new valuation table for Punjab, and the preparation of a new table in

NWFP; elimination of preferential treatments and exemptions under UIPT; indexation of

the UIPT; unification of a motor vehicle taxes and introduction of a motor fuel tax, and

piggybacking of the sales tax on services and the professions tax on the federal sales and

income tax bases.

xiii

Rethinking the Federal Role

To encourage provincial governments to undertake what they will perceive as

unpopular tax measures, the NFC awards might be restructured to introduce an incentive

for increased revenue mobilization. To be successful, the incentive would have to be

large enough to draw out a greater tax effort, but not so large as to significantly harm

equalization. This will call for some rethinking of the formulas used in the

intergovernmental transfer system.

There are two other areas where the federal government might rethink its fiscal

philosophy and rules. One is about the interpretation of the constitution as holding to a

separation of taxing powers between the federal and subnational levels of government. If

this interpretation is firm, it limits the possibilities for tax base sharing between levels of

government, and therefore limits the possibilities of provincial governments taking

advantage of the stronger federal tax administration infrastructure. The second area is the

requirement that the NFC formula gain agreement from all provinces before it can be

implemented. This requirement severely limits the NFC from ever reaching agreement

on any formula. If the agreement clause can be interpreted to allow more flexibility in

formula design, the NFC might begin rethinking the balance in the present system

between revenue mobilization incentives and equalization.

What to do Next?

If this work is to become part of a national dialogue about provincial tax reform, the

next step is to carry out a similar study for the other two provinces. Then, the federal

government should appoint a blue ribbon commission to consider two tasks: a rethinking

of the efficacy of the present system of tax assignment, and the development of an

incentive feature in the NFC awards. Finally, the provinces should appoint commissions

to begin work on developing a blueprint for tax restructuring and implementation. This

study can be a starting point for the provincial commissions.

PAKISTAN: PROVINCIAL GOVERNMENT TAXATION

∗

The purpose of this study is to review the status of revenue mobilization by sub-

national governments in Pakistan, and to evaluate reform options that might lead to a

higher level of revenues and to a better functioning decentralization. This analysis is

based on case studies of two provinces: Punjab and North-West Frontier Province

(NWFP).

A central issue of provincial finance in Pakistan is the significant vertical

imbalance in the intergovernmental fiscal system. The four provincial governments

account for 35 percent of all government expenditures but only 7 percent of all taxes

. At

a time when central government taxes are only about 10 percent of GDP, there is a

premium on increased revenue mobilization by provincial governments. The federal

government has called on the provinces to double their tax-to-GDP ratio in the medium

term (Government of Pakistan, 2007).

The barriers to such an increase in revenue mobilization by provincial

governments are formidable. They range from structural problems with the present tax

system, to administrative shortcomings, to the absence of incentives for provincial

governments to increase their tax effort. There also would appear to be some murkiness

in revenue assignments between levels of government, and some important constitutional

limitations on the choices that provincial governments might make. All of these barriers,

∗

The Government of Pakistan has requested the assistance of the World Bank and the Andrew Young

School of Policy Studies of Georgia State University on developing a roadmap for tax policy reform. The

objectives of the 2008 Pakistan Tax Policy Report are to understand the constraints to raising tax revenues

and propose policy options on how to improve tax collection in an efficient and equitable manner. This

draft policy paper is one in a series of background papers prepared as input into this report.

Calculated from Table 4.2, Statistical Appendix in Government of Pakistan, 2007.

2 International Studies Program Working Paper Series

and the way around them, are discussed below.

The goal here is to identify options for reform rather than to make hard

recommendations. While the magnitude of the revenue increase causes us to stress the

need for comprehensive reform, we also lay out a program of piecemeal adjustments to

the present system. Where possible, the revenue impact of each reform is estimated.

The emphasis in this study is on structural reform and revenue mobilization. We

do not provide a detailed analysis of the tax administration system in the two provinces,

nor do we propose specific changes in staffing, management and organization. To be

sure, these are important issues, but they are beyond the scope of this work.

Moreover,

our view is that administrative improvements can have a better impact if implemented in

the context of a well designed tax structure.

There are other areas that we do not study, including the budgetary choices of

subnational governments. This study is focused on the tax side rather than on

expenditure side of the budget. This means that we do not study the efficiency of user

charges, and that we take the present revenue assignments as fixed.

Finally, politics is a key determinant of the level and structure of taxes in

Pakistan, as it is in most countries. We offer no remedies for removing political

constraints to good tax structures other than to argue that more transparency and a better

appreciation of the gains to be had from good tax policy might lead to better outcomes.

We do not provide an analysis of the politics of tax reform. To constrain this analysis by

considering only reforms that would find political favor in Pakistan would have led to a

very brief report.

Others have carried out such analysis. See, for example, Khan (2004).

Pakistan: Provincial Government Taxation 3

The Provincial Economies

Government Finance in Pakistan is the responsibility of the federal government,

four provincial governments and a national capital district.

There are sizable differences

between NWFP and Punjab in their economic condition (Table 1), and therefore sizable

disparities in both their capacity to raise resources and their expenditure needs.

The most commonly used index of the level of economic development of a

country (or a province) is per capita GDP. From the province-level estimates of GDP, we

can learn that Punjab has a much stronger economy than does NWFP.

Whereas per

capita GDP in Punjab is reported to be about equal to the national average level, that in

NWFP is more than 30 percent lower. From this we can infer that the taxable capacity of

NWFP is well below that of Punjab.

Not only is the tax base larger in Punjab, but it should be easier to reach. Another

indicator reported in Table 1 is the percent of population living in urban areas. Over 80

percent of population in NWFP is rural, employed in agriculture or self-employed in

family businesses (World Bank, 2005a). Only 18 percent of the population lives in urban

areas, compared to one-third of the population in Punjab. Presumably, tax collections in

urban areas are easier than collections in rural areas. NWFP also has a heavy

concentration of subsistence farming in its economy, which further weakens taxable

The federal government administers the Federally Administered Tribal Areas and the Federally

Administered Northern Areas. These are not subjects of this report.

In Pakistan, provincial GDP is not estimated directly but is pegged to national GDP estimates and to

assumptions about regional shares and growth rates. The approach in Punjab involves using sectoral data

on GDP where available, but is still thought to be a rough approximation of provincial GDP (Government

of the Punjab, et. al. 2005). NWFP has set its estimates at 6.7 percent of GDP growth (for 2007-08), an

estimate which is based on the assumption that provincial growth will be 93 percent of the national GDP

growth rate. It is projected by provincial officials that NWFP output will reach 97 percent of the national

growth rate by 2010-11 (Government of NWFP, 2007a).

4 International Studies Program Working Paper Series

capacity.

While the potential for revenue raising from local taxes and charges is

considerably greater in Punjab than in NWFP province, it is no easy matter to assess and

collect provincial and local taxes in either province. According to the Pakistan Labor

Force Survey (Federal Bureau of Statistics, 2006a, Table 17), the non-agricultural

informal sector accounts for 77 percent of total employment in Punjab. The comparable

shares of this hard-to-tax sector are 72 percent in NWFP and 73 percent in all of Pakistan.

Are there trends in play that might, over time, reduce these income disparities?

Note that the two provinces have grown at about the same rate over the last decade.

Agricultural output has shown a significant increase in the 2000s and this has contributed

to the per capita real growth in both Punjab and NWFP, as shown in Table 1. Moreover,

there was some decline in rural poverty in Pakistan during this period (World Bank,

2007). It is not clear, however, that these improved conditions in rural areas have

significantly increased taxable capacity or reduced expenditure needs in either province.

Note there has not been an uptick in the rate of revenue mobilization in either province

during this decade. Note also that NWFP continues to rank worst among the provinces in

terms of the perception of investment climate (FIAS, 2007).

There are substantial differences in the socio-economic makeup of the two

provinces. Punjab’s economy is much larger (population and land area) and it is

significantly more urbanized. Some analysts estimate that there is not much difference

between the two provinces in the percent of population living below the poverty line

(Table 1).

Can we infer differences in expenditure needs from these disparities? The

World Bank estimates (2005), however, show the poverty rate in Punjab to be much below that in NWFP,

and the backlog of public services to be much less.

Pakistan: Provincial Government Taxation 5

answer is that we cannot. The percent of high-cost, poverty level population certainly

pressures budgets upward. NWFP is more rural, suggesting a higher cost of getting

services to people, but Punjab has three times as much land area and four times as many

people to serve.

What might be concluded from this pattern of disparities is that the per capita cost

of providing the same level of services may not be so different between the two

provinces, but the present level of services and the capacity to finance these services is

much lower in NWFP.

Deficits and Fiscal Weakness

As we demonstrate below, both Punjab and NWFP face a structural fiscal deficit,

i.e., they must borrow and postpone certain planned expenditures to eliminate the gap

between revenues and expenditures. The situation is not dire in that the size of the deficit

is only 0.85 percent of GDP in Punjab and 1.11 percent in NWFP. This is in contrast to

the India experience where the aggregate deficit of the state governments reached 4

percent of GDP by the end on the 1990s (World Bank, 2005b). Still, these amounts are

not inconsequential and could grow if corrective fiscal measures are not introduced.

Budgetary Position: Punjab

The budgetary position of Punjab Province, as reported by the government, is

described in Table 2 for 2006-2007. The current account position (row 3) is shown to be

in surplus, primarily because of the large inflow of federal transfers. The amount of the

current surplus is equivalent to more than 25 percent of general revenue receipts. After

6 International Studies Program Working Paper Series

accounting for capital spending (rows 4 and 5) and capital receipts (row 10), there is

reported to be an overall fiscal deficit of Rs 43 billion (row 11). This deficit is covered

from existing balances. This statistical picture of fiscal health may be misleading. The

format in which the Province presents its budgetary position calls for some explanation.

In the Pakistan budget nomenclature, there is a category of “current capital

expenditures” (row 4). The largest components of these expenditures are debt repayment,

expenditures made for the wheat subsidy program, and transfers to local governments.

These outlays might be viewed as more current than capital expenditures because they

represent amounts “consumed” in the current fiscal year. As shown in Table 2, the total

of current capital expenditures exceeds the current surplus available, suggesting a current

account deficit.

The third general category, development expenditures (row 5), includes two

components. The first is development revenue expenditures (row 5.1), which are akin to

current expenditures in that they include items of government consumption expenditure,

e.g., staff salaries, books for school children, feasibility studies, and provision of

contraceptives under the population control program. However, they are viewed by the

government as developmental in that they include start up costs for capital facilities,

project management for capital projects, etc. The second component (row 5.2) is the

more traditional capital expenditures, i.e., outlays for the creation of long-lived physical

assets. When these expenditures are included in the calculus, the overall deficit against

recurrent revenues rises to about Rs 149 billion for Punjab (row 6).

Pakistan: Provincial Government Taxation 7

The financing of this deficit (rows 7, 8 and 9) is primarily from loans, and

revenues from wheat sales. The remaining amount of deficit is about Rs 43 billion,

which is financed from existing cash balances.

We might recast this budget format to get a better picture of the budgetary health

of the province. Our primary goal in this restatement is to estimate the balance between

recurrent revenues and current expenditures, where the latter are those outlays that are

“consumed” during the current fiscal year. In Table 3 we combine all current revenues,

including general revenue receipts. We then combine all current expenditures to include

current revenue expenditure, current capital expenditure, intergovernmental grants and

development revenue expenditure. We have treated wheat trading operations as a

separate enterprise account and we show its fiscal position to be in balance (row 3).

This restatement reveals a current budget deficit of Rs 9 billion (row A, Table 3).

When capital expenditures are accounted for, the overall deficit is equal to Rs 78 billion,

or 1.5 percent of provincial GDP. About 44 percent of this deficit is financed from

borrowing, and the remainder from a drawing on reserves. We can say that Punjab does

pass the golden rule in capital finance, because the amount borrowed (row 5) does not

exceed the amount spent for capital purposes (row 4).

Punjab is not in a financial crisis, but neither is it in a sustainable budgetary

position. The State Bank of Pakistan has noted that the province has been following an

expansionary fiscal policy combining a meager growth in revenues with a drastic rise in

expenditure, substantially reducing the revenue surplus

. Among the vulnerabilities

brought on by these policies are the following:

State Bank of Pakistan 2007a, Vol I. p.54

8 International Studies Program Working Paper Series

• The recurrent budget deficit of Rs 9 billion might be thought of as the

structural budget deficit of the Province. It is equivalent to about 3

percent of total general revenues, and about 14 percent of provincial own

source (tax and non tax) revenues. A 29 percent increase in provincial tax

revenues would be required to eliminate this component of the deficit.

• At present, reserves are adequate to cover the current deficit. These

reserves accumulate because of unfilled positions or lagging expenditures

for various projects. When these reserves are exhausted (e.g., by using the

funds from unfilled positions), the province will be in a position of having

to cut spending, raise own revenues, or increase borrowing.

If the

government chose to finance its full current deficit from loans, then the

result would be tantamount to rolling over debt repayment with additional

loans. If we assume that the Provincial Government is currently

borrowing the maximum amount that it can afford, we might think of Rs

43 billion financed from reserves as the structural deficit. Taxes would

need to be increased by 137 percent to cover this deficit.

• The equivalent of about one-third of capital spending by the province is

directly financed from foreign loans.

• About three-fourths of all current revenues are received in the form of

intergovernmental transfers from the federal government.

• The finances of many public enterprises and other contingent liabilities are

off-budget. Contingent liabilities had been estimated to have risen

significantly, from Rs 1.7 billion in 1990-91 to Rs 7.8 billion in 1999-

2000. (World Bank 2001, p. 57). The provincial government’s outstanding

loans to autonomous bodies, nearly all of them non-performing, were Rs

35 billion, with an additional Rs 6 billion in non-performing bank loans

and Rs 500 million in unfunded pension liability of their employees

(World Bank, 2001, p.58). The government has not yet completed a

financial analysis of the large number of autonomous bodies of the

Government of Punjab (Government of the Punjab, 2007c).

Finally financial condition must always be weighed against the level of public

services offered. In Punjab, there are serious deficiencies, as cited in the annual

On the question of these funds becoming exhausted, it should be pointed out that the practice of covering

capital expenditures with funds from unfilled positions was already an issue in the 1990s (World Bank,

2000, page 51).

Pakistan: Provincial Government Taxation 9

presentation of the Chief Minister (Government of Punjab, 2007e). For example, only 19

percent of the rural population has access to piped water, and infrastructure in general is

deficient. Such public service needs can always be seen as a vulnerability.

Budgetary Position: NWFP

The budgetary position in NWFP is described in Table 4. These data and this

reporting format show a current account surplus (row 3) of about Rs 11 billion (17

percent of general revenues). As in the case of Punjab, however, expenditures for

“current capital” purposes (row 4) exceed the current surplus. The overall deficit of Rs

33 billion, calculated as the difference between total revenues and total expenditures, is

reported in row (6).

Borrowing is approximately equal to expenditures for creation of long-lived

assets, hence over-borrowing would not seem to be an issue. However, capital

expenditures are closely tied to the level of foreign loans, either directly or indirectly.

This is a point of vulnerability in the spending plans of the province.

As in the case of Punjab, this reporting might result in a misleading interpretation

of the budget condition of the province. As described above for Punjab, the financial

accounting might be recast to compare current expenditures with current revenues (Table

5). Under this format, NWFP shows a current deficit of about Rs 3 billion, equivalent to

about 5 percent of total general revenues.

This structural deficit of the province in 2006-

2007 is almost equivalent in amount to provincial tax revenues. When capital

expenditures are accounted for, the overall deficit rises to about Rs 27 billion, or about

This includes the trading deficit of the wheat subsidy program.

10 International Studies Program Working Paper Series

3.5 percent of provincial GDP.

This is financed by borrowing (66 percent) and by a

drawdown of existing balances (34 percent). The State Bank of Pakistan has noted that

the deficit would have been much larger if the expenditures growth had not slowed.

Borrowing is a drain on current resources available in that interest and repayment

account for about 9 percent of current expenditures. There are prospects for reducing this

amount. Prior to 2000, the province obtained cash development loans from the federal

government at high interest rates as budgetary support for capital spending, but these

have decreased significantly. World Bank borrowing ($130 million annually) is being

used to retire these high interest rate loans. Currently the only federal loans to the

province are project funds for salinity and logging reclamation.

Is this budgetary performance of NWFP sustainable over the long run? Some

questions might be raised. First, the current account deficit is equivalent to only about 5

percent of general revenues, but this does constitute a kind of structural imbalance. To

cover it would require an increase in provincial own taxes equivalent to about 96 percent

based on 2006-2007 levels. And then, there is the question of whether this higher level of

provincial taxes could be structured so as to grow in step with current expenditures.

Second, about Rs 9 billion of the overall deficit is now being financed from

existing balances (row c). There are reasons to believe that these balances could

NWFP GDP for 2006-2007 is projected here from GDP in 2005-06 using the average growth rate for the

last six years.

State Bank of Pakistan 2007a, p.55.

Proposals for project funding originate in the line departments (education, health, etc.). The total

development budget for 07-08 is Rs 39.462 billion: Rs 7.975 billion from foreign support, Rs 23 billion

from provincial resources, and Rs 9 billion from federal funds. Large projects are funded with a 3 year

time frame. Capital expenditures comprise most of these outlays. Currently about 80 percent of funding is

for on-going programs and 20 percent for new programs. The expectation is that many old programs will

be completed in 2008.

Pakistan: Provincial Government Taxation 11

disappear in the long run. One reason is that the balances have accumulated in part

because of unfilled positions. If these positions are filled, the balance will be depleted.

Another is that development projects have been slow in absorbing funds; i.e., the

utilization rate is very low when compared to the budgeted amounts. Toward the end of

the fiscal year these unspent balances are taken as ‘surrenders’ from the implementing

departments and are used to help balance the budget. These intra-budget transfers, which

fund about one-third of the deficit, will not likely continue over a long period of time. If

we assume that the provincial government is currently borrowing the maximum amount

that it can afford, we might think of the Rs 9 billion as the structural deficit. Taxes would

have to increase by three times to cover this deficit.

A third question has to do with whether the present budgetary condition is in step

with the provincial government’s plan to reduce its fiscal deficit from 0.5 percent of GDP

to 0.2 percent by 2011 (Government of NWFP, 2007a). On the financing side, provincial

own revenues are small. During the 2006-2007 budget year, increases in federal transfers

and a windfall in collection of arrears had a significant effect on budget balance.

NWFP’s share of the NFC award increased from 13.82 percent in 2005-2006 to 14.95

percent in 2006-2007. This one-year increment is equivalent in amount to about 11

percent of 2006 expenditures. This revenue inflow plus debt retirement has created some

fiscal space for the Province.

The provincial government’s projections are optimistic about the prospects of

holding the line on expenditure growth and continuing to realize significant revenue

increases from the transfer system. On the expenditure side of the budget, NWFP

proposes to keep the wage bill at 4 percent of GDP and proposes to reduce interest

12 International Studies Program Working Paper Series

payments to 0.4 percent of GDP. Baseline expenditures for operations and maintenance

will increase between 4 percent and 10 percent over the period, and transfers to districts

will increase by 10 to 15 percent. The development budget will increase from 3.4 percent

to 4.5 percent of GDP. For this fiscal plan to work, NWFP will need to be accurate in

their estimate of a 15-18 percent growth in revenue from 2008 to 2011. According to the

NWFP White Paper

15-18 percent overall (nominal) revenue growth in the next three

years is a reasonable estimate. This may be an ambitious target. Revenue (own source) is

currently equivalent to about 0.7 percent of provincial GDP, and has shown an income

elasticity of 0.72 in recent years. Revenues from the NFC awards should grow in step

with the growth of Federal Government tax revenues.

Finally, we might take the broader view of the structural deficit, and consider that

it should include service level deficiencies. In this case, the structural deficit could be

thought of as much larger. The literacy rate is well below that in the other provinces, as

is the percent of population that has access to safe drinking water. School enrollment

rates for women are among the lowest in Pakistan (World Bank, 2005).

Fiscal Profile

A fiscal profile of the provinces is presented in Table 6. Since there are wide

inter-province variations in per capita GDP, and since the NFC awards are distributed

among provinces according to population, significant fiscal disparities might be expected.

Surprisingly, that is not what we observe. The level of per capita provincial government

expenditures in NWFP is only about 3 percent lower than that in wealthier Punjab in

Government of NWFP, 2007a, p.7

Pakistan: Provincial Government Taxation 13

2006-2007 (Table 6). The explanation for this relatively small expenditure disparity is

that the NFC awards are distributed on an equal per capita basis,

tax effort is about the

same in the two provinces (see below), and access to loan funds is about proportional to

population.

All four provinces receive most of their revenues from central government

transfers

, but NWFP and Balochistan are most dependent on intergovernmental

transfers relative to own source revenues.

The heavy reliance of provinces on federal

transfers has been noted with concern by the State Bank of Pakistan (2007a, p.54). It also

has been noted that the overall level of revenue mobilization has shown little growth in

either province. The provincial dependence on transfers has been increasing since 1974

(Pasha, et. al. 1992).

The picture is also surprising when it comes to Provincial revenue effort

(measured in Table 6 as the ratio of own source revenue collections to GDP). The

expectation is that the poorer, more rural province (NWFP) would have fewer good “tax

handles”, and would raise even less than its lower GDP would suggest. However, note

from Table 6 that revenue mobilization in Punjab and NWFP (tax and non tax sources)

are about the same, and in both cases the ratio is less than 1 percent of provincial GDP.

This finding must be qualified because some transfers have been classified as non tax

revenues so revenue mobilization is overstated for both provinces in Table 6. The proper

Since 1974, equal per capita shares has been the basis for distributing revenues among provinces.

Asian Development Bank, et. at. (2004). Vol. II, pp.18-19.

The dependence on intergovernmental transfers may be understated in Tables 2-5 above. Some non-

development and development grants outside the NFC arrangement are classified as non-tax revenue

receipts. In Punjab these amounted to Rs 18,348 million in 2006-07 (Government of Punjab, 2007b) and in

NWFP they were Rs 9,713 million in the same year. NWFP reports the royalty on hydro-electricity,

Rs.6000 million, as a non-tax receipt (Government of NWFP, 2007c).

Earlier estimates had placed the level of tax effort in Punjab well above that in NWFP (World Bank,

2000, page 37).

14 International Studies Program Working Paper Series

conclusion to draw here is that neither province extends itself very much to mobilize

resources from its own tax bases. Provincial revenue mobilization in general has been

weak and has steadily declined (World Bank 2004, p. 26).

Are Punjab and NWFP different from provincial level governments in other

countries in terms of the role they play in the intergovernmental fiscal system?

International comparisons are not easily made because the assignment of expenditure

responsibilities to the provincial level varies greatly across countries. Two dimensions of

fiscal structure that can be assessed, however, are (a) the share of total government

spending that is made by the provincial governments, and (b) the reliance of provincial

governments on transfers from the center as a source of finance. The results of such

comparisons, shown in Table 7, reveal that Pakistan’s expenditure decentralization of 35

percent is not so unusual by comparison with some other large federations. The limited

reliance of provincial governments on their own sources of revenue does defy best

practice in terms of fiscal decentralization, but it is also the model of choice in countries

such as Russia, Indonesia and China. On the other hand, countries such as Argentina,

Brazil and India follow the more conventional advice and decentralize significantly more

revenue raising power to their state governments. The international practice, even among

large countries, is quite mixed.

Revenue Assignment and Structure

The Constitution in Pakistan lays down a separation of taxing powers. This

assignment system is described in some detail in Appendix A. In general, the provinces

are denied access to the broad-based and more revenue productive income and

Pakistan: Provincial Government Taxation 15

consumption taxes. These tax assignments have left the provinces with bases that are

hard to reach (the income tax on agriculture and the sales tax on services), or costly to

administer (the property tax). Some would argue that the Constitution also closes off

possibilities for tax base sharing by the federal and provincial levels of government, but

not everyone agrees with this interpretation. India’s intergovernmental system is also

built around the constitutional principle of separation of tax bases (vs. concurrent taxing

powers, as are allowed in many federal countries) (Bahl, Heredia-Ortiz, Martinez-

Vazquez and Rider, 2005).

Provincial and local government taxes are authorized by provincial acts and the

provincial governments have some authority to alter tax rates and bases and to administer

their own taxes. The tax structure and administration in Punjab and NWFP are similar in

many respects suggesting either a heavy central influence or some “copycat” behavior.

There also is a method for dispute resolution on tax assignment issues (See Box 1).

The structure of taxes is summarized for Punjab and NWFP provincial

governments in Table 8. Data on local government taxes are not available. It should be

kept in mind that in both provinces, total own source revenues are so small that they play

only a minor role in financing. While there are more than 15 tax sources available to the

provincial governments, most revenues in Punjab are derived from taxes on property

transfers (including stamp duties, mutation and registration fees) and from taxes on motor

vehicles. In the case of NWFP, motor vehicle taxes, property transfer taxes and the GST

on services are the most important own source revenues. The concentration of tax

revenues may be illustrated by the following. In Punjab, 8 of the 14 tax sources listed in

Since the abolition of “one unit” governance in 1970, the provinces have adopted Punjab tax laws and

followed the tax policy of Punjab. The Inter-provincial Coordination Committee also seeks tax

harmonization.

16 International Studies Program Working Paper Series

Box 1. Inter-Provincial Coordination Committee

The inter-provincial Coordination Committee (IPCC) is a mechanism for intergovernmental dispute

resolution. It is chaired by the Minister for Interprovincial Coordination. All provincial Chief Ministers

are members. Any federal minister can be invited for a meeting when the subject relates to his sector.

The Cabinet Secretariat organizes the meetings.

In recent years the federal government and the provinces have used IPCC meetings for coordination

of tax policies. The IPCC mandate, according to the Cabinet Division, is:

1. General Coordination between the Federal Government and the Provinces in economic, social

and administrative fields.

2. Promoting uniformity of approach in the formulation of policies and their implementation by

the Provinces and the Federal Government in all fields of common national concern.

3. Discussion of policy issues emanating from the Provinces that have economic, social or

administrative implications for the country as a whole.

4. Coordination with Ministries/Agencies concerned to develop a suitable response to criticism of

Government policies, so as to project a proper image of the Government.

5. Any other matter referred by the Province or any of the Ministries or Divisions of the Federal

Government.

IPCC is not a constitutional body. The Council of Common Interests, which is a constitutional body

with a similar mandate, has met infrequently at least by default, IPCC performs an important role.

Table 8 account for only 14 percent of the tax revenues. In NWFP, 8 of the tax sources

listed account for only 10 percent of the collections. Administrative effort seems to be

spread quite widely. This suggests that a less complicated tax structure might allow more

administrative effort to be directed toward those taxes that have a greater revenue

potential. This recommendation has also been made in earlier reports (World Bank,

2000).

While the tax structures described in Table 8 outline the current practice, they do

not show the structure that would arise if full revenue potential was reached. The

provinces do have access to some taxes that have broad enough bases and potentially

enough built-in growth to form a more revenue productive tax system. This list would

certainly include the property tax, motor vehicle taxes and the sales tax on services.

Pakistan: Provincial Government Taxation 17

However, all of these taxes presently are levied at very low effective tax rates, so that

they yield a relatively low level of revenues. In the analysis presented in the report, we

look for the determinants of this underperformance.

It is no easy matter to compare tax structures among provincial-level governments

in developing countries. Different countries give different names to subnational

government taxes and there is no ready source of international comparison. The

following examples give some feel for the variation, and for the possibilities.

• Both Argentina and India allow states to levy broad based sales taxes, though

local rate-setting discretion is not allowed in the India case.

• Russia experimented with a subnational sales tax from 2001-2004, which

raised substantial revenue. Subnational governments were allowed some rate

setting authority.

• The principal revenue source of Colombia’s departments (provinces) are

excises, principally on alcoholic beverages, tobacco and gasoline. (Bird and

Acosta, 2005).

Punjab and NWFP follow almost exactly the same pattern of tax administration,

owing to the fact that a uniform system was in place for all provinces between 1954 and

1970. The Excise Tax Department is responsible for collection of most taxes, including

the taxes on urban property, motor vehicles, excises, and entertainment. The Board of

Revenue collects the taxes on rural properties, agricultural income, property transfers,

and other stamp duties. There appears to be little coordination between the two arms of

the provincial tax administration and this compromises collection efficiency. The sales

tax on services is assessed and collected by the central government on behalf of the

provinces, but there is little cooperation between the two levels of government in terms of

information sharing.

18 International Studies Program Working Paper Series

Revenue Mobilization

The time pattern of revenue mobilization for the two provinces, by major revenue

source, is described in Table 9. The results for both provinces show little change in the

rate of revenue mobilization (relative to GDP) over the 2002-2006 period. In fact the

overall level has declined between 2002 and 2006 in both provinces (bottom row of Table

9). One could offer six reasons to explain this weak revenue – GDP elasticity

(buoyancy).

First, provincial taxable capacity is low and the tax base is hard to reach. NWFP

is the poorest province in Pakistan and has a high concentration of poverty, leading

provincial officials to argue that “it is tough to expect to get much more out of the

system”. A similar argument is made in Punjab. Per capita GDP is higher, but there also

is a high concentration of poverty and large informal sector. Even so, many would argue

that the economic base is strong enough to give up more in provincial government tax

revenues than the 0.36 percent and 0.42 percent of GDP that were collected in Punjab and

NWFP respectively in 2005-2006. Moreover, both provinces have shown significant

growth in GDP in recent years. The “low taxable capacity” argument for low revenue

buoyancy is not persuasive.

Second, the tax administration machinery has not been effective in either

province.

Both provinces are plagued by incomplete and out of date records,

Technically, the revenue–GDP elasticity is the percent change in revenue divided by the percent change

in GDP, assuming that all revenue increases due to discretionary changes have been removed from the

numerator. If the revenue impacts of discretionary changes have not been removed, the term “revenue

buoyancy” is used. In Punjab and NWFP, discretionary changes have been so infrequent that the buoyancy

and elasticity coefficients are about the same.

The collection cost for all taxes in Punjab is reported (by Provincial officials) to be equivalent to 4

percent of collections. The collection rate, which would take into account the difference between the base

assessed and the true tax base, is much smaller.

Pakistan: Provincial Government Taxation 19

suggesting that there is not a good sense of the true tax base. Moreover, most tax

subjects (e.g., professions tax, land taxes) have not been recently surveyed, hence tax

bases are understated. Most of the recordkeeping system in both provinces is manual.

Particularly in NWFP, there are serious constraints on assessment and collection.

Revenue collections, except for some excises, take place only in urban areas. For

example, there are 24 districts in NWFP but 70 percent of all property tax collections are

from Peshawar. Over 50 percent of excises come from 7 districts. In fact, some districts

in NWFP are all but excluded from the tax system. About one-third of the NWFP is made

up of provincially administered tribal areas (PATA). Only a few taxes are collected in

these districts, e.g., tax on the transfer of property, stamp duty and the local rate. UIPT is

collected in only 16 of 24 districts. While there is no question about NWFP facing a

challenging environment for tax collection, the situation is by no means hopeless. A

thorough review and analysis of the tax administration system in NWFP (Khan 2004)

points out numerous approaches to overcoming some of these obstacles.

In Punjab, the tax administration does not appear to be effectively mining the

significant taxable capacity in urban areas. Property values have grown but property tax

collections have not, the number of motor vehicles has grown but motor vehicle tax

revenues have not kept pace, and so on. Part of the problem is that the province has

given away much of its tax base in the form of preferential treatment, but another part of

the problem is that underassessment is considerable and collection rates are low. With

respect to rural areas in Punjab, the story of underassessment and low collection rates is

much the same.

20 International Studies Program Working Paper Series

The two provinces have a common administrative problem of not being able to

effectively reach the agricultural sector. Neither of the provinces do a particularly good

job with collection of agricultural income tax or with property transfer taxes. Certainly

part of the problem is with the structure of these taxes, but there also are major

administrative failings. These include poor recordkeeping and surveillance, exclusion of

part of the tax base, and a failure to update valuation information.

Third, the structure of taxes is such that significant increases in revenue relative to

GDP should not be expected. One reason for this is that the tax structure is partly based

on specific rates. Another is that land is being acquired by government and non-profits,

thereby taking it off the tax rolls. It is also the case that provincial governments are not

taking discretionary action to increase the effective rate of tax collection, such as

revaluation of property or increases in nominal rates. Finally, the growth in tax revenues

might have been slowed because some faster growing components of the tax base are not

taxed or are given exemption or preferential treatment, e.g., owner-occupied property,

industrial property and vacant land, and the consumption of services.

Fourth, increases in intergovernmental transfers from the center have been large

enough to allow a slowing of the effort exerted to collect provincial taxes. In Figures 1a

and 1b, we describe the pattern that has occurred between 2001 and 2006. The increase

in central government assistance has been significant in both provinces while the growth

in own source revenues has been nearly flat. This pattern should come as no surprise.

There is no incentive built into the transfer formula that would reward provinces for

increasing their tax effort, or penalize them for not doing so.

Pakistan: Provincial Government Taxation 21

Fifth, the central government has encroached enough on provincial tax bases that

potential revenue growth has been dampened. Many provincial officials feel that the

Provincial Government is too limited by the federal government in terms of the fiscal

space it has been given. Some of these limits stem from the Constitution, but there also

are limits imposed by federal government policy. Five examples are regularly mentioned

by provincial officials.

• The only tax which provinces alone are specifically empowered to levy is

the tax on professions, trades and callings

. In theory, this is the only tax

on which the federal government cannot encroach. The fact that more

revenue productive taxes are not assigned exclusively to the subnational

governments is seen as a limiting factor on revenue growth.

• The urban immovable property tax is a provincial government tax, but

most of the revenue collected is assigned to local governments.

• Motor vehicle registration and licensing taxes (MVT) belong to the

provincial governments. The collection rate is only about 70 percent.

Some argue that the collection rate is this low because there is mandatory

collection of the (federal) presumptive income tax at the time of vehicle

registration. This additional tax payment stiffens resistance to payment of

motor vehicle taxes, and would reinforce opposition to any proposed

increase in the provincial levy on motor vehicle taxes. It is in this sense

that the federal government is seen as encroaching on the provincial tax

base.

• The federal government imposes a 2 percent capital value tax on property

transfers, raising the total rate on each transfer and arguably reducing the

rate of compliance with provincial stamp duty and registration taxes.

We qualify this statement by presentation in Appendix A.

This assignment was made under the Local Government Ordinances 2001, which some of the provinces

perceive to be a result of a federally driven reform.

22 International Studies Program Working Paper Series

Figure 1a. Revenue Growth by Source in Punjab

Figure 1b. Revenue Growth by Source of NWFP

100

150

200

250

300

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

Year

Rs. in Billions

Total Expenditure

Federal Transfer

OSR

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

Ye a r

Rs. in B illions

Total Exp enditu re

Federal Transfer

OSR

Pakistan: Provincial Government Taxation 23

Finally, elected local officials are hesitant to increase tax effort for fear of losing

political support. There have been no increases in tax rates or expansions in tax bases for

8 years in NWFP and 5 years in Punjab. The provincial government in Punjab postponed

the introduction of the new property tax valuation roll, due in 2007, in part because of

upcoming elections. Enforcement is lax in both provinces. Politics has been perhaps the

major reason why provincial tax structures have not developed. Clearly politicians have

felt pressure from strong interest groups (agriculture, property owners) to hold off on

increasing taxes, and in a sense they have been “protected” by increased allotments under

the NFC. In NWFP, political leadership has not insisted on an aggressive administration

in areas of civil unrest. There is of course much more than this to the political economy

story, but a thorough analysis of the politics that led to the present state of affairs is well

beyond the scope of this work.

Intergovernmental Transfers

The system of (three) NFC transfers to provinces in Pakistan is quite transparent.

The NFC award is by far the largest of the three transfers in the system

. The National

Finance Commission is charged with making a decision every fifth year on the size of the

sharing pool and on the distribution of this amount among the four provinces.

In practice, the NFC awards have not been so simple to execute. In the last

iteration, the NFC was not able to reach agreement on the sharing formula. The NFC

distribution formula decided in 1996, initially valid for five years, was continued through

2005. The 7

NFC Award was finalized only in January 2006 after the NFC could not

Actually, there are five types of federal transfers: (1) shared tax revenues; (2) GST financed pass-through

grant for local government; (3) subventions; (4) natural resource royalties; (5) discretionary federal grants.

24 International Studies Program Working Paper Series

reach a consensus on the sharing arrangement despite 11 meetings after July 2000.

The fundamental issue with the NFC award is that the Constitution mandates that

the four provinces must agree on the proposed formula. Given the great differences in

wealth, needs and demographic conditions in the four provinces, agreement is quite

unlikely. This consensus requirement has held up the final decision of the NFC. In

January 2006, the President announced a formula for sharing of resources, which is

technically not an NFC award.

At present, the provincial pool for the NFC award is 41.5 percent of the federal

divisible pool and is scheduled to increase by 1 percent per year up to 46.25 percent by

2011. The distribution of this pool among provinces is by population shares: NWFP

receives 13.82 percent and Punjab receives 52 percent. The pattern of distribution of

intergovernmental transfers to the two provinces is described in Table 10. From the data

presented here, we can see that the shares of Punjab and NWFP have remained

approximately constant since 1999. According to the structure of the NFC grant

program, the only revenue growth for a province during an award period comes from

increases in the rupee amount of the vertical share. This in turn depends on the growth in

federal government tax revenues. So, there is stability in the distribution system that

helps long term fiscal planning.

The largest increases in the real per capita amounts received came at the time of

the formation of the new award, in 2004-2005, because of the increased vertical share for

The finalization came as a presidential decision. (Ahmad, et. al. 2007).

NFCs in the 1990s always finalized the awards during “caretaker” setups when Provinces were not

represented by elected governments. So, arriving at a consensus was easier. Since 2002, elected

governments have been in place in the provinces. The 2001 award was held up largely because the

provinces did not agree on a distribution formula. The current formula was promulgated in January 2006

by the President (and per se is not an NFC Award). Technically, an NFC Award is an outcome of the NFC

deliberations.

Pakistan: Provincial Government Taxation 25

provincial governments. We might look back at the 2000-2006 period and ask whether

the growth in revenues from the NFC awards has been buoyant. The answer we get is

that for every one percent increase in provincial GDP over this period, NFC revenues

increased by 1.01 percent in Punjab and 1.18 percent in NWFP. Certainly for NWFP,

the balance between transfers received and own source revenues has changed in favor of

transfers during the past seven years. This pattern holds for all provinces taken together.

(See Figures 1a and 1b).

The other two types of NFC transfers are much smaller. The sharing pool for the

GST transfer is 1/6 of national GST collections. The distribution of this pool is

determined by baseline octroi and zila tax collections (the two taxes were abolished in

1998 and the “baseline collection” refers to the collections in the final year). NWFP

receives 9.93 percent of this pool which was its share of baseline collections and Punjab

receives 50 percent of the pool according to the same principle. This transfer is

designated for pass-through to local governments.

The third transfer is for grants-in-aid to provinces (“subventions”). In the first

year the total allocation was Rs 27.75 billion with NWFP (35 percent) and Balochistan

getting larger shares. The size of the overall pool is mandated to grow at the rate of

growth in federal taxes.

We examine the stability in the composition of the flow of NFC transfers to

Punjab and NWFP and report this in Table 11. The considerable stability that we find

suggests that Provinces can rightly view this flow as an annual entitlement.

