May 5, 2010 / 11:40 AM / 10 years ago

Pakistan to impose VAT but faces public backlash

KARACHI (Reuters) - A value added tax (VAT) Pakistan must impose to gain help from the International Monetary Fund could spark widespread tax evasion as a protest from businesses and a public that has been ill-prepared for the change.

Gold bangles are displayed at a jewelry shop in Karachi November 24, 2009. REUTERS/Akhtar Soomro/Files

The VAT is a requirement set by the IMF for Pakistan when it agreed to an emergency package of $7.6 billion in November 2008 to avert a balance of payments crisis and shore up reserves.

The loan was increased to $11.3 billion in July last year, a lifeline for the nuclear-armed U.S. ally.

The IMF said last week Pakistan had indicated the VAT would be rolled out on July 1, but analysts are sceptical about its impact because they say the government has not done enough to make taxpayers aware of what it entails.

Pakistanis are already grappling with 13 percent annual inflation, and chronic power shortages. VAT, which will replace a general sales tax, could add to prices, although economists say its long-term impact on inflation would be minimal.

The government, distracted by an Islamist militant insurgency and U.S. pressure to clamp down on al Qaeda and the Taliban, has done little to ease concerns that the new tax will only bring more pain.

“The government has failed to prepare the public for this tax,” said Mohsin Khan, a senior fellow at the Peterson Institute for International Economics in Washington.

“The tax payers, since they have no idea how VAT would work, could resort to agitation and may even close down markets,” added Ashfaque Hasan Khan, dean of Islamabad’s NUST Business School.

Pakistan has a woeful tax revenue-to-gross domestic product (GDP) ratio of about 9 percent, one of the lowest in the world.

Whole sectors of the economy, including agriculture, do not pay tax and the IMF is pressing the government to increase its revenue. It wants the government to use the VAT to raise its tax-to-GDP ratio by 3 to 4 percentage points.

Some analysts said improperly educated tax collectors would be unable to fill out the extensive documentation required to process the VAT, which would mean the money would not eventually go to the government.

Others said ordinary people and businesses may just opt not to pay. “There will be hue and cry from the powerful lobbies as earnings of companies would also be affected,” said Sayem Ali, economist at Standard Chartered bank.

“We could even see a short-term liquidity problem.”

“NEED TO EDUCATE”

The government has announced few details of how the tax will be applied. The Federal Board of Revenue, which oversees tax collection, has proposed a 15 percent VAT.

“There is a need to educate,” said Meekal Ahmed, another former IMF official. “It is possible we will not see the VAT at full potential before two to three years.”

But a Finance Ministry official brushed aside the concerns, saying the IMF package was in jeopardy and the tax would be introduced on July 1, the beginning of the new financial year.

“This is a major commitment with the IMF, that Pakistan will shift to VAT with effect from July 1,” said the official, who declined to be identified due to the sensitivity of government negotiations with the IMF.

“The IMF has said in categorical terms ‘no VAT, no money”, so the