26 International Studies Program Working Paper Series

In the top panel of Table 11 we can see.

• Transfers received as a percent of provincial GDP have remained constant

for both provinces. Note that the transfer share of provincial GDP in

NWFP remains above that in Punjab. The equal per capita distribution of

the NFC awards makes the system implicitly equalizing because per capita

GDP is lower in NWFP and Balochistan.

• The dependence on the NFC award as a source of financing total

expenditures has fallen in both Punjab and NWFP because of the

significant increase in loan-financed projects, debt retirement, and

structural adjustment credits. Since loans to provinces are allocations that

are either made by or approved by the central government, they also might

be viewed as transfers. If we had used this metric, the importance of

transfers in financing provincial expenditures would have shown an

increase over this period.

We might ask whether the federal government’s emphasis on intergovernmental

transfers has changed in the past few years. We can study the determinants of changes in

the federal government’s emphasis on transfers to provincial governments with the data

presented in the bottom panel of Table 11. The determinants of federal transfers to

provinces (FT) as a percent of GDP (FT/GDP) are the product of: (a) the federal

expenditure share of GDP (FE/GDP) and (b) the federal transfer share of federal

expenditures, (FT/FE), i.e.,

FT/GDP = (FE/GDP) (FT/FE)

As may be seen in Table 11, the federal government has held the level of transfers

to provinces between 3.3 and 3.7 percent of GDP, i.e., the GDP elasticity of transfers is

about 1.0. Neither have the components of this growth changed very much. NFC awards

have remained within a narrow band between 32 and 35 per cent of federal expenditures,

and federal expenditures have remained at a level equivalent to about 10 percent of GDP.

Pakistan: Provincial Government Taxation 27

Urban Immovable Property Tax: Punjab

The property tax in Punjab is levied by authority of The Property Tax Act of 1958.

Following the Local Government Ordinance of 2001, it is designated a local government

tax and the city districts and TMAs have the authority to set the rate. Assessment and

collection can be at the district level. In terms of the actual practice however, the UIPT is

a provincial level tax subject to revenue sharing with the city districts and TMAs.

Recently, the provincial government approved a medium term policy framework

to decentralize the property tax administration to local governments and carry out other

reforms (Government of Punjab, 2007a). According to the framework, by 2012 the

provincial government will assign tax policy and collection to five city district

governments and Tehsil Municipal Administrations in other districts, while it will retain a

role for itself for oversight and policy advice. The assignment of powers and functions to

TMAs will follow a “readiness” criterion. Details of the new legislation, staff assignment

from provincial government to local government and guidelines on valuation will be

worked out as this framework in implemented. The provincial government will continue

to provide the legislative framework for levying property tax, i.e., questions relating to

defining the tax base and the basic methodology for calculating tax liability will stay with

the province for now.

The UIPT is an old tax in Pakistan, but it has never generated significant amounts

of revenue. For instance, the national property base was estimated to be Rs 70 billion in

1996 and if the statutory tax rate were only 10 percent, the national collection would have

There is enough difference between the practice in Punjab and NWFP that we have chosen to treat them

in different sections in this report. Still, much of what we say about the practice for Punjab also applies to

NWFP.

28 International Studies Program Working Paper Series

been Rs 7 billion in that year.

Property tax collection in all four provinces in 1995-

1996 was only Rs 506 million. In 2002-2003 it had increased to Rs 2.795 billion, still

much below Rs 7 billion. With the new medium term policy framework, and the overall

decentralization initiative in Pakistan, there is an imperative to upgrade the property tax

to a significant revenue source (Cyan, 2007). As is discussed below, there is ample

revenue potential, but implementing structural and administrative reform will be no easy

task. In particular, there is a question about when the TMA’s and city districts will be

able to effectively administer the UIPT.

Revenue Performance

The urban property tax in Punjab produces a very modest amount of revenue,

even by developing country standards. In per capita terms, the yield was less than Rs 13

($US 0.31) in 2006. Collection fell in 2005-2006, to a level equivalent to about 4 percent

of own source revenues and 0.03 percent of GDP (Table 12).

This level of collections

is low in the absolute, and it is low by comparison with other developing economies,

where the average is about 0.5 percent of GDP (Bahl and Martinez-Vazquez,

forthcoming). We note, however, that there is great variation among developing and

transition countries in the level of property taxation that they choose (See Table 13 and

Box 2).

Ghaus-Pasha et. al. (1998), p.11

A new valuation method was introduced in 2001-02. It met legal challenges with the result that

collections were low in 2001-02. Collections surged in 2002-03 as arrears were collected, but were lower

again in 2003-04 as arrears petered out.

Pakistan: Provincial Government Taxation 29

The revenue elasticity of the property tax can be calculated as the ratio of the

percent increase in property tax revenues to the percent increase in GDP.

Ideally, the

elasticity of the property tax would track the GDP elasticity of local government

expenditures, which would appear to be close to unity in Punjab. The year-to-year

pattern of collections in Punjab has been too erratic to allow meaningful point estimates

of the revenue-income elasticity.

The arc elasticity during the period 2003-2006, when

the 2002 roll was in effect, is 0.24, i.e., revenues from the property tax grew at about one-

fourth the rate of provincial GDP. The major source of revenue growth, the introduction

of the new valuation roll, has been postponed. Thus it is almost certain that property tax

revenues did not keep pace with the demand for provincial and local government public

services during this period.

Box 2. International Practices in Property Taxation

A remarkable feature of the practice of property taxation in developing and transition countries is its

wide variation. Countries have chosen to tax rental value (Columbia), site value (Jamaica) and capital

value (Philippines), and in some cases the local governments are free to decide on their own base (South

Africa). Exemption policies vary widely, e.g., Thailand exempts owner-occupiers and Tanzania taxes

only buildings. Some countries have progressive rate systems while others choose flat rates. Central

governments levy the property tax in some countries (Indonesia), state governments in some cases

(India) and local governments in other countries (Hungary). Fiscal planners in Pakistan will not have

much luck in looking for a generally accepted “best practice”.

With respect to problems, however, there are some commonalities. Most developing and transition

countries are plagued by weak administration, which leads to undervaluation, incomplete cadastres and

low collection rates. A commonly cited underlying problem is an acute shortage of skilled staff.

For discussion of the international practice, and of individual country practices, see Bahl, Martinez-

Vazquez and Youngman (forthcoming) and Bird and Slack (2004).

There were no discretionary rate or base changes during this period.

The revenue flow is erratic because of late payments and collections of arrears.

30 International Studies Program Working Paper Series

Rent and Base

In, Punjab, the property tax is levied on a base of annual rental value at a flat rate

of 20 percent on properties with an annual value of Rs 20,000 or less.

If annual rental

value is greater than Rs 20,000, a flat rate of 25 percent is applied. Section V of The Act

defines annual rental value (ARV) as the amount of rent that could be obtained in an

unencumbered market transaction, less an allowance for maintenance and repairs. A large

number of “special treatments” of properties, however, have moved the assessed base to

one that barely resembles this definition of annual rental value.

Exemptions and preferential reductions in tax liability include:

• A 10 percent reduction in taxable value is allowed for every property, to

provide for maintenance expenditures (“depreciation”). This would seem

to be in keeping with the defined tax base.

• Owner-occupied units are assessed in a way that the imputed ARV is

about one-tenth of the ARV of a comparable rented unit. So, owner

occupiers pay 10 percent of the normal tax liability. One might speculate

that since two-thirds of housing units are owner occupied, this preferential

treatment was driven by political considerations.

• Owner-occupied, residential properties with a lot area less than 5 marla

(125 square yards) are exempt. Vacant properties are not taxed. The

results of this preferential treatment are that an estimated 300 thousand of

750 thousand properties in Lahore are not taxed.

• Retired government employees who are owner occupiers enjoy an

exemption if they live on plots up to 500 square yards of land.

• Widows, orphans and the disabled receive a deduction of Rs 48,000 in

ARV.

• Government properties are not taxed. Properties in cantonment areas are

not taxed.

Prior to the Property Tax Act of 1958 there was a house tax, and a separate property tax, each levied at

10 percent of rental value. Later, through an amendment to the Act of 1958, these two taxes were unified

into a tax on rental value at 20 percent.

Pakistan: Provincial Government Taxation 31

• Other exemptions (charities, religious use, etc,) seem to follow normal

practice.

Valuation

Valuation is the responsibility of the provincial excise tax department (ETD) and

the devolved district excise tax departments. Under the new framework, valuation will be

given to local governments over time. Leadership in this work (methodology and overall

guidance) remains with the Provincial E&T department. A valuation table is developed

using a combination of market data and expert judgment about rental values. This table

serves as the basis for valuing all properties in the province.

The methods employed to

arrive at taxable value are somewhat similar to those used in other low income countries

that follow the area method.

The department issues a valuation table that shows value per area unit

in various

“value zones”, with differentials for on “main roads” and “off main roads”. The

valuation rate per area unit falls after a threshold level of land area, or structure area, is

reached. There also is a use factor in that different valuation tables apply to residential

and commercial properties, with the latter carrying higher rates. When one takes account

of all the different categories of property use and value-determining characteristics, there

are 392 different valuation classes (The Urban Unit, 2006).

This is the approach taken in most developing and transition countries where reliable data on market

rents or property sales values are not available.

The system is different in Pakistan vs. most other countries using the area method in that it defines an

“area unit” as the sum of land area in square yards and covered area in square feet.

32 International Studies Program Working Paper Series

Determination of Tax Liability

The determination of tax liability for a property might be best understood by

tracking through the steps taken by the excise tax department.

• A location zone (A-G) must be selected from the valuation table, and on-

road/off-road character of the property must be designated. The “A” areas

are the prime locations, usually closer to the city center.

• The property must be classified as residential or commercial, and if

residential, as owner occupied or rented. Industrial properties are

classified as residential for purposes of property tax.

• The property tax base (ARV) is calculated as the number of square yards

of land multiplied by the valuation coefficient for land, plus the number of

square feet of covered area multiplied by the valuation coefficient for

structures. A 10 percent reduction for maintenance is applied to all

properties.

• Residential, owner-occupied properties with a lot size of less than 5 marla

are exempt. Vacant land is exempt.

• Rent control creates a distortion in the rental value market and would

depress the ARV (The Urban Unit 2006, p.18).

• Other exemptions, as noted above, are taken account of.

• A tax rate of 20 percent is applied if ARV is less than or equal to Rs

25000. If the ARV is greater than Rs 25000, a tax rate of 25 percent is

applied to the full value of the base. Preferential rate reductions are taken

into account at this point in the process.

Appeals and Collections

After a draft valuation list is prepared, it is opened for review and objection. The

final list is reported in the PT- 1 file. The other controlling document is the PT-8, which

shows the tax payment history for 5 years, and all outstanding arrears.

The Excise Tax Department demands payment by sending a notice, and then a

For a discussion of the record keeping system, see The Urban Unit (2007).

Pakistan: Provincial Government Taxation 33

follow up notice. If payment is not made, ETD has the power to attach a property. In

fact, this is rarely done. The owner is liable for payment, but collection may be taken

from the tenant. Payment may be made directly at designated banks (branches of the

State Bank and the public owned National Bank), and a 5 percent discount is allowed if

payment is made early. Total delinquent taxes are equivalent to about 10-15 percent of

annual liability. This is not an unusual level for developing or transition countries.

Intergovernmental Dimensions

As it operates now, Punjab’s urban immovable property tax is an

intergovernmental transfer rather than a local government tax. The tax rate and base are

set by the province, and tax administration is carried out under the leadership of the

Province. The revenues are mandated for distribution to the districts and TMAs as

specified in the Local Government Ordinance 2001:

Province 15 percent

TMAs 85 percent

Until very recently, the distribution did not work out this way. The actual

distribution has been:

Provincial Government Collection Fee 5 percent

Provincial Government Revenue Share 15 percent

Utility Payments of Local Governments 58 percent

TMAs 22 percent

In Argentina, about 20-25 percent of taxpayers fail to pay their property taxes. In Tamil Nadu, a

relatively well-managed Indian state, arrears were equivalent to about 50 percent of demand. In Poland,

arrears were equivalent to less than 10 percent of taxes billed. (Bird and Slack, 2004; and Bahl and

Martinez-Vazquez, forthcoming).

34 International Studies Program Working Paper Series

The controversial elements of this revenue sharing were the 15 percent that was retained

by the province and the 58 percent that was intercepted by the province to cover the

utility bills of local governments.

According to the Local Government Ordinance (2001), the property tax is to be

fully devolved to the local governments. In theory, the TMAs have the authority to set

the tax rate and to administer the tax. In fact, neither the province nor the TMAs have

been willing to use their taxing power. Under the medium term policy framework

approved in December 2007, the provincial government will prepare new legislation to

reconcile the property tax legislation and the Local Government Ordinance. Tax policy

and valuation will be given to five city district governments initially. In time, the Tehsil

Municipal Administrations will be allowed to choose tax rates from a range set by the

province. Implementation will rely on a “readiness” criterion. The Province will continue

to perform an oversight function, lay down acceptable ranges of tax rates, and review

valuation and tax collection procedures. After decentralization, local governments will

continue to use uniform methodologies for valuation and tax collection.

Issues and Problems

The UIPT in Punjab is beset by a number of problems. For implementation of the

medium term policy framework, a number of issues will require attention. Some are

structural and some are administrative, but none are insurmountable with present levels

of technology and with some upgrading of staffing numbers and skills.

Revenue sharing of the property tax certainly is not unheard of. For example, the central government

property taxes in Indonesia and Chile are shared by formula with subnational governments.

Pakistan: Provincial Government Taxation 35

The Tax base. The legal basis for property taxation is annual rental value. Many

observers take the position that this tax base is not appropriate for Pakistan. One reason

is that most residential properties in urban Pakistan are owner-occupied vs. rented, so the

capital value of a premise would be a more compatible base. Advocates argue that it

would be more acceptable to taxpayers. Another issue is that vacant properties are not

taxable under the present system because they “have no rental value”. A capital value

base presumably would allow taxation of vacant properties. Finally, the valuation of

industrial properties is uncertain under a rental value system, because a capitalization rate

must be assumed. Under a capital value system, a reconstruction cost method of

assessment, or even a book value approach, could be used. These latter two problems

are longstanding criticisms of the annual value system that might be remedied by

adopting a capital value base for property taxation.

There are, however, problems with the capital value base. Most of these have to

do with valuation. One assessment approach is to estimate the market value of the total

property (land and structure). This is a very expensive process that requires a cadre of

skilled valuers. It does not lend itself well to mass appraisal in most developing

countries.

The basic problem is that valuation under a capital value system requires

accurate data on sales of properties. With the high property transfer tax rates that now

exist, accurate reporting of sales values is not likely.

The alternate approach to valuation is to separately estimate the market value of

land and structures, probably using some notional approach to valuation. If this took the

Eckert (forthcoming) argues that computer assisted mass appraisal can be applied in transition and

developing countries, and cites evidence of its successful use in both Kosovo and South Africa. He also

argues that the use of computerized mass appraisal can accelerate the development of real estate markets.

36 International Studies Program Working Paper Series

form of land value coefficients and a construction cost table for structures (as is done in

many developing countries), the system would not be very different from that presently in

force in Pakistan. Other than resolution of the vacant land issue, there might be little to

gain from switching to a capital value base.

A third approach is to tax only the land. The advantage here is that assessment is

not very different from what is done now (establishing location values within urban

areas), and landowners are given no disincentives to develop the land in its optimal use.

Assessment would be easier since buildings would not be valued, and the tax roll would

be easier to keep current since land-related characteristics change less often than

buildings. The disadvantage is that nominal rates must be higher to yield the same

revenue, and there is a perception of unfairness in that higher valued structures go

untaxed.

Are any of these three tax base choices most suitable to Punjab? The argument

for capital value is that it offers a way to include vacant properties in the base, and it

offers a reasonable way to view the taxable value of industrial properties. It also may be

more acceptable, in concept, to taxpayers. Adopting a capital value base would do little

harm, and it would be in step with international practice. However, with respect to

gaining a better estimate of the market value of residential properties, the switch to a

capital value approach may not make much difference. In fact, there is an equivalence

between the capital value and the rental value systems. Capitalized rental values and

capital value are approximately equivalent, if the data underlying the valuation process

are accurate. If a capital value base were adopted, and a notional assessment instituted,

not much will have changed for residential properties and most commercial properties.

Pakistan: Provincial Government Taxation 37

The government of Punjab needs to make a decision either to stay with the rental

value approach or to adopt a capital value approach (if it is constitutional to do so).

Either way, it will be necessary to develop a method for taxing vacant properties and

properly assessing industrial properties, and finding a way to value residential and

commercial property at more nearly their market rates.

Tax rate. There is some discussion that a statutory tax rate of 20-25 percent of

annual value is too high, and presumably is above the international average. There was

discussion at one point to roll the tax rate back to 4 percent upon introduction of the new

valuation list. The fact is however, that the statutory rate in Punjab (or in most countries)

has little meaning because it is levied against a base that is well less than market rental

value. If the base were to be fully assessed, the proper level of the normal tax rate would

depend on the revenue target chosen (See below). In the absence of an accurate sales-

assessment ratio study, we cannot estimate the size of the base that would result from a

full market valuation.

Neither is there much merit to the argument that the property tax rate in Punjab is

“too high”. If anything, the statutory tax rate of 20-25 percent in Punjab is low. The

ratio of UIPT collections to GDP is 0.026 in Punjab and the ratio of property tax

collections to GDP averages about 0.5 in developing countries.

Low revenues. The revenue yield is very low (about 0.026 percent of provincial

GDP in 2006 and about 2 percent of provincial government expenditures). We can

conclude safely that there is little connect in the eyes of taxpayers between the level of

local public services provided and the amount of property taxes paid. Thus Punjab

misses the opportunity to charge property owners/users for the public service benefits

38 International Studies Program Working Paper Series

they receive and by so doing it takes a step back from a central tenant of successful fiscal

decentralization.

The low revenue yield might be attributed to a number of factors: (a) taxpayers do

not see adequate value in the services they receive from local governments, hence they

are not willing to tax themselves at a higher rate, (b) the property tax is an inherently

unpopular way to raise revenues and elected politicians are loathe to force it on to voters,

intergovernmental transfers provide subnational governments with adequate revenues at

low political cost with the result that there is no incentive for increased property tax effort

and (e) there is weak enforcement. The fact that Punjab officials postponed introduction

of the new valuation roll in 2007, because elections were near, is some evidence of the

political sensitivity of property tax policy. To move property tax revenues to a higher

level, all of these barriers will need to be addressed.

Undervaluation. The evidence available suggests that properties that are in the tax

base are dramatically under-assessed. Unfortunately, there are no independent estimates

of property values or rental values, so it is not possible to get a fix on the true tax base.

Moreover, the government does not carry out an assessment-sales ratio study that would

allow calculation of the degree of underassessment, so it is not possible to make an

objective estimate of the revenue cost of underassessment. Educated guesses, anecdotal

evidence and some available data however, suggest that the degree of underassessment is

quite large. One senior official in ETD gave an example of a “good” area of the city

where one marla of land (25 square yards) would sell for Rs 12 million. Based on the

valuation table presently in use, the property tax assessment in that area would be

Pakistan: Provincial Government Taxation 39

equivalent to less than one percent of market value. Another anecdotal example is

outlined in Box 3, and gives a similar result. Even if such judgments about market value

are reasonably accurate, they relate to only one location and variations in the assessment

ratio are likely to be quite large within the province. One could not use such anecdotal

evidence to infer the average level of undervaluation.

We might also look for evidence of undervaluation using data related to the sales

of property. Declared values for land transfers are notorious for being understated in

developing countries, and the degree of understatement in Punjab might tell us something

about the degree of undervaluation in the case of the urban property tax. An evaluation

of the stamp duty in Punjab involved comparison of the taxed value with “indicative

market value” in selected areas in Lahore district (Government of Punjab, 2007f). The

results show assessment ratios (assessed value to market value) that ranged from 55 to 79

percent. This evidence is based on stamp duty assessments, and it is not based on a

scientific survey, so it is only an indication of the degree of undervaluation for the urban

property tax.

Perhaps better evidence on the degree of undervaluation in the present (2002)

valuation tables comes from comparison with the 2007 valuation table. Though the latter

has not yet been released, ETD officials estimate that it would result in a fivefold increase

in values for some properties, i.e., the present system is capturing only about 20 percent

of true market value in the case of those properties. Other provincial government

estimates of the increase in property taxes that would result from adopting the new

valuation table suggest a 180 percent increase in values with the new roll. This implies

that the average property is undervalued by about 45 percent.

40 International Studies Program Working Paper Series

Box 3. An Example of Undervaluation

A one kanal house in Gulberg, with a covered area of 3500 square feet is rented for Rs 40,000 per

month. Its market annual rental value is Rs 480,000. (These values are based on “expert judgment”

evidence provided by Punjab ETD officials).

According to the ETD classification, Gulberg is an A area. Applying the rates under the rented

residential property category from the ETD Valuation Table we calculate the ARV of the property to be

Rs 15,815 as shown below.

Property Components Valuation rate Value

Land area

First 500 square yards 4 2000

Next 105 square yards 3 315

Covered area

First 3000 square feet 4 12000

Next 500 square feet 3 1500

Total ARV Rs 15,815

Using the assessed ARV, we then calculate the ratio of the assessed value (Rs 15,815) to the market

value (Rs 480,000) as 3.2 percent.

An assessment ratio

of 55 percent would not be out of line with the experience

in many developing countries. The ratio of assessed to market value is reported to be 25

percent in Indonesia, and to range between 20 and 70 percent in Kenya, 45 to 85 percent

in Chile, and 20 to 50 percent in Mexico (Bahl, Martinez-Vazquez and Youngman,

forthcoming; and Bird and Slack, 2004).

ETD officials also stated that even the new roll will not capture the full market

value of the property. This implies that the current degree of undervaluation is well

more than 45 percent. The undervaluation is thought by some ETD officials to be greater

for commercial than that for residential property.

In sum, we cannot find evidence that will allow us to name the exact degree of

undervaluation. We can say that property tax revenues increased by 14 percent in

The assessment ratio is assessed rental value expressed as a percent of true market rental value.

Pakistan: Provincial Government Taxation 41

nominal terms, between the time when the 2002 tax roll came into effect and 2006. Over

the same period, property values are thought to have increased at a faster rate. One

service reports an increase of 36 percent for the 2002-2007 period (State Bank of

Pakistan 2007b; Table 8.1, p208).

Some observers are interested in the possibility of self-assessment as a way of

reducing assessment cost and gaining a better estimate of true market value. In fact, a

number of developing countries practice self assessment. These include Indonesia,

Bangalore (India), The Philippines, and Hungary among others. In most cases self-

assessment means reporting the physical characteristics of the property. In Columbia,

however, self-assessment includes a declared value of the property and the government

puts in place a safeguard against underassessment. Self assessment is not a panacea for

Pakistan. It can provide additional information but in the near future, it cannot be a

substitute for independent property valuation.

Revenue growth. There has been little growth in property tax revenues in recent

years. The revenue-GDP elasticity is only 0.24 for this valuation period. Should we

have expected a greater rate of natural increase during this period? Property tax

revenues can increase for several reasons. The most obvious is an increase in taxable

property values. The new valuation table was due in 2007, and is ready for

implementation, but has been postponed. In the meantime, the 2002 valuation roll

remains in effect. The introduction of the new table in 2007 would have led to a

significant increase in revenues, though, as discussed above, it is difficult to estimate the

exact amount.

It takes about one year to develop a new valuation table.

42 International Studies Program Working Paper Series

Even without a new valuation list, taxable property value could increase because

of new construction. In fact, newly developed properties are not being brought on to the

tax roll and there is no annual revenue pickup due to expanding economic activity. The

ETD attributes this to the unwillingness of the TMAs to assign a tax rate to the new

properties. Another side of the story, that is discussed below, is that TMAs (until very

recently) have had little incentive to assign a tax rate in these areas.

Under the Local Government Ordinance, since 2001, all newly built up areas have

been declared zero rated areas. Under the Property Tax Act of 1958 an area had to be

declared ‘urban’ by the provincial government before ETD could carry out an assessment

and levy a property tax. The Local Government Ordinance removed this step and made

provisions for the TMA councils to increase the rate from zero to a positive one through a

resolution. This can be interpreted in the following way: ETD can carry out assessments

for any built-up area because the legal bar has been removed; but for the department to

collect property tax, a TMA resolution naming a positive tax rate is required. Another

provision in the Local Government Ordinance requires that 85 percent of property tax

collection should be given to the TMA where the tax is collected. However, the province

did not transfer responsibility for property tax collections or revenue to the TMAs in this

manner in the first years after the creation of the new local government system. This led

to low credibility of the system, and certainly provided no incentive for TMA councils to

pass a resolution increasing the tax rate from zero upward. By doing so, the TMAs

would have earned political problems without any assurance of monies flowing into their

accounts. More recently, the 85 percent payment to districts and TMA’s has been made.

Pakistan: Provincial Government Taxation 43

Changes in the location value of properties (due, for example, to new public

improvements) also could lead to a revenue increase. However, as a matter of practice,

changes in assessed location value do not occur between valuation periods. So, the

structure of the property tax, and its administration, cause us to expect little revenue

increase between valuation periods. A revenue – GDP elasticity of 0.24 confirms this

expectation.

Tax preferences. The legal base for taxation is dramatically narrowed by

exemptions and other preferential treatments. The government does not keep a record of

the revenue cost of the exemptions, but an impressionistic judgment by excise tax officers

is that the cost is equivalent to about 20 percent of tax collections. This is almost

certainly a very conservative estimate, given that nearly one-half of all properties in

Lahore alone are outside the net. These preferential treatments also create great inequities

in the distribution of property tax burdens and thereby contribute to noncompliance, and

resistance to increasing the statutory rate and improving valuation.

Our estimates of the revenue cost of preferential treatments is Rs 3.7 billion, an

amount equivalent to 132 percent of the current level of demand for collections. If the

new tax roll were brought on line, the revenue cost of preferential treatments would rise

to Rs 7.6 billion. The estimates of this revenue cost are reported in Table 14 and the

methodology used to derive this estimate is spelled out in Appendix B. These estimates

are made with the help of some simplifying assumptions, but the results suggest that even

other reasonable assumptions would yield a similar result. This is an important finding if

one wants to estimate the revenue potential of the property tax in Punjab. Bringing in a

44 International Studies Program Working Paper Series

new valuation roll and eliminating preferential treatments alone could lead to more than a

tripling of revenues.

Sticky Nominal tax rates. Revenue increases also could be the result of nominal

tax rate increases. However, there have been no rate increases imposed by the province

since 2002. TMAs have been empowered to alter the rates since 2001, but none have

chosen to do so.

Incentives for Inefficient Land Use. The UIPT is structured to fall more heavily

on improvements than on land. This is built into the system because the same tax rate is

applied to square yards of land and square feet of covered area. This feature of the tax

structure might be seen as discouraging efficient land use and encouraging a less

intensive use of land. This disincentive to a more efficient use of land is reinforced by the

full exemption of vacant properties. At current low levels of property tax, these

disincentives to more intensive land use may not matter very much, but under an

upgraded property tax they would be of greater importance. (See Box 4)

Administration. Property tax records are manually recorded, in Urdu, and there is

no automation in billing or in tracking collection rates. This makes an efficient collection

process very costly and likely dampens the collection rate. Payment records are said to

be out of date, and the matching of property tax payment with motor vehicle registration

and other third party information cannot be done. A World Bank financed project is now

undertaking computerization of rural land records. It aims to complete work in 8-10

years. Currently, it is not mandated to prepare computerized records for urban areas.

On the assessment side, there is little or no evaluation of the effectiveness of the

process as it now operates. Three points in particular require special note. First, there are

Pakistan: Provincial Government Taxation 45

no sales-ratio studies hence it is not possible to grade the effectiveness of the valuation

process in estimating market value. Only anecdotal evidence (and small area studies) is

available regarding underassessment, and about whether the process is fair in assigning

the same values to similarly situated properties. Second, the government does not

Box 4. Taxing Land and Structures

Does this system of taxing property imply a differential tax treatment of land and improvements?

We cannot answer this question directly because values of land and structures are not separately reported.

If the present system does not intend to treat land and structures differently under the property tax, there is

an important assumption that a “value unit” is one square foot of land and nine square feet of structure. We

can say that under the present system,

ARVaSL =×

⎟

⎠

⎞

⎜

⎝

⎛

Where

L = Land area in square feet

S = Covered area in square feet

a = Valuation factor (location factor)

In other words,

ARVVV

and

Where T

= the tax rate on a square foot of land

= the tax rate on a square foot of structures

= value per square foot of land

= value per square foot of structures

Since T

= T

= 9V

It is not clear how this equivalence was developed or justified.

If encouraging a more efficient use of land is a goal of property tax policy, which is true in some

countries, a consistent structural reform would be to tax land more heavily than improvements. In the case

of Pakistan, a first step toward this goal would be to tax land and improvement value equally, hence the

area unit would become square feet of land plus square feet of buildings. The impact would be increased

revenue, a shift in burden toward those who own more land relative to improvements, and a more

progressive distribution of burdens (to the extent land owners are higher income).

46 International Studies Program Working Paper Series

systematically evaluate the impacts of the various exemptions that have been given. For

example, estimates of the revenue cost of the important 5 marla exemption have not been

made by the Government. Third, there is no up-to-date survey of all properties in urban

areas. Therefore, the completeness of the tax roll is suspect.

Intergovernmental Issues.

A major problem is that the Provincial Government

has not come to grips with the fundamental question of whether it wants the property tax

to be a provincial levy or a local levy. The medium term policy framework approved by

the provincial government attempts to remove this ambivalence by committing to pass

this responsibility to local governments by 2012. The legal authority is in place, but

provincial actions in the past suggest a reluctance to release this authority. For example,

• TMAs are not regularly notified of their revenue entitlements,

• Property tax revenues have until recently been intercepted for payment of

local utility bills, and

• No significant fiscal incentives have been put in place to encourage local

governments to impose higher rates.

Neither have the local governments shown a willingness to take on the property

tax as a major local revenue source. Certainly they have not used the rate setting power

that they have been given. This is probably due to some combination of the significant

rate of inflow of intergovernmental transfers from the province, the fact that elected local

politicians are close to those who would pay the tax, and a suspicion on the part of local

officials that the revenues would not flow to them even if they did raise the rate. As the

implementation of the medium term policy framework begins, the provincial government

plans to closely monitor the property tax actions of the local governments. Presumably

Pakistan: Provincial Government Taxation 47

this will include an assessment of the extent to which they are prepared to assume their

new administrative responsibilities.

Reform Options

Two basic, underlying issues must be faced in property tax reform in Punjab. The

first is whether this tax will become an important source of financing for government

services. If a significantly higher level of revenue is to be reached, a comprehensive

reform of the property tax is called for. The base and rate structure, the administration,

and the intergovernmental arrangement all should be changed (The Urban Unit 2006).

Coordination of these changes and a phasing in plan will necessarily be part of the reform

program. Administrative issues alone would likely require an overhaul of the law.

Whether the needed fixes are politically feasible, and whether there is any incentive to

adopt them, are the more important issues.

The second underlying issue is whether it will be left to local governments (city

districts and TMAs), or to the provincial government, to govern the tax so as to reach the

target level of revenue. This question has been answered to a considerable extent by the

approval of the medium term policy framework (Government of Punjab, 2007a). The

framework lays down a timeline for assignment of tax policy and valuation functions to

local governments, beginning with the five city districts. Simultaneously, the framework

indicates addressing other policy issues.

There are a number of reform options open to the Punjab government to make the

property tax more revenue productive, and arguably more fair. Some, but not all, of what

48 International Studies Program Working Paper Series

we propose here has been discussed in other research reports (The Urban Unit, 2006,

2007) and is also contained in the recently approved medium term policy framework.

Revenue Target. The first reform decision to be taken is the revenue target for the

property tax. Ideally, this will be determined with reference to the amount of

expenditures to be covered by the tax, or by all own source revenue. Under the new

intergovernmental arrangement, the property tax rate, and therefore the revenue target,

will be set by the local councils by 2012. Until then, the provincial assembly will play a

major role in determining the revenue target. In order to develop revenue estimates for

the short run, we will assume UIPT to be a provincial tax with a uniform province-wide

practice and a target revenue yield set by the provincial government.

For purposes of illustration, we arbitrarily set the level of target revenue at the

international average for less developed countries of approximately 0.5 percent of GDP.

At 2006 levels of provincial GDP, this would imply a rupee target of Rs 25 billion for

property tax revenues.

Achieving this target would require an increase of about Rs 23

billion in property tax revenues. (See rows 1-3 of Table 15). This tenfold increase is

more than a little ambitious. Still, this target can be achieved with a combination of

structural reforms, rate increases and administrative improvements. The economic

impact of this increase --- Rs 255 ($4.24) per capita or 0.45 percent of GDP --- is

An interesting idea that has become part of the discussion is that the cost of property tax exemptions will

be estimated, and will act as an offset to the inflow of intergovernmental transfers.

See Bahl and Martinez-Vazquez (forthcoming). Calculations by Roy Bahl and Bayar Tumennasan

(Georgia State University, reported in Bird and Slack (2004, p5), place the developing country average at

0.42 percent of GDP in the 1990s, and the transition country average at 0.54.

After the implementation of the medium term policy framework, the targets could be assigned to local

governments according to their shares in provincial GDP or other measures of tax base.

Pakistan: Provincial Government Taxation 49

probably in the acceptable range.

The political feasibility of so large a tax shock might

be quite another question. Note that the provincial government has set a much more

modest target of Rs. 6.1 billion for 2007-2008. (Government of Punjab 2007b, p.15)

Valuation, revaluation and indexing. The most obvious revenue-raising (and

fairness) measure is the introduction of a new valuation roll. If fully implemented under

the present rate structure, it could lead to a significant one-time increase in revenues. This

could be perceived to cause enough “tax shock” that it might need to be phased in, but it

should be introduced as soon as possible.

The new valuation roll would lead to a

revenue increase of Rs 2.9 billion with the present tax rates and tax base and with current

rates of compliance (row 4 of Table 15). In terms of revenue target, however, the per

capita tax burden would rise only to Rs 32 ($US 0.53). As welcome as revaluation

would be, its introduction without other changes would cover only about 12 percent of

the gap between the current level of property taxes and the target level.

Base Broadening Measures. Revenues could be markedly increased, and the tax

burdens could be made more fair, if the present package of exemptions and preferential

treatments were to be significantly reduced. The reform argued here is to tax all property

at the same rate, except that which is exempt by normal convention (e.g., places of

worship, charities) and that which is exempt to protect low income families. There is

some question about whether the exemption of low valued properties will protect low

income families from property tax overburdens. The implicit assumption made here, that

low income families will reside in low-valued premises, has not been tested in Pakistan.

The major potential impacts are a capitalization into lower real estate values, and a shift of investment

away from the real estate sector as after-tax rates of return fall in that sector.

“Tax shock” refers to taxpayer reaction to a large one time increase in taxes, irrespective of the amounts

involved.

50 International Studies Program Working Paper Series

In addition, we can note that the exemption of low valued properties would provide

administrative relief, because the assessment of such properties and collection from their

tenants can be eliminated without much revenue loss.

The view here is that the temptation to use property taxation as an instrument of

social or economic policy should be resisted in favor of other, more appropriate policy

instruments. Let property tax policy be centered on the goal of raising a target amount of

revenue in the most fair and least distortionary way possible.

We have made estimates of the revenue gains from eliminating five types of

preferential treatments: The 5 marla exemption, owner-occupied preferences, the vacant

property exemption, the taxation of industrial property at residential rates, and the

exemption of provincial government properties. The results from this analysis are shown

in Table 14.

The five marla lot size exemption for residential properties is arguably the most

egregious of the present preferential treatments. It is difficult to see what social goal, if

any, the architects of this preferential treatment had in mind in designing this exemption.

Almost all reform studies of property taxation in Punjab have recommended elimination

of this exemption, and most government officials interviewed have agreed.

The

problem is, as might be expected, the political sensitivity. Even tax policy mistakes, as

the 5 marla exemption clearly is, do not go away quietly once they become entrenched in

the system. We have made an independent estimate, as reported in Table 14, of a

revenue cost of the exemption of Rs 2.1 billion, or an amount equivalent to nearly 75

similar results.

Tax Structure

In Punjab, there are six general categories of “profession”, with a fixed amount of

tax assessed to each category. Each category has multiple subcategories so that in total,

47 “professions” are taxed. NWFP lists 11 main categories. As seen in Table 32, the

specific rates range from Rs 200 to Rs 100,000 in Punjab and from Rs 100 to Rs 50,000

in NWFP. The tax rates were last changed in 2002-03 in both provinces. Most taxpayers

who are subject to the professions tax are also subject to the federal income tax.

The tax is structured so that it may fall on the corporate entity (“companies

registered”), on self-employed professionals (doctors, lawyers, marriage hall

entrepreneurs, etc.), and on employees (presumably in the formal sector). The latter

category is taxed at a very low rate. This definition of the base gives the professions tax

some characteristics of a business license fee for companies and self-employed, and an

additional wage tax for individuals employed in these sectors (categories 7 and 9 in Table

98 International Studies Program Working Paper Series

32). If one accepts that the tax is a fee levied on business for services provided by the

provincial government, it is not at all obvious that there should be an additional fee levied

on individuals employed in these businesses. Instead of having an additional category of

taxpayers and an additional tax administration, it might be preferable to roll the tax on

workers in the formal sector into the amount that is levied directly on the business.

It is no easy task to determine the revenue potential of the professions tax in either

province. To do this, one would have to know the number employed in each taxed

category. The Pakistan Labor Force Survey (Federal Bureau of Statistics, 2005b and

2006b) offers some detail on the level of employment by occupation, but it is difficult

from that survey to determine who is self-employed versus who is employed by a

company, and it is difficult to determine the level of sales/exports for the companies and

self-employed businesses, etc. We make an estimate of the revenue potential for the

following occupational categories: Professionals, Technicians and Associate

Professionals, and Legislators, Senior Officials and Managers. For the tax rate, we use a

very rough (and conservative) average of Rs 500 per employed person. Excluding any

tax on companies, this analysis demonstrates the revenue potential of the tax—Rs 1.3

billion in NWFP and Rs 6.3 billion in Punjab (Table 33). In both cases, the analysis

suggests that current collections are less than 4 percent of revenue potential.

An analysis of Lahore data can give some indication of the relative importance of

the different categories of profession in current revenue collection. Based on data from

the Punjab Excise and Taxation Department for Lahore District, 2006-07, most of the

revenue from the tax (49.2 percent) comes from category 5 in Table 32 (persons engaged

Malik (2004) finds similar results.

Pakistan: Provincial Government Taxation 99

in a profession, trade, calling or other employment, who are subject to the income tax).

The next largest revenue producers for Lahore are: companies with paid up capital

exceeding Rs 200 million (10.9 percent), real estate agents within metro and municipal

limits (7.3 percent), companies with paid up capital exceeding Rs 50 million (6.9

percent), and companies with paid up capital exceeding Rs 5 million (4.1 percent). This

analysis demonstrates that nearly 80 percent of the revenue take is from employed

individuals (some of whom are employed by “paying” companies) and directly from

companies.

Administration

Administration of the tax is very weak in both provinces. Provincial officials

confirm our belief that there is much higher revenue potential than is currently exploited.

The excise tax departments in both provinces build their tax rolls by using income tax

statistics, limited company directories, professional association lists, etc. In Punjab,

officials attempt to obtain information to identify professionals from the chamber of

commerce and from professional associations. In Punjab, about 35 lower level officers

are working on assessment and collection of this tax (but they also work on other taxes).

In Lahore district alone, there are over 250,000 taxpayers on the tax rolls. However there

are no designated “professions tax” officers. Assessments and demand notices are

carried out by the excise tax department. The process is very labor intensive. This

imbalance between officers and clients suggests the root of the administrative problem

and exacerbates the compliance problem.

In NWFP, an initial demand notice (“notification bill”) is sent to individuals and it

100 International Studies Program Working Paper Series

contains their professions tax liability. According to officials in NWFP, if the notice is

ignored, the penalty is a doubling of the tax. Still, the reported collection rate is very

low. It is estimated by officials to be on the order of 30 to 40 percent. There is little

manpower designated for administering the tax in NWFP. For example, in Peshawar

district there are only 7 inspectors assigned to cover the tax on professions. Khan

(2004) notes that Peshawar’s population is about 1.5 million, and that there are over

50,000 shops and 3000 doctors. But he reports that the relevant records on professions

tax shows that only a fraction of these “potentials” are in the base. His calculation is that

each inspector has the impossible task of supervising about 10,000 tax units.

In some cases payment of the tax may be made by a principal on behalf of a group

of taxpayers, e.g., unions on behalf of particular groups of traders, or employers on behalf

of employees. Malik (2004) reports that confusion between the provincial government

and local governments regarding collection authority may decrease compliance.

According to Malik (2004, p38), local governments “insist on collecting this tax” even

though it is not a local government tax.

Problems and Issues

The professions tax is an attempt to reach a part of the personal income base in

the province. However, the tax is levied at such low rates that it would likely fail on the

revenue raising objective, even if administration were efficient. To give an idea of how

low effective tax rates can be, it was noted (by ETD officials) that a physician can make

Rs 20,000 per day, but pay only Rs 1,000 per year in professions tax. In such a case, the

tax is little more than a nuisance.

Pakistan: Provincial Government Taxation 101

Another problem is the uncertain justification for levying this tax. The

professions tax might be justified on the basis of benefits received from provincial

government services, i.e., it is a tax paid by a business, employee or self-employed

person for the privilege of doing business in the province. Or, it might be an attempt to

tax higher paid professions at higher rates. However, the variable rate of tax across

professions suggests neither a benefits rationale or an ability to pay element. A benefits

tax approach would suggest transforming the professions tax into a business levy, or a

piggyback on the federal corporate income tax. As a general income tax, the professions

tax might be replaced by a more transparent income tax.

Other features of the tax structure are just unclear. For example, some

professionals are taxed twice—once through an official employer and then again as a

professional employee. This practice is suggestive of a general benefits tax such as an

income tax. In short, it is not easy to infer the objectives of the tax from its structure.

As a stand-alone tax, the professions tax would be hard to collect in the best of

circumstances. Professionals not tied to an incorporated business are notoriously difficult

to find for purposes of tax administration. The sheer number of professionals (2.7 million

in NWFP and 12.5 million in Punjab) would make efficient administration of the tax a

very costly proposition. Many states in India require a registration process for the tax on

professions. This process may be effective if the registration is required for other

important business transactions or tax payments. These might include contracting with

the federal government, customs procedures, workers welfare and workers profit

participation funds (these would be applicable to companies only), motor vehicle

registration, etc. The crux of the problem is the identification of eligible taxpayers, and it

102 International Studies Program Working Paper Series

is no easy task to identify all potential taxpayers. Khan (2004), in his analysis of tax

administration in NWFP calls for a detailed survey to identify businesses and individuals

liable for the tax on professions. An integrated data base that captures professional

registration, motor vehicle registration, government contracting, and other activities

would go a long way toward resolving the administration problems of the professions tax.

Most would point to weak revenue performance as the major failure of this tax.

As was discussed above, collections under the current system are estimated at less than

10 percent of what they would be if the collection rate was 100 percent.

Reform Options

ETD officers in Punjab believe that the tax, even as currently structured, could

raise up to 3 times more in revenue if there was more focus on its collection. This seems

a feasible if not conservative target. Khan (2004) has the same view for NWFP, and

argues that the tax could be significantly more productive.

There are several ways to improve the practice of taxing professionals at the

Provincial level. We would suggest five reform options. One is to take the view that the

professions tax is more a nuisance than a productive levy, so it should be abolished as a

provincial tax. It would be better to invest the administrative resources used in

potentially more productive areas of revenue mobilization. Under this scenario, the

professions tax might be turned over to the TMAs or union councils and perhaps be

treated as a kind of general charge for the privilege of doing business in the local area.

However, this transfers the difficulties in collection to a lower level of government if the

data base and administrative capacity for collection are not enhanced.

Pakistan: Provincial Government Taxation 103

The second route is to take the view that there is need for a more broad-based

provincial tax to reach the growing fiscal capacity, particularly in urban areas. The

professions tax could be converted into a piggyback levy on the federal income tax, (on

individuals and/or corporations) with collection by the federal government. Provincial

governments could choose a piggyback rate within a prescribed range and the federal

government could collect the income tax as it does now

. For example, a three percent

piggyback on collections for individuals and self employed in Punjab could yield Rs 487

million per year and Rs 83 million in NWFP—both substantially more than current

collections.

Objections to this option are that it could be struck down as a “double tax”

particularly on workers in complaint enterprises, and unconstitutional. Also, increasing

the overall income tax rate, even by this small amount, might reduce compliance.

Another objection would be that under this scheme the self-employed would escape the

local tax net altogether since they often evade the federal income tax. This is a valid

objection because the self-employed are notoriously hard to tax. To deal with this, the

piggyback income tax might be supplemented by a presumptive income tax administered

by the province. Even if the presumptive tax on the self-employed was not effective, it

would be no worse than the present professions tax administration where 80 percent of

collections come from those already in the income tax base. This option is included in the

For purposes of illustration, this piggback is for individuals and self-employed only. A similar change

could be done for companies.

We used data on federal income tax collections to develop this estimate. We have company income tax

collections by province but we do not have individual salaried or non-salaried collections by province. We

calculated the share of company receipts to total receipts by province, and assumed that the same share

would hold for salaried and non-salaried individual collections. For NWFP this share is 3.7 percent and in

Punjab it is 21.5 percent.

104 International Studies Program Working Paper Series

policy matrix and it is the opinion of the authors that this option has the most potential

given the current state of administrative resources.

Alternatively, the tax could be piggybacked on the gross receipts of companies

and self-employed. A gross receipts tax (or gross turnover) would be more simple.

Gross-receipts taxes, however, can be very distorting in nature and could increase the tax

burden of compliant start-up businesses by a substantial amount and possibly lead to

cascading in output prices. A number of transition countries have chosen this route with

limited success. Examples are Albania, Azerbaijan, Kazakhstan, Kyrgyzstan, Ukraine,

and Serbia (Engelschalk, 2004).

A third reform route would convert the current professions tax into a sales tax on

services. Many professionals provide some type of service although not all are covered

under the current tax on services. If option 2 (piggyback on the income tax) is not a

viable option, replacing the professional tax with an expanded provincial sales tax on

selected services is an alternative. A drawback with this option is that services delivered

by a firm or an individual whose headquarters office was in a different province than the

where the service was delivered would raise some controversy about where the tax

should be credited. Unfortunately, we cannot make a revenue estimate for this option

with data that are currently available. Services are difficult to tax, but because of the

existing federal sales tax infrastructure, the collection rate of a sales tax on services

probably would be higher than that for the current professions tax.

A fourth option would retain the tax, but adjust the specific rates to be higher and

more in line with expected levels of income for the various professionals, and to

eliminate the tax on salaried individuals who are employed in companies. A matrix of

Pakistan: Provincial Government Taxation 105

illustrative rates is included in Appendix F, as suggested by Ahmad Khan in a review of

the professions tax. However, without a significant improvement in administration, such

reform options are unlikely to yield much in additional revenues. The necessary first step

here is a survey to enumerate all of those professions liable for the tax, and an automation

of this data base. Because such a data base does not presently exist, we cannot make an

estimate of the revenue impacts of increasing the nominal rates. While this option has its

merits—it is an income-based tax that has its roots in the current professions tax -- the

provincial authorities would have to commit increased resources to administer the tax.

Changes would need to encompass training, performance evaluation, and data base

development in addition to other considerations.

A fifth option would be to restructure the tax as a benefits charge for services

provided by the provincial government (e.g., road infrastructure, certain utilities). In this

case, the tax might be levied on businesses and not necessarily on employees of

taxpaying entities (although there may be a similar benefits argument for individuals). A

provincial level business registration fee (flat fee or progressive fee based on type or size

of business) could be assessed annually as a presumptive tax. Here again there are

difficulties of compliance, record keeping and administration that may dampen revenue

significantly.

Land Revenues: Land and Property Transfer Taxes

The Board of Revenue (BOR) is responsible for assessing and collecting rural

land taxes and charges, the agricultural income tax, and all property transfer taxes. The

tax administration set up is the same in both NWFP and Punjab. Most revenues collected

106 International Studies Program Working Paper Series

by the BOR come from taxes on property transfers in urban and rural areas. There are

also a number of fees/charges that add up to a significant amount of revenue. There is no

annual tax on land that is collected by the Board of Revenue in Punjab.

There is

however, an annual tax on agricultural land in NWFP. In both provinces, there is an

additional tax on property transfers that is collected by the local government (and is not

covered in this report). The following table shows the tax rates for the four different

taxes levied on a property transfer:

(Rates as percent of value)

Tax NWFP Punjab

Stamp Duty (Province) 3 2

Registration or Mutation Fee

(Province)

2 1

Capital Value Tax (Federal) 2 2

Tax on Transfer (Local) 0.5 1

Total 7.5 6

Revenue Performance

Board of Revenue collections of land revenues in Punjab and NWFP (shown in

Tables 34-36) account for less than one percent of GDP in both provinces, and are much

lower in NWFP than in Punjab. In light of the fact that agriculture accounts for about 27

percent of provincial GDP in Punjab and 30 percent in NWFP, this is a surprisingly low

revenue share. Even when account is taken of the share of subsistence farming, the

revenue contribution seems low.

Neither has the revenue trend been impressive (Table

35).

The UIPT is collected by the Excise Tax Department.

Another way to look at the revenue burden from land taxes is in terms of the tax per hectare of cultivated

land. In the table below we show that Punjab taxes a hectare of cultivated land 2.6 times more heavily than

does NWFP.

Pakistan: Provincial Government Taxation 107

The level of collections of land revenues are shown by major type for Punjab in

Table 36. The results of this disaggregation reveal that stamp duties, mostly collected

from property transfers, are the major revenue component of taxes collected by the BOR.

Taxes on property transfers also include a mutation fee or a registration fee. Liability for

each of these taxes depends on the type of property being transferred, and to some extent

on the choice made by the taxpayer.

The total amount of revenue collected from each form of property transfer tax is

reported in Table 37.

The stamp duty on property transfers yielded about Rs 7.8 billion

in Punjab, i.e., about 20 percent of own source revenues in 2006-07. In recent years, the

nominal tax rate has been lowered in an effort to increase compliance. (None of these

tables reports collections of transfer tax by local governments, or the federal government

capital value tax on property transfers.

Only provincial government revenues are

shown in Tables 36 and 37).

Land taxes per hectare of cultivated land

(2005-2006)

(In rupees)

Taxes

Punjab NWFP

Agriculture income tax 25.83 17.09

Registration fee 82.90 10.25

Land revenue 133.09 80.57

Stamp duty 229.90 73.24

Total 471.73 181.15

For agricultural land, a person can choose to have the transaction recorded as a “mutation only” or a

“registration” followed by a “mutation.”

The data reported in Tables 34-36 differ from that reported in Table 37. This is because the data sources

differ and because of classification differences.

Aggregate data on local government finances are not available for either province.

108 International Studies Program Working Paper Series

Mutations and Registrations

There are two forms of property transfer: “mutation” and registration (Box 7). A

mutation involves a transfer of property when there is a record of ownership but not

necessarily a deed. This is the form of transfer used in rural areas where much of the

land has been inherited. Registration is used mostly in urban areas where in general there

are no comprehensive records of ownership. Regular or organized land records do not

exist in most urban areas. There are no patwaris for the urban areas and a mutation

purchasers. In other cases, where land records exist (e.g., rural land and in one part of

Peshawar old city) registration is preferred because it gives a stronger title (since a

registered deed has a presumption of truth attached to it under the evidence laws).

Legally, the same presumption is attached to mutations, but due to deterioration of land

records, the courts may call for additional evidence and do not always accept a certified

mutation as a sufficient basis for establishing ownership.

Box 7. Mutations and Registrations

Mutation is applicable primarily to the transfer of agriculture land. For a mutation, the transfer is

reported to the patwari who enters it in the mutations register where he notes the reference in the record-

of-rights and the number of the parcel. The mutation is then certified in a public gathering by the

Tehsildar when he visits the patwar circle. In general this happens once a month. Upon certification by

the Tehsildar in the mutation register, the transfer becomes final. The patwari then makes a red ink entry

in the records-of-rights register. This entry forms the basis of changes in the ownership column of this

parcel of land when the next edition of the record-of-rights is prepared. The editions are prepared every

four years. Mutations are carried out for all forms of transfer, including inheritance, sale or in

compliance with a civil court decree. The tax treatment varies by type of transfer.

Registration, applies mostly to urban property, for which the records-of-rights do not exist. For

registration, the transfer deed is prepared on a stamped paper and attested to by the registrar of

properties. The registrar maintains a record of the deeds but there is no comprehensive record of

properties in most urban areas. If a person wishes to carry out registration for agricultural land, he is

allowed to do so as an additional step after the mutation.

Pakistan: Provincial Government Taxation 109

Tax Base: Rural Properties. Technically, the base of the property transfer tax is

the market value of the property transfer. In practice, it is not completely clear how the

transfer is valued for purposes of tax. The process in rural areas in Punjab is described to

be as follows: The buyer and seller make a declaration of the value. The Patwari (Box 8)

is consulted about the “reasonableness” of this declaration. The law provides for a right

of preemption, i.e., neighbors may buy the land for a price higher than the stated

declaration. These checks, in theory, will lead to a proper self-declaration of land value.

However, experience tells us that it cannot be assumed that preemption is costless, or that

there will not be collusion among neighbors, therefore preemption may not be invoked in

many cases.

Resort to the Patwari to check on the reasonableness of declared value is not

likely to be effective for a number of reasons. One of these reasons is that the claims on

the Patwari’s time (e.g. court appearances) may preclude the possibility of his doing the

necessary research. The result is that undervaluation is thought to be very common

because the declared selling price is usually accepted as the base of taxation (Government

of Punjab, 2007f).

The method used is somewhat different in NWFP. The base for the tax is not

declared value but a notional value that is drawn from a table of estimated market values

for lands in different locations. This table is certified by a committee. The committee is

chaired by the collector and its membership includes the executive district officer of

finance and the district officer of Works and Services. The latter will provide inputs on

value-enhancing developments in different zones. In fact, the valuation table is an

average of the declared values in the past year, for each type of land. A similar table is

110 International Studies Program Working Paper Series

prepared in urban and rural districts. There is an ample number of transfers to calculate

an average value. In Punjab the collector formulates a valuation table for urban areas

only.

In neither province is there a sales ratio study to enable an estimate of

undervaluation. Such studies usually require independent appraisals of market value.

The only supporting evidence prepared for rural areas in Punjab (and for urban and rural

areas in NWFP) is the ausat yaksala which is an average sales value for different types of

land in a recent period. In both provinces, this document is prepared by the patwari. It is

not thought to give a reliable estimate of full market value.

Tax Base: Urban Properties. A valuation table is used for land in urban areas in

both provinces. The valuation tables are prepared by the district collector, who is head

of the land revenue department. He is empowered by law to carry out any survey or adopt

any means necessary to do the valuation.

In theory, these values are based on a combination of subjective, expert judgment

and objective price information. They are updated regularly. In practice, the approach

may be more ad hoc. In Punjab, the land values in the table are reported to be the same

as those laid down in the (repealed) Wealth Tax Act of 1963. (Government of Punjab,

2007f). This suggests little by way of a regular updating. Moreover, the table does not

include the value of structures.

Available evidence suggests that properties are undervalued, but there is no good

evidence of the extent of this undervaluation. One (non-scientific) survey of 11 selected

areas in Lahore district came to the conclusion that the assessment ratio against market

value varied from 55 percent to 79 percent (Government of Punjab, 2007f). We can find

Pakistan: Provincial Government Taxation 111

no such evidence in rural areas. In neither province is there any coordination between the

Board of Revenue in its land valuation process, and the ETD in its urban property tax

valuation process. This would seem to be a missed opportunity.

Tax Rates. Property transfers are subject to an array of tax rates and special fees.

A Rs 200 fee is applied to any mutation. Transfers by inheritance and those transferred

under court decree pay only this amount. Otherwise, mutation transfers and registration

transfers are subject to a 1 percent registration tax in Punjab and 2 percent in NWFP, and

a 2 percent stamp duty on the value of the transfer in Punjab and 3 percent in NWFP.

A local transfer tax of one percent is collected separately by the TMA in Punjab. In

NWFP the local transfer tax rate is 0.5 percent.

In addition, there is a 2 percent capital

value tax levied by the central government.

Land Records. There are detailed records of land ownership, land characteristics

and land use in the rural areas. They are maintained by the patwari. All districts in

Punjab and most areas in NWFP have these records. Areas which have these records are

called “settled”.

The local tax on transfer of property is collected by the TMA through private contractors. The TMAs

award annual contracts based on a competitive bidding process. The reservation price that the TMA

announces is generally a notional incremental increase in the previous year’s price. They do not conduct

valuation surveys or market research to compute a more realistic reservation price. The in-house expertise

of TMAs is weak. They do not have staff expertise in property markets. The contractors assign their

collection personnel to sit at the registrar’s office. The registrar, following government instructions, will

insist on seeing a receipt for payment of property transfer tax before he attests the registration deeds. The

valuation of the property is however carried out by the registrar. He does this by reviewing the reported

value of transaction. The contractor’s representative at the point of collection does not have clear incentives

to collect the full amount of revenue due to the municipality. If the parties offer to settle for a sufficiently

low valuation resulting in a lower liability, they can still save money after paying the contractor. The

contractor’s representative collects the revenues and deposits the amount according to the payment

schedule, not necessarily according to the payment received. The contract calls for a lump sum amount

payable to the TMA.

112 International Studies Program Working Paper Series

By contrast, records are not very good on the physical characteristics of properties

in urban areas because these properties have never been surveyed. The degree to which

this is a problem varies by type of urban area. Urban areas are of various kinds: (i) those

which are old urban settlements, (ii) those where urban growth has sprawled into rural

areas, (iii) urban localities developed by development authorities, or (iv) urban areas

developed by private developers. The state of property records differs among these

property types. For (i), in some cases, old records are available. However, in cases where

Box 8. The Patwari

He is the junior most official of the BOR tax collection administration. He is underpaid, does not

have any staff or transport and in many cases does not have a government-provided office. The bundle of

registers he is required to maintain mostly is wrapped in the cadastral map or latha, when he needs to

carry it around. In this sense he has a mobile office.

A patwari’s importance belies his junior standing. He has numerous important duties. (1) He is the

custodian of land records. In rural lands, and some urban areas, a presumption of truth is attached to the

records of rights in the courts. Invoking these records, titles are determined. (2) The record-of-rights is

updated every four years under the law. The patwari writes the record with his pen, specifying the titles,

occupancy and other rights in land. The four yearly editions are maintained by him. (3) He keeps a

‘Mutations Register’, which is linked with the four yearly record-of-rights register. The process of

mutation is initiated and completed with the patwari. He enters the details of property, records the

transaction and upon attestation by a Revenue Officer, makes a cross entry in the record-of-rights

liability for taxes on property transfers. (5) The patwari maintains a Crop Register or Khasra Girdawari.

In this register he records the results of his six monthly crop inspections for each parcel of land, also

recording the ownership and occupancy. (6) For Valuation Tables prepared for any land-related taxes he

provides the estimates—the ausat yaksala. (7) Estimates of crop yields, jhar padawar, are prepared with

inputs from patwari. (8) He issues the ownership certificate, fard malkiyat, required for many basic

citizenship documents and mortgage and banking requirements. (9) He certifies ownership for

agriculture loans. (9) In many cases he issues a “no-dues certificate”. (10) With the assistance of the

village lambardar, he collects land related dues. (11) In cases of natural disaster, he is dispatched as the

vanguard of assistance to assess damages and thereby recommend compensation. (12) A patwari

prepares records and notifications for acquisition of land for government or large private projects,

determines titles, prepares valuation estimates and certifies payment to owners. (13) Informally, the local

officials count on him for miscellaneous functions including public meetings, arrangements of some

official functions and data gathering. (14) Due to his role in land administration, the patwari is sought

after by local elite and he in turn can count on their support. His accountability to the department

leadership is limited. (15) He maintains land records in Urdu which are based on antiquated survey

techniques. A patwari will determine the boundaries of a certain property if there is a dispute. (16) He is

called to attend courts and render evidence in cases disputed title, possession, partition and

compensation. As the number of land-related litigation cases has multiplied, increasing amounts of his

time is spent in court. This has the result of his spending less and less time on maintaining records and

carrying out field inspections, setting up a vicious circle.

Pakistan: Provincial Government Taxation 113

these are available they are not up to date and often have only a historical value. In the

case of (ii) the patwari records are available and may or may not give good evidence of

the current status of the property. Development authority properties (iii), have reasonably

complete records which were prepared at the time of their development. All parcels of

land are numbered and the original allottees or buyers are recorded. However,

development authorities do not update the records after the first transfer of ownership to

the buyers. For (iv) records are not fully developed and are not up to date. All four

categories of land may exist in notified urban areas.

In the absence of any formal property records, the PT-1 register of the excise tax

department is the only record of these properties that might give evidence of ownership.

However this fiscal register does not give any proof of ownership. At best it provides

corroborative evidence. Preparation of comprehensive land records for the urban areas is

an important task that remains to be completed.

Stamp Duty

The base for stamp duty includes virtually all kinds of transfers and legal

documents. For example, more than 120 items are subject to stamp in NWFP. The

stamp duty rates vary by type of document, but most revenue is collected from stamps on

property transfers. The Province has proposed a new schedule of stamp duty rates, but it

is not clear that this revision will be accepted. Stamp duty reform has also been under

discussion in Punjab. The proposed reform includes a reduction in the tax rate on

property transfers, per an ADB recommendation (Government of Punjab, 2007f). In

Punjab the stamp duty rate is 2 percent on the value of property transfers. This is in

114 International Studies Program Working Paper Series

addition to the 1 percent registration fee, 2 percent CVT and 1 percent local rate. Hence

the total rate paid on a property transfer is 6 percent (7.5 percent in NWFP).

Approximately 75-80 percent of stamp duty revenue is from property transfers in Punjab.

Other Land Taxes in NWFP

While the system of mutation, registration, and stamp duty is much the same in

the two provinces, there are some differences in terms of additional taxation of land

imposed in NWFP. Ushr is essentially a contribution collected by the BOR. The funds

are turned over to the district Zakat account, which is managed by a committee appointed

from within the district. The committee allocates the money among welfare projects and

assistance to the needy. The ushr revenue is not included in the Provincial Government

budget.

The base of the tax is the volume of the produce of a farm. The assessment may

be made at the farm gate. The tax rate is 10 percent for unirrigated or barani (rain

irrigated) land, and 5 percent in the case of irrigated land. Irrigation can be by tubewell,

canal or any other means (the lower rate of tax is meant to reflect the cost of irrigation).

Exemptions from the tax are for land that is not cultivated, and for farms producing less

than 1000 kilos of wheat. The exemption does not apply to cash crops. Those following

Fiqh Jafaria are given an exemption from paying ushr. Revenue collections are

reportedly weak by comparison with revenue potential. Some observers take the view

that major administrative improvements and monitoring are required.

Payment may be in-kind. The government agent may collect the payment, for

example of wheat, at the time of threshing. The Government then sells the produce and

Pakistan: Provincial Government Taxation 115

passes the money to the Zakat Department. In practice most of the collection is in cash.

There may be a compliance problem. It was noted by provincial officials that collection

was difficult other than for grain products. The difficulties in collection are compounded

by the high rate of tax which contributes to lowering voluntary compliance. Revenue

from Ushr in 2002/03 was Rs 1.7 million.

NWFP also imposes a land tax which is a general revenue in the provincial

government budget, but is a minor revenue source. The base of the tax is the area of land

owned. The tax rate is Rs 50 per acre for irrigated land and Rs 25 for unirrigated land up

to 12.5 acres. Irrigated farms of 12.5 to 25 acres in size are taxed at a rate of Rs 72 per

acre. The rate is 100 rupees per acre for farms larger than 25 acres. The rates for

unirrigated land are one-half of the rate for irrigated farms. Orchards are taxed at Rs 300

per acre. Land tax is levied on cultivated land only. Uncultivated land is exempt.

Only farmers with ownership of less than 5 acres in a revenue estate are exempt.

The tax liability is worked out on the basis of a person’s ownership in one revenue estate.

Ownership of land in another jurisdiction will not cause a land owner to be bumped to a

higher tax bracket. This provision is by default, because the land records are not

interlinked. Until they are, there is no way to fully capture the tax base.

Water Rates

These revenues are transferred by the province to the districts on a derivation

basis. Water rates are assessed by the provincial irrigation department, but are collected

by the village headman on behalf of the BOR. The village headman is supported by the

patwari. Presently, the Board of Revenue in Punjab has assigned patwaris to work

116 International Studies Program Working Paper Series

directly under the irrigation department to solve the inter-departmental coordination

issues. Estimated revenue collections are about Rs 5 billion, even though collection rates

are only about 60-65 percent of amounts due. The department also collects a local rate

which is Rs 2 per acre on all types of agricultural land.

Determination of the use of water is linked to crop types, which in turn is deduced

from the patwari’s crop inspections. Better quality inspections can help determine the

usage more accurately. The rate structure should also be reviewed with an eye toward

increasing revenue from this source.

Problems and Issues

About 27 percent of province-wide GDP is generated in the agricultural sector in

Punjab and 30 percent in NWFP. Anecdotal evidence in Punjab suggests that both urban

and rural property values have increased considerably in recent years. However,

revenues from the various land taxes are not keeping pace with either inflation or GDP

(Table 35).

The problem is that property transfers are not being taxed at their market values,

as is called for in the law. The only objective evidence used in the valuation process

would appear to be the averages computed by the Patwari for rural areas. But since this

is an average of stated or declared values, it is almost certainly much below the true

market value. In compulsory land acquisition cases, the courts have routinely refused to

accept the annual average value worked out from patwari records and have awarded

higher compensation to land owners. A Supreme Court judgment in the 1990s ordered

Land revenue (largely mutation fee), registration fee and stamp duty have declined as a percentage of

GDP in both Punjab and NWFP from 2004-2005 to 2005-2006.

Pakistan: Provincial Government Taxation 117

that government should pay on the basis of market values instead of on the patwari’s

ausat yaksala.

Neither is there confidence that the urban area valuation tables recognize full

market value. These tables are prepared by the collectors but apparently are based on no

more accurate a data base. The opinion of those government officials interviewed is that

the valuation tables represent only a fraction of market value and are not based on an

adequate survey. Officials from the provinces speculate that taxed values are probably in

the range of 25 – 50 percent of true values, and much less in the case of new development

areas. The property values assessed on the basis of the valuation table in Lahore were

estimated to range from 55 percent to 79 percent of the corresponding market values.

The upshot of this situation is that the transfer taxes are yielding only a fraction of

their revenue potential at current rates. Since sales ratio studies are not carried out, the

true coverage of the tax base is unknown.

A second problem is that the tax base has been narrowed by exemptions ---

sometimes given for political reasons and sometimes given for reasons of administration.

Officials in NWFP offered the following list of issues, but much of this would be

applicable to Punjab as well.

1. Large tracts of land in some districts have not been ‘settled’, which means

that detailed records for them have not been prepared. They remain

outside the tax base.

2. PATA districts in NWFP are largely outside the land tax base because of

their legal status. The tax laws have not yet been extended to cover them.

3. Small farms are exempt. Due to subdivision of land, through inheritance,

the base is shrinking.

Government of Punjab 2007c, p.89

118 International Studies Program Working Paper Series

The tax base is narrowed for administrative reasons as well. In rural areas, the

Patwari’s office is overburdened with duties which do not relate to tax collection. He

does not have staff, office or mobility. He is dependent on local support for performance

of his official duties. (See Box 8). The result is significant delay in recording property

transfers and collecting taxes due.

Third, there is a significant problem with record keeping. An updating of the

“record of rights” is required every fourth year. But in many instances the records are

not updated on time. The Government of Punjab (2007f) reports the records in Lahore to

be 20 years out of date. Organized records for land in urban areas do not exist. The

quality of records also leaves much to be desired. Reportedly, errors in records have

contributed significantly to civil litigation.

Are the Basic Tax Instruments Adequate?

Before considering a specific reform package for the present system of stamp

duties and other property transfer taxes, it would be useful to question the purpose of

these taxes. Underneath this questioning is the concern about whether the present regime

is the most suitable for Pakistan. In raising this question, we might look to the

international practice.

Stamp duties are a part of the tax system in most countries, but they are widely

criticized. The fundamental question to be addressed in Pakistan (and elsewhere) is “why

have a stamp duty?” Clearly there is need to legalize documents and assure that they are

properly filed, and a government stamp is one way to do this. To levy a service charge

This section draws heavily and directly from Bahl (2004).

Pakistan: Provincial Government Taxation 119

that would cover the stamping and verification cost would seem a reasonable

justification. There might be some justification for differentiating the rate of charge by

type of document, given the different degree of examination required for various types of

documents. The problems arise with respect to property transfers --- such as the regime

that includes stamp duty, mutation fee and registration fee in Pakistan.

There are a number of reasons why real estate transfers have found their way into

tax systems in many developing countries, including Pakistan. First, it is an easy tax

handle in that most buyers/sellers desire to legally record the transfer and therefore will

voluntarily comply. Second is the revenue motivation and what might appear to be a

very low cost of collection. When property values escalate, as happens periodically in

most countries, the revenue take can be quite significant. Third, if property ownership is

concentrated in the higher income classes, the distribution of tax burdens may be

progressive. Fourth, the number of people in the taxpaying population in any given year

is much smaller than in the case of more general taxes, hence the opposition to the tax

may not be as great as would be the case if, say, an increase in the value added tax were

proposed. Finally, a property transfer tax might reach that part of the population that

ordinarily avoids payment of most income tax and value added taxes.

There are major disadvantages to the property transfer tax. First, it raises the cost

of property transactions thereby reducing the volume of transactions, hence slowing the

development of the real estate market. Second, if the tax is properly assessed,

administrative costs could be high, at least because of the need to check the self-reported

property values and revalue when necessary. Third, a property transfer tax gives property

owners an incentive to understate taxable value, hence weakening the database that is

120 International Studies Program Working Paper Series

called on for assessment of the urban property tax.

A moment’s reflection will lead to the conclusion that the problems with the

property transfer tax are dependent on the level of the nominal tax rate chosen. At very

low rates, these problems may be of less consequence. But when the tax rate is high, the

implications of these problems are magnified.

In fact, countries choose very different rates of taxation on the value of property

transfers. An illustrative list of rates for various countries is shown in Table 38. These

data suggest a great deal of variation in the practice. South Africa, for example, taxes

property transfers and also subjects these sales to a 14 percent VAT. But in many

countries, the rates are below those levied in Pakistan. The reform options most often

seen for property transfer taxes in recent years are reductions in the rate to mitigate the

problems described above. Examples include Czech Republic in 2003, Portugal in 2003,

Slovakia in 2002, Taiwan in 2003, and Dominican Republic in 2003.

Reform Options

The primary, short run reform goal of provincial tax reform is to increase

revenues to finance services. This should be done by rationalizing the system of taxation

so that the revenue flow is adequate to meet the revenue target, the tax burdens are fairly

spread between urban and rural residents, and undesirable behavioral effects are avoided.

Simplification in the tax structure should be sought, especially given the limited

administrative capacity of the provincial government. This is the context in which we

consider reform of the present system of land taxes.

An obvious change is to collapse the three different provincial property transfer

Pakistan: Provincial Government Taxation 121

taxes into one levy. This would simplify the tax regime and make it more transparent and

manageable. Initially the tax rate could be set at the present (aggregate) level.

In the short run, some will argue for an increase in property transfer tax rates as a

revenue enhancement measure. This might be done by simply raising the rate, or by

indexing the existing rates to some indicator of average property value growth.

This is

not a good solution to the revenue problem, and it is not good tax policy, because it

ignores the underlying valuation problem and might even exacerbate it. Higher rates

would provide even more incentive for underdeclaration of values. The alternative route,

indexing, would penalize properties that experienced slower growth in favor of those

experiencing faster growth. The goal of developing the real estate market would also be

thwarted.

Others will argue to lower the tax rate so as to encourage compliance. It would be

reasonable to conclude that lower rates would improve compliance, but we have no hard

evidence on the extent of the response. Reportedly, some local governments in Punjab

realized an increase in compliance after lowering the tax rate. However, only anecdotal

evidence on this experience is available.

An essential element to any sustainable reform is to improve the method of

valuing property transactions so as to better approximate true market value. There are a

number of necessary actions that must be taken to eliminate or at least reduce the gap

between assessed and market value. In fact, several of these proposals are presently

under consideration.

Among the possibilities for an index are the rate of growth in agricultural sector GDP.

122 International Studies Program Working Paper Series

• Carry out a survey of all properties so that a full cadastre is available for

compiling the tax roll.

• Subject all declared transfer values to independent valuations carried out

by the BOR.

• Increase the staff of qualified valuers used in updating the tax roll and in

making the assessments. If the goal is to subject all property transfers, or

even all suspect declarations, to desk and possibly field verification, a

significant (and costly) increase in staff will be called for.

• Settle on a method of valuation and develop the appropriate procedural

manual. Given the present state of valuation in the two provinces, this

method will likely involve making use of a combination of expert

judgment and objective information (e.g., realtor opinions and the

valuation data established in urban areas for UIPT).

• Carry out regular sales-assessment ratio studies to monitor valuations and

to update the valuation tables in both urban and rural areas. This could be

done by the increased staff, and with the use of expert opinions.

• Enact a substantial surcharge on tax due in the case of declarations that are

found to be well below market levels based on independent valuation.

• A potential check on valuation might be made by coordination with the

valuations placed on urban properties by the excise tax department for

purposes of UIPT. At present, there is no such coordination.

We cannot estimate the amount of additional revenue that might be expected from

such enhancements to the valuation process. There are no reliable sales-ratio studies

available, but anecdotal evidence suggests that a 50 percent undervaluation of transferred

property might be a reasonable estimate.

In this case, a 15 percent increase in taxable

For a good discussion of assessment quality in the context of an emerging economy, see Bell and

Bowman (2002)

In 2005-2006, revenue collections in Punjab were Rs 11.4 billion and the property transfer rate was 20

percent, implying a total value of exchanged property of Rs 378.786 billion. If property exchanges hands

on average, every fifth year, the implied total value of land is Rs 1,893.933 billion. If the assessment ratio

were 50 percent, the estimated total land value would be Rs 3,787.865 billion, which is 86 percent of

regional GDP.

Pakistan: Provincial Government Taxation 123

values, and tax collections, would be well within the reach of provincial governments if

they chose to make the necessary administrative improvements. This would yield an

additional Rs 1.7 billion in collections in Punjab. In NWFP it will yield an additional Rs

100 million. Some observers would place the degree of underassessment at a greater

level, perhaps 70 percent. In this case, our proposed 15 percent increase in values

underestimates the revenue potential from revaluation, even taking into account the

political considerations that would dictate “going slow”.

What might be the timetable for such a reform program? Preparing the cadastre,

developing the valuation mythology and hiring and training of the additional staff could

take two years. Therefore, it could be three years before significant revenue

enhancement would appear.

A more comprehensive reform of the taxation of the rural sector might pull back

from taxing property transfers altogether. The rationale for this proposition is straight

forward. Provincial taxes might be seen as a payment for public services received. It

seems more reasonable to extract this payment yearly rather than at the time of a transfer.

Moreover, there might be some administrative economies since UIPT and the agricultural

income tax are annual taxes, and since a cadastral survey is required in any case.

The present regime of taxing only transfers could be replaced with an annual tax

on land in rural areas, perhaps imposed as a presumptive income tax on rural land. The

umbrella for this new tax would be the agricultural income tax in the case of lands used

for agricultural purposes (see the proposal below). For rural lands not used in farming, it

would be a tax on annual rental value at highest use. Valuation would be carried out

124 International Studies Program Working Paper Series

following the steps noted above. Urban land would continue to be taxed under the UIPT.

No property would be assessed both a rural and an urban property tax.

How would this restructuring be done? First, the mutation fee, registration fee

and stamp duty on property transfers would be combined into a single land tax, levied on

the basis of the market value of land. The rate would be set according to revenue

considerations. Second, and in order to move to a unified annual tax, it will be necessary

to prepare a cadastre showing the ownership and physical characteristics of every parcel.

After this, a valuation table would be prepared for the province, and updated on a

periodic basis. These comprehensive administrative improvements are within the reach

of the provincial government. Necessarily, they would precede the structural reform.

The revenue yield from a unified annual tax on urban and rural property will

depend on the nominal tax rate that is chosen. The elasticity will depend on the accuracy

and timelines of revaluation and on whether there is indexation of property values. A

unified, annual land tax with “reasonable” rates and proper valuation could easily result

in well more than a doubling of rural land tax revenues.

Not all would agree with eliminating the tax on property transfers. One reason is

that a property transfer is an event that is easily identified by the taxman. Undervaluation

may be common, but completely escaping the tax probably is not. There also are

important transition issues. This structural reform would bring a major shift from the

present tax regime, so a great many details would need to be worked out. Moreover, a

political consensus would have to be reached among the many stakeholders before any

legal drafting could go forward. However, the administrative reforms that would support

Pakistan: Provincial Government Taxation 125

this restructuring could be implemented in any case, since they also are necessary for

improving the present regime.

Another reason why some would argue that the present regime cannot be

abandoned is that property transfer taxes are a proxy for capital gains taxes on property

investments. This is not a good justification for the present regime because the sales

price of a property probably bears little relationship to the size of a capital gain. The

capital gain depends on the real appreciation in value since purchase, whereas the

property transfer tax depends solely on the gross selling price irrespective of any other

factors including whether or not any gain had been made. (See Box 9).

A capital gains tax on land could be introduced in addition to the annual land tax

proposed above. In theory, the concept of a capital gains tax on land is straightforward.

The tax liability would be taken on the difference between the buying and selling price of

the property, indexed for inflation. The buying price (base) would be set according to

historical records of purchase price. Owners could petition to have this base increased.

The selling price would be verified by the valuation staff in the capital gains tax office.

Note, however, that there would be a self-enforcing feature.

The nominal gain would

be adjusted for inflation and for the cost of allowable improvements to the property (e.g.,

irrigation).

Buyers would have a disincentive to underdeclare the purchase price because their basis for a future tax

on capital gains would be too low.

126 International Studies Program Working Paper Series

Box 9. A Capital Gains Tax or a VAT on Property Transfers?

One idea with some currency is to introduce a capital gains tax on property (real estate). This

would serve the purposes of generating revenues and closing off an avenue of avoidance of income

taxes.

There are two ways that this might be done. One is to institute a separate capital gains tax on real

property in place of the current transaction taxes on real estate sales. Capital gains taxes on property

are not unknown in developing economies. They are levied, for example, in Columbia, Korea,

Zimbabwe and Taiwan. However, the implementation of a capital gains tax on real property raises

some serious administrative issues.

As the international practice shows, there are a number of important issues:

• How would records of the original selling price be documented and verified?

• How would records of the increase in basis be kept and verified? For example, records would

be required to show the cost of improving properties to enhance the selling price.

• Would there be an inflation adjustment?

• How would inter-family transactions be handled?

One might conclude that the tax administration in Pakistan is not yet ready to support an effective

capital gains tax on real property.

Another choice is to eliminate the stamp duty and property transfer tax on property sales, and bring

residential real estate transfers under the value added tax. Buyers and sellers would have an incentive

to report correctly, and a more accurate flow of information about land values would result. The tax

would be levied at 15 percent on the selling price of land, less the (real or notional) tax paid on the

purchase price. For some sales, the tax burden would be well below that of the current rate on total

transaction value.

This would violate the notion of a VAT as a consumption tax since housing is consumed over

many years. The practice varies widely among the industrialized countries. Some cover certain types

of property sales under the VAT (e.g., new vs. used buildings as in Germany and Belgium), some use a

transfer tax much as Pakistan does and zero rate new buildings (UK), and there are numerous types of

special treatments and exemptions. A good discussion of the treatment of real property under the VAT

is in Bird and Gendron (2007, p81-86).

One disadvantage to this approach is that capital gains on real property would be

taxed in a different way from capital gains in other sectors of the economy (Thirsk,

forthcoming). A major drawback is administration, especially establishing the basis for

a capital gains tax, and developing a method for indexing for inflationary increases and

adjusting for qualified investments in real property. As complicated as these

Pakistan: Provincial Government Taxation 127

administrative requirements seem, they are not any more daunting than the present

requirement of establishing a true market values for every real estate transaction.

Such a tax system would have appeal. Revenues would not ebb and flow with

land market activity, and the number of different taxes levied on rural land would be

reduced. Once a capital gains tax became established, the unified administration would

be more efficient at collecting revenues than is the case under the present regime. The

incentives for underdeclaration of property prices at the time of sale would be lessened.

The result might be a better flow of information about land prices, which is necessary to

develop a property market.

Agricultural Income Tax (AIT)

The Agricultural Income Tax is collected by the Board of Revenue in both NWFP

and Punjab. Agricultural income is exempt from federal income tax (Federal Income Tax

Ordinance 2001) and this has caused some controversy regarding both the ownership and

the legality of the AIT. Malik (2004) claims that one of the main reasons for the

controversy is that the tax is not specifically called out in the Constitution. Both

provinces, however, do impose the tax, although as a presumptive tax, and not directly as

a tax on agricultural income. NWFP started levying a land tax and agriculture income tax

in July 2001, and is credited with some of the early policy development of the tax.

The Punjab Provincial Agricultural Income Tax Act of 1997 defines the base, rate

and collection of the tax. In theory, the base is income derived from agricultural land. In

the 1997 Act, agricultural income is defined as rents received from property used for

agricultural purposes, income derived from cultivation, or income derived from owner-

128 International Studies Program Working Paper Series

occupied buildings on the property (including small businesses such as dairies). The

Punjab Act provides for two alternative calculations of the tax. The first is based on land

area and the second is based on agricultural income. Officials in both provinces note that

the land area method is the one actually used and the income base is not used to apply the

actual tax. In this regard, the agricultural income tax may be thought of as a presumptive

income tax.

Revenue Performance.

The AIT raises a relatively small amount of money for the government of Punjab

(see Tables 34-36). Estimated collections in Punjab are Rs 658 million in 2006 or 2.06

percent of total own source revenue. This represents an average of Rs 170.3 per farm, or

an average of Rs 1,669 per farm greater than 12.5 acres in size, based on data from the

2000 Census of Agriculture. Real per capita collections have fallen dramatically since

1999-2000, and by 2005-06, represented only 32 percent of 1999-2000 collections.

The level of tax collections in NWFP also is quite small—70 million rupees in

2005-06. This amounts to 1.53 percent of total own source revenue. In NWFP, AIT

collections are about on par with the level of collections from the professions tax. Based

on data from the 2000 Agricultural Census, the average burden of the tax in NWFP is

51.6 rupees per farm, or 241 rupees per farm greater than 5 acres. Real per capita

collections remained approximately constant in NWFP between 1999 and 2006.

Pakistan: Provincial Government Taxation 129

Valuation and Tax Base.

In theory, all agricultural land is taxable under the agricultural income tax in both

provinces. According to the law, the agriculture income tax can be assessed in two ways:

one based on the value of crop output and the other a presumptive tax with flat rupee

rates by farm size.

The tax laws provide detailed schedules for unirrigated land and irrigated land. In

Punjab, irrigated land of less than 12.5 acres is exempt, and non-irrigated land with less

than 25 acres is exempt.

In NWFP, there is no exemption level if the tax is calculated

based on land area. However, in NWFP, the income-based schedule does include an

exemption of Rs 80,000 of agricultural income. The theory of the income-based

exemption is that it provides for a minimum level of income from which families can

take care of their basic needs. This Rs 80,000 exemption is somewhat low by the current

standard for the federal income tax—which is now Rs 150,000 The same justification

may be offered for the 12.5 acre exemption in Punjab, though some officials argue that

12.5 acres is too generous and represents more than a subsistence farm. However, using

data from the Census of Agriculture on crop yield, the income earned from a 12.5 acre

farm that specializes in growing wheat would be substantially less than Rs 80,000

(depending on the treatment of rent and other inputs). In the case of most other crops

reported by the Census, a 10 acre farm would generate income of Rs 80,000 or more. Past

efforts to reduce the minimum taxable farm size below 12.5 acres have failed in Punjab.

For the income method, the technical description of the valuation process is as

follows. Theoretically, the land revenue staff establishes an average yield per acre for all

In all cases, the land area is sown land area.

130 International Studies Program Working Paper Series

crops cultivated in the district. (The document is called Jhar Paidawar.) Upon

certification by the district collector this becomes the operative formula for calculation of

the tax base.

Similar estimates are prepared for each revenue estate (revenue estates are

units within districts). In some cases, depending upon soil types and local factors, the

revenue estate estimate may differ from the district estimates. In such cases the revenue

estate formula is applicable for calculation of the tax base. Input prices and market prices

for crops are based on surveys and analysis conducted as part of the Census of

Agriculture. Many of the prices are fixed by government.

The focus of the tax is sown land area, but the valuation process is much less

focused on crop inspections than on land tenure. In practice, the patwari performs a crop

inspection every 6 months (called a girdawari) and uses these data to update the special

reflected accurately, but in some cases, negotiation between the land owner and patwari

can be substituted for the inspection. Land tenure, therefore, appears to be the central

concern of the patwari’s work, and the crop valuation is relegated to a secondary concern.

The lack of accurate, timely, and detailed data on ownership of land, crop yield, and input

prices leads to a situation where there is little basis to establish the AIT liability based on

income. That may be a principle reason that, according to our interviews, both NWFP

and Punjab use the farm area imputation to calculate AIT liability.

There are typically two growing seasons and if a farmer grows in one season but not in another, he is

supposed to be taxed as having grown all year according to the explanation given by the Board of

Revenue). Based on the description of the valuation method, it is not at all clear that this provision can be

enforced.

Pakistan: Provincial Government Taxation 131

Tax Rates

In Punjab, the tax rate schedule for irrigated land (under the acreage tax base) is:

i. Less than 12.5 acres exempt

ii. 12.5 to 25 acres Rs 150 per acre

iii. Over 25 acres Rs 250 per acre

iv. Orchards Rs 300 per acre

v. Non irrigated one half the above

vi. Idle land no tax

These tax rates have been constant since 1996 but the exemption level has changed over

time. Prior to 1997, the tax was under the Land Revenue Act and the exemption was for

2.5 acres. When the Agricultural Income Tax was imposed in 1997, the exemption was

set at 5 acres for a short time, before increasing to 12.5 acres. At some point after 2001,

the BOR attempted to reduce the exemption back to 5 acres, but that proposal was met

with significant political opposition.

The per acre tax rate structure is not a graduated marginal rate structure. Instead,

all acreage of farm land in a rate class is taxed based on the same slab rate. For example,

for a parcel of 50 irrigated acres, the tax rate is 250 rupees on all 50 acres. Once the

exemption threshold is reached, all land is taxable. This leads to large changes in the tax

rate at each size boundary and may in fact encourage individuals to claim that they own

smaller properties. Since the valuation system is not transparent, there may be a high

probability of under reporting and not being detected.

In contrast, the income-based rate structure in Punjab, as shown below, is a

progressive marginal rate structure.

132 International Studies Program Working Paper Series

Income bracket Rate

Agricultural income is less than Rs.80,000 Exempt

Agricultural income is less than Rs.100,000 5%

Agricultural income is between Rs.100,000

and 200,000

Rs.5000 plus 7.5% of the amount

exceeding Rs.100,000

Agricultural income is between Rs.200,000

and 300,000

Rs.12500 plus 10% of the amount

exceeding Rs.200,000

Agricultural income is greater than Rs.300,000 Rs.22,500 plus 15% of the amount

exceeding Rs.300,000

In NWFP, the acreage-based structure does not allow for any exemption level, as

seen in the schedule below:

Slab of land ( 1 irrigated acre = 2 unirrigated acres,

excluding orchards)

Rate per acre

Less than 5 acres Rs.50

5 to 12.5 acres Rs.72

Greater than 12.5 acres Rs.100

Orchards (any acreage) Rs.300

Under the income valuation method, each owner of land is obliged to file a tax

return, and is subject to the rates shown below. Theoretically, if the assessed tax under

this method is less than that calculated by the acreage schedule, then the liability is to be

determined by the second method (see schedule below). The BOR view (based on

interviews in June 2007) in NWFP is that the patwaris and their supervising Tehsildars do

not have the capacity to assess AIT using the income method. Moreover, the land owners

do not typically file an income tax return which reduces the ability to track tax liability.

Income bracket Rate

Agricultural income is less than Rs.80,000 Exempt

Agricultural income is less than Rs.100,000 5%

Agricultural income is between Rs.100,000 and

200,000

Rs.5000 plus 7.5% of the amount

exceeding Rs.100,000

Agricultural income is between Rs.200,000 and

300,000

Rs.12500 plus 10% of the amount

exceeding Rs.200,000

Agricultural income is greater than Rs.300,000 Rs.22,500 plus 15% of the amount

exceeding Rs.300,000

Pakistan: Provincial Government Taxation 133

In practice, the acreage method is used in both provinces.

General Administration

To the extent they exist, records on land holding and crops are maintained in

duplicate; one copy is with the patwari and the second is kept at the district office. The

patwari is in charge of all of the land records at the local level. The district collector is a

registrar for the district as well as a tax collector, but in effect most of the record keeping

functions are carried out by the patwari. The hierarchy of Kanungo, Tehsildar and

District Collector perform supervisory roles.

Records. The AIT piggybacks off of the land transfer taxes in the sense that the

information recorded for each parcel is used for both taxes. The information includes the

total land area, owner, tenant if any, type of land, and any encumbrances. Lands are

inspected every six months and the status of occupancy and crops is updated (although

the rigor of the crop inspection is suspect, as noted above) and by Khan (2004). There is

discussion of computerizing this information in both provinces.

Titling. The system is 400 years old. The Patwari maintains records on title and

ownership. Bank loans require copies of the records, and any mortgage is reflected in the

records. The registers are often hand-carried by the Patwari (tied in cloth) for field visits,

following an age old tradition. The titling and tenure records are very important to the

AIT, whether a land-based or income-based tax is levied, since that information is needed

to identify the taxpayer. Clearly there is need to modernize the mode of record keeping.

Collection. The patwari has responsibility for collections. He prepares the

demand notice on the basis of his records and bi-annual crop inspections. A demand note

134 International Studies Program Working Paper Series

is presented to the taxpayer by the patwari. Collection is in cash and deposits are made

into the government account. The patwari receives no incentives for higher levels of

collections.

Penalties. In all cases, there are penalties for nonpayment, including seizure of

land. The enforcement mechanism provided in the Land Revenue Act 1967 is the basic

legal mechanism which is invoked for collection of nearly all taxes and government dues

in arrears. It is formally referred to as ‘arrears of land revenue’. Once there is a

declaration of the amount as ‘arrears of land revenue’ the provisions of sections 80 to 89

of the act follow eight stages for collection including:

a. Notice

b. Attachment of personal property

c. Detention of the defaulter, which may continue till the time payment in

full or in part has been received

d. Attachment of real property and appointment of a receiver. The receiver

then collects the arrears and deposits them with the government

e. Attachment of real property

f. Seizure of property and sale for recovery of the arrears

In Punjab, the penalty for non-payment of tax is assessed at a rate of 5 percent per

year of the unpaid amount (not to exceed 50 percent of the total unpaid amount). There is

little evidence that land seizures or other of the penalties for non-compliance are carried

out in either province.

Pakistan: Provincial Government Taxation 135

Issues and Problems

The effective rate of agricultural income taxation is very low. The AIT provides

very little support to the provincial budgets despite the fact that agriculture is one of the

largest sectors in the provincial economy.

The revenue potential of the agricultural income tax is much greater than its

current yield. We have made estimates of this revenue gap using census data. The

underlying data used in this analysis (baseline data of the area cultivated, by farm size)

are presented in Table 39. An estimate of the potential AIT revenue, under the current

land based tax structures for NWFP and Punjab, is presented in Table 40. In Punjab, we

estimate the potential revenue under current law to be Rs 2.9 billion or more than 4 times

the actual collections in 2000. For NWFP, we estimate potential collections under

current law of Rs 249 million, or 10 times the current level of collections. Malik (2004)

got much the same result for NWFP in an earlier study. While these estimates are rough,

they do suggest that the orders of magnitude of evasion, compliance, and administrative

problems are very large.

The major reasons for these revenue shortfalls are because the tax base has been

significantly eroded by exemptions in the case of Punjab and because the tax is not well

administered in either province. The level of exemption in Punjab (12.5 acres)

significantly narrows the tax base. Based on data from the Agriculture Census 2000

(ACO, 2000), approximately 85 percent of all properties are outside the tax base. While

some provincial level officials in Punjab took the position that 12.5 acres of irrigated land

was well above subsistence and there was room for taxation, others said this was not the

case. They also pointed out the political difficulties inherent with increasing this tax.

136 International Studies Program Working Paper Series

We simulate the potential revenue associated with reducing the exemption in

Punjab from 12.5 acres to 5 acres. This would yield potential AIT revenue of Rs 4 billion

(See Table 41) but would tax some farmers with incomes less than Rs 80,000.

If the

relative compliance rate and administration costs were similar for large and small farms

before and after this change, this would increase actual AIT revenue in 2005-06 from an

estimated Rs 658 million to nearly Rs 910 million in Punjab.

Another problem with the present structure is that it makes no allowance for the

fact that some crops are more lucrative than others. For example, sugar cane yields

15,000 net rupees per acre, while many other crops net 8,000-9,000 rupees per acre

(Agricultural Policy Institute, 2004).

This results in an unfairness in the tax system.

The system of administration, while well documented in law, is not enforced.

Observers point out that neither the revenue officials nor the taxpayers are adequately

familiar with the legal requirements and details. The required information and records are

not maintained so that holdings and crop values are not updated. While there is

information available to estimate crop value, gross income is typically determined on an

ad hoc basis.

Is the Agricultural Sector Undertaxed?

Some would argue that there is a broader question of whether the agricultural

sector is “undertaxed” in Pakistan. This concern might be put forward in its most simple

form: while agriculture’s share of national income is 23 percent (20.6 in 2006-07), the

Including those farmers growing low yield crops such as wheat.

It is our understanding that the sugarcane crop yields cover one year while the other crop yields cover

less than a full year.

Pakistan: Provincial Government Taxation 137

sector “pays” a very small percentage of tax revenue. There has been a debate about

whether these statistics are suggestive of an “undertaxation”. Chaudhry (1999) refutes

the underpayment argument and points out that there are implicit taxes on agriculture

such as those associated with price controls for many farm products. These controls keep

agricultural prices (and revenues) artificially low relative to the world price. Khan (1999)

points out, correctly, that the incidence of all taxes—implicit or explicit—is on

individuals and the focus should be the incidence of the tax on consumers, labor, or

capital and not on sectors. By this argument, the concept of the “tax burden of the

agricultural sector” does not have a great deal of meaning.

Clearly, there is merit to the argument that implicit taxes have resulted in higher

effective tax rates on agriculture relative to statutory rates, and relative to effective tax

rates on some other sectors in the developing world. These “taxes” come via

macroeconomic policies as well as explicit taxes on the agricultural sector. Many

countries protect their industrial sector—artificially raising prices of certain agricultural

inputs, while controlling output prices for the agricultural sector (often below world

market prices). In addition, in many countries, protectionism has led to increases in the

exchange rate which in turn reduced the competitiveness (and net returns) from

agricultural exports. Chaudhry and Kayani (1991) calculated the implicit taxes on

agriculture in Pakistan between 1970 and 1990 and found effective rates as high as 75

percent, with wide variation among crops and years. Rajaraman (2000) discusses the

impact of the same set of macroeconomic factors and taxes on the agricultural sector in

India.

138 International Studies Program Working Paper Series

The World Bank (2007) argues that the net taxation of agriculture has fallen

dramatically in most countries during the last twenty years. The estimates take account

of both implicit and explicit taxes. Can we assume that Pakistan has followed this same

pattern? We have not analyzed all of the explicit and implicit taxes on agriculture in

Pakistan. However, the absence of export taxes and declining customs duties suggest that

the effective tax rate on agriculture in Pakistan has followed the worldwide trend of

decline. A full analysis of macroeconomic policies and federal and local tax policies

toward agriculture would be needed to make a good estimate of the total tax burden on

agriculture. Anderson (forthcoming, reported in World Bank 2007) finds that in

Pakistan, the effective level of taxation of agriculture declined from approximately 18

percent to less than 5 percent (see Box 10). Implicit taxes on agriculture still exist in

Pakistan, but there is evidence that they are much smaller now than in previous years.

We might shift the question from whether we have the “right” level of burden on

the agricultural sector, to whether there is a case for increasing the level of taxes raised

from agricultural income. From a horizontal equity perspective, there seems to be some

justification for a higher level of agricultural income tax. Agricultural income is exempt

from income tax, so non-farming households at any given income level face a higher tax

burden on their labor income than do agricultural households. While there are certainly

inequities in other parts of the tax system, this one can be particularly egregious because

the federal income tax generates a substantial portion of revenue for the central

government and because there are large numbers of individuals employed in the

agricultural sector. In 2005-06, 44.4 percent of employed people in Punjab were engaged

in “agriculture, forestry, hunting, and fishing” and 44.3 percent in NWFP were in this

Pakistan: Provincial Government Taxation 139

sector (Pakistan Statistical Yearbook, 2007). While these figures include those in

forestry, hunting and fishing, these are upper-bound estimates of the relative size of the

agriculture labor force. Additionally, these figures do not account for the level of relative

productivity among the sectors.

Box 10. Changes in Protection and Taxation of Agriculture Sector

1980-84 to 2000-24

Anderson (forthcoming, reported in World Bank 2007) reports that in three groupings of countries

(agriculture-based, transforming, and urbanized) macro and public finance policies reduced the effective

rate of taxation on agriculture in 24 out of 28 countries. In his analysis, higher explicit and implicit taxes

yield a negative “nominal rate of assistance”, where subsidies or protection of the sector yields a positive

nominal rate of assistance. Most urbanized countries now provide a positive rate of assistance while the

rate of assistance in most transforming countries is negative:

Transforming Country Estimate of nominal rate of

assistance 1980-84

Estimate of nominal rate of

assistance 2000-04

Indonesia +10 to 15 +35

India +0 to 5 +15

Thailand - 5 to - 1 +5 to + 10

Malaysia -10 to -5 +3 to +5

China -50 +1

Pakistan -18 to -15 -5 to -2

Sri Lanka -10 to -8 -7 to -3

Egypt -20 to -15 -15 to -10

Senegal -30 -18 to -15

Zimbabwe -45 -70 or less

Source: Estimates based on information presented in World Bank, 2007 and Anderson (forthcoming as

reported in World Bank, 2007)

Secondly, because agriculture is such a large part of Pakistan’s economy, not

taxing agricultural income means that effective tax rates on other sectors of the economy

must be higher (or public service levels must be lower). This is bound to decrease the

economic efficiency of the tax system as taxpayers in these other sectors seek ways to

avoid or evade those taxes. Third, the agriculture income tax may be justified, at least

partially, on the principle that government infrastructure provides benefits to the

agricultural sector. The agricultural sector also benefits from low interest loans and

140 International Studies Program Working Paper Series

public expenditures on research and development. Though we have not done a cost-

benefit analysis, it might be argued that this flow of benefits constitutes a justification for

increasing the agricultural income tax.

All of this said, there is still the question of price controls (both for inputs as well

as final outputs of the agricultural sector). This complicates the discussion of raising the

revenue take from the agricultural income tax. Raising taxes without releasing these

price controls could effectively reduce the level of taxpayer profits. There would be no

possibility to shift the tax increase to consumers, as there might be if demand for the

output was relatively inelastic. Farmers could reduce output (or quality) as a result of the

tax increase. Federal government reactions to a provincial tax increase (eliminating

output price controls or increasing subsidies for inputs) are impossible to forecast. In the

short-run, it is very possible that the incidence of any tax increase on the agricultural

sector would fall on the farmers and on farm owners.

Reform Options

In both provinces, the BOR officials discussed the need for the agricultural

income tax to become a larger contributor to the budget. Officials also discussed the

need (theoretically at least) for the tax to become an income-based levy. These reform

ideas are not new, and they are controversial. A number of previous studies have

analyzed the agricultural income tax in Pakistan. Chaudhry (1999) notes that between

1959 and 1993, nine commissions were formed to study the AIT and only two

recommended an income based agricultural tax. Khan (1999) notes that the studies of the

Ahmed and Stern (1991) also discuss whether agriculture should be taxed differentially relative to other

sectors of the economy.

Pakistan: Provincial Government Taxation 141

1960s and 1970s recommended against an AIT because of other implicit and explicit

taxes that existed during that time. Other studies have pointed out that although the

majority of farmers are subsistence farmers, some make large incomes (Coopers and

Lybrand, 1989, NTRC, 1986).

Malik (2004) concludes his study of NWFP with the

view that there is substantially greater revenue potential in the tax.

Structural and Administrative Changes. There are a number of options for

reforming the agricultural income tax. Administrative reforms should come first. The

major reform risk is that no option will yield substantial increases in revenue if the

administration of the system is not enhanced. The Punjab Resource Management

Program (Government of Punjab, 2007f) outlines changes in administration that might

increase compliance with whatever AIT system is considered. Some of these changes are

quite dramatic relative to the current practice and include additional checks and balances

in the system. The Punjab Report discusses pros and cons of these alternatives. In

addition, the report presents a major restructuring of the BOR and Excise Tax

Departments under one Provincial Revenue Authority. These administration reform

options include the following:

• Creating a withholding system for the AIT, where tax is withheld on the

purchase of agricultural inputs, with an exemption limit for small

farmers,

• Creating a withholding system on the sale of cash crop outputs,

The agricultural income tax in India is also a state levy, but it is used in only six states (Rajaraman,

2000). Sundharam and Andley (2003) discuss the need for an agricultural income tax levied on

presumptive income in India. The Indian Taxation Inquiry Commission recommended an income-based

agricultural tax that would eventually be merged into the general income tax system. These

recommendations have not been accepted in India (Sundharam and Andley, 2003).

An observer points out that this may be most useful in the case of government procurements and that

universal application could lead to additional leakages in the system.

142 International Studies Program Working Paper Series

• Expansion of the self assessment scheme,

• Expand the information kept in the base records (Khasra Girdawari) to

include the Produce Index Unit System (estimates of costs of inputs and

gross receipts by crops) into the records.

If these types of administrative reforms are brought on line, some structural

changes could go forward. One major change is that the provinces could retain the basic

approach of taxing the farm size, but this could be augmented with a presumptive

assessment based on crop type and expected net income. Eventually, self-assessment

must be considered as part of this process. But, until the administration is upgraded, we

do not think that self assessment would reduce the inequities in the system or increase tax

revenues.

A reform program for the agricultural income tax might begin by considering two

types of options --- land-based presumptive options or income based presumptive

options.

Land-based Presumptive Reforms:

• Reduce the exemption level in Punjab. The exemption of 85 percent of all

land would seem an unreasonable level. An alternative would be to have

no exemption and to charge a nominal (flat) amount for small farms. This

would raise administrative and compliance costs but would expand the tax

base to cover the entire sector. As shown above, this would increase

revenue in Punjab by 38 percent.

Another alternative is to tax rental income. It has been reported in various interviews that many of the

farms are actually worked by sharecroppers—individuals and families who rent the land. Rental values

should reflect the potential value of agricultural output of the land, so taxing rents would be similar to a

presumptive income tax. Non-rented plots could be taxed presumptively by using established rental values.

However, there is little evidence that information on rental values and tenants is readily available. Since

there is a mechanism to measure crop output and values (as flawed as it might be), it may be

administratively easier to estimate potential value of output. Also, the tax might be integrated with the

general income tax. However, given the constitutional issue related to the taxation of agricultural income,

it might be difficult to treat agricultural income like other forms of income for tax purposes.

Pakistan: Provincial Government Taxation 143

• Second, the tax rates could be increased. The new rates could be set

according to revenue targets, or to redress sectoral imbalances, or to gain

parity with taxpayers in other sectors of the provincial economy or among

those with similar levels of income.

• Third, a more progressive rate schedule could be developed.

These options have some advantage over the income-based option because of

their simplicity. However, they may perpetuate a presumptive system and prevent the

AIT from growing into a “true” income-based tax in the long-run.

Income-based Presumptive Reforms:

• Define a presumptive net income amount by farm, based on farm size and

crop type. The rates could be flat or variable. A subsistence level of

income could be exempt from tax, similar to the personal income tax

exemption of 100,000 rupees.

This option has the benefit of keeping the

AIT a direct tax on income.

We estimate the impact of such reform options on total revenue, assuming that

full collection takes place. In other words, these should be considered potential revenues

from these reform alternatives. In most cases, our base data are from the 2000

Agricultural Census, Pakistan. We do not attempt to update the size distribution of farms

from the 2000 Census.

We simulate a variety of land-based rate structures. Different crops yield very

different levels of net income for farmers. So, it might be considered more equitable to

impose the land-based taxes at a differential rate based on crop. The overall progressivity

of the tax could also be enhanced by adjusting the slab rates—by crop and acreage or

simply by acreage.

The actual level of income tax exemption is currently Rs 150,000 as of 2007. This represents a steep

increase in the threshold which may not be sustainable. For purposes of the reform options analyzed here,

we use the previous income tax threshold of Rs 100,000 as a benchmark, Thrisk (forthcoming).

144 International Studies Program Working Paper Series

The Agriculture and Policy Institute Center (2004, 2007)

estimate the profit/loss

per acre for major crops in Pakistan. Based on their data for Punjab for 2002-03,

sugarcane is the most lucrative crop (yielding 7,503 rupees per acre including cost of land

rent), while wheat profitability is actually negative (542 per acre) if land rent is included.

The estimates for Sindh are larger, and Malik (2004) uses the values from Sindh as

proxies for NWFP in estimating potential income from agriculture. After sugarcane, rice

and cotton are the most lucrative crops. More scenarios could be considered (for

example, a progressive rate structure depending on crop type or more distinction among

crops

), but adding too much complication to the system could result in a further

deterioration of tax compliance. We consider three specific reform programs.

Two land-based reform scenarios that might be considered are as follows:

Option a. Progressive rate structure (independent of crop): 7.5 acre

exemption for irrigated or unirrigated land; 7.5 to 25 acres taxed

at 100 rupee per acre, 25 to 50 acres at 150 rupees per acre, 50 to

150 acres at 200 rupees per acre, and Rs 300 per acre for farms

greater than 150 acres.

Unirrigated land would be taxed at half

the rate of irrigated land and orchards would be taxed at 300 rupees

per acre. Our simulations by farm size give a result of an 11

percent revenue increase in NWFP and a 21 percent increase in

Punjab.

Option b. Flat rate structure by crop type: 7.5 acre exemption for all farms

(except orchards); wheat taxed at 100 rupees per acre, cotton taxed

at 200 rupees per acre, rice taxed at 300 rupees per acre, and

sugarcane taxed at 350 rupees per acre. These amounts were

chosen based on the relative level of profitability of these crops.

Unirrigated land taxed at 150 rupees per acre regardless of the

Formerly the Agriculture Price Commission.

Gurmani et al (2006) document differences in profitability among grains, for example.

While the exemption level chosen is largely illustrative, it corresponds to an income exemption of Rs

80,000 for crops yielding Rs 10,000 rupees or more per acre. This would be on the high end of

productivity for typical crops according to the Agriculture and Policy Institute. The 7.5 acre cut off is used

since it corresponds to readily available data on crop size that is produced by the Census of Agriculture.

Pakistan: Provincial Government Taxation 145

crop.

100

Orchards would be taxed at 300 per acre. Our simulations

show that revenues would increase by 27 percent in NWFP and 37

percent in Punjab.

An income-based reform scenario might be considered:

Option c. Tax presumptive net income based on crop yield and profitability,

with exemption of 100,000 rupees and progressive rates from 5 to

15 percent. Our simulations show that revenues would increase by

20 percent in NWFP and 10 percent in Punjab.

Using data from the Agricultural Census, Board of Revenue, and Agriculture and

Crop Reporting Center, we can estimate the revenue impact of these proposals. Relative

to current law, Option a) increases revenue by 11 percent in NWFP and by 21 percent in

Punjab. The resulting distribution of tax burden is more progressive than the present

system under this reform scenario. Option b imposes a tax structure based on farm size,

but adjusted for crop type. Adjusting the land-based rates by type of crop is admittedly a

more complicated way to go. However, this type of reform brings the AIT closer to a tax

on potential income than the tax structures based on land alone. We estimate this

approach considering four crop types: wheat, cotton, rice, and sugarcane. For these

purposes, we collapse other grains and fruits and vegetables into the wheat category.

These categories can easily be changed. The revenue impact for NWFP is an increase in

AIT of 27 percent and the increase in Punjab is 37 percent under this structure.

Finally, we estimate the revenue potential of a tax based on potential income

(Option c), where income is estimated based on the average profit/loss including land rent

per crop, per acre. To simplify the analysis (similar to that done by Malik, 2004), we

estimate the potential revenue assuming an average net profit per acre of Rs 4,000 (lower

100

We do not have detail on the profitability of farms by crop type for unirrigated plots so those estimates

are not included in this analysis.

146 International Studies Program Working Paper Series

bound of all crops) and Rs 8,000 per acre (an upper bound estimate of the average crop

yield). With a threshold of 100,000 rupees for tax purposes, on average, only farms of 25

acres or more would be taxable. The revenue analysis suggests that this structure could

yield 280 million rupees in NWFP (a 20 percent increase) and approximately 2.9 billion

in Punjab (a 10 percent increase), assuming that such a tax could be administered. The

smaller increase in Punjab is due to the relatively large number of farmers that would be

exempted due to the Rs 100,000 threshold.

Sales Tax on Services

The Constitution of Pakistan reserves certain tax bases for the federal

government. All other (residual) tax bases can be claimed by provincial governments.

The Constitution provides for federal taxation in the case of “taxes on the sales and

purchases of goods imported, exported, produced, manufactured or consumed”. This

leaves open the possibility for provincial governments to levy a sales tax on services. All

four provincial governments tax some services.

Tax Base and Rate

In theory, the constitution is permissive in allowing each province to define its

own sales tax base i.e., to determine which services it will tax. In practice, the laws for

each province were written by the federal government and were adopted (as ordinances)

by the four provinces. These ordinances include a more or less uniform list of services to

be taxed. The base is the gross amount of sales, and the tax rate is set by the federal

Pakistan: Provincial Government Taxation 147

government at the national rate of 15 percent. Service providers are entitled to claim

input tax credit for the tax paid on taxable purchases, inputs and utilities.

Tax Administration

Tax assessment and collection is the responsibility of the sales tax collectorate of

the federal government. A collection fee of 2 percent is retained.

Revenue Performance

The revenue performance is described in Table 42. The sales tax on services

yields 9.15 percent of own revenues in NWFP and 7.52 percent in Punjab, which makes it

a considerably more important revenue source than the property tax, but a considerably

less important source than either taxes on property transfers or motor vehicle taxes. Still,

revenues amount to only about 0.05 percent of GDP.

The composition of sales tax revenues is described in Table 43. The pattern

shown is one where 98 percent of total national collections is made in Punjab and Sindh.

Note that revenue collections are concentrated on four services: hotels and restaurants,

travel and shipping agents, advertisements and courier services.

Problems and Issues

There are four issues to be addressed in evaluating the sales tax on services as a

provincial government revenue source: (a) whether it has a significant revenue potential

for provinces, (b) administrative concerns, (c) the matter of encroachment on this tax

base by the federal government, and (d) economic disincentives.

148 International Studies Program Working Paper Series

Revenue Potential. In theory, the sales tax on services could be a lucrative

revenue source for provincial governments. The base of the tax is potentially large. We

can note from the national accounts in Punjab that 10 percent of provincial GDP is

classified as “other services”. This sector is defined in the provincial accounts to exclude

transport, storage and communications. If this rough estimate of the broad version of the

base for the sales tax on services is indicative, we can say that the effective tax rate at

present is well less than one percent.

However, there are some significant challenges in taxing this base and ratcheting

up revenues. First, the provincial government would need to be willing to expand its

presently taxed base to include additional services. As noted above for other provincial

taxes, a combination of the growing NFC awards and political opposition to provincial

tax increases lead to a situation where there is little incentive for the political leadership

to increase tax effort. Second, the service sector is notoriously hard to tax because it is

composed of many small firms that are difficult to identify and their recordkeeping often

is problematic. Third, there is a “headquarters” problem, i.e., the tax may be paid at the

headquarter location rather than at the point of consumption. Note, for example, that

Punjab accounts for 57.2 percent of Pakistan’s GDP but only 40 percent of total

provincial sales tax collections on services. Sindh, where many headquarters are located,

accounts for 29.8 percent of national GDP but 58 percent of provincial collections of the

sales tax on services.

101

Tax Administration. Administration may pose a constraint to a more revenue

productive sales tax. On the one hand, the federal sales tax administration may be neutral

101

Sindh GDP is estimated based on Provincial Finance Department statistics.

Pakistan: Provincial Government Taxation 149

in its collection of the provincial tax on services vs. collection of a national sales tax. On

the other, why should the central government aggressively pursue collections against a

broader services base, when 98 percent of the revenues accrue to the provincial

governments? The deeper the province decides to go into the services base, the harder to

assess will be the base, and the more costly to the central government will be the

administrative effort required. In, fact, the government of Punjab proposed an expansion

of the tax base to include marriage halls and beauty parlors, but according to provincial

officials, the central government sales tax administration department was unwilling to

collect from these sectors. Administrative complication was cited as the reason. Punjab

province also has proposed an expansion of the base to 44 additional categories of service

but no action has yet been taken.

This highlights a significant problem. The split between administrative

responsibility and rate/base determination is not likely to work effectively unless there is

significant revenue sharing. The levying government (province) will accept the political

risk only if the revenue rewards are great enough, and the collecting government (federal)

will not allocate the resources necessary to administer the tax properly if the revenue

benefits do not justify taking on the additional costs. While the correct split of revenues

to accomplish the goal of “adequate” revenues for the province and the federal

governments has not been worked out, it seems clear that the present 98 percent/2 percent

division is not the answer.

There is another dimension to the administration problem. The provinces

complain, rightly, that they do not receive regular reports from the federal sales tax

administration department concerning the details of collections. If the provincial

150 International Studies Program Working Paper Series

governments are to be expected to move forward with base expansion, and to use their

comparative advantage of “familiarity” to identify new firms for inclusion in the net,

there must be full sharing of information about tax assessment and collection. However,

it is not clear whether the underlying problem is that the central government is unwilling

to supply this information, or whether their statistical data base is so weak that the data

are not available.

Encroachment. Third, there is the issue of “encroachment”. The Constitution

does not reserve the right to tax services for the federal government. Presumably this

leaves the provinces free to levy a sales tax on services. In fact, however, the federal

government also levies a sales tax on services, in the form of excise taxes. While the

federal government sees this as a matter of national interest, the provincial governments

see it as encroachment. The ten services now taxed by the federal government as excises

are listed in Table 44. The total yield on these is Rs 28.2 billion vs. Rs 4.2 billion in

collections under the provincial ordinances.

102

Most of the federal revenue (95 percent)

is collected from telecommunications services. Paradoxically, the provinces would be

better off in revenue terms if the sales tax on services was a federal tax with revenues

included in the NFC sharing pool.

Economic Incentives.

Finally, there is a question about whether a 15 percent tax

on services would damage the economy and perhaps force some firms out of the market.

For example, some hotels and places of entertainment might see the tax as significantly

cutting into their profit margin. Another outcome is that consumers might find their

consumption of services more expensive, to the extent the tax can be shifted to them.

102

The Rs 28.2 billion refers only to collections made in “the VAT mode”, i.e., under the value added tax

administration.

Pakistan: Provincial Government Taxation 151

These are possible, even probable outcomes according to some observers. Should this

cause a rethinking of the proposals to extend the sales tax on services?

The answer here is that it should not. Services should be taxed, just as other

consumption is taxed. Why should the sales tax treat the purchase of clothing or an

appliance any differently than an expenditure on a restaurant meal or a visit to a beauty

parlor? Services have enjoyed a preferential tax treatment in Pakistan for many years,

and the proposal here is to remove that preference. While some service sector activities

will be negatively impacted, and there might be an employment effect, the more level

playing field would allow producers of goods to expand their output as consumer choices

shift.

Reform Options

The most obvious reform option is for the provincial government to selectively

expand its base by bringing more services into tax. This expansion should begin by

including those services that could most easily be reached under current administrative

practice.

103

This proposal would need to be accompanied by an incentive package that

would stimulate an increase in revenue effort on the part of the provinces i.e., to reward

provincial governments for taking this politically unpopular step. (We further discuss the

incentive issue below). It is likely that if the incentive strategy was successful, this

option would lead to disproportionately heavy revenue collection in Punjab and Sindh

where the service sector is more developed.

103

Malik (2004, p46) carried out such an analysis for NWFP and identified 25 services for inclusion in the

sales tax base. Pasha (1995), in an earlier study, carried out a similar exercise for all provinces.

152 International Studies Program Working Paper Series

There is no easy way to identify the “best” candidates for inclusion in the tax base

for the sales tax on services. One might imagine the following steps.

1. Charge the federal government with the responsibility for compiling a

comprehensive list of services, perhaps by reference to the categories

listed in the standard industrial classification.

2. Charge the provinces with responsibility for identifying those services to

be brought into tax and assisting the federal sales tax department in

building the tax roll. Provinces might start this process by determining

whether a useful establishment survey exists or could be carried out.

Other files that can be useful in identifying firms for inclusion in the sales

tax are UIPT records, electricity duty payments, and professional

registries. An issue to be resolved is whether all provinces would need to

tax the same set of services. Under a provincial administration, each

province would be able to choose its own base from among the list of

eligible services. Under a federal administration, there might be more

pressure for uniformity.

3. Each province should work with the federal sales tax administration to

identify a size threshold for inclusion in the services tax net, and then

estimate revenue yield.

4. The federal sales tax department in each province should develop

comprehensive reports on assessment and collection detail, and

delinquency lists. These reports should be shared with the provincial

governments.

5. It is likely that new provincial ordinances will be required.

An important consideration that underlies all of the reform options proposed here

is that the tax base will become more complicated as additional services are added. As

noted above, there is question about the willingness of the central government to expand

its administrative efforts so as to reach those smaller firms and self-employed individuals

who provide services. This problem might be erased in either of two ways. The first is to

transfer administrative responsibility for the services tax to the provincial government. If

this were done, the provinces would need to gain expertise in sales tax administration, a

Pakistan: Provincial Government Taxation 153

comparative advantage which the central government now has. In the long run,

provincial administration of provincial taxes could be the right direction for reform in a

federal country such as Pakistan. (See Box 11). It would however, be difficult to protect

revenues during what might be a long transition period. If provincial governments were

not up to the task of efficiently collecting the tax on (services and many analysts share

this concern), the reform would bring little revenue gain. Moreover, it should be

considered that a federal sales tax administration avoids duplication of efforts between

the two levels of government, and likely is a lower cost administrative option.

The other solution is to hold to the federal administration but to give a collection

incentive to the federal government by converting the sales tax on services to some form

of shared tax. (An example of how this might be done is discussed below). If federal

revenue retention from collections was high enough, a more aggressive administrative

effort might be drawn out. It is doubtful that a 2 percent collection fee is the answer.

The issue of federal encroachment on the provincial sales tax base is also difficult.

In fact, “encroachment” is a pejorative that may not properly describe the issue. The two

levels of government are in competition for the same revenue base. The provincial level

feels that it has a constitutional right to the tax base, and would like to have the federal

government give it an exclusive on taxing services. The federal government sees its right

to tax services when in the national interest, and when the headquarters problem makes

provincial taxation infeasible. The middle ground is a shared tax, where each side has a

claim on this tax base.

154 International Studies Program Working Paper Series

Box 11. Who should Administer the Sales Tax on Services?

Provincial governments have some comparative advantage in administering the sales tax on services.

The identification of liable tax payers, and the maintenance of the tax roll are comparative advantages of

the province because of its greater familiarity with the local economy. Since the sales tax on services is

a provincial revenue source, there should be more incentive to assess and collect the tax than is the case

under the present centrally administered system. Finally, there might be some significant advantage to a

coordinated collection of the sales tax on services, the professions tax and the urban property tax.

A centrally administered system also has some advantages. Staff is familiar with sales tax

assessment, and with audit. Collection also may be a comparative advantage of the central government

because the provincial government would find it difficult to enforce the tax where powerful local

interests are involved.

In the long run, given the objectives of a fiscal federalism, the best options are either (a) to move the

administration of provincial taxes to the provincial government, on a “readiness” basis, or (b) to have

provincial rate setting under a shared sales tax on services.

Revenue sharing does not resolve the interprovincial competition issue that

surrounds the headquarters problem. There is no one best resolution to the headquarters

problem. Countries have tried various approaches. One step that might be taken is to

allocate all final sales for a company across provinces. If this can be done, the proration

can be used to deal with the headquarters problem. However, this is administratively

difficult, involves a good deal of subjectivity in establishing an allocation formula, and

increases the compliance costs on companies. This approach is used, for example, in the

allocation of the state government corporate income tax base across states in the US.

Second, each company could be asked to report its taxable sales by province, but this

could significantly increase compliance costs and administrative costs. Third, those

components of the service tax base where the headquarters problem is particularly

serious, could be assigned to the federal tax base, and a revenue sharing scheme could be

worked out. A fourth approach is to introduce a tax effort component into the NFC

award, but to eliminate “headquarters taxes” from the tax effort computation. In this

case, the federal government would be responsible for identifying “headquarters taxes”,

Pakistan: Provincial Government Taxation 155

i.e., provincial taxes whose burdens are largely exported. None of these proposals could

be implemented without a great deal of arbitrariness.

Depending on the goals that the federal and provincial governments have set for

the sales tax on services, consideration might be given to three reform options.

Option 1: One course of action is to fold the sales tax on services into the federal value

added tax (i.e., eliminate the excise tax approach). Since federal collections on goods

are part of the NFC revenue sharing pool, then over 40 percent of sales tax collections on

services would accrue to the provinces.

104

By comparison with the present system, the

province would do better in terms of revenues. Why not leave it at that? There are several

reasons. One is that the service sector may remain untaxed while goods are taxed at 15

percent under the VAT. This would continue the unwanted distortion in the national

sales tax system.

105

A second drawback with this option is that continuing with the present system

does not address the disconnect between who administers the tax and who gets the

revenue, hence the absence of an incentive for aggressive administration will remain in

place. A more focused collection effort, as a provincial sales tax on services might give,

could lead to an increased revenue take on the service sector. Finally, this system does

not allow a province to easily ratchet up collections if it should choose to do so. Revenue

growth will likely be modest under this option.

104

The GST on goods is collected by the federal government. After deducting a collection fee (5 percent),

one-sixth of the revenues from the pool for the pass-through grant to local governments. The inter-

provincial distribution of this pool is on the basis of octroi collections in 1998-1999. The remaining five-

sixths of the revenue becomes part of the general divisible pool and is distributed between the federal

government and the provinces (vertical sharing) and among the provinces horizontally according to the

NFC formula.

105

VAT administrations in most low income countries concentrate efforts on the import and manufacturing

stages, and are less successful in taxing services.

156 International Studies Program Working Paper Series

Option 2: The ten services that are presently taxed by the federal government

could be transferred to the provinces. This would increase provincial revenues from the

service tax by a factor of more than seven.

106

(Another version of this option would be

to limit the transfer to those services that are not collected in the VAT mode, (but the

revenue take would be small in that case). This transfer of base could establish the sales

tax on services as a provincial tax. Sales tax administration would also be transferred to

the provinces, The next step would be for the provinces to begin expanding their tax base

selectively by bringing the easier to reach services into tax.

The disadvantage to this approach is that the “easier to tax” services with a broad

base are likely to come away with a much heavier tax burden than other services. This

would continue a pattern of taxing those sectors where administration is manageable,

while allowing the tax burden on the hard-to-tax services to remain low. There is also the

problem of the difficulty that provinces would have in administering this tax. The proper

accounting for cross-province sales of inputs would be particularly difficult for the

province tax authorities given their limited experience with the sales tax. Finally, there is

the shortcoming that the federal government would almost certainly resist surrendering

this taxing power.

The revenue yield from this option depends not only on how quickly the

provinces learn sales tax administration, but on which services are brought into the tax

net. This involves a detailed analysis, service by service, of the potential taxable base.

Short this preparatory work, we can only suggest revenue targets that might be feasible.

But even these kinds of calculations are convincing of the very significant revenue

106

We do not have data to break out the division of this revenue by province, but estimate that the

variations are quite wide.

Pakistan: Provincial Government Taxation 157

potential. For example, at present, the GST on services in Punjab is equivalent to about

0.05 percent of GDP originating in the “other services” sector. If the goal is to double

this effective rate (to only 0.1 percent of provincial GDP in this sector), the increase in

revenue would be Rs 2.2 billion in Punjab. If we assume that the GDP share of “other

services” is the same in NWFP as in Punjab, doubling of the present tax effort on services

would yield an additional Rs 420 million in revenue. This kind of revenue potential

would seem high enough that each province would want to undertake an effort to identify

those services that could be brought into the base. Reformers would do well to

remember, however, that gaining access to the service tax base is only part of the

challenge. The provincial governments would then have to develop the wherewithal to

assess and collect the sales tax on services.

Option 3: A third reform option is to convert the sales tax on services to a

shared tax with the federal level. The federal and provincial governments would tax the

same services, with assessment and collection carried out by the federal government.

There would be a separate federal and provincial government tax rate (not to exceed 15

percent). The services to be taxed would have to be the same under such a regime, and

the federal rate would be the same in all provinces. The provincial tax rate could vary

according to the decision of the provincial government. This autonomy in provincial rate

setting would preserve an important fiscal decentralization feature, even though it could

introduce some administrative complication. There might be restrictions here, e.g., the

federal rate might be set at 7.5 percent and the provincial rate would be limited to 7.5

percent.

158 International Studies Program Working Paper Series

Because revenues would be shared between the two levels of government, there

would be more incentive for aggressive tax administration by the federal government.

The revenue increase under the shared tax could be (potentially) quite significant. This

approach combines the rate setting discretion of provincial governments with the superior

administration capacity of the federal government.

One disadvantage of this approach (from the point of view of provinces) is a

giving up of the formal (exclusive) claim on this base by provinces. Another

disadvantage is that the headquarters problem would remain. Particularly Sindh could

follow a strategy of taxing services heavily and exporting its tax burden to other

provinces.

Tax Burdens. Would revenue increases from the sales tax on services be feasible

in terms of the burden it would impose on taxpayers in the provinces? To try and answer

this question, we estimate of the distribution of the burden of the sales tax on services

using HIES data on the consumption of personal and professional services by households

at various income levels.

107

In Tables 29 and 30 we compare the distribution of income

across population deciles with the distribution of consumption of personal services. For

example, the top 10 percent of the households in NWFP account for about 44 percent of

all household income, but only about 36 percent of consumption of personal services.

The distribution presented in this table shows that the lower income groups allocate a

greater share of their budgets to services. This suggests that the GST on services is a

mildly regressive tax. A repeat of this analysis for Punjab gives almost exactly the same

result (See Table 30).

107

We assume full forward shifting of the tax to consumers. For a full discussion of the method used, see

Wallace (forthcoming).

Pakistan: Provincial Government Taxation 159

Other Taxes

The revenue performance of all other taxes in the province are reported in Table

45. Both provinces levy more or less the same set of “smaller” taxes. In a few cases, the

tax base calls for some differentiation, e.g., tobacco in NWFP and cotton in Punjab. In

total these smaller taxes add to administrative costs and do not generate significant

revenue. Notwithstanding that these are minor levies, their potential is not being fully

exploited. Even the present narrow revenue bases are only partially captured because of

weak administrative efforts.

Entertainment Tax

The Entertainment tax (duty) is a minor levy on various types of entertainment

events (cinemas, circuses, stage plays, casual entertainment). The tax rates have been

lowered in recent years. Administration is by inspectors, and the management of an

event is responsible for collections. In both provinces, there is a notional determination

of the tax liability. It is set at a fixed percent of the announced admission price, but with

an assumption that only 20 percent of the seating capacity of the theatre will be occupied.

Entertainment duty accounts for less than 0.1 percent of provincial government revenues

in both Punjab and NWFP.

The entertainment duty is beset by a number of problems. The base has been

narrowed by exemptions, so that some entertainment events are not taxable.

108

This

imposes a revenue cost and it introduces some unfairness. Exemptions may be given by

local government officials and so the coverage of the tax may vary greatly from district to

108

Cinemas in cantonment areas are exempt.

160 International Studies Program Working Paper Series

district. Another problem is that the tax rate (65 percent) is high enough to encourage

evasion. This is an especially important problem because of the difficulty of collecting

the tax under present administration arrangements. Collection rates are unknown.

Finally, because cinemas have been closing, this tax is losing its revenue raising capacity.

Many in the ET department in Punjab think it should be eliminated.

Excise Duty

Excise tax revenue is collected mostly from the sale of licenses to produce alcohol

products used for industrial purposes, e.g., denatured alcohol. There also is a duty levied

at a specific rate on the production of all spirits. In total these duties account for a very

small amount of revenue (Table 45).

Cotton and Tobacco levies

There is a levy of 8 paisa per kg on the receipt of cotton at the mill. The tax is

collected directly from the ginning factories in Punjab province. The revenue yield is

very small.

The tobacco development cess is levied as a specific tax on the amount of tobacco

production in NWFP. The tax rate is 2 rupees per kilogram of tobacco. Assessment and

collection are relatively straightforward. The Pakistan Tobacco Board sets an annual

target of production based on their information about the demand for tobacco by the two

major cigarette manufacturing companies. The tax is levied on the target and is easily

administered. Most of the tobacco grown in the Province is purchased by two companies

which simplifies collections.

Pakistan: Provincial Government Taxation 161

The main tobacco manufacturing plants are in Karachi. Tobacco sales have

expanded beyond these two companies, so the department now uses (since 2004) a

private contractor to collect the tax on open market transactions. This has resulted in an

increase in collections. Still, revenue collections are very low.

Hotel Tax

The hotel tax is levied at an ad valorem rate on room rentals. In Punjab, the rate

is 8 percent (except in hill stations, where the rate is 4 percent). In NWFP, the rate is 5

percent. There is provision for self assessment, but in practice the tax liability is assessed

by ETD in both provinces. The assessment formula used is the same. Gross receipts are

estimated as the product of the rate per bed and the number of beds. The tax rate of 5

percent is applied to the estimated revenue base that assumes a 50 percent occupancy.

This notional determination of tax liability frees the ETD from having to monitor the self-

assessed base and keep track of actual occupancy rates.

There are a number of problems with the hotel tax. Some hotels object to the use

of a notional 50 percent occupancy rate for beds versus an actual occupancy calculation.

A case is pending in the court. In NWFP, the hotel tax is not levied in the PATA

districts. Many resorts that operate in these districts, with a large number of beds, are

outside the tax net. Another problem is overlap with the general sales tax on services,

whose revenues also accrue to the provinces. Services provided by hotels are already

listed as a possible base for the sales tax on services.

162 International Studies Program Working Paper Series

Electricity Duty

In 1964 Punjab levied an electricity duty through its Finance Act.

109

The duty is

levied on consumption of electricity. The consumers under various categories are liable

for its payment. All federal, provincial and local government official facilities are

exempt. In addition, places of worship and street lights are exempt. The duty is collected

by the licensee (mostly WAPDA) on behalf of the provincial government when selling

electricity to consumers. The rates vary across classes of consumers. The rates were

revised in June 2007,

110

replacing the rates that had applied since 1980. Under the

Finance Act 2007, the following rates apply:

A In case of energy supplied by a licensee to

consumers of any of the following categories:

Electricity Duty on the amount of the

variable charges or the supply charges

worked out according to electricity

tariff (percent)

1 Domestic; 1.5

2 Commercial; 1.5

3 Industrial undertakings 1

Tube wells for irrigation and agricultural

machinery

Premises where the supply of energy by a

licensee is un-metered

1.5

In case of energy not supplied by a licensee to

consumers of any of the following categories

Electricity duty per unit

1 Domestic 5.5 paisa

2 Industrial undertakings 1.5 paisa

WAPDA collects the tax as part of the electricity bills and pays it to the provincial

government. The provinces have harmonized rates and laws, through consultations in

IPCC. The duty is therefore structured similarly in NWFP and Punjab. Collections from

109

Government of Punjab 1964, Section 13 and Fifth and Sixth Schedules

110

Government of Punjab 2007h`, Section 3

Pakistan: Provincial Government Taxation 163

this duty are a small amount of provincial revenue. In Punjab it was 0.74 percent of total

revenues in 2005-2006. In NWFP electricity duty revenues were 0.68 percent of total

provincial revenues in the same year.

Problems and Reform Options

The “other taxes” levied by the provinces do not generate much revenue. The

sum of hotel tax, entertainment tax, excises, and tobacco and cotton levies and other

agricultural cesses, yielded an amount equivalent to only 1 percent of total revenues in

Punjab and about 1.5 percent in NWFP. The administrative costs of efficiently collecting

these taxes would be high. In the case of entertainment tax and hotel tax, the assessment

is notional and exemptions have compromised fairness.

One reform route is to abolish the hotel tax in favor of including it in the sales tax

on services. This could lead to a revenue gain, even if the smaller hotels are subjected

only to a flat charge. The electricity duty might also be moved to the sales tax on

services. The entertainment tax could be passed down to the local governments, since

they are in a better position to administer the tax efficiently. Khan’s (2004) conclusion

about the entertainment tax in NWFP is that “There is not much potential in this tax,

hence no reason to continue with it”. The excise duties also might be abolished, on

grounds that revenue yield does not justify the administrative effort.

The agricultural cesses and excises should be folded into the agricultural income

tax. This could increase fairness and revenue flow, if the agricultural income tax is

reformed in terms of its assessment. In the case of tobacco in NWFP, another option

might be considered. The tobacco cess could abolished in favor of a surcharge on the

164 International Studies Program Working Paper Series

federal excise duty on tobacco products. The additional revenue could be returned to the

province. This approach could eliminate unnecessary administrative expenditure on

collections of provincial cess.

This reform package would free up administrative resources at the province level,

to be devoted to taxes where the yield potential is greater. The net revenue losses would

be small.

Hydel Profits: NWFP

According to a constitutional provision (article 162 (2)), the provinces are entitled

to the net profits from the generation and sale of electricity at power stations located in

their area, when these stations are owned and operated by federally owned utilities. The

biggest power station in NWFP is located at Tarbela. The dam and its power house were

commissioned in 1974. The construction was financed by the federal government.

Despite the constitutional provision, NWFP did not get the net profits for many years

after the Tarbela facilities went into operation. The matter has been challenged by the

province on a continual basis and remains unresolved even today.

Currently, the province receives a partial payment of its claims against revenues

from electricity sales. Even at this level, the net profits from hydroelectric sales in 2007-

2008 are seven percent of total provincial current revenues and 96 percent of provincial

own source revenue.

In 1991 an initial agreement was reached when the Council of Common Interests

(CCI), a constitutional body for resolution of intergovernmental disputes, ruled that net

profits along with arrears should be paid by WAPDA to NWFP on an annual basis. At

Pakistan: Provincial Government Taxation 165

this stage the CCI also laid out a methodology for calculation of net profits. For the year

1991-1992, the net profits were calculated to be Rs 6 billion Government of NWFP,

2007a). NWFP has been paid an annual amount of Rs 6 billion ever since. This implies

an erosion in real value by more than 60 percent between 1992 and 2005 (World Bank,

2005a). The province disputes this payment as being too low, and in addition it asks for

payment of Rs 596 billion in arrears. According to the Government of NWFP, the

electricity tariff has been increasing ever since this 1991 calculation, but the

determination of profits has been kept constant.

NWFP raised this issue during the 6

NFC discussions. As a result it was decided

between the federal government, the controlling authority of WAPDA, and NWFP that

the matter will be referred to an independent arbitration tribunal. Following this decision,

WAPDA and NWFP presented their claims and supporting arguments to the arbitration

tribunal in 2005. WAPDA, contesting the NWFP claim of unpaid arrears, presented a

counter claim that an overpayment of Rs 11 billion had been made to the province

between 1991 and 2005 and that this should be adjusted against the future payments.

WAPDA’s claim is based on the argument that some of the surcharges do not form part

of the revenue entitlement of the province.

In October 2006, the tribunal decided in favor of the NWFP claim and concluded

that an amount of Rs 110 billion was payable to the province, and that this amount should

be paid in five installments. After the tribunal’s decision, NWFP requested payment from

WAPDA and its guarantor, the federal government. WAPDA in turn has filed a civil suit

challenging the tribunal’s decision. The Government of NWFP has approached the

Supreme Court to get the tribunal’s decision implemented. The payment of profits in the

166 International Studies Program Working Paper Series

meanwhile remains constant at Rs 6 billion per year.

Conclusions and Implementation

There are good opportunities for reforming the system of provincial level taxation

and fiscal decentralization in Pakistan, but the job will not be an easy one. A

comprehensive reform will require both federal and provincial government involvement.

The leadership in program design for this activity might come from FBR, but any reform

of the intergovernmental system must leave significant room for provincial level

discretion.

A properly designed reform must at once allow the federal government to satisfy

its objective of increasing provincial level taxes in a framework of good tax policy, and

the provincial government to satisfy its objective of enhancing both public service levels

and fiscal autonomy. In keeping with the spirit of fiscal decentralization one would not

expect all provinces to choose exactly the same reform program. It is imperative, then,

that the federal government be clear on what is inside and what is outside the legal

boundaries for provincial revenue mobilization.

The design of the tax reform might center on four elements. The first is to

determine appropriate targets for provincial tax revenues, i.e., by how much should

revenues be increased? The second is to identify structural reforms that would make the

provincial tax system operate in a more efficient way, would hit these revenue targets,

and would further the decentralization goals that the government has adopted. The third

is to put appropriate incentives in place to encourage provinces to implement tax reforms

that will generate increased revenues. The fourth is to lay out the elements of a feasible

Pakistan: Provincial Government Taxation 167

implementation program for these structural reforms. We cover all four of these elements

in the discussion below, and in a final note we add a discussion of actions that the federal

and provincial governments might take to begin moving toward implementation.

Perhaps most important of all considerations about the proper reform package is

its political acceptability. The reform program laid out above is more fair than the

present system in that it moves toward treating all taxpayers in the same way by

removing tax preferences from many households and businesses. Special treatments are

rarely given up without a fight, however, and the more influential are those who have

enjoyed the preference, the tougher will be the fight. In addition, the reform package

includes a net revenue increase of significant amount. Taxpayers usually are resistant to

tax increases, even when account is taken of the possible improvement in public services.

Tax reform coupled with tax increase will require a strong political will on the part of the

leadership in both provinces.

Revenue Targets

How much tax revenue should be raised by provincial governments? The most

conservative of politicians will favor low risk options, usually a tinkering with the present

system. But tinkering will not raise much money. We see the basic goal of this reform to

be a significant increase in revenue mobilization by provincial governments. This calls

for a more far-reaching set of reforms, and much higher revenue targets. This is perhaps

the first matter for policy makers to sort out.

Estimating a tax revenue target for Pakistan’s provinces is at best a subjective

exercise. For example, the federal government has called for an increase in provincial

168 International Studies Program Working Paper Series

taxes to reach a level equivalent to one percent of GDP.

111

Achieving this target would

require a doubling of the present level of revenues in both provinces. There is no

documentation available on how this central government target was determined, nor are

there proposals for how it might be reached.

There are systematic approaches to fixing on provincial revenue targets, and

arguably this is where the formation of an intergovernmental fiscal reform program

should begin. Probably the best approach is to start with expenditure targets that reflect

minimum acceptable service levels (ME). From the identity

ME – Tr = OSR

where Tr = transfers

OSR = own source revenues,

we can develop a revenue target for provincial governments. After accounting for

financing from intergovernmental transfers, the remainder of the cost of providing

minimum service levels would be covered by own source revenues. This normative

service level approach to determining the minimum needed level of tax effort is what

each provincial government should do, i.e., revenue needs should be based on an

expenditure plan.

112

However, the major difficulty with this approach is that “minimum

service level” is itself a subjective concept. Determining minimum service levels, and

costing them out, becomes a balancing act between affordability and what a province

considers to be its most pressing needs for upgrading services.

113

111

This target was presented in the Economic Survey (Government of Pakistan, 2007, p.65).

112

The revenue target for motor vehicle taxes, discussed above, was set in reference to roadway

expenditures. This is an example of expenditure needs driving a revenue target.

113

South Africa uses such an approach by allocating a portion of its “equitable shares” grant to local

Pakistan: Provincial Government Taxation 169

Sometimes the balancing act is driven more by affordability (and political)

considerations than by service upgrading. This would seem to be the case in Pakistan.

Politics often has driven higher investments in the expansion of service delivery

networks. In the 1990s, costly CDLs were used to carry on infrastructure development

programs despite revenue shortfalls. The provinces recognize that the services they

provide are greatly inadequate, but they have not been willing to increase taxes to cover

this gap. In fact, it is more likely that expenditure levels are driven primarily by the

amount of transfers (and loans) received from the center.

114

The solutions to this problem

are either (a) to leave it to local voters to push elected officials for increases in service

levels that would lead to tax increases, or (b) to put in place a system of

incentives/penalties for higher/lower rates of provincial revenue mobilization. Either of

these solutions is consistent with the fiscal decentralization approach to governance.

However, it does not appear that any of Pakistan’s provinces have established minimum

spending or service levels. Under the ADB’s Punjab Devolved Social Services Program,

minimum service delivery standards have been developed but they have not been adopted

(ADB, 2007). Nor does the federal government target for provincial taxes appear to be

driven by this concept. Expenditure benchmarks were established in the Poverty

Reduction Strategy Paper in 2004 (Government of Pakistan 2004, Table 71, page 110).

A second approach is to set the provincial revenue target as the amount necessary

to eliminate the structural budget deficit for each province. Based on the analysis

governments on a basis of expenditure needs. The approach is to provide each local government with a

block grant that is equal to the estimated cost of providing ‘basic services’ to poor households

(Reschovsky, 2003).

114

This too is subject to a hard budget constraint and therefore implies a role for the NFC in Provincial

finance reform.

170 International Studies Program Working Paper Series

presented above and summarized in Table 3, we can argue that the shortfall in Punjab is

equivalent to 137 percent of total provincial taxes in 2006-2007. The analogous number

for NWFP is about 300 percent of total provincial taxes (Table 5). This calculation

suggests quite large target increase in provincial taxes for both provinces. Note however

that this “fiscal discipline” approach to setting budget targets is driven more by goals of

budget balance than by public service needs. While it is a good thing that provincial

governments are financially solvent, the reasons for this solvency can be as much due to

low spending and low taxes as to fiscal prudence. A companion reform to upgrade

provincial services would call for an even higher tax target.

The revenue target might also be set by using international comparisons. The

average level of subnational government taxes in developing countries is equivalent to

about 10 percent of total taxes raised by central and subnational governments (Bahl and

Wallace, 2005). Thus each province might take the target of raising its ratio of taxes to

GDP to a level that is equivalent to 10 percent of the central government’s tax to GDP

ratio. Using this approach, we can estimate that Punjab’s target would require an

increase of 111 percent in taxes and NWFP’s would require a 179 percent increase in

taxes. The fault with the international standards target is that it is calculated without

reference to expenditure needs or to expenditure responsibilities assigned to the

provincial and local governments, it is based on uncertain (IMF) data, and it is arbitrary.

The illustrative targets for property taxation, discussed above, were set in this manner.



In developing the revenue profile for a comprehensive reform program, we will

work with two targets: Scenario “A” is based on eliminating the structural deficit of the

provinces, and scenario “B” is based on an international norm approach. These targets

Pakistan: Provincial Government Taxation 171

can give a first approximation of the amount of revenue to be raised with tax structure

revisions. This is summarized in rows 1 and 2 of Table 46 and 47 for Punjab and NWFP,

respectively. For example, Punjab’s tax targets are Rs 65.3 billion (A) and Rs 46.7

billion (B) while actual collections are Rs 22.1 billion. NWFP’s targets are Rs 12 billion

(A) and Rs 7.7 billion (B) while actual collections are about Rs 2.8 billion. We base the

analysis on 2005-2006 fiscal year data so as to take advantage of reported actual

amounts.

Note that these targets call for provincial taxes to rise to between 1.06 and 1.66

percent of GDP, hence they also meet the goals laid out by the federal government. On

the other hand, these two revenue targets call for some provincial taxes to increase

several fold over their present levels. As is discussed in the analysis above, there are

restructuring options for provincial taxes that could lead to such increases. However,

these options suggest the need for a considerable upgrading of the administrative

capabilities of the provincial governments, as well as a difficult political sell.

Structural Reforms

Some will argue that these targets are too ambitious. On the other hand, these

targets may be viewed in the context of the very low current level of taxation, the many

preferential treatments that have been given, and lax administration. The whole idea of

this reform option is to significantly increase the participation of provincial governments

in revenue mobilization, so it follows that the targets should be high. If the provincial

political leadership feels uneasy with the target levels of revenue mobilization, it is

probably a sign that the reform program suggested has met its objectives. Also, there is

172 International Studies Program Working Paper Series

the question of the timing required to reach these targets, i.e., a one year tripling of a tax

might be politically infeasible, but a four year time horizon might make the same reform

palatable.

As demonstrated in some detail above, this range of revenue targets can be

reached with what many would see as “reasonable” structural reforms. Moreover, the

reforms outlined here have other beneficial properties in terms of improving the equity of

the system, reducing the administrative cost, and rationalizing the choice of tax

instruments. It should be said early (and often) that these policy changes and revenue

enhancements cannot be realized without a significant upgrading of the tax assessment

and collection efforts of the provincial governments.

The structural reform opportunities that can be pursued under a comprehensive

reform are outlined in Table 48, with estimates of the revenue potential for each reform

shown in Tables 46 and 47.

115

For example, in the case of the reform of the property tax

(UIPT) for Punjab, the specific package of reforms is outlined in Table 48. In row (4) of

Table 46, we show that these UIPT reforms would generate revenues of Rs 14.2 billion at

2005-2006 levels. This would account for about 22 percent of the structural deficit target

(Rs 65.3 billion, and about 30 percent of the international average target (Rs 46.7

billion).

116

However, such an increase in property tax revenues would bring a major tax

shock. Note that it would require more than a tenfold increase in property taxes, and

would bring the UIPT to a level of 0.3 percent of GDP. An increase of this magnitude is

115

Only the comprehensive reform package is outlined in Tables 46-48. Several other options have been

presented in the analysis above, and are summarized in the policy matrices shown in Appendix E.

116

This increase in revenues is less than the amounts shown in the property tax analysis above, because

there is no provision here for an increase in the nominal tax rate, and because the analysis here is for 2005-

2006.

Pakistan: Provincial Government Taxation 173

rarely observed, which might lead some to conclude that it is impossible. Another way to

look at it is that the present levels of property tax in Punjab and NWFP are so low that

this reform is tantamount to introducing a new tax. Moreover the recent decision to

assign the tax to local government is an opportunity to completely overall the urban

property tax. Even so, the full “reform” would need to be phased in, perhaps over a

period of three years. Roughly the same scenario for UIPT is shown for NWFP in Table

47. It would be incorrect, in our view, to assume that an increase of this magnitude is not

possible. And, we note that even with this increase, property tax revenues in both

provinces would be lower than the international average for developing countries.

We offer a full package of comprehensive reforms (Table 48) for the other

provincial taxes, with revenue estimates shown in Table 46 for Punjab and in Table 47

for NWFP. The revenue estimates, are drawn from the individual analyses presented

above, and are further summarized in Appendix E. As shown in Table 46 (bottom row)

this package of reforms can cover about 73 percent of the structural deficit in Punjab, and

raise the level of provincial taxes to approximately the 1 percent federal government

target. In the case of NWFP (Table 47), these same structural reforms fall short of the

structural deficit target by about 44 percent. This result is not unexpected. NWFP is a

poorer province, and even with the same tax effort it cannot cover desired expenditures.

With respect to Target B, this package of reforms enables Punjab to raise taxes to the

international average, but in case of NWFP it falls short of the target by about 12 percent.

What to make of these results? First, even this ambitious program does not allow

Punjab to cover its structural deficit. However, the administrative reforms that

accompany this set of rate and base changes may cover the remaining gap – equivalent to

174 International Studies Program Working Paper Series

about 25 percent of the present level of taxes. If not, a further increase in the effective

tax rates proposed here will be necessary. In the case of NWFP, we might make the same

observation, but note that even with administrative improvements, a significant gap will

remain. Part of the solution here will include increased equalization transfers.

Incentives

Provincial governments must be willing to enact and implement these reform

measures if revenue gains are to be realized. As discussed above, there has not been

much interest in revenue mobilization on the part of the provincial governments in the

past. There are three ways in which this reluctance might be overcome enough to reform

the tax system. The first is to convince taxpayers that a result of the reform will be

improved public services. The second is to convince taxpayers that a comprehensive

reform will bring about a more fair tax system, in that similarly situated households and

businesses will be treated the same. It also can be argued that such a tax system will be

friendly to economic development because of its fairness and because the higher rate of

revenue mobilization could lead to infrastructure improvements. The third is to offer an

incentive that is lucrative enough to help provincial governments overcome their

reluctance to increase taxes. The discussion below focuses on the incentive route.

Punjab finances only 9 percent of its expenditures from its own taxes, and NWFP

finances only 3 percent. The remainder of revenues come from intergovernmental

transfers and from loans. This state of affairs raises two problems. First, it weakens the

link between the expenditure benefits enjoyed by local residents and the burden

associated with paying for those expenditures. The result is a weak accountability of

Pakistan: Provincial Government Taxation 175

provincial/local officials to their voting constituency. Second, provincial and local

governments have a comparative advantage in raising certain types of revenue. Their

failure to aggressively collect these revenues imposes a “cost” in terms of an overall

lower level of revenue mobilization in the country. The consequence is a lower level of

public services than otherwise would be the case.

The question arises as to why provincial government taxes are not higher. In

Punjab and NWFP the standard answers to this question are weak taxable capacity,

inadequate tax sources, deficient tax administration, and voter resistance. All of these

arguments are open to some debate, but as we have shown above, the provincial tax share

of GDP has remained low during this decade.

A possible explanation of the failure of provincial governments to mobilize more

revenue is that they have too little incentive to do so. The central government provides

significant and growing revenue through transfers and loan funds, so why incur the wrath

of voters and take on the local elite by raising taxes? Arguably, political leaders in

provincial governments would rather be accountable for the present levels of public

services than spend their political capital. A related issue is that provincial governments

are not very good at spending for public services. In fact, provincial spending patterns

are characterized by unfilled positions and delays in capital project disbursements. If

provinces cannot spend what they have available now, why raise more in taxes? This is

yet another dimension to the provincial tax effort issue.

An Incentive Model.

To address the problem of incentives for increasing taxes,

the federal government may want to reconsider the structure of transfers by including a

reward for increased revenue mobilization in the distribution formula.

176 International Studies Program Working Paper Series

At present, the distribution of the NFC award among the four provinces is done

according to population size. The awards in 2005-2006 are shown in columns 1 and 2 of

Table 49. Note that the awards are structured so as to be invariant with respect to tax

effort. This means that if a province had a higher rate of revenue mobilization than

shown in column 3, it would receive neither more nor less in NFC award. The goal of an

incentive program is to change this state of affairs.

We propose that the NFC award be divided into two components: an NFC

incentive award (NFCIA) and an NFC normal award (NFCN). NFCN would continue to

be distributed according to population shares (or according to other criteria that a future

Finance Commission would choose). The Finance Commission would decide on the

relative sizes of the incentive pool and the normal pool. For example, they might decide

to distribute 10 percent through the incentive pool and 90 percent through the normal

pool. The more weight placed on the goal of increased tax effort, the greater will be the

share of the incentive pool.

The other dimension of the NFC award, the distribution of the incentive pool

among provinces, raises more difficult questions. There are many ways to structure an

incentive grant, and this will require a study and careful empirical analysis.

Such a study

would include all four provinces, and involve simulation of the possible impacts of

various formulae. Because only two provinces are included in this study, we can offer no

more than a hypothetical example, based on assumed numbers for Sindh and Balochistan.

Pakistan: Provincial Government Taxation 177

To illustrate, one possible formula would be the following:

NFCIA

ἱ

Ʃ TE

ἱ

. NFCIA) +

ἱ

Ʃ TG

ἱ

. NCFIA)

Where

NFCIA

ἱ

= incentive award given to the

ἱ

province

NFCIA = total size of the incentive fund

Wt = weight given to the tax effort component

ἱ

= tax effort index in the

ἱ

province

= weight given to tax effort index improvement

ἱ

growth in tax effort in the

ἱ

province

Such a formula would reward both higher levels of tax and the growth in taxes. But this

formula is only illustrative and there is much work to do in designing this kind of grant

program. Four conceptual decisions must be made. These decisions suggest how

difficult it might be to make the choices necessary to design and implement the formula.

The first difficult choice is the size of the incentive fund vs. the normal fund. The

bigger is the incentive fund, the greater the potential to compromise equalization (if

higher income provinces exert a greater tax effort). That is, if Punjab and Sindh made the

highest tax effort, this formula would result in shifting resources toward Punjab and

Sindh and away from NWFP and Balochistan. The larger the size of the incentive fund,

the greater the shift. This raises the difficult issue of what would happen to the losing

provinces under such a regime. The failure of a province to raise taxes could lead to

compromises in service levels in that province. The federal government would have to

decide if it is ready to face the fallout from such a shift in resources in order to encourage

178 International Studies Program Working Paper Series

more resource mobilization at the provincial level. Alternatively, it could consider

establishing a separate equalization component in its NFC award.

The other side of the issue is that the incentive reward must be large enough to

draw a tax effort response from the provincial government. The province will want an

answer to the question, “how much in additional transfer do I get if I raise Rs 1 million in

additional taxes”? The larger the potential reward, the more willing might the province

be to implement revenue enhancement measures.

A second difficult problem is defining the measure of tax effort. Ideally one

would measure the level of taxes collected as a percent of the capacity to raise taxes. Tax

collections as a percent of provincial GDP is the most obvious candidate. But, there are

three flaws in using such an indicator: (a) the measurement of provincial GDP in Pakistan

is not well developed, (b) the composition of GDP may matter greatly in determining

taxable capacity, and (c), a province may be able to export the burden of taxes (e.g., the

headquarters issue in Sindh) and still have the collections count toward its higher tax

effort.

The third difficult choice is whether and by how much to reward the level of tax

effort vs. the increase in tax effort. There are arguments for and against both indicators.

If only the level of tax effort is rewarded, high taxing provinces might not have adequate

incentive to “do better”. If only the increase in tax effort is rewarded, historically lower

taxing provinces might be favored over historically higher taxing provinces.

Finally, there are difficult legal and political hurdles to overcome in building an

incentive component into the NFC awards. On the legal side, is there a way to

circumvent the requirement that all provinces must agree to the formula structure of the

Pakistan: Provincial Government Taxation 179

NFC award? Can this formula adjustment be done by federal government mandate? So

long as consensus is a binding constraint on the NFC distribution formula, it seems

unlikely that an incentive plan will be acceptable. The possible opening is that the

incentive grant might be structured out of the federal share and under clause (b) of article

160 or sub-article (7) of article 160 of the constitution. On the political side, provinces

have already shown themselves to be unwilling to increase taxes, even in the face of poor

public service levels. This does not bode well for the prospects of provinces accepting a

reward/penalty program based on their tax effort choices.

Empirical Test: An Illustration. For purposes of illustration of how such a

scheme might work, we propose a model with the following features:

• 75 percent of the NFC award is allocated to the normal pool and is distributed

by population.

• 25 percent of the NFC award is allocated to an incentive pool.

• The incentive pool is allocated across provinces 50 percent according to the

level of tax effort and 50 percent according to the increase in tax effort.

• Tax effort is measured as the ratio of provincial taxes to GDP and the change

in tax effort is the change in the ratio of taxes to GDP. Negative changes in

tax effort earn a zero allocation.

The results of our illustrative simulation are shown in Table 49. In columns 1 and

2, we report the distribution of the NFC award under the present system. For example,

NWFP receives 12.86 percent of the total NFC award. In columns 3, 4 and 5, we show

the measures of tax effort and changes in tax effort. (Note that the values for Sindh and

Balochistan are assumed, hypothetical amounts). The results of this simulation are

shown in columns 6 and 7. The following are worth remark.

180 International Studies Program Working Paper Series

• Sindh exerts the highest tax effort in this illustrative model, and the result

is a shift in the NFC award toward Sindh. NWFP also has a high tax

effort and also gains an increased share. The Sindh share of total NFC

revenues increases from 28 to 37.3 percent, while that for NWFP rises

from 12.9 to 13.2 percent.

• Punjab has a lower tax effort, and its share of the NFC award declines. In

this illustration the decline is from 52 to 42 percent of the total award.

• Balochistan makes the lowest tax effort, but still gains an increased share

of the NFC award. This is because even with a low level of tax effort, it

has a stronger position than in the population sharing pool.

Implementation and Institutional change

If there is a clear message in this analysis of provincial taxes, it is that reform

must be comprehensive, i.e., it must address policy design, incentives to increase the rate

of revenue mobilization, and tax administration. The focus of this analysis is tax policy

but the success of a structural reform will depend on whether an improved tax

administration can be achieved. Without significant improvements in tax administration,

especially updated surveys of taxable subjects, more accurate valuation, and the

automation of recordkeeping, better tax structures will come to naught. An important

first step toward improving the system of tax administration is to reconsider the

fragmented responsibility for tax assessment and collections. With a unified tax

administration in place, it will be easier to measure and assess tax bases.

In Punjab and NWFP, the principal tax collecting agencies are the Board of

Revenue (BOR) and the Excise and Taxation Department. The BOR is mainly concerned

with taxes on rural lands. Specifically, it assesses and collects stamp duty, mutation fee,

registration fee, land revenue and agriculture income tax. In the case of stamp duty and

Pakistan: Provincial Government Taxation 181

registration fee, BOR is also responsible for collections in urban areas. The ETD collects

UIPT, motor vehicle taxes, professions tax, provincial excise duty and some smaller

provincial taxes. In the case of the sales tax on services and electricity duty, the finance

departments of the federal and provincial governments, respectively, play a primary role.

In all of this work, there appears to be little collaboration between ETD and BOR, or

between the federal and provincial government.

This state of affairs is counterproductive to effective policy and collection. The

kind of problems that arise might be illustrated with three examples. First, the valuation

tables for the property transfer taxes and the UIPT are separately done, even though both

taxes rely on much the same information to establish a base of taxation. Increasingly, the

two agencies are said to be coordinating at the field level to ensure reliability of

information, but still their records are not aligned with each other. Second, the record

keeping function can fall between the two agencies. In areas which are newly urbanized,

the patwari does not update his record to reflect the development of housing units on

erstwhile agriculture land. If the area is not notified as urban, the ETD does not cover it

in their surveys nor do they pick it up on their valuation registers. The fact that BOR is

primarily concerned with rural lands means that its record keeping does not extend into

urban areas. Nearly all urban areas lack a systematic record of property titles. The

systems and expertise of the BOR is not used for urban areas. The result is that nearly

all urban areas lack a systematic record of property titles. Third, there is no way to cross

check for compliance problems, either within or between agencies. For example, motor

vehicle registrations cannot be cross checked against land ownerships records (which

could aid compliance and would be a desirable feature of a motor vehicle registration

182 International Studies Program Working Paper Series

system that had a residence requirement).

The present organizational structure is recognized by many observers as sub-

optimal. The Government of Punjab has discussed creating a unified tax authority. A

Provincial Board of Revenue might be set up with all provincial tax assessment and

collection functions assigned to it. (Property titling may or may not be included in its

functions). A joint BOR, organized according to tax functions would give the provinces a

better functional capacity to raise the revenues assigned to them. It should be equipped

with computerized systems of tax base documentation, qualified tax administrators and

adequate resources to manage collection. There are numerous advantages to be had from

a unified tax administration at the provincial level.

• All tax bases and tax payment histories could be cross–referenced. For

example, payment of motor vehicle annual tax, UIPT and professional tax

could be linked by a unique taxpayer number.

• There could be a complete enumeration of all land (rural and urban) in the

province, and this enumeration could include physical dimensions, value

information, use, ownership and tax payment history.

• A unified tax administration would allow the government to capture

economies of scale in both training and EDP.

It is well beyond the scope of this study to evaluate this proposal in detail, but the

possible gains from a unified authority are great enough to merit a serious review, despite

the history of objections to this proposal.

Implementation: Timetable

Another dimension of implementation is a timetable for reform. Some of the

reforms suggested in this review can be adopted quickly, if government chooses to do so,

Pakistan: Provincial Government Taxation 183

while others would require more time to prepare for implementation. The following

schedule is one set of suggestions about the time required to put these reforms in place, if

Government chose to do so.

Reforms that could be introduced quickly (within one year)

• Prepare a new valuation table in Punjab

• Eliminate preferential treatments under UIPT

• Adopt a new property tax base in NWFP

• Unify motor vehicle taxes into an annual tax

• Introduce a motor fuel tax

• Convert the sales tax on services to a shared federal-provincial tax

• Bring the hotel tax and the electricity duty into the sales tax on services

• Allocate the entertainment tax to local governments

Reforms that would require 1-3 years to Introduce

• Unify land taxes as an annual tax on land value, based on a new survey of

all properties in the province; eliminate the property transfer tax

• Introduce a new valuation roll in NWFP

• Expand the base of the Professions Tax

• Convert the agricultural income tax to a presumptive tax on income based

on land area and crop type. Bring all agricultural cesses into this tax base.

• Expand the base of the sales tax on services

• Introduce an incentive element into the NFC formula

Longer term reforms

• Adopt a capital gains tax on land

• Convert the professions tax to an income tax surcharge

184 International Studies Program Working Paper Series

What to do Next?

The federal and provincial governments might use this report as an input in

beginning to think about long run tax reform for the provincial governments. The first

task to be undertaken is to develop analyses similar to this for Sindh and Balochistan, so

that a complete picture of the current situation is gained. It would be inappropriate to

begin developing national policy without a better understanding of the relevant

differences in these two provinces vs NWFP and Punjab. Following this, two blue ribbon

committees should begin working: one at the federal government level and one at the

provincial government level.

Federal Blue Ribbon Commission on Fiscal Federalism. The Federal

Commission would take on two major tasks. The first would be to address the problems

with tax assignment, and the second would be to revisit the NFC award formula.

(i) Tax assignment. Some of Pakistan’s fiscal problems have their origins in a

deep-seated philosophy about taxation and revenue sharing. The constitution and its

interpretation call for a revenue assignment model where certain tax instruments are

renewed for each level of government (either directly or by exclusion). This raises two

problems of fiscal balance that contribute significantly to the fiscal problems of the

provincial governments.

The first is the vertical imbalance between the significant expenditure role that

provinces have been asked to play, and the less productive revenue sources that have

been assigned to them. The agricultural sector, the consumption of services, and real

estate are all notoriously hard to tax. The result is that most of the provincial budget is

financed with revenue sharing from central government taxes. Direct revenue

Pakistan: Provincial Government Taxation 185

mobilization by provincial governments is much less important. One of the main

advantages of a decentralized fiscal system --- the ability of elected subnational

governments to choose a level of taxes that matches their preference for public

expenditures --- is not captured.

The second imbalance is in the area of tax administration. The federal

government’s ability to assess and collect income and consumption – based taxes is much

superior to that of sub-national governments. Even if the power to access a broad-based

tax were given to provincial governments, the administrative ability to do so would not

be in place.

The resolution to this problem is to move toward a tax base sharing model where

the federal government defines the tax base, sets a federal tax rate and administers the

tax. Each provincial government would choose its own tax rate, probably within some

limits. This tax base sharing approach could be applied to the sales tax on services and to

a piggyback on the individual income tax to replace the professions tax.

(ii) Intergovernmental Transfers. The Commission might take this occasion to

review the present system of intergovernmental transfers. In some ways the system is

working well. It is transparent, and full entitlements are distributed. The vertical share is

growing, and the importance of NFC transfers in provincial government finance is

increasing. If there are issues surrounding the NFC awards, they have to do with the

failure to agree on a formula in a timely manner and with some dissatisfaction with the

formula finally arrived at.

117

The problem that is more central to this analysis is that provincial government

117

The discussion in the press around the time of and award suggests disagreement on the population –

based formula.

186 International Studies Program Working Paper Series

revenue mobilization is not increasing, arguably because the NFC award is carrying so

much of the revenue load. In theory, the federal government could address this issue by

building a greater equalization component into the formula thereby reducing the

assignment of NFC awards to the provinces where revenue mobilization potential is

greatest. This would force the higher income provincial governments (Punjab and Sindh)

to either increase taxes or cut services. A second alternative is to build an incentive for

increased tax effort directly into the allocation formula, similar to that outlined above.

Neither of these options are easily structured, and they represent very difficult

choices. The federal government might undertake a thorough modeling exercise to try

and estimate the impacts of various restructurings on provincial finances.

Provincial Blue Ribbon Commissions on Taxation. Each province might appoint

a blue ribbon commission to begin working on this issue. The goal would be to develop a

comprehensive reform program, based on best practice and on the objectives that the

province set for itself. A further goal would be to find the right fit for provincial taxes in

the national scheme. The FBR would join these commissions in an advisory capacity. It

is important that the TOR for the commissions include all of the relevant pieces. As this

report makes clear, the issues of tax policy, tax administration and intergovernmental

transfers cannot be separated if a viable reform is to be designed and implemented. All

should be part of the TOR for the commissions. The term of reference should call for

study and recommendations in three areas, as discussed below.

First, the structure of taxation should be simplified, perhaps even further than

suggested above. Possibly building on the analysis in this paper, the Commission could

recommend improvements in the tax structure as well as increases in the level of taxes

Pakistan: Provincial Government Taxation 187

that would be consistent with provincial revenue targets. Much of the work of the

Commission would involve debating the merits of alternative tax packages.

The view in this study is that in the long run, the provincial tax structure might

include only the following:

• An urban property tax and an annual tax on agricultural and other rural land.

The former would be devolved to local governments.

• A capital gains tax on land.

• A Federally administered surcharge on the individual income tax and a

federally administered and expanded sales tax on services. Both could feature

provincial level rate setting. The provincial share of revenues would flow

directly to the provincial governments.

• An annual tax on motor vehicle use, and a tax on motor fuels.

• All other taxes in the system would be abolished or folded in to those above.

The second part of the work would be to identify the kind of tax administration

that is desired. In the long run, a unified (or coordinated) provincial tax administration,

and shared federal and provincial tax administration responsibilities should be in the mix.

A stronger, automated recordkeeping system for taxation is essential. Training of tax

officials is a high priority, to establish state of the art methods of assessment and

collection.

The third component of the Commission study would be intergovernmental fiscal

relations within the province. This would involve a reassessment of the relationship

between the province and its junior bodies, i.e., districts, TMAs and union councils. The

three questions to be addressed in this analysis are expenditure assignment, revenue

assignment and the system of intergovernmental transfers. Questions of the goals for

188 International Studies Program Working Paper Series

revenue mobilization by local governments, and equalization, will be central to this work.

The results of the Provincial Commission work in each province should be

brought together in a consensus report, a White paper on Provincial government Finance,

which could serve as a blueprint for provincial fiscal policy in the next decade.

Pakistan: Provincial Government Taxation 189

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Government of Punjab (2007h). Finance Act 2007, Finance Department, Government of Punjab.

Government of Punjab (2007i). Annual Budget Statement 2007-2008, Finance Department, Government of

Punjab.

Gurmani, Zulfiqar Ali, Muhammad Zia-ul-Hassan, M. Imran, Ali Raza Jamali, and Muhammad Bashir

(2006), “Cost Benefit Analysis of Wheat Barley and Oat Crops for Grain Production,” Journal of

Agricultural Research 44(4): 335-341.

IMF (2006). Government Finance Statistics 2006, International Monetary Fund, Washington DC

192 International Studies Program Working Paper Series

IMF (2007). Government Finance Statistics 2007, International Monetary Fund, Washington DC

Kemal, A. R. (2006). Income Inequalities in Pakistan and a Strategy to Reduce Income Inequalities, PRSP

Secretariat, Ministry of Finance, Government of Pakistan

Khan, Ahmad (2004). “Reform of Tax Administration in NWFP”, Report of the Study Sponsored by DFID,

Mimeograph.

Khan, Muhammad Aslam (1999),”Comments on The Theory and Practice of Agricultural Income Tax in

Pakistan and a VIable Solution," The Pakistan Development Review 30(4): pp. 766-768

Malik, Sohail J. (2004). “Study on Tax Potential in NWFP” (Innovative Development Strategies, Ltd.,

Mimeographed)

McLure, Charles E., Robert Pitcher, and Lonette Turner (2007). “Taxation of Commercial Motor Fuel in

the United States and Canada: The International Fuel Tax Agreement” Bulletin for International

Taxation, volume 61, no.12, December, pp 541-548.

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Islambad

Orissa State Government. 2000 Finance Department Notification on Orissa Act 7, Tax on Professions,

Trade, Callings, and Employment, accessed on January 1, 2008

http://ws.ori.nic.in/salestax/PT/ptaxrule.htm

Pasha, Hafiz (1995). “Sales Taxation of Services By Provincial Governments” Conference on Resource

Mobilization and Expenditure Planning, Lahore, March 11-13.

Pasha, Hafiz, Aisha Ghaus, Rafia Ghaus and Rizwanullah Khan (1992). Fiscal Policy in Pakistan, Social

Policy and Development Center, Karachi

Rajaraman, Indira (2000). Fiscal Features of Rural Local Government in India, in Governance,

Decentralization, and Reform in China, India, and Russia, Jean-Jacques Dethier, ed. (Bonn, Kluwer

Academic Press).

Reschovsky, Andrew (2003). “Intergovernmental Transfers: The Equitable Share” in Restructuring Local

Government Finance in Developing countries: Lessons from South Africa, edited by Roy Bahl and

Paul Smoke (Cheltenham, UK: Edward Elgar Publishing), pages 173-236.

Soares de Silva, David Roberto R. (2006). “Fuel and Energy Taxation in Brazil is a Work in Progress” Tax

Notes International, (October 23).

State Bank of Pakistan (2007a). Annual Report, 2006-2007, State Bank of Pakistan, Karachi

State Bank of Pakistan (2007b). Statistical Bulletin, November 2007, State Bank of Pakistan, Karachi

State of West Bengal. 2008. Professions Tax in West Bengal, accessed on January 1, 2008

http://wbcomtax.nic.in/ptax.htm

Sundharam, K.P.M and K. K. Andley. 2003. Public Finance Theory and Practice. (New Delhi: S. Chand

and Company).

The Urban Unit (2006). “Property Taxes in The Punjab, Pakistan” World Bank Infrastructure and Energy

Department, South Asia Region and Planning and Development Department, Government of Punjab.

Pakistan: Provincial Government Taxation 193

The Urban Unit (2007). “Property Tax System in The Punjab: Post-Devolution Scenario – A case for

Reforms” Planning and Development Department, Government of the Punjab.

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194 International Studies Program Working Paper Series

APPENDIX A

Legal roots of Revenue Assignment in Pakistan

Revenue assignment in Pakistan is derived from the constitution and certain

statutes. At the first level, revenues are assigned between the federal government and the

provinces by specific constitutional provisions. Local governments are a creation of the

provinces. So the provinces assign some of their revenue sources to local governments.

This second level of assignment is through statutes like the Local Government

Ordinances 2001.

The federal-provincial assignment is either through express constitutional

provisions or through the federal and concurrent lists

118

. The principle here is that a

revenue source can be assigned to the federation or a province by an express provision in

an article of the constitution or through classification in the federal or the concurrent lists

of subjects. In the latter case if the revenue source is mentioned in the Federal List it

belongs to the federation only, but if it is in the Concurrent List it is a shared base and

both the federation and the provinces can develop legal instruments to tax the base. If a

revenue source is neither mentioned in the Federal List nor it appears in the Concurrent

List, it belongs to the province only.

The revenue assignment between the federal and provincial governments,

according to the constitutional scheme, is shown in the following table:

Table A.1. Federal Revenues

Revenue Assignment/Tax Legal provision

1. Personal income tax (except agri income) Federal List (subject 47)

2. Corporate income tax Federal List (subject 48)

3. Customs Federal List (subject 43)

4. Sales tax on goods Federal List (subject 48)

5. Excise duty (except on alcohol, narcotics) Federal List (subject 44)

6. Capital value tax Federal List (subject 50)

7. Estate duty Federal List (subject 45, 46)

8. Mineral oil, minerals, natural gas Federal List (subject 51)

9. Tax on production capacity Federal List (subject 52)

10. Terminal taxes on goods transport and passengers Federal List (subject 53)

11. User charges on federal subjects Federal List (subject 54)

118

The lists are appended to the constitution and lay down the distribution of subjects between the federal

and provincial governments.

Pakistan: Provincial Government Taxation 195

Table A.2. Provincial revenues

1. Excise duty on alcohol, liquor, narcotics Assigned to province by bar

on the federation in the

Federal List (subject 44)

2. Sales tax on services Residuary assignment

3. Tax on professions Article 163 of the

constitution

4. Motor vehicle tax Residuary assignment

5. Property tax Residuary but there is bar in

the Federal List (subject 51)

6. Capital gains Assigned through bar on the

federation in the Federal List

(subject 50)

7. Agriculture income tax Through bar on the

federation in the Federal List

(subject 47)

8. Stamp duty Residuary assignment

9. Registration fee Residuary assignment

10. Mutation fee Residuary assignment

11. Natural gas excise duty Article 161 of the

constitution

12. Net hydro profits Article 161 of the

constitution

13. Electricity duty Article 157(2) (b)of the

constitution

14. User charges Residuary assignment

Taxes at number 1 to 6 in the table above are shared revenues under the NFC

clauses of the constitution. The base and rate are set by the federation.

The following table summarizes the revenues assigned to local government by the

provinces under the Local Government Ordinances 2001:

196 International Studies Program Working Paper Series

Table A.3. Local Revenues

119

Devolution in Pakistan, ADB/DfID/WB 2004

District Councils Tehsil and Town Councils Union administrations

• Education tax.

• Health tax.

• Tax on vehicles other than

motor vehicles.

• Local rate on lands assessable

to land revenue.

• Fees in respect of schools,

colleges, and health facilities

established or maintained by

the district government.

• Fees for licenses granted by

the district government.

• Fees for specific services

rendered by a district

government.

• Collection charges for

recovery of tax on behalf of

the government as prescribed.

• Toll on new roads, bridges,

within the limits of a district,

other than national and

provincial highways and

roads.

• Local tax on services.

• Tax on the transfer of immovable property.

• Property tax on annual rental value of

buildings and lands.

• Fee on advertisement, other than on radio

and television, and billboards.

• Fee for fairs, agricultural shows, cattle fairs,

industrial exhibitions, tournaments and

other public events.

• Fee for approval of building plans and

erection and re-erection of buildings.

• Fee for licenses or permits and penalties or

fines for violation of the licensing rules.

• Charges for execution and maintenance of

works of public utility like lighting of

public places, drainage, conservancy, and

water supply.

• Fee on cinemas, theatrical shows and tickets

thereof, and other entertainment.

• Collection charges for recovery of any tax

on behalf of the Government, District

Government, Union Administration or any

statutory authority as prescribed.

•

Fees for licensing of

professions and

vocations.

• Fee on sale of animals

in cattle markets.

• Market fees.

• Fees for certification

of births, marriages

and deaths.

• Charges for specific

services rendered by

the union council.

• Rate for the

remuneration of village

and neighborhood

guards.

• Rate for the execution

or maintenance of any

work of public utility

like lighting of public

places, drainage,

conservancy and water

supply.

Pakistan: Provincial Government Taxation 197

APPENDIX B

Methodology Used in Estimating the Revenue Cost of Tax Preferences in Punjab

Estimation of the revenue cost of property tax preference builds on actual data

from Punjab ETD. However, some necessary data are not available and we make some

assumptions. Different assumptions of course will yield different results, but the

estimates give a better way to study the revenue cost of tax preferences then does pure

guesswork.

The data in the top panel of columns (1) and (2) in the Appendix Table

Exemptions were provided by ETD. The assumptions are shown in the bottom panel of

the table. The data in column (3) to (5) are the estimates.

Owner Occupied Residential Units. The property tax demand for rented,

residential units is Rs.3718 per unit. We apply this average tax rate to 95% of the 383,021

owner occupied residential units to estimate a “true demand” of Rs.1.4 billion (column

3). The remaining five percent of the owner occupied units are assumed to be industrial

units. The difference between this amount and the Rs.451 million demanded in 2006-07

(column 2) is the tax preference (Rs. 901 million).

Owner Occupied Commercial Units. The average tax demand on a rented

commercial unit is Rs.4440. We apply this average tax rate to 234,986 owner occupied

commercial units and estimate a demand of Rs.1.04 billion (column 3). The tax

preference in this case is Rs.463 million.

Industrial Units. We assume the number of industrial units to be equal to 5% of

residential properties, which comes to 28,486. Then we apply the average tax of rented

commercial units to this number and estimate the demand for industrial units as Rs.127

million. We calculate the current demand from industrial units to be Rs.57 million by

applying the average owner occupied residential rate to the number of units. The tax

preference is therefore estimated to be Rs.69 million.

Vacant lots. Assuming that vacant lots are equal to 5% of the residential property

units, we calculate a property tax demand from vacant lots applying a rate 1.5 times the

average tax on rented residential units. It comes to Rs.159 million. Vacant lots are not

taxed at all, therefore the size of tax preference in this case is Rs.159 million.

5-marla units. Using ETD estimates, we calculate the number of 5 marla units to

be 1,139,436, (twice the number of residential properties on the tax roll). Then we apply

a rate equal to half of the average tax on rented residential units to calculate a demand of

Rs.2 billion for this category.

The results of this exercise show that the elimination of these preferential treatments

would increase property tax revenue by Rs.3.7 billion. The estimates are made based on

the current tax roll.

198 International Studies Program Working Paper Series

The ETD’s estimated demand with introduction of the new roll is Rs.5.2 billion.

The actual demand for 2006-07 was Rs. 2.9 billion. From this we derive a factor of 1.8.

We apply this factor to project the demand from all the categories of property under the

broader base. The results reported in column 5 are total projected demands and the

additional revenue in column 6 is net of the baseline demand in each category. If the new

valuation roll were in place, we could estimate the revenue cost of exemptions and

preferential rate treatments as Rs. 7.5 billion.

Pakistan: Provincial Government Taxation 199

APPENDIX C

Methodology Used in Estimating the Revenue Cost of Tax Preferences in NWFP

For NWFP we did not have the estimated number of properties under each tax

category. But we had the numbers for Peshawar zone only. We calculated the impact of

the reforms for Peshawar Zone (rows 1 to 10). The ETD reported that nearly 75% of

collection comes from Peshawar Zone. Using this fact, we project the total revenue from

the reforms for the province in the last row.

Owner Occupied Residential Units. The property tax demand for rented,

residential units is Rs.1096 per unit. We apply this average tax rate to 95% of the 50518

owner occupied residential units to estimate true demand of Rs.53 million (column 3).

The five percent of the owner occupied units are assumed to be industrial units. The

difference between this amount and the Rs.18 million demanded in 2006-07 (column 2) is

the tax preference (Rs. 35 million).

Owner Occupied Commercial Units. The average tax demand on a rented

commercial unit is Rs.5488. We apply this rate to 59,400,000 owner occupied

commercial units and estimate a demand of Rs.247 million (column 3). The tax

preference in this case is Rs.188 million.

Industrial Units. We assume the number of industrial units to be equal to 5% of

residential properties, which comes to 3757. Then we apply the average tax of rented

commercial units to this number and estimate the demand for industrial units as Rs.21

million. We calculate the current demand from industrial units by applying the average

owner occupied residential rate to the number of units as Rs.2 million. The tax preference

is Rs.18 million.

Vacant lots. Assuming that vacant lots are equal to 5% of the residential property

units, we calculate a demand from vacant lots applying a rate 1.5 times the average tax on

rented residential units. It comes to Rs.6 million. Vacant lots are not taxed at all,

therefore the size of tax preference in this case is Rs.6 million.

5-marla units. Using ETD estimates, we calculate the number of 5 marla units to

be 150,284 (twice the number of residential properties on the tax roll). Then we apply a

rate equal to half of the average tax on rented residential units to calculate a demand of

Rs.82 million for this category.

The ETD has not developed a new roll. Assuming the property revaluation will

increase the current values by at least 1.5 times, we simulate for introduction of a new

roll and applying the factor of 1.5, project the demand from all the categories of property

(column 4). The demand in column 4 is net of the baseline demand in each category.

200 International Studies Program Working Paper Series

APPENDIX D

Method Used to Estimate Revenues from a Motor Fuel Tax in Punjab and NWFP

Punjab

The goal in this calculation is to estimate the tax rate for motor fuels in Punjab

that will lead to revenues of Rs 6,333 million, which is the amount necessary to cover

roadway expenditures. We calculated the tax rates going through the following steps:

1. In Punjab, according to the Ministry of Petroleum and Natural Resources,

Government of Pakistan data

120

, the consumption of diesel in 2006-07 was 3.982

million metric tons. For motor fuel, it was 0.714 million metric tons. This gives a

total of 4.696 million metric tons.

2. Using a weight-volume conversion used by the oil industry

121

, this can be

converted to 6,049 million liters of diesel and 1,013 million liters of motor fuel.

3. From the oil company advisory website,

122

we can find that the price of motor

fuel is Rs 53.7 for motor fuel and Rs 37.7 for HSD (diesel), an average for the

year.

4. The ad valorem base is the product of the consumption of gas (1,013 m litres) and

the price per litre (Rs 53.7), or Rs 54,369 million. For diesel it is (6,049 m litres)

* (Rs 37.7) = Rs 228,034 million. The total base for 2006-2007, then, is Rs

282,403 million.

5. We assume we want an ad valorem rate, in order to maintain an elasticity. We

further assume we want the same ad valorem rate for motor fuel (MS) and Diesel

(HSD).

6. The rate is calculated as the quotient of the revenue target (Rs 6,333 million) and

the base (Rs 282,403), and is equal to about 2.24 percent. It would be equivalent

to Rs.0.9 per liter (if we have the same rate for gasoline and diesel).

120

http://www.ocac.org.pk/province.asp

121

1 metric ton of diesel equals 1519 liters and 1 metric ton of regular motor fuel is 1418 liters at 86°F

(30°C); http://www.eppo.go.th/ref/UNIT-OIL.html

122

http://www.ocac.org.pk/province.asp.

Pakistan: Provincial Government Taxation 201

NWFP

The goal is again to estimate the tax rate for motor fuels in NWFP that will lead to

revenues of Rs 1,284 million, which is the amount necessary to cover roadway

expenditures.

1. In NWFP, the consumption of Diesel in 2006-07 was 1.221 million metric tons,

according to the Ministry of Petroleum, Government of Pakistan data

123

. For

motor fuel, it was 0.063 million metric tons. This gives a total of 1.284 million

metric tons.

2. Using a weight-volume conversion, this can be converted to 1,840 million liters of

diesel and 89 million liters of gasoline. Again we use the oil industry weight

volume conversions.

3. From the Oil company advisory website

124

, we can find that the price of motor

fuel is Rs 53.7 for motor fuel and Rs 37.7 for HSD (diesel).

4. The ad valorem base is the product of the consumption of gas (89 m litres) and the

price per litre (Rs 53.7) or Rs 4,797 million. For diesel it is (1840 m litres) * (Rs

37.7) = Rs 69,350 million. The total base for 2006-2007, then, is Rs 74,147

million.

5. We want an ad valorem rate, in order to maintain an elasticity. We further

assume we want the same ad valorem rate for motor fuel (MS) and Diesel (HSD).

6. The rate is calculated as the quotient of the revenue target (Rs 1284 million) and

the base (Rs 66995), and is equal to about 1.73 percent. This will be equivalent to

Rs.0.67 per liter if we used the same rate for diesel and gasoline.

123

http://www.ocac.org.pk/province.asp

124

http://www.ocac.org.pk/province.asp

202 International Studies Program Working Paper Series

The calculations are given in the following table:

Table D.1. Conversion and Rate Calculation

Revenue Target (Punjab) Rs 4,154 million

Punjab

Mil Mt

Tons

Conversion Factor

Million

Liters

Price/

Liter

Ad valorem base

(Rs.)

Rate

Diesel

3.982 1519 6,048.66 37.7 228,034.41

Motor fuel

0.714 1418 1,012.45 53.7 54,368.67

Total

4.696 7,061.11 282,403.08

Ad valorem rate 1.47

Specific rate

Diesel 0.52

Motor Fuel 1.00

Rev target (NWFP) Rs 677 million

NWFP

Mil Mt

Tons

Conversion Factor

Million

Liters

Price/

Liter

Ad valorem base

(Rs.)

Rate

Diesel

1.211 1519 1,839.51 37.7 69,349.49

Motor fuel

0.063 1418 89.33 53.7 4,797.24

Total

1.274 1,928.84 74,146.73

Ad valorem rate 0.91

Specific rate

Diesel 0.33

Motor Fuel 0.75

Notes:

The quantities of petroleum products are from http://www.ocac.org.pk/province.asp

Conversion factor used by oil industry, valid at 86 Fahrenheit or 30 Centigrade.

1 metric ton of diesel

equals 1519 liters and 1 metric ton of regular motor fuel is 1418 liters at 86°F (30°C); from

http://www.eppo.go.th/ref/UNIT-OIL.html

Rates have been arbitrarily chosen to achieve the revenue target.

Pakistan: Provincial Government Taxation 203

APPENDIX E

Table E.1. Policy Matrix UIPT Reforms

Structural and Administrative

Measures

Revenue impact

(in percent increase)

Comments

Punjab should bring in its new

valuation roll, and settle on the

definition of its tax base.

Punjab (13 percent) NWFP needs to acknowledge a

value based system and revise

its value coefficients; This

reform could be implemented

in two years.

Eliminate 5 marla ,vacant land,

and government property

exemptions

Punjab (17 percent)

NWFP (7 percent)

Introduce an exemption for low

value properties

Remove preferential treatment of

owner occupied property,

industrial property, and

governmental property.

Punjab (20 percent)

NWFP (49 percent)

Introduce an exemption for low

value properties

Index the Property Tax Base Punjab (4 percent)

NWFP (3 percent)

The alternative is a three year

valuation cycle, or both

measures could be adopted

Punjab should adopt a single

nominal rate

Depends on the rate adopted

The area-unit tax base should be

changed to square feet of land

and square feet of covered space.

n.a., but the result would be a

revenue increase, depending on

the rate adopted.

Would encourage a more

efficient use of land.

Carry out a survey of all

properties

This is necessary to complete a

proper valuation roll in both

province. Identification of new

properties would have a positive

revenue effect.

This will require additional

staff and training, and possibly

an expenditure for contractor.

Prepare a new valuation roll for

introduction after the survey is

completed.

If full market value is assessed,

the property tax base

might

double in value.

This will require additional

staff and training

Value all

properties, and separate

the valuation function from the

rate setting and exemption

function

Nil Allows the technical valuation

function to operate

independently from the

political rate setting and

exemption decisions

Do an annual sales ratio study The revenue impacts are indirect.

The sales-ratio study identifies

uniformity in assessment and can

be used to improve the valuation

process.

This will require additional

staff and training

204 International Studies Program Working Paper Series

APPENDIX E

Table E.1. Policy Matrix UIPT Reforms (continued)

Structural and Administrative

Measures

Revenue impact

(in percent increase)

Comments

Devolve rate setting powers to

city district governments and

TMAs

Revenue impacts will depend on

the efficiency with which the

local governments administer the

property tax, and on their

willingness to impose higher

effective rates.

This will require additional

staff and training

Note:

1. As a percent of total tax revenue in the province in 2005-2006.

Pakistan: Provincial Government Taxation 205

APPENDIX E

Table E.2. Policy Matrix Motor Vehicle Tax Reforms

Structural and Administrative

Measures (Comprehensive Reform)

Revenue impact

(in percent increase)

Comments

1 Unify registration and token tax into an

annual tax on motor vehicles, with a

simplified rate structure. Index the rates.

18 percent in Punjab, and

36 percent in NWFP, based

on three rates and a

consumer price index.

Would cover the cost of roadway

expenditures at present levels in

both provinces.

2 Fuel levy at an ad valorem rate, with rates

varying by province and by type of motor

fuel VS diesel

The increase would be 19

percent of present motor

vehicle tax revenues in

Punjab and 24 percent in

NWFP, based on an ad

valorem rate of two percent.

Tax rates could be set at levels

sufficient to raise the same

amount of many as does the

present motor vehicle tax regime.

Structural and Administrative

Measures (Piecemeal Reform)

Revenue impact

(in percent increase)

Comments

3 Registration Tax (a): adopt a residence

requirement, or

n.a. Revenues would

probably increase for both

NWFP and Punjab.

Enforcement and policing would

require new techniques, and the

allocation of additional resources

for administration.

4 Registration Tax (b): Double the nominal

tax rate in each vehicle class and

introduce a residence requirement, or

12 percent in Punjab and 16

percent in NWFP

Leakage of registrations would

probably be accelerated with the

higher rate.

5 Registration Tax (c): transfer to the

central government with agreement to

share the revenues on a basis’ of the size

of the road network.

NWFP would lose

revenues, but Punjab would

probably gain.

Would convert a provincial tax to

an intergovernmental transfer.

6 Annual (token) tax: increase and index

the specific rates.

The impact of the rate

increase depends on the rate

chosen. The impact of

indexing would be 5 percent

in NWFP, and 8 percent in

Punjab.

There could be a negative

compliance effect.

7 Do a census and computerize registration

records.

n.a., but the net impact

would be a revenue

enhancement.

Update and Computerize motor

vehicle registration records;

Require windscreen stickers or

number plate stickers

206 International Studies Program Working Paper Series

APPENDIX E

Table E.2. Policy Matrix Motor Vehicle Tax Reforms (continued)

Structural and Administrative

Measures (Comprehensive Reform)

Revenue impact

(in percent increase)

Comments

8 Token tax Collections:

Automate payment records to check

compliance

n.a., but the net impact

would be a revenue

enhancement.

Increased fines and penalties

would be a good supporting

reform.

9 Token tax and registration tax: Adopt a

unique tax identifier to enable a cross

check with at least the property tax

n.a., but the net impact

would be a revenue

enhancement.

Would require additional

resources.

Notes:

1. As a percent of total tax revenue in the province in 2005-2006.

2. We assume registration equals 1/3 of total collections reported under motor vehicle tax.

Pakistan: Provincial Government Taxation 207

APPENDIX E

Table E.3. Policy Matrix Professions Tax

Structural and Administrative

Measures

Revenue impact

(in percent increase)

Comments

(a) Abolish the tax Revenue loss of 1.0 percent of

total tax revenues in Punjab and 3

percent in NWFP

Delegate the tax to TMAs or

Union councils

(b) Convert to a 3 percent levy

on federal personal income

tax liability

6 percent in Punjab and 8 percent

in NWFP

Could be unconstitutional

services

n.a. Many professionals supply

services, and in some cases,

administration would be

feasible.

(d) Retain the present structure

but raise the rates.

n.a. Need a comprehensive survey

of professionals

(e) Convert to a business

registration fee, levied on a

presumptive basis

n.a. Employees would not be taxed

separately, but professionals

would be taxed separately.

(f) Carry out a complete survey

of tax base

This may be a duplication of

the work of the income tax

department though at present

the database of the department

is far from complete. There will

be a gain in doing it in

coordination with the IT

department.

Note:

1. As a percent of total tax revenue in the province in 2005-2006.

208 International Studies Program Working Paper Series

APPENDIX E

Table E.4. Policy Matrix land Tax Property Transfer Taxes

Structural and Administrative

Measures (Comprehensive

Reform)

Revenue impact

(in percent increase)

Comments

Eliminate transfer taxes in favor

of a unified annual tax on rural

land.

Revenue impact would depend on

the rate chosen, but with a new

survey and valuation, a 15 percent

increase in revenues from this

source would seem feasible. The

increase might be larger.

An annual tax would be levied

for all rural lands under this

new land tax. Lands used in

farming would be subject to

AIT. Urban lands would be

subject to the UIPT. No

property would be subject to

more than one tax. Preparatory

work could take three years.

Adopt a capital gains tax on real

property transfers.

Cannot estimate from available

data. Property transfers yielded

Rs.11.4 billion in Punjab and

Rs.0.7 billion in NWFP, so a

capital gains tax could yield a

higher amount.

This would be superior to the

present system of taxing

transfers as a surrogate for

capital gains, but would be

administratively difficult.

Could take three years to

design and introduce.

Structural and Administrative

Measures (Piecemeal Reform)

Revenue impact

(in percent increase)

Comments

Combine all property transfer

taxes into a single levy

Nil under present rates, unless

valuation is enhanced.

Aggregate rate will be held

constant; improves

transparency of the tax

Survey all properties and

produce an updated valuation

Table.

1.7 billion (8 percent of total tax

revenue) increase in Punjab and

Rs 101 million in NWFP (4

percent of total tax revenue),

assuming a 15 percent increase in

values.

This process could take 3

years, and would require staff

upgrading.

Upgrade staff to verify all

declared values.

Revenue increase would be

significant, but there are no data

on which to base on estimate.

Could be implemented in two

years. Would involve

significant administrative costs.

Note:

1. As a percent of total tax revenue in the province in 2005-2006.

Pakistan: Provincial Government Taxation 209

APPENDIX E

Table E.5. Policy Matrix Sales Tax on Services

Structural and Administrative

Measures

Revenue impact

(in percent increase)

Comments

Convert the sales tax on services

into a shared tax with separate

provincial and federal rate

setting.

Even after a doubling of revenues

at the province level, the sales tax

on services would still account for

less than one percent of GDP

originating in the “other services

sector. Revenue yield would be

Rs 2.2 billion in Punjab (10

percent of total tax revenue) and

Rs 420 million in NWFP (15

percent of total tax revenue).

Administration would be by the

federal government as is done

now.

Alternate Plan: Shift

responsibility for taxing services

fully to the provinces.

Nil in the short run. Collections could fall until

administrative skills were

developed.

Alternate Plan: No change in

structure.

Nil in the short run. Federal administration has been

unwilling to tax additional

services.

Note:

1. As a percent of total tax revenue in the province in 2005-2006.

210 International Studies Program Working Paper Series

APPENDIX E

Table E.6. Policy Matrix Agricultural Income Taxes

Structural and Administrative

Measures (Comprehensive

Reform)

Revenue impact

(in percent increase)

Comments

Reduce the exemption level in

Punjab to 5 acres

Increase AIT revenue in Punjab

by 38 percent

This would increase the scope

of the AIT in the Province and

bring it into line with treatment

in NWFP. A 5 acre exemption

is less generous than the Rs

150,000 federal individual

income tax threshold.

Increase the tax rates for a area-

based AIT; 7.5 acre exemption;

progressive rates

Increase AIT revenue by 11

percent in NWFP and by 21

percent in Punjab.

Increases the progressivity of

the tax and may be viewed as

more equitable; requires an

updating of the Agricultural

Census to keep track of farm

size and landowner.

Increase tax rates for area based

AIT; flat rate by crop type

Increase AIT revenue by 27

percent in NWFP and by 37

percent in Punjab.

Increases the equity of the tax

but requires that the authorities

keep current with crop type and

profitability and landowner.

Increase tax rates for area based

AIT; flat rate by crop type

Increase AIT revenue by 27

percent in NWFP and by 37

percent in Punjab.

Increases the equity of the tax

but requires that the authorities

keep current with crop type and

profitability and landowner.

Structural and Administrative

Measures (Administrative

Reform)

Revenue impact

(in percent increase)

Comments

Expansion of a withholding

system on agricultural inputs

n.a. This would increase the tax

handle associated with the tax;

however, it may not be

effective for much local

trading—is likely to be most

effective for government

transactions.

Create a withholding system for

AIT based on the sale of cash

crops

n.a. This would increase the tax

handles but would be most

effective for larger farmers.

Note:

1. As a percent of total tax revenue in the province in 2005-2006.

Pakistan: Provincial Government Taxation 211

APPENDIX E

Table E.6. Policy Matrix Agricultural Income Taxes (continued)

Structural and Administrative

Measures (Administrative

Reform)

Revenue impact

(in percent increase)

Comments

Introduce a self-assessment

scheme

n.a. This would move the AIT to a

more “modern” income tax;

however, it is unlikely to be

effective without massive

follow up by tax authorities and

detailed record keeping on the

part of the authorities for crop

type, ownership, and

profitability.

Expand the administrative data

to include estimates of the cost

of crops, prices of outputs

n.a. These changes are necessary at

the least in the case of a move

toward more income-based

measures. They require

updating of the crop reporting

and detailed maintenance of

ownership records.

Note:

1. As a percent of total tax revenue in the province in 2005-2006.

212 International Studies Program Working Paper Series

APPENDIX E

Table E.7. Policy Matrix: Other Taxes

Structural and Administrative

Measures (Administrative

Reform)

Revenue impact

(in percent increase)

Comments

Shift entertainment Tax to local

governments

Nil Would free up provincial level

tax administration resources

Shift Cotton and Tobacco Levies

to the agricultural income tax

Nil Would simplify the tax

structure.

Shift hotel tax and electricity

duty to the sales tax on services.

Nil Appropriate to tax these as

services. The effective tax rate,

would be higher so there could

be some revenue increase.

Note:

1. As a percent of total tax revenue in the province in 2005-2006.

Pakistan: Provincial Government Taxation 213

APPENDIX F

Illustrative Rate Reform for the Professions Tax

Existing Categories Existing Rate Proposed Categories Proposed Rates

Persons engaged in any Profession, trade, calling either wholly or

part time within the Province whose monthly income or earning

i) When exceeds Rs 3000 but does not exceed Rs 5000

ii) when exceeds Rs 5000 but does not exceed Rs 10,000

iii) When exceeds Rs 10,000

Rs 100

Rs 150

Rs 200

All persons engaged in any Profession, trade, calling

or employment, other than those mentioned

hereinafter, within the Province of NWFP, whether

Provincial or Federal employees

i) When exceeds Rs 6000 but does not exceed Rs

10,000

ii) when exceeds Rs 10,000 but does not exceed Rs

20,000

iii) When exceeds Rs20 ,000

Rs 100

Rs 150

Rs 200

Companies registered under the Companies Ordinance 1984

with paid up capital

a. Exceeding Rs 0.2 million but not exceeding Rs 1.0 million

b. Exceeding Rs 1.0 million but not exceeding Rs 2.5 million

c. Exceeding Rs 2.5 million but not exceeding Rs 10 million

d. Exceeding Rs 10 million but not exceeding Rs 50 million

e. Exceeding Rs 50 million but not exceeding Rs 100 million

f. Exceeding RS 100 million

Rs 1000

Rs 3000

Rs 6000

Rs 10,000

Rs 25,000

Rs 50,000

All limited Companies, Modarbas, Mutual Funds,

and any other body corporate with paid capital or

paid up capital and reserves in the preceding year

which ever is more

a. not exceeding Rs 10 m

b. exceeding Rs 10 m but not exceeding Rs 25

million

c. exceeding Rs 25 m but not exceeding Rs 50

million

d. exceeding Rs 50 m but not exceeding Rs 100

million

e. exceeding Rs 100 m but not exceeding Rs 200 m

f. exceeding Rs 200 million

EXPLANATION:

The paid capital in the case of foreign banks shall be

the minimum paid up capital as determined by the

State Bank of Pakistan

Rs 10,000

Rs 15,000

Rs 20,000

Rs 50,000

Rs 75,000

Rs 100,000

214 International Studies Program Working Paper Series

APPENDIX F

Illustrative Rate Reform for the Professions Tax

(continued)

Existing Categories Existing Rate Proposed Categories Proposed Rates

Persons other than Companies owning factories and commercial

establishments with ten or more employees

Rs 750

Persons other than Companies owning factories,

commercial establishments, Private Educational

Institutions and Private Hospitals with ten or more

employees

Rs 1500

Persons holding licenses under the Import and Export Control

Act who during the preceding financial year have imported or

exported goods of the value of

a. not exceeding Rs 50,000

b. exceeding Rs 50,000



Rs 1000

Rs 1500

Holders of import or export license under the Import a

Export Act assessed to income tax in the preceding ye

with annual turn over

a. not exceeding Rs 500,000

b. exceeding Rs 0.5 million but not exceeding Rs 5 m

c. exceeding Rs 5 m but not exceeding Rs 25 m

d. exceeding Rs 25 m but not exceeding Rs 100 m

e. exceeding Rs 100 m but not exceeding Rs 500 m

f. exceeding Rs 500 m but not exceeding Rs 1000 m

g. exceeding Rs 1000m

Rs 1500

Rs 2500

Rs 5,000

Rs 7,500

Rs 10,000

Rs 30,000

Rs 75,000

Clearing Agents licensed or approved as Custom House Agents Rs 1000 Same Rs 1500

Travel Agents

a. IATA

b. Non-IATA

Rs 5000

Rs 2000

Travel Agents

A .IATA

b. Non-IATA

Rs 7500

Rs 3000

Restaurants and Marriage Halls Rs 5000 Restaurants Rs 7500

Advertising Agencies RS 1000 Advertising Agencies Rs 5000

Doctors

a. Specialists

b. Non Specialists including Medical Practitioners, Hakeems

and Homeopaths

RS 1000

Rs 300

Same

Rs 1500

Rs 500

Pakistan: Provincial Government Taxation 215

APPENDIX F

Illustrative Rate Reform for the Professions Tax

(continued)

Existing Categories Existing Rate Proposed Categories Proposed Rates

Clinical Laboratories

a. Located at Peshawar and Abbotabad

b. Located at other places

Rs 5000

Rs 1000

Clinical Laboratories including pathological and

chemical laboratories

a. Located at Peshawar and Abbotabad

b. Located at other places

Rs 7500

Rs 1500

Contractors/Suppliers/Consultant who during the preceding

financial year supplied to the federal or any provincial

government or any local authority goods, commodities, or

rendered service of the value

a. exceeding Rs 10,000 but not exceeding Rs 1 million

b. Exceeding Rs 1 million but not exceeding Rs 2.5 million

c. Exceeding Rs 2.5 million

Rs 1000

Rs 1500

Rs 5000

Contractors/Suppliers/Consultant who during the

preceding financial year supplied to the federal or

any provincial government or any local authority

goods, commodities, or rendered service of the value

a. exceeding Rs 10,000 but not exceeding Rs 1

million

b. Exceeding Rs 1 million but not exceeding Rs 2.5

million

c. Exceeding Rs 2.5 million

Rs 2000

Rs 3000

Rs 10000

Petrol Pumps whose commission earned in the

preceding year

a. does not exceed Rs 0.2 m

b. exceeding Rs 0.2 m but does not exceed Rs 0.4 m

c. exceeding Rs 0.4 m but does not exceed Rs 0.6 m

d. exceeding Rs 0.6 million

Rs 1500

Rs 2500

Rs 3500

Rs 4000

All establishments including video shops, real estate

shops/agencies, car dealers not assessed to income

tax in the preceding financial year

Rs 1000.

Note:

1. Based on correspondence with a reviewer.

216 International Studies Program Working Paper Series

Glossary of Terms

FATA: Federally Administered Tribal Areas; they are not part of NWFP

but traditionally the Governor of NWFP exercises executive

authority over them as an agent of the federal government and

administers them through political agents. Provincial civil servants

are seconded to work in the FATA.

1. Bajaur Agency

2. Mohmand Agency

3. Khyber Agency

4. Kurram Agency

5. Orakzai Agency

6. North Waziristan Agency

7. South Waziristan Agency

Frontier Regions In addition to the two categories above there are smaller tracts of

land in some districts which are called FR Regions; they are part

of the districts but are administered under the federal laws. Some

are

Kala Dhaka (or Black Mountain) in Mansehra

Darra in Kohat

FR Bannu

FR Tank

Cantonment Urban areas administered by the army under a special

law. They are mostly the best areas in most cities, sustained by

subsidized development, low or no taxes. Most of the land is

owned by army which is given out on long term lease.

Nazim

Elected head of the local government; there are Zila, Tehsil and

Union Nazims. Naib Nazim heads the council.

PATA Provincially Administered Tribal Area

1. District Kohistan

2. District Swat

3. District Shangla

4. District Buner

5. District Upper Dir

6. District Lower Dir

7. District Chitral

8. Malakand Agency

Pakistan: Provincial Government Taxation 217

Patwari The junior most field officer of the land revenue department. (See

Box 8).

Tehsil When used to describe a unit of area It is a conglomeration of

revenue estates; When used to describe an administrative unit. It is

a sub-district; a Tehsildar heads a tehsil and supervises the work of

Kanungos and Patwaris working for him.

When used in local government tehsil Municipal Administration is

the second tier of local government in rural areas (in urban areas

the second tier is called Town); it has an elected council and an

indirectly elected Nazim; their mandate is to provide municipal

services. Property tax (85 percent of the revenue) has been

assigned to the TMA under the new law.

Tehsildar In charge of the land revenue administration in a Tehsil

Ushr

A tax based on religious tradition; literally means one-tenth. It is

levied on agricultural produce: 1/10 of the produce if the land is

not irrigated; 1/20 if the land is irrigated

WAPDA Water and Power Development Authority is a public sector

monopoly with a mandate for power generation, transmission and

distribution all over the country, except Karachi. It also manages

water reservoirs, barrages and link canals, feeding provincial

irrigation networks.

Zakat A religious tax; the base is all kinds of wealth which has not been

put to any use for a 12 month period. The state collects in from

bank accounts. People pay it on their own and have a choice of

giving it to the government or give it to private charities.

Overwhelmingly the second option is taken.

218 International Studies Program Working Paper Series

Table 1. Disparities in Economic Condition

Variable Pakistan Punjab NWFP

Population

(in millions) 161.7 91.2 21.2

(percent of Pakistan) - (56) (13)

Per capita GDP (in rupees)

49,200 48,362 34,307

(percent of Pakistan) - (98) (69)

Percent of GDP

Agriculture 19.3 27.0 29.6

Manufacturing 17.3 16.1 16.1

Percent of population below poverty line

34.5 45.8 44.6

Land area (sq kms)

796 205 74

(percent of Pakistan) (26) (9)

Urban population (millions) 53.9 28.6 3.9

(percent in urban areas)

(33) (31) (18)

Percent increase in real per capita GDP(1998-06)

23.4 22.9 23.1

Notes:

Provincial populations are based on the estimates for 2006 prepared by National Institute of Population

Studies. National population for 2006 reported from Government of Pakistan (2007)

Calculations for the national per capita GDP are based on data from Table 1.5 in Government of

Pakistan (2007), for the Punjab estimate we have relied on Punjab Bureau of Statistics GDP tables and

for the NWFP per capita GDP we have used data from NWFP Finance Department. Government of

Punjab estimates GDP to have reached Rs.59,219 per capita in 2007, (reported in Government of

Punjab 2007e, p.2)

Table 1.5, Statistical Appendix, Government of Pakistan (2007) for the national percentages. The GDP

percentages for NWFP are for the year 2002-03 from Government of NWFP (2005) and for Punjab the

percentages are for the year 2002-03 from Table 1.5 in Government of Punjab (2005).

The poverty data are for year 2002 from Sohail J. Malik (2004), p. 12-13, a background study carried

out by PRSP Secretariat, Ministry of Finance; Government of Punjab estimates poverty in 2007 at 21

percent (reported in Government of Punjab, 2007e, p.8). The World Bank (2007) estimates that 35

percent of NWFP households lived below the poverty line in 2001-2002.

Government of Pakistan 2007

Planning Commission of Pakistan

Calculated from Table 1.5, Statistical Appendix, Government of Pakistan (2007), Punjab Planning and

Development Board GDP tables and NWFP Finance Department data.

Pakistan: Provincial Government Taxation 219

Table 2. Budgetary Position Punjab 2006-07

(Rupees in millions)

Budgetary Position

2006-07

1. General Revenue Receipts

276,252

1.1 Federal Transfers

191,264

1.2 Provincial tax revenue

31,456

1.3 Provincial non tax revenue

35,184

1.4 Development /Non-development grants

18,348

2. Current Revenue Expenditure

201,081

3. Surplus (1-2)

75,171

4. Current Capital expenditure

87,681

4.1 Account - I

4.1.1 Foreign & Domestic Debt Management (Charged)-CDLs

6,367

4.1.2 Intergovernmental transfers

9,283

4.1.3 State Trading (Medical Store Depot)

Total Expenditure - I

15,661

4.2 Account – II

4.2.1 State Trading- Wheat a/c

39,289

4.2.2 Domestic Debt (Charged)Cash credit from Commercial banks

32,732

Total Expenditure - II

72,020

5. Development Expenditure

137,112

5.1 Development Revenue Expenditure-General public service, safety

affairs, economic affairs, health, local government, Agriculture etc

68,817

5.2 Development Capital Expenditure- Irrigation, town development,

roads, bridges, Government buildings, loans to municipalities etc

68,295

6. Gross Deficit 3-4-5

-149,622

7. General Capital receipts- Account I

7.1 Recoveries of loans from Local Governments, government servants,

Non-Bank Financial Institutions 670

7.2 Permanent foreign debt- PRMP, ESR, ASPL II, etc

24,880

8. General Capital Receipts- Account II

8.1 State trading schemes receipts

39,036

8.2 Floating debt- Cash credit accommodation

32,984

9. Development Capital Receipts-foreign debt from federal government 8,876

10. Total Capital receipts (7+8+9)

106,445

11. Net deficit (6+10)

-43,176

Notes:

Government of Punjab (2007i)

Cash development loans (CDLs) are long term federal loans to provincial governments for capital

development expenditures.

220 International Studies Program Working Paper Series

Table 3. Budgetary Position Punjab 2006-07

(Rupees in millions)

Budgetary Position (Rupees in millions) 2006-07

1. General Revenue Receipts 276,252

1.1 Federal Transfers 191,264

1.2 Provincial tax revenue 31,456

1.3 Provincial non tax revenue 35,184

1.4 Development /Non-development grants 18,348

2. Current Revenue Expenditure 285,558

2.1 General (Salaries, Operation & Management) 201,081

2.2 Intergovernmental grants 9,283

2.3 State trading (medical store) 11

2.4 Development revenue expenditure 68,817

2.4 Foreign and domestic debt 6,367

3. Wheat trading operations 0

3.1 State trading (wheat account) receipts 39,036

3.2 Floating debt-cash credit accommodation (short term loans) 32,984

3.3 State trading (wheat account) purchase 39,289

3.4 Domestic debt, commercial banks, (repayment of short term loans) 32,732

A. Current Deficit (1-2+3)

-9,307

4. Capital expenditure

68,295

4.1 Development capital expenditure 68,295

B. Overall Deficit (A+3)

-77,602

5. Financing 34,425

5.1 Recoveries of loans from LG, civil servants, NBFI 670

5.2 Permanent foreign debt (PRMP, ESR, ASPL II etc) 24,880

5.3 Development capital receipts-foreign debt 8,876

C. Uncovered Deficit (4-B)

-43,176

Note:

Government of Punjab (2007i)

Pakistan: Provincial Government Taxation 221

Table 4. Budgetary Position NWFP 2006-07

(Rupees in millions)

Budgetary Position (Rupees in millions)

2006-07

1. General Revenue Receipts

66,142

1.1 Federal Transfers

44,645

1.2 Provincial tax revenue

3,050

1.3 Provincial non tax revenue

18,448

2. Current Revenue Expenditure

55,174

3. Surplus (1-2)

10,969

4. Current Capital expenditure

14,869

4.1 Account - I

4.1.1 Foreign & Domestic Debt Management (Charged)-CDLs

4,204

4.1.2 Loans to government servants and Non financial institutions

Total Expenditure - I

4,228

4.2 Account - II

4.2.1 State Trading- Wheat a/c

8,161

4.2.2 Domestic Debt (Charged)Cash credit from Commercial banks

2,480

Total Expenditure - II

10,641

5. Development Expenditure

29,501

5.1 Development Revenue Expenditure-General public service, safety

affairs, economic affairs, health, Local government, Agriculture etc

5,589

5.2 Development Capital Expenditure- Irrigation, town development,

roads, bridges, Government buildings, loans to municipalities etc

23,912

6. Gross Deficit 3-4-5

-33,401

7. General Capital receipts- Account I

7.1 Recoveries of loans from Local Governments, government servants,

NBFIs

400

7.2 Permanent foreign debt- Program loans etc

7,930

8. General Capital Receipts- Account II

8.1 State trading schemes receipts

4,409

8.2 Floating debt- Cash credit accommodation

2,139

9. Development Capital Receipts-foreign debt from federal government 9,212

10. Total Capital receipts (7+8+9)

24,090

11. Net deficit (6+10)

-9,310

Notes:

Government of NWFP (2007b).

Cash development loans (CDLs) are long term federal loans to provincial governments for capital

development expenditures.

222 International Studies Program Working Paper Series

Table 5. Budgetary Position NWFP 2006-07

(Rupees in millions)

Budgetary Position (Rupees in millions) 2006-07

1. General Revenue Receipts 66,142

1.1 Federal Transfers 44,645

1.2 Provincial tax revenue 3,050

1.3 Provincial non tax revenue 18,448

1.4 Development /Non-development grants

2. Current Revenue Expenditure 64,990

2.1 General (Salaries, O&M) 55,174

2.2 Foreign and domestic debt 4,204

2.3 Loans to civil servants & non-financial institutions 24

2.4 Development revenue expenditure 5,589

3. Wheat trading operations -4,093

3.1 State trading (wheat account) receipts 4,409

3.2 Floating debt- cash credit accommodation (short term loans) 2,139

3.3 State trading (wheat account) purchase 8,161

3.4 Domestic debt, commercial banks, (repayment of short term loans) 2,480

A. Current Deficit (1-2+3)

-2,941

3. Capital expenditure 23,912

3.1 Development capital expenditure 23,912

B. Overall Deficit (A+3)

-26,853

4. Financing 17,542

4.1 Recoveries of loans from LG, civil servants, NBFI 400

4.2 Permanent foreign debt (Program loans, SACs) 7,930

4.3 Development capital receipts-foreign debt 9,212

C. Uncovered Deficit (4-B)

-9,310

Note:

Government of NWFP (2007b).

Pakistan: Provincial Government Taxation 223

Table 6. Intergovernmental Fiscal Profile of the Four Provinces

Year

Own Source Revenue

as a Percent of GDP

Per Capita

Expenditures

Intergovernmental Transfers

as a Percent of Total Revenues

NWFP Punjab NWFP Punjab Balochistan NWFP Punjab Sindh

1999-2000 0.7 - - - 94 86 81 84

2000-01 0.7 - - - 94 88 82 82

2001-02 0.8 0.6 - - 94 86 83 82

2002-03 0.7 0.7 - 1,645 94 88 83 82

2003-04 0.7 0.7 - 1,845 92 86 80 81

2004-05 0.7 0.8 2,575 2,877 92 88 81 81

2005-06 0.6 0.7 4,086 3,396 92 88 83 81

2006-07 - - 4,485 4,604 - - - -

Source: Calculated from data provided by the World Bank, Islamabad

Note:

Includes only NFC transfers.

224 International Studies Program Working Paper Series

Table 7. Fiscal Comparisons: Provincial Level Governments

Country Years

Percent of Total Government

Expenditure by

Provincial Governments

Intergovernmental Transfers as

a Percent of

Total Provincial Revenues

Pakistan

2006-2007 35 83

India 2003 50 37

Russia

- 47 75

Argentina

2004 40 19

South Africa

2005 45 96

Malaysia

2003 8 35

Sources:

Calculated from Table 4.2, Statistical Appendix, Government of Pakistan 2007. It reports revised

estimates for the year.

IMF (2007) and Martinez, Rider, and Wallace (forthcoming)

IMF (2006)

Pakistan: Provincial Government Taxation 225

Table 8. Revenue Structure of Provincial Governments in 2005-2006

Punjab NWFP

Rupees

(in millions)

Percent of own

source revenues

Rupees

(in millions)

Percent of own

source revenues

Direct Taxes:

Urban Property Tax

674 2.28 300 6.70

Agriculture income tax

658 2.23 70 1.56

Registration fee (Transfer of Property)

2,113 7.15 42 0.94

Land revenue

(includes mutation fee

3,392 11.48 330 7.37

Taxes on professions, trades & callings

225 0.76 75 1.67

Indirect Taxes:

Motor vehicle tax

4,154 14.06 677 15.11

GST on Services

2,224 7.53 420 9.37

Stamp duties

5,859 19.83 300 6.70

Entertainment tax

13 0.04 13 0.29

Electricity duties

1,270 4.30 270 6.03

Hotel tax

245 0.83 29 0.65

Provincial excises

846 2.86 30 0.67

Education cess

0 0.00 57 1.26

Cotton cess

443 1.50 - 0.00

Other

31 0.11 43 0.96

Total

22,180 74.97 2,762 59.27

Source: Calculations are based on provincial revenue time series data provided by the World Bank, Islamabad.

Notes:

Own source revenue is a total of tax and non tax receipts.

Includes transfers by mutation and miscellaneous land revenue.

The "other" category is calculated as a residual and there are wide variations between years, indicating there may be changes in classification. The NWFP

collection reported under "other" is Rs.150 for 2005-2006, while it was less than Rs.5 million in the three preceding years. We use the average amount of the

four years for this table.

The total does not add to 100 percent because non-tax receipts are not included. The total for NWFP is based on actual collections in 2005-2006 and does not

use the calculation for others described in note ‘c’.

226 International Studies Program Working Paper Series

Table 9. Revenue Mobilization in Punjab and NWFP, 2002-2006

Revenue Source

Punjab NWFP

Revenue as a percent of GDP Revenue as percent of GDP

2001-2002 2005-2006 2001-2002 2005-2006

Urban Property Tax 0.001 0.026 0.039 0.041

Excise Duty 0.021 0.019 0.005 0.004

Land taxes 0.086 0.077 0.049 0.045

Motor Vehicle Taxes 0.064 0.094 0.110 0.093

Professions Tax 0.007 0.005 0.010 0.010

Other Taxes 0.000 0.001 0.014 0.005

Fees and Charges 0.196 0.135 0.255 0.209

Total 0.375 0.358 0.482 0.424

Source: Calculations based on provincial revenue time series data provided by the World Bank, Islamabad

Pakistan: Provincial Government Taxation 227

Table 10. The Changing Reliance on Intergovernmental Transfers

by Provincial Governments

Period

Per Capita Transfer

Amount (nominal)

a,b

(in Rupees)

Per Capita Transfer

Amount (in real terms)

(in Rupees)

Percent of Total Federal

Transfers to

four Provinces

Punjab NWFP Punjab NWFP Punjab NWFP

1999-2000 889 889 889 889 51 12

2000-01 984 977 909 903 52 12

2001-02 990 974 894 880 51 12

2002-03 1,111 1,136 961 982 52 12

2003-04 1,076 1,172 864 941 51 13

2004-05 1,427 1,495 1070 1122 53 13

2005-06 1,562 1,653 1073 1135 52 13

Sources:

Calculations are based on:

Provincial revenue time series data provided by the World Bank, Islamabad

NIPS population data

FBS GDP deflator

Note: Transfers reported here include only the NFC award.

228 International Studies Program Working Paper Series

Table 11. The Growth in Federal Transfers

Note:

Transfers include only shared taxes.

Years

Total Federal

Transfers as

percent of GDP

Total Federal

Expenditures as

percent of GDP

Federal Transfers as

percent of Federal

Expenditures

2000-2001 3.64 - -

2001-2002 3.60 - -

2002-2003 3.74 - -

2003-2004 3.28 10.33 31.77

2004-2005 3.62 10.46 34.63

2005-2006 3.53 10.26 34.38

Sources:

Table 5.10, Government of Pakistan (2007)

For federal expenditures we used Table 5.10, Government of Pakistan (2007) and for transfers we have

relied on the provincial time series data provided by the World Bank, Islamabad.

Years

Transfers received as percent of

Provincial GDP

Transfers received as percent

of Total Expenditure

Transfers received as percent of

Total Federal transfers

Punjab NWFP Punjab NWFP Punjab NWFP

2000-2001 3 5 - - 52 12

2001-2002 3 5 - - 51 12

2002-2003 3 5 68 - 52 12

2003-2004 3 5 58 - 51 13

2004-2005 3 5 50 58 53 13

2005-2006 3 5 46 40 52 13

Pakistan: Provincial Government Taxation 229

Table 12. Revenue Performance of the Urban Immovable Property Tax

Years

Per capita Nominal Amount

(Rupees)

Per capita Real Amount

(Rupees)

a,b,c

Percent of

Own source revenue

Percent

of GDP

d,e

NWFP Punjab NWFP Punjab NWFP Punjab NWFP Punjab

1999-2000 3.63 2.39 3.628 2.39 2.55 1.14 0.019 0.009

2000-01 7.19 5.86 6.641 5.42 5.23 2.74 0.036 0.020

2001-02

8.26 0.33 7.464 0.30 5.19 0.17 0.039 0.001

2002-03 7.72 11.67 6.677 10.10 4.96 5.22 0.034 0.036

2003-04 10.78 10.73 8.654 8.62 5.80 3.93 0.042 0.029

2004-05 10.20 18.44 7.651 13.83 5.09 5.70 0.034 0.044

2005-06 14.17 12.45 9.733 8.55 6.54 3.84 0.041 0.026

Sources:

Calculations are based on:

Provincial revenue time series data provided by the World Bank, Islamabad

NIPS population data

FBS GDP deflator

Punjab Bureau of Statistics, provincial GDP estimates

NWFP GDP estimates from Government of NWFP (2005)

In 2001-2002 the one year dip in collections in UIPT collection occurred due to the legal challenges to

the new valuation roll.

Note: Base Year = 1999-2000

230 International Studies Program Working Paper Series

Table 13. International Comparison of Property Tax Revenues: Selected Countries

Country

Percent of GDP

Pakistan

Punjab 0.026

NWFP 0.041

Chile 0.7

Ethiopia 0.5

Croatia 0.2

Indonesia 0.1

Slovak Republic 0.6

Sri Lanka 0.7

Thailand 0.3

Hungary 0.3

Poland 1.1

Argentina 0.9

Mexico 0.3

South Africa 0.7

Sources:

Bahl and Martinez-Vazquez (forthcoming) and calculations from IMF (2005) for all the countries

reported in the table except Pakistan

The Pakistan provincial percentages are authors’ calculations reported in Table 12.

Pakistan: Provincial Government Taxation 231

Table 14. Revenue Impact of Removing Preferential Property Tax Treatment in Punjab

(Columns 2 to 6 are in rupees)

Property Class

(1)

Number of

Property units

(2)

Property Tax

Demand in 2007

(3)

Demand

including the

taxation of

exemptions

(4)

Additional

Revenue (1)

(5)

Projected Demand

with New Roll

(6)

Additional

Revenue (2)

A. Total residential units

569,718 1,146,134,484

owner occupied (OO) units 383,021 451,923,976 1,353,011,408

901,087,432 2,435,420,534 1,983,496,558

Rented units 186,697 694,210,508 694,210,508 1,249,578,914 555,368,406

B. Total Commercial units

496,826 1,742,684,401 -

Commercial (OO) 234,986 580,013,405 1,043,428,837 463,415,432 1,878,171,907 1,298,158,502

Commercial (Rented) 261,840 1,162,670,996 1,162,670,996 - 2,092,807,793 930,136,797

C. Assumptions

industrial units

28,485.9 57,306,724 126,488,427

69,181,703 227,679,169 170,372,444

vacant lots 28,485.9 0 158,882,478.2 158,882,478 285,988,461 285,988,461

5 marla units

1,139,436 0 2,118,433,042

2,118,433,042 3,813,179,476 3,813,179,476

Total

2,888,818,885 6,657,125,696 3,711,000,087 11,982,826,253 9,036,700,644

Notes:

We have used demand/unit for projections, since ARV estimates are not available for each type of property unit

For OO, owner occupied, (residential and commercial) units, we have used the demand/unit of rented units for projections

Industrial units are assumed to be 5 percent of total residential units

5 marla units are assumed to be 2/3 of all units (200 percent of currently taxed residential units)

For industrial units, we use 1.5 x demand/unit of rented commercial unit

For 5 marla units, we use 1/2 the demand/unit of ordinary rented residential unit to cater to a lower than average value

Additional Revenue (1) is the difference between column 3 and 2 (using zero demand for industrial units since it is counted already in the residential units

for the base year).

The actual demand for 2007-2008 when projected by a factor of 1.8 equals the projected demand with the new roll. We use this factor to project the demands

in each category.

Additional Revenue (2) is difference between columns 5 and 2

232 International Studies Program Working Paper Series

Table 15. Illustrative Property Tax Reform Program for Punjab

(Rupees in millions)

Revenue Impacts of Reform Package Amount

1. Revenue Target 2006-07

25,478

2. PT Collection 2006-2007 2,311

3. Gap 23,167

4. Revenue impact of introducing a new valuation roll on the existing

tax base

2,889

5. Revenue impact of base broadening measures after introduction of

the new roll

7,551

6. Indexation (Additional Revenue)

827

7. Payment in lieu of tax 611

8. Revenue gap [3-(4+5+6+7)] 11,289

9. Property tax rate required to cover the gap

0.40

Notes:

Revenue target is 0.5% of Provincial GDP (we use GDP estimate for 2006-07 by Punjab Bureau of

Statistics)

Revenue impact is based on the assumption that a new roll is introduced for 2006-07. This is

computed by subtracting the actual collection in 2005-06 from the new demand worked out by ETD

after revaluation.

Net impact of removal of exemption for 5 marla properties, vacant properties and provincial

government properties, and removing preferential treatment for owner-occupied properties and

industrial properties. For details see Appendix B.

See column 4, Table 16.

We use a rate of 22 percent (an average statutory tax rate, considering the nominal rates of 20% and 25

percent) to calculate ARV of the assessed property from the actual collection. Then we add the

projected revenue from reform to the baseline collection and calculate the new ARV, using an effective

tax rate of 22 percent. To conclude we use the calculated ARV and the total revenue target to calculate

the effective tax rate required to bridge the gap.

Pakistan: Provincial Government Taxation 233

Table 16. Simulation of the Effects on Indexing the Property Tax in Punjab

(in Rupees)

Notes:

Base year for Column 3 is 2002-2003, the first year when the new roll prepared in 2001-2002 was

implemented.

The property tax collection for 2006-07 is the estimated collection from Government of Punjab

(2007i).

Rs.5.2 billion was the projected demand in 2006-2007 with the proposed introduction of the new roll.

Since the new roll was not implemented in 2006-2007 and is expected to be enforced in 2007-2008, we

have moved the 2006-07 target to 2007-2008.

The annual increase with indexation.

We apply a factor of 1.8 to the actual collection in 2004-2005 to project the demand for 2005-2006.

Then for 2006-2007, we apply the average rate of increase in property tax collection from 2003-2004

to 2005-2006 to the calculated demand for 2005-2006. For 2007-2008, we assume that the demand will

be the same as projected after introduction of the new roll.

Calculated as the difference between projected collections in 2008 and 2007.

Year

(1)

Index (t-1)

(2)

Actual

Collections

(3)

Indexed

Collections

(4)

Revenue increase

(5)

3-year

revaluation

2001-2002 100 27,580 - - -

2002-2003 107.7329 994,000 994,000 - 994,000

2003-2004 115.30144 935,227 1,007,547 72,320 935,227

2004-2005 125.93201 1,643,776 1,895,297 251,521 1,643,776

2005-2006

135.77545 1,135,444 1,429,887 294,443 2,958,797

2006-2007

146.39 2,311,055 3,137,846 826,790 4,171,903

2007-2008 156.64 5,200,000 5,200,000 - 5,200,000

One-yr increase

- 2,888,945 2,062,154 - 1,028,097

234 International Studies Program Working Paper Series

Table 17. The Tax Rate Structure in NWFP

(Rupees per area unit)

Location Residential Commercial

A 1.5 9

B 1.25 7

C 1.0 5

D 0.75 3

Source: Excise and Taxation Department, NWFP

Pakistan: Provincial Government Taxation 235

Table 18. Revenue Impact of Removing Preferential Property Tax Treatment in NWFP

(Columns 2 to 6 in rupees)

Property Class

(1)

Number of

Property units

(2)

Property Tax

Demand in 2007

(3)

Demand

including

taxation of

exemptions

(4)

Additional

Revenue (1)

(5)

Projected

Demand with

New Roll

(6)

Additional

Revenue (2)

A. Total residential units

100,742

144,595,690

owner occupied (OO) units 74,771 91,440,383 145,383,377 53,942,994 218,075,066 126,634,683

Rented units 25,971 53,155,307 53,155,307 79,732,961 26,577,654

B. Total Commercial units

174,446 129,438,113

Commercial (OO) 129,090 95,784,204 396,316,317

300,532,113 594,474,475 498,690,271

Commercial (Rented) 45,356 33,653,909 139,246,273

105,592,364 208,869,410 175,215,501

C. Assumptions

industrial units 5,037

7,229,785 15,464,283

8,234,499 23,196,425 15,966,640

vacant lots 5,037

0 15,464,283 15,464,283 23,196,425 23,196,425

5 marla units

124,207

0 127,109,337

127,108,337 190,662,505 190,662,505

Total

274,033,803 610,874,589 1,338,207,265 1,056,943,678

Notes:

The number of residential units include properties above 5-marla only and is based on ETD, NWFP records

We have used demand/unit for projections, since ARV estimates are not available for each type of property unit. For details see Appendix C.

For the commercial properties, the break up for owner occupied and rented categories is not available; we have used the average tax for both categories

We use 1.5 times the average tax rate of rented residential property to calculate demand for commercial property, assuming that it will be higher for the

commercial category.

Industrial units are assumed to be 5 percent of total residential units.

Vacant lots are assumed to be 5 percent of the residential units.

The number of 5 marla units is based on ETD, NWFP estimates

To calculate the demand for industrial units, we use 1.5 times the average tax rate of a rented residential unit.

To calculate the demand for 5 marla units, we use 1/2 the demand/unit of rented residential units.

Projections with the introduction of a new roll assume an increase by a factor of 1.5 for each category.

236 International Studies Program Working Paper Series

Table 19. Illustrative Property Tax Reform Program for NWFP

(Rupees in millions)

Revenue Impacts of Reform Package (2005-2006 data) Rupees in millions

1. Revenue Target 2005-2006

3,631

2. PT Collection 2005-2006 300

3. Gap 3,331

4. Revenue impact of introducing a new valuation roll on the existing

tax base

150

5. Revenue impact of base broadening measures after introduction of

the new roll

1,030

6. Indexation (Additional Revenue)

7. Payment in lieu of tax

511

8. Revenue gap [3-(4+5+6+7)] 2,073

9. Percent increase in location coefficient required to cover the gap 200

Notes:

Revenue target is 0.5 percent of the provincial GDP for 2005-2006 from Government of NWFP

(2005).

NWFP does not have a projected demand based on a new roll. We assume it will be 1.5 times the

2005-06 demand.

Net impact of removal of exemptions for owner occupied units, higher rates for industrial property,

taxation of vacant plots (from Table 18, adjusted for the additional revenue for rented residential units

category).

Using 2002-2003 as the base line year (see Table 20).

Payment in lieu of taxes calculated as 12 percent of ARV (Government expenditure is 12 percent of

GDP).

Pakistan: Provincial Government Taxation 237

Table 20. Simulation of the Effects on Indexing the Property Tax in NWFP

(in Rupees)

Notes:

Base year for Column 3 is 2002-2003.

The revenue increase column gives the annual increase with indexation.

We show the impact of a 3-year valuation by projecting a new demand for 2005-2006, assuming a 1.5

times increase on the revenue collected in 2004-2005.

Year

(1)

Index (t-1)

(2)

Actual

Collections

(3)

Indexed

Collections

(4)

Revenue increase

(5)

3-year

revaluation

2001-2002 100 159,556,748 - - -

2002-2003 107.73 152,536,587 152,536,587 - 152,536,587

2003-2004 115.30 218,000,000 234,857,711 16,857,711 218,000,000

2004-2005 125.93 211,000,000 243,286,048 32,286,048 211,000,000

2005-2006 135.77 300,000,000 377,796,038 77,796,038 360,000,000

2006-2007 146.39 - - - -

2007-2008 156.64 - - - -

238 International Studies Program Working Paper Series

Table 21. Revenue Performance of Motor Vehicle Tax

Years

Per capita Nominal Amount

(Rupees)

Per capita Real Amount

(Rupees)

a,b,c

Percent of

Own source revenue

Percent of GDP

d,e

NWFP Punjab NWFP Punjab NWFP Punjab NWFP Punjab

1999-2000 22.65 20.18 22.65 20.18 15.93 9.65 0.12 0.07

2000-01 23.54 19.60 21.76 18.12 17.12 9.17 0.12 0.07

2001-02 23.22 19.35 20.98 17.48 14.59 9.85 0.11 0.06

2002-03 22.60 22.83 19.55 19.75 14.52 10.20 0.01 0.07

2003-04 24.03 29.93 19.29 24.03 12.93 10.96 0.09 0.08

2004-05 26.44 38.53 19.83 28.91 13.19 11.90 0.09 0.09

2005-06 31.98 45.55 21.97 31.29 14.76 14.05 0.09 0.09

Sources:

Calculations are based on:

Provincial revenue time series data provided by the World Bank, Islamabad

NIPS population data

FBS GDP deflator

Punjab Bureau of Statistics, provincial GDP estimates

NWFP GDP estimates from Government of NWFP (2005)

Pakistan: Provincial Government Taxation 239

Table 22. Growth in Motor Vehicles and Population in Punjab

Years

Number of

Motor Vehicles

Motor Vehicle

Growth Rate

Population

Growth Rate

2003

3,031,728 - -

2004

3,322,974 0.10 0.02

2005

3,836,986 0.15 0.02

2006

4,325,776 0.13 0.02

2007

4,998,026 0.16 0.02

Source: Excise and Taxation Department, Punjab

Note:

Column 1 shows the number of registered vehicles in the province.

240 International Studies Program Working Paper Series

Table 23. Implied Tax Burden on a Standard Motor Car in NWFP

(Rupees)

New Purchase Used Car

Present situation

Capitalized Registration fee

2,400 200

Annual (Token) Tax 2000 2000

Combined Annual Tax 4,400 2,200

Reform

Annual Token Tax 5000 5000

Combined Annual Tax 7,400 5200

Increase in tax liability

If Registration Fee abolished (A) 600 2800

If Registration Fee retained (B) 3,000 3,000

Increase in tax liability as a percent of per capita GDP

If Registration Fee abolished (A) 2% 8%

If Registration Fee retained (B) 9% 9%

Annual car consumption (C)

120,000 100,000

Current Tax as percent of (C) 3.7 2.2

Tax after reform as percent of (C) 4.2 5.0

Notes:

For a corolla 1300 cc priced at Rs.1200,000, we calculate the annual incidence of registration fee by

dividing the registration fee in ten equal installments over the year life of the new car.

The decrease, because of high registration fee rates, will be steeper for vehicles with a larger engine

capacity.

For a new car we calculate the consumption by dividing the value of car into hen equal parts (assuming

that an equal amount is consumed each year). For a used car we assume the price to be Rs.500,000 and

that the car has a remaining life of five years.

Pakistan: Provincial Government Taxation 241

Table 24. Implied Tax Burden on a Standard Motor Car in Punjab

(Rupees)

New Purchase Used Car

Present situation

Capitalized Registration fee

2,400 200

Annual (Token) Tax 2000 2000

Combined Annual Tax 4,400 2,200

Reform

Annual Token Tax 5000 5000

Combined Annual Tax 7,400 5,200

Increase in tax liability

If Registration Fee abolished (A) 600 2800

If Registration Fee retained (B) 3,000 3000

Increase in tax liability as a percent of per capita GDP

If Registration Fee abolished (A) 1% 6%

If Registration Fee retained (B) 6% 6%

Annual car consumption (C)

120,000 100,000

Current Tax as percent of (C) 3.7 2.2

Tax after reform as percent of (C) 4.2 5.0

Notes:

For a corolla 1300 cc priced at Rs.1200,000, we calculate the annual incidence of registration fee by

dividing the registration fee in ten equal installments over the year life of the new car.

The decrease, because of high registration fee rates, will be steeper for vehicles with a larger engine

capacity.

For a new car we calculate the consumption by dividing the value of car into hen equal parts (assuming

that an equal amount is consumed each year). For a used car we assume the price to be Rs.500,000 and

that the car has a remaining life of five years.

242 International Studies Program Working Paper Series

Table 25. Proposed Reform in Motor Vehicle Taxes: Punjab

(Rupees in millions)

MVT Collection 2005-06 = Rs 4,154.17 million

Road sector expenditure = Rs 6,333.28 million (= Revenue Target)

Vehicles by category Registered

Annual Liability

with new rate

Collection 2005-06

at specific rate

Collection 2006-07

with Indexation

Motorcycles/scooters 3,169,095 200 634 766

Rickshaws 115,250 200 23 28

Tractors 572,519 200 115 138

Motor cars 799,173 5,000 3,996 4831

Jeeps 25,613 5,000 128 155

Station Wagons 27,761 5,000 139 168

Pickups 34,477 5,000 172 208

Station Wagons (city) 8,361 5,000 42 51

Station Wagons (Intercity) 20,862 5,000 104 126

Station van (loader) 35,815 5,000 179 217

Ambulance 2,196 5,000 11 13

Bowzer petrol 660 5,000 3 4

Bowzer 533 5,000 3 3

Taxies 17,677 5,000 88 107

Coaches 2,203 5,000 11 13

Station vans (stage carriage) 7,652 5,000 38 46

Delivery vans 50,294 5,000 251 304

Private carrier (trucks) 24,587 8,000 197 238

Luxury vehicle 267 8,000 2 3

Buses 37,613 8,000 301 364

Minibuses 11,411 8,000 91 110

Minibuses (intercity) 16,455 8,000 132 159

Other vehicles 1,357 5,000 7 8

Total 4,981,831 6,667

8,061

Notes:

Revenue target = Provincial Roads O&M expenditures + Total Grants to District * (District

O&M/District Grant) + Current Capital Expenditure on Roads. We use data on Faisalabad District

O&M expenditure (Faisalabad , 2007) and grant from the province (Government of Punjab, 2007i) to

calculate the fraction of PFC grant allocated to road O&M in the districts.

In the three categories, personal liability/rates have been selected to arrive at the target revenue.

Tax collection in 2007-08 with indexation, if projected inflation is 7.0 percent, and the annual increase

in the number of vehicles is 13 percent. We make the second assumption because the annual increase

in registered vehicles from 2002 to 2007in Punjab is around 13 percent.

Pakistan: Provincial Government Taxation 243

Table 26. Proposed Reform in Motor Vehicle Taxes: NWFP

(Rupees in millions – except rates which are in rupees)

MVT Collection 2005-06 = Rs 677.00 million

Road sector expenditure = Rs 1,284.61million

Vehicles by category Registered

Annual Liability

with new rate

Collection 2005-06

at specific rate

Collection 2006-07

with Indexation

Motorcycles/scooters

96,488 200 19 23

Rickshaws

20,606 200 4 5

Tractors

29,757 200 6 7

Motor cars/jeeps/

Station wagons

105,608 5,000 528 638

Delivery vans/pickups/

Station wagons

16,492 5,000 82 100

Taxies

18,431 5,000 92 111

Buses/minibuses

36,952 8,000 296 357

Public carrier (trucks)

28,971 8,000 232 280

Private carrier (trucks)

8,225 8,000 66 80

Other vehicles

13,484 5,000 67 82

Total 375,014 1,393 1,684

Notes:

Revenue target = Expenditure on the road sector + 10% of district transfers.

In the three categories, personal liability/rates have been selected to arrive at the target revenue.

Tax collection in 2006-07 with indexation, if projected inflation is 7.0 percent.

244 International Studies Program Working Paper Series

Table 27. Indexation of the Token Tax

(Rupees in millions)

Year

Actual Collections Indexed Collections Revenue Gain

Punjab NWFP Punjab NWFP Punjab NWFP

1999-2000 1,602 417 - - - -

2000-01 1,593 444 1,695 504 102 60

2001-02 1,610 448 1,740 484 130 36

2002-03 1,944 447 2,484 476 540 29

2003-04 2,608 486 3,681 563 1,073 77

2004-05 3,435 547 4,764 654 1,329 107

2005-06 4,154 677 5,315 885 1,161 208

Total 16,946 3,467 19,680 3,566 4,335 517

Notes:

Column 1 and 2 are actual collections from the provincial revenue time series provided by the World

Bank, Islamabad.

A 7 percent indexation has been applied from 1999-2000 onwards.

Pakistan: Provincial Government Taxation 245

Table 28. Revenue Potential of a Motor Fuel Tax

Punjab NWFP

Motor Vehicle Revenues in 2005 -2006 (in Rs millions)

4,154 677

Consumption of Petroleum (Litres in millions)

Diesel 6,049 1,840

Motor Fuel 1,013 89

Necessary Tax Rate

Specific Rate per litre (in Rs)

Diesel 0.52 0.33

Motor Fuel 1.00 0.75

Ad valorem rate (percent)

1.47 0.91

Notes:

Base calculated by using conversion factors used by oil industry, valid at 86 Fahrenheit or 30

Centigrade. Detailed calculation given in Appendix D.

We use the total rupee value of the consumed fuel as the base for this calculation. For details see

Appendix D.

246 International Studies Program Working Paper Series

Table 29. Distribution of Consumer Expenditures for

Selected Consumption Items: NWFP

Population Decile Percent of Income

Percent of Expenditures for

Personal Services Transport Motor Fuel

1 2.9 4.0 3.0 0.2

2 3.7 5.3 3.7 0.2

3 5.5 6.3 5.3 0.4

4 6.9 8.9 6.8 0.3

5 7.1 7.9 7.2 2.0

6 9.0 10.4 7.8 1.5

7 10.7 11.1 10.0 3.6

8 10.3 10.0 10.0 5.2

9 14.8 14.8 13.9 11.9

10 29.1 21.4 32.4 74.7

Source: Authors’ calculations from Pakistan Household Income and Expenditure Survey.

Pakistan: Provincial Government Taxation 247

Table 30. Distribution of Consumer Expenditure for

Selected Consumption Items: Punjab

Population Decile Percent of Income

Percent of Expenditures for

Personal Services Transport Motor Fuel

1 3.4 5.1 3.0 0.3

2 5.1 6.4 4.4 0.6

3 5.3 6.3 4.8 0.7

4 6.2 7.1 4.9 0.9

5 6.8 7.0 5.7 1.4

6 7.5 8.9 6.5 2.6

7 8.5 8.7 6.7 3.6

8 10.9 10.4 10.7 8.4

9 14.8 13.3 14.5 13.4

10 31.5 26.9 39.0 68.1

Source: Authors’ calculations from Pakistan Household Income and Expenditure Survey.

248 International Studies Program Working Paper Series

Table 31. Revenue Performance of the Professions, Trade and Callings Tax

Years

Per capita Nominal Amount

(Rupees)

Per capita Real Amount

(Rupees)

a,b,c

Percent of Own

Source Revenue

Percent of GDP

d,e

NWFP Punjab NWFP Punjab NWFP Punjab NWFP Punjab

1999-2000 1.12 2.36 1.12 2.36 0.79 1.13 0.006 0.009

2000-01 1.33 2.27 1.23 2.10 0.97 1.06 0.007 0.008

2001-02 2.12 2.10 1.92 1.90 1.33 1.07 0.010 0.007

2002-03 2.26 2.02 1.96 1.75 1.45 0.90 0.010 0.006

2003-04 1.93 2.20 1.55 1.76 1.04 0.80 1.037 0.006

2004-05 2.37 2.21 1.78 1.66 1.18 0.68 1.182 0.005

2005-06 3.54 2.47 2.43 1.69 1.63 0.77 0.010 0.005

Sources:

Calculations are based on:

Provincial revenue time series data, provided by the World Bank, Islamabad

NIPS population data

FBS GDP deflator

Punjab Bureau of Statistics, provincial GDP estimates

NWFP GDP estimates from Government of NWFP (2005)

Pakistan: Provincial Government Taxation 249

Table 32. Taxes on Professions and Callings

Category Rate NWFP Rate Punjab

1. Companies registered under

Companies Ordinance 1984

Rates range from Rs 1000 to Rs

50000 based on amount of paid

up capital

Rates range from Rs 5000 to Rs

100,000 based on amount of paid

up capital

2. Persons other than companies

owning factories and

commercial establishments

Rs 750 (companies with 10 or

more employees)

Rs 1000 to Rs 5000 based on the

number of employees

3. Persons other than companies

owning commercial

establishments having more

than 10 employees

Rs 3000 within metro and

municipal corporation limits

Rs 2000 all others

Rs 1000 all other commercial

establishments other than

wholesalers and retailers

4. Persons engaged in import or

export

Rs 1000 to Rs 1500 based on

value of imports or exports

Rs 2000 to Rs 5000 based on

value of imports or exports

5. Persons engaged in

profession, trade, calling or

employment who were

assessed to pay income tax

Rs 200

6. Contractors, builders, and

property developers

Rs 1000 to Rs 5000 based on the

amount of sales

Rs 500 to Rs 10000 based on the

amount of sales

7. Persons engaged in other

professions and callings

Rs 100 to Rs 200 based on

monthly income

Rs 500 to Rs 10000 based on

profession

8. Customs and clearing house

agents

Rs 1000

9. Travel Agents Rs 2000 to Rs 5000

10. Restaurants and Marriage

Halls

Rs 5000

11. Advertising agencies Rs 1000

12. Doctors and Labs Rs 300 to Rs 5000 based on type

of profession

250 International Studies Program Working Paper Series

Table 33. Revenue Potential: Tax on Professions (2005)

(Rupees)

Professionals

Technicians and

Associate Professional

Legislators, senior

officials, and managers

TOTAL

NWFP Rural 37,062,000 128,412,000 215,064,000

NWFP Urban 108,054,000 289,188,000 552,276,000

TOTAL 145,116,000 417,600,000 767,340,000 1,330,056,000

Punjab Rural 126,647,000 462,475,000 1,091,441,000

Punjab Urban 434,015,000 1,159,745,000 2,988,300,000

TOTAL 560,662,000 1,622,220,000 4,079,741,000 6,262,623,000

Pakistan: Provincial Government Taxation 251

Table 34. Total Revenue Collections of Land Taxes: By Component

(Rupees in millions)

NWFP Punjab

AIT Registration Land Revenue

Stamp Duty AIT Registration Land Revenue

Stamp Duty

1999/00 71 11 172 142 1,217 247 2596 4,416

2000/01 23 9 177 139 672 227 2714 3,218

2001/02 47 10 200 152 556 232 2430 3,458

2002/03 44 55 250 177 623 341 3645 4,281

2003/04 58 37 292 265 768 527 4484 6,536

2004/05 47 42 375 333 615 2,186 7311 6,324

2005/06 70 42 330 300 658 2,113 3392 5,859

Source: Provincial time series data provided by the World Bank, Islamabad.

Notes:

Land Revenue in NWFP includes mutation fee and land tax.

Land Revenue in case of Punjab includes mutation fee, some minor charges and rent from government lands.

252 International Studies Program Working Paper Series

Table 35. Revenue Performance of Land and Property Transfer Taxes

35.1 AIT

35.2 Registration

35.3 Land Revenue

f, g

Years

Per capita Nominal Amount

(Rupees)

Per capita Real Amount

(Rupees)

a,b,c

Percent of Own

Source Revenue

Percent of GDP

d,e

NWFP Punjab NWFP Punjab NWFP Punjab NWFP Punjab

1999-2000 3.85 15.33 3.85 15.33 2.71 7.33 0.020 0.057

2000-01 1.20 8.27 1.10 7.64 0.87 3.87 0.006 0.028

2001-02 2.46 6.68 2.22 6.03 1.54 3.40 0.012 0.022

2002-03 2.25 7.32 1.94 6.33 1.44 3.27 0.010 0.022

2003-04 2.87 8.82 2.30 7.08 1.54 3.23 0.011 0.024

2004-05 2.27 6.90 1.70 5.18 1.13 2.13 0.008 0.016

2005-06 3.31 7.22 2.27 4.96 1.53 2.23 0.010 0.015

Years

Per capita Nominal Amount

(Rupees)

Per capita Real Amount

(Rupees)

a,b,c

Percent of Own

Source Revenue

Percent of GDP

d,e

NWFP Punjab NWFP Punjab NWFP Punjab NWFP Punjab

1999-2000 0.58 3.12 0.58 3.12 0.40 1.49 0.003 0.012

2000-01 0.47 2.80 0.43 2.59 0.34 1.31 0.002 0.010

2001-02 0.54 2.79 0.48 2.52 0.34 1.42 0.003 0.009

2002-03 2.81 4.01 2.43 3.47 1.80 1.79 0.012 0.012

2003-04 1.83 6.05 1.47 4.85 0.98 2.21 0.007 0.016

2004-05 2.03 24.52 1.52 18.40 1.01 7.57 0.007 0.058

2005-06 1.98 23.17 1.36 15.91 0.92 7.14 0.006 0.048

Years

Per capita Nominal Amount

(Rupees)

Per capita Real Amount

(Rupees)

a,b,c

Percent of Own

Source Revenue

Percent of GDP

d,e

NWFP Punjab NWFP Punjab NWFP Punjab NWFP Punjab

1999-2000 9.35 32.71 9.35 32.71 6.58 15.63 0.049 0.121

2000-01 9.40 33.40 8.69 30.87 6.84 15.63 0.047 0.114

2001-02 10.36 29.21 9.35 26.38 6.51 14.86 0.049 0.096

2002-03 12.64 42.80 10.93 37.02 8.12 19.13 0.055 0.131

2003-04 14.44 51.47 11.59 41.32 7.77 18.84 0.056 0.138

2004-05 18.12 82.01 13.60 61.52 9.05 25.33 0.061 0.195

2005-06 15.59 37.19 10.71 25.54 7.19 11.47 0.045 0.077

Pakistan: Provincial Government Taxation 253

35.4 Stamp Duty

Sources:

Calculations are based on:

Provincial revenue time series data provided by the World Bank, Islamabad

NIPS population data

FBS GDP deflator

Punjab GDP estimates from Punjab Bureau of Statistics

NWFP GDP estimate from Government of NWFP (2005)

Notes:

Land Revenue in NWFP includes mutation fee and land tax.

Land Revenue in case of Punjab includes mutation fee, some minor charges and rent from government

lands.

Years

Per capita Nominal Amount

(Rupees)

Per capita Real Amount

(Rupees)

a,b,c

Percent of Own

Source Revenue

Percent of GDP

d,e

NWFP Punjab NWFP Punjab NWFP Punjab NWFP Punjab

1999-2000 7.71 55.63 7.71 55.63 5.42 26.59 0.040 0.206

2000-01 7.38 39.60 6.83 36.59 5.37 18.53 0.037 0.135

2001-02 7.89 41.56 7.13 37.54 4.96 21.14 0.037 0.137

2002-03 8.96 50.28 7.75 43.49 5.76 22.47 0.039 0.154

2003-04 13.10 75.02 10.52 60.23 7.05 27.46 0.051 0.202

2004-05 16.09 70.94 12.07 53.22 8.03 21.91 0.054 0.169

2005-06 14.17 64.24 9.73 44.12 6.54 19.81 0.041 0.133

254 International Studies Program Working Paper Series

Table 36. Disaggregation of Provincial Government Land Taxes by Component for

Punjab (2005-06)

Tax Per capita collection (Rs.) Percent of GDP

Percent of Land

Taxes

Stamp Duty 83.89 0.13 49.78

Mutation 41.5 0.08 24.64

Registration 24.4 0.05 14.47

Agriculture Income Tax 16.05 0.02 9.53

Source: Government of Punjab (2007i).

Note:

Excludes federal capital value tax and local government tax on transfer of property.

Land tax total includes stamp duty, mutation, registration and agriculture income tax.

Pakistan: Provincial Government Taxation 255

Table 37. Collection by Type of Provincial Government Property Transfer Tax

(Rupees in millions)

Land Taxes Punjab

NWFP

Agriculture Income tax 1,493 70

Land Revenue 249 421

Mutation fee 3,861 -

Registration fee 2,267 47

Stamp duty 7,802 285

Notes:

Excludes federal capital value tax and local government tax on transfer of property.

The Punjab collections are from Government of Punjab (2007b).

The NWFP collections are from Government of NWFP (2007b).

The classification in this case is not clear; it may include mutation fee.

256 International Studies Program Working Paper Series

Table 38. Property Transfer Taxes on Real Estate: Selected Countries

Country Tax Rate

Pakistan

Punjab 9 percent

NWFP 10.5 percent

Jamaica 13

percent

Portugal

Graduated rate ranging from 2 percent to 6.5 percent. Rate varies by value

and land use.

Germany 3.5 percent

Slovakia 1 percent to 6 percent, depending on value

Czech Republic 3 percent

Netherlands 6 percent

Pakistan 5 percent

Bhutan 5 percent

Taiwan 7.5 percent

Mauritius Between 5 percent and 10 percent

Swaziland Between 3 percent and 4 percent, depending on value

Costa Rica 1.5 percent

El Salvador Up to 3 percent depending on value

Kenya 4 percent

Sources:

Portugal, Tax Notes International, April 21, 2003, p. 227

Germany, Tax Notes International, January 14, 2002, p. 102.

Slovakia, Tax Notes International, March 8, 2004, p. 915.

Czech Republic, Tax Notes International, January 5, 2004, p. 26.

Netherlands, Tax Notes International, June 16, 2003, p. 1093.

Bhutan, Taxes and Investment in Asia and the Pacific, Supplement No. 104, 1993, International Bureau of

Fiscal Documentation.

Taiwan, Taxes and Investment in Asia and the Pacific, Supplement No. 165, 1998, International Bureau of

Fiscal Documentation.

Mauritius, African Tax Systems, Supplement No. 117, 2000, International Bureau of Fiscal Documentation.

Swaziland, African Tax Systems, Supplement No. 105, 1997, International Bureau of Fiscal

Documentation.

Costa Rica, Latin American Taxation Database, Supplement No. 122, 2000, International Bureau of Fiscal

Documentation.

El Salvador, Latin American Taxation Database, Supplement No. 113, 1998, International Bureau of Fiscal

Documentation.

Kenya, “Land Value Taxation: A Case Study Approach,” McCluskey and Franzsen, 2001

Pakistan, data supplied by Provincial Government Officials. Rates are inclusive of the central government

capital value tax and the local government tax.

Pakistan: Provincial Government Taxation 257

Table 39. Distribution of Cultivated Area by Farm Size, 2000

Cultivated area Irrigated Area Of which orchards Unirrigated area

NWFP

Farm Size (acres)

All Farms 4,096,033 2256518 68202 1839515

Govt farms

2,414 2271 203 143

Private Farms 4093619 2254247 67999 1839372

under 1 139271 73320 8503 65951

1 to under 2.5 634503 308591 20080 325912

2.5 to under 5 741897 383937 9134 357960

5 to under 7.5 591398 316867 4731 274531

7.5 to under 12.5 643086 359488 6514 283598

12.5 to under 25 491899 258750 4432 233149

25 to under 50 391901 203571 6825 188330

50 to under 100 215082 152105 2637 62977

100 to under 150 95600 78118 2871 17482

150 and above 148980 119485 2273 29495

Cultivated area Irrigated Area Of which orchards Unirrigated area

Punjab

Farm Size (acres)

All Farms 25,485,032 21500989 427705 3984048

Govt farms

45,326 36674 1179 8653

Private Farms 25439706 21464315 426526 3975395

under 1 160592 117906 1434 42687

1 to under 2.5 1408581 1157827 13147 250757

2.5 to under 5 2778289 2390055 29913 388244

5 to under 7.5 3315357 2876676 42497 438682

7.5 to under 12.5 4836591 4214124 66261 622457

12.5 to under 25 5489884 4735774 94293 754118

25 to under 50 4062726 3275912 79248 786818

50 to under 100 1954161 3134852 52629 453268

100 to under 150 520610 421982 15124 98629

150 and above 912909 773174 31988 139737

Source: ACO (2000)

258 International Studies Program Working Paper Series

Table 40. Potential AIT, Current Lax

Current Law Potential NWFP

Farm Size (acres) Irrigated Unirrigated Orchards Grand Total

under 1 3,240,850 1,648,775 2,550,900 7,440,525

1 to under 2.5 14,425,550 8,147,800 6,024,000 28,597,350

2.5 to under 5 18,740,150 8,949,000 2,740,200 30,429,350

5 to under 7.5 22,473,792 9,883,116 1,419,300 33,776,208

7.5 to under 12.5 25,414,128 10,209,528 1,954,200 37,577,856

12.5 to under 25 25,431,800 11,657,450 1,329,600 38,418,850

25 to under 50 19,674,600 9,416,500 2,047,500 31,138,600

50 to under 100 14,946,800 3,148,850 791,100 18,886,750

100 to under 150 7,524,700 874,100 861,300 9,260,100

150 and above 11,721,200 1,474,750 681,900 13,877,850

TOTAL 163,593,570 65,409,869 20,400,000 249,403,439

Current Law Potential Punjab

Farm Size (acres)

Irrigated Unirrigated Orchards Grand Total

under 1 0 0 430,200 430,200

1 to under 2.5 0 0 3,944,100 3,944,100

2.5 to under 5 0 0 8,973,900 8,973,900

5 to under 7.5 0 0 12,749,100 12,749,100

7.5 to under 12.5 0 0 19,878,300 19,878,300

12.5 to under 25 696,222,150 56,558,850 28,287,900 781,068,900

25 to under 50 799,166,000 98,352,250 23,774,400 921,292,650

50 to under 100 770,555,750 56,658,500 15,788,700 843,002,950

100 to under 150 101,714,500 12,328,625 4,537,200 118,580,325

150 and above 185,296,500 17,467,125 9,596,400 212,360,025

TOTAL 2,552,954,900 241,365,350 127,960,200 2,922,280,450

Source: ACO (2000)

Pakistan: Provincial Government Taxation 259

Table 41. Revenue Impact of Reducing the Exemption to 5 acres in Punjab, 2000

Proposal 1: reduce the exemption

Farm Size (acres)

Irrigated Unirrigated Orchards Grand Total

under 1

0 0 430,200 430,200

1 to under 2.5

0 0 3,944,100 3,944,100

2.5 to under 5

0 0 8,973,900 8,973,900

5 to under 7.5

425,126,850 32,901,150 12,749,100 470,777,100

7.5 to under 12.5

622,179,450 46,684,275 19,878,300 688,742,025

12.5 to under 25

696,222,150 56,558,850 28,287,900 781,068,900

25 to under 50

799,166,000 98,352,250 23,774,400 921,292,650

50 to under 100

770,555,750 56,658,500 15,788,700 843,002,950

100 to under 150

101,714,500 12,328,625 4,537,200 118,580,325

150 and above

185,296,500 17,467,125 9,596,400 212,360,025

TOTAL

3,600,261,200 320,950,775 127,960,200 4,049,172,175

Source: ACO (2000)

260 International Studies Program Working Paper Series

Table 42. Revenue Performance of the Sales Tax on Services 2005-2006

Province

Per capita Collection

(Rupees)

Percent of

Own Source Revenue

Percent of GDP

NWFP 19.83 9.15 0.06

Punjab 24.38 7.52 0.05

Sources:

Calculated from

Provincial revenue time series data provided by the World Bank, Islamabad and the NIPS population

estimates.

Provincial revenue time series data provided by the World Bank, Islamabad.

Pakistan: Provincial Government Taxation 261

Table 43. Sales Tax Collection from Services (Provincial)

(Rupees in millions)

Item Name

Punjab Sindh NWFP Balochistan Total

1. Hotels/Restaurants/Fast

food/Catering (Services)

1343.25 514.13 54.60 17.27 1929.25

2. Services provided by Travel

Agents/Stevedores/Shipping

Agents/Ship Chandlers

240.51 648.20 4.44 2.45 895.59

3. Advertisements on T.V. / Radio 48.98 667.79 0.21 0.05 717.03

4. Courier Services 42.78 608.17 0.04 0.01 651.00

5. Caterers, Suppliers of Food/Drinks 2.57 18.37 0.00 0.00 20.94

6. Services provided for Inland

Carriage of goods

10.22 0.00 0.00 0.00 10.22

7. Clubs (Services) 3.76 0.26 0.00 0.00 4.02

8. Marriage Halls and Lawns 1.91 0.00 0.00 0.29 2.20

9. Cable TV Operator and Others 0.19 0.00 0.30 0.00 0.49

10. Beauty Parlours/Clinics/Sliming

Clinics

0.16 0.24 0.00 0.00 0.41

11. Service Rendered by Foreign

Exchange

0.03 0.16 0.00 0.00 0.19

12. Services (Architects, Town

Planners, Contr)

0.04 0.02 0.00 0.00 0.06

13. Laundries/ Dry Cleaners 0.05 0.00 0.00 0.00 0.05

Total 1694.43 2457.34 59.59 20.08 4231.44

Percentage Share 40.04 58.07 1.41 0.47

Source: Federal Board of Revenue, Sales Tax Wing.

262 International Studies Program Working Paper Series

Table 44. Sales Tax/Excise Duty (in VAT mode) in Services in Pakistan

• In Pakistan, six services are chargeable to sales tax @ 15% through Provincial Sales Tax Ordinances

promulgated in year 2000. These are:

(i) Services provided by hotels, marriage halls, clubs and caterers

(ii) Advertisements on TV and Radio

(iii) Custom agents

(iv) Ship chandlers

(v) Stevedores

(vi) Courier services

* Services provided by beauty parlors and dry cleaners are exempted.

• Four services are chargeable to federal excise duty @ 15% (in VAT mode):

(i) Telecommunication services

(ii) Advertisements on CCTV/cable TV

(iii) Inland carriage of goods by air

(iv) Domestic air Travel

• Six services are chargeable to federal excise duty at specific rates:

(i) International air travel

(ii) Shipping agents

(iii) Insurance except life insurance

(iv) Non-fund services of banks

(v) Franchise services

Source: Federal Board of Revenue, Sales Tax Wing.

Pakistan: Provincial Government Taxation 263

Table 45. Revenue Performance of Taxes as Percent of Total Revenues

45.1. Punjab

1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06

Urban Property Tax 0.22 0.49 0.03 0.87 0.80 1.05 0.66

Agriculture income tax 1.40 0.69 0.56 0.55 0.65 0.39 0.38

Registration fee 0.28 0.23 0.24 0.30 0.45 1.40 1.23

Land revenue (includes mutation fee) 2.69 2.56 2.23 2.91 3.37 3.29 1.97

Taxes on professions, trades & callings 0.21 0.19 0.18 0.15 0.16 0.13 0.13

Motor vehicle tax 1.84 1.64 1.63 1.71 2.22 2.20 2.41

GST on Services 0.00 0.96 1.11 1.09 1.20 1.03 1.29

Stamp duties 5.07 3.31 3.50 3.77 5.56 4.05 3.41

Entertainment tax 0.27 0.21 0.12 0.11 0.09 0.02 0.01

Electricity duties 0.09 1.59 0.16 0.15 0.17 0.42 0.74

Hotel tax 0.11 0.08 0.09 0.08 0.12 0.10 0.14

Provincial excises 0.54 0.50 0.53 0.49 0.62 0.49 0.49

Cotton cess 0.32 0.00 0.36 0.30 0.28 0.32 0.26

Other 0.84 2.50 0.93 0.01 0.01 -0.59 0.09

All taxes 13.88 14.95 11.67 12.48 15.69 14.33 13.21

Source: Calculations are based on provincial revenue time series data provided by the World Bank, Islamabad

Note:

Total revenue includes all intergovernmental transfers.

264 International Studies Program Working Paper Series

45.2 NWFP

1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06

Urban Property Tax 0.35 0.64 0.73 0.60 0.79 0.60 0.76

Agriculture income tax 0.37 0.11 0.22 0.17 0.21 0.13 0.18

Registration fee 0.06 0.04 0.05 0.22 0.13 0.12 0.11

Land revenue (includes mutation fee) 0.91 0.84 0.91 0.98 1.06 1.07 0.83

Taxes on professions, trades and callings 0.11 0.12 0.19 0.18 0.14 0.14 0.19

Motor vehicle tax 2.20 2.11 2.05 1.75 1.77 1.56 1.71

GST on Services 0.00 1.04 1.17 1.16 1.24 1.11 1.06

Stamp duties 0.75 0.66 0.70 0.69 0.96 0.95 0.76

Entertainment tax 0.12 0.04 0.04 0.03 0.03 0.01 0.03

Electricity duties 1.39 1.04 2.02 1.27 0.50 0.52 0.68

Hotel tax 0.09 0.00 0.00 0.02 0.04 0.04 0.07

Provincial excises 0.08 0.07 0.10 0.09 0.08 0.06 0.08

Education cess 0.13 0.00 0.00 0.21 0.42 0.63 0.14

Other 0.21 0.25 0.26 0.01 0.00 0.01 0.38

All taxes 6.76 6.98 8.42 7.37 7.38 6.95 6.98

Source:

Calculations are based on provincial revenue time series data provided by the World Bank, Islamabad

Note:

Total revenue includes all intergovernmental transfers.

Pakistan: Provincial Government Taxation 265

Table 46. Tax Revenue Targets and Reform Options Punjab

(Columns 1 and 2 are rupees in millions)

(1)

Tax Revenues

(2005-06)

Reform Program Options

(2)

Amount

(Post Reform)

(3)

Percent

Increase

(4)

Percent of

GDP

Target A

65,356 195 1.48

Target B

46,756 111 1.06

Total Taxes 22,180 0.50

Individual Taxes

UIPT 1,135 14,189 1,150 0.32

MVT 4,154 8,061 94 0.18

Motor Fuel Tax

… 4,156 100 0.09

Land Taxes

11,364 13,068 15 0.30

Agriculture Income tax 658 796 21 0.02

Professions tax 225 487 116 0.01

Sales tax on services 2,224 4,448 100 0.10

Other taxes

2,540 2,540 0.05 0.06

Total taxes with reform 47,745 115 1.08

Notes:

Based on 2005-06 levels.

Structural Deficit Approach: We assume the unfunded deficit of the province (see Table 3, Row C) in

2006-2007, also held in 2005-2006. To this amount, we add the tax collection in 2005-2006 to arrive at

the revenue target.

International Average Approach: The national tax effort is 10.6 percent of GDP (Table 1.5, Statistical

Appendix, Government of Pakistan, 2007). We calculate the provincial target as 0.0106*Provincial

GDP.

This revenue target can be achieved using the rate structure used for illustration in Table 28.

Land taxes include Mutation Fee, Registration Fee and Stamp Duty

Other taxes include Entertainment Tax, Electricity Duty, Hotel Tax, Provincial Excise, Cotton Fee, and

"Others'' in the Provincial Tax Revenue classification in Government of Punjab (2007b).

266 International Studies Program Working Paper Series

Table 47. Tax Revenue Targets and Reform Options NWFP

(Columns 1 and 2 are rupees in millions)

(1)

Tax Revenues

(2005-06)

Reform Program Options

(2)

Amount

(Post Reform)

(3)

Percent

Increase

(4)

Percent of

GDP

Target A

12,072 337 1.66

Target B

7,699 179 1.06

Total Taxes 2,762 0.38

Individual Taxes

UIPT 300 2,069 590 0.28

MVT 677 1,684 149 0.23

Motor Fuel Tax

… 674 100 0.09

Land Taxes

672 773 15 0.11

Agriculture Income tax 70 78 11 0.01

Professions tax 75 83 11 0.01

Sales tax on services 420 840 100 0.12

Other taxes

549 576 0.05 0.08

Total taxes with reform

6,776 145 0.93

Notes:

Based on 2005-2006 levels.

Structural Deficit Approach: We assume that the unfunded deficit of the province (see Table 5, Row

C) in 2006-2007 held in 2005-2006. To this amount, we add the collection in 2005-2006 to arrive at

the revenue target.

International Average Approach: The national tax effort is 10.6 percent of GDP (Table 1.5, Statistical

Appendix, Government of Pakistan, 2007). We calculate the provincial target as 0.0106*Provincial

GDP.

This revenue target can be achieved using the rate structure used for illustration in Table 28.

Land taxes include Mutation Fee, Registration Fee and Stamp Duty

Other taxes include Entertainment Tax, Electricity Duty, Hotel Tax, Provincial Excise, Education Cess

and "Others'' in the Provincial Tax Revenue classification in Government of NWFP (2007c).

Pakistan: Provincial Government Taxation 267

Table 48. Policy Reform Matrix

Tax Comprehensive Reform Components

UIPT

• Eliminate 5 marla exemption

• Eliminate preferential treatment of owner occupants

• Bring in new valuation roll (Punjab)

• Upgrade valuation table (NWFP)

• Bring land and structures to same basis

• Adopt a single rate (Punjab)

• Tie TMA rate setting to provincial transfers

Motor Vehicle Taxes

• A unified annual (license) tax on motor vehicles

• Adopt a motor fuels tax

Professions Tax

• A 3 percent piggyback on federal individual income taxes

Property Transfer Taxes

• A unified annual tax on rural land

Agricultural Income Tax

• Progressive rate structure by farm size

• Reduce exemption from 12.5 to 7.5 acres (Punjab); increase

exemption to 7.5 (NWFP)

Sales Tax on Services

• A shared federal-provincial tax with federal administration

Tax Reform Components

UIPT • Same as above

Motor Vehicle Taxes • Abolish registration tax or shift to the federal level

• Adopt a simplified token tax rate structure

• Increase the token tax rate

Property Transfer Taxes • Improve valuation methods

• Update property records

Agriculture Income Tax • Same as above

Professions Tax • Same as above

268 International Studies Program Working Paper Series

Table 49. Distribution of NFC Transfers: Impact of an Incentive Scheme

Province

Distribution

(3)

Taxes as

percent

of GDP

(4)

Provincial

Tax Effort

as fraction

total Tax

Effort

(5)

Change

Tax

Effort

2005 to

2006

Distribution Under

an Incentive Scheme

(1)

Amount

(Rupees in

millions)

(2)

Percent

(6)

Amount

(Rupees in

millions)

(7)

Percent

Punjab 142,498 52.36 0.36 0.24 -0.06 115,084 42.29

NWFP 34,990 12.86 0.42 0.29 -0.01 35,983 13.22

Balochistan 18,354 6.74 0.25 0.17 0.00 19,504 7.17

Sindh 76,306 28.04 0.45 0.30 0.02 101,577 37.32

Notes:

For Balochistan and Sindh we are using hypothetical Tax/GDP ratios to demonstrate how the scheme

works. For Punjab and NWFP the tax effort has been calculated for the year 2004-2005 from the

provincial time series data provided by the World Bank Islamabad. We use the provincial GDP

estimates of the Punjab Bureau of Statistics and Government of NWFP (2005).

We calculate each row in this column as a fraction of the total tax effort of the provinces in 2005-2006;

From 2004-2005 and 2005-2006, the tax effort decreased both in Punjab (from 0.41 to 0.36 percent)

and in NWFP (from 0.43 to 0.42 percent of GDP). We assume, in order to demonstrate the effect of

the incentive formula, that the tax effort remained constant at 0.25 percent in Balochistan and

increased from 0.43 to 0.45 percent in Sindh, from 2004-2005 to 2005-2006.

75 percent of the grant is distributed on population basis and the remaining 25 percent on the basis of

the incentive formula.

This is the total grant a province will receive under the incentive formula), S

which is calculated as:

() ()

⎥

⎦

⎤

⎢

⎣

⎡

⎟

⎠

⎞

⎜

⎝

⎛

⎥

⎦

⎤

⎢

⎣

⎡

⎟

⎠

⎞

⎜

⎝

⎛

−−

∑∑∑

2006200520062005

75.0125.0 oolDivisibleP

Pop

oolDivisibleP

Where

S Share of a province

Tax effort of a province in 2005-2006 and

∑

Sum of the individual tax efforts of the provinces in 2005-2006

=Δ

Change in the tax effort of a province from 2004-2005 to 2005-2006 and

TETE Δ=Δ

if ≥ 0

And

0=Δ

if < 0

=Δ

∑

Sum of the changes in the tax efforts of the provinces

()

20062005−

oolDivisibleP = This equals the total of the NFC grants given to the provinces in 2005-

2006

Pop

Population of a province in 2005-2006 according to NIPS estimates

∑

Pop

Sum of the population of the four provinces

The changes in shares between columns 1 and 2 (original shares) and columns 6 and 7 (shares after

application of the incentive formula) are explained below:

1) Punjab’s share decreases significantly because the provincial tax effort has declined from 0.41

to 0.36 of GDP, which is a major decrease in the tax effort.

Pakistan: Provincial Government Taxation 269

2) NWFP’s share has increased even when its tax effort has declined from 0.43 to 0.42 percent

of GDP, a smaller decrease compared with Punjab, because its tax effort at 0.42, is still higher

than Punjab, at 0.36 of GDP. But the increase in the NWFP share would have been greater

had the tax effort increased.

3) In case of Balochistan, the provincial share has increased slightly from 6.74 to 7.17 percent of

the Divisible Pool, because Balochistan’s tax effort has held constant when it has gone down

in two out of four provinces.

4) Sindh has gained (from 28 to 37 percent of the total transfers) because of two reasons: (a) its

tax effort is higher than other provinces; (b) its tax effort (by our assumption) has gone up

from 0.43 to 0.45 percent of GDP

5) In general the changes show the effects of both the level of tax effort in a province compared

with the other provinces as well as the change in the tax effort over the last one year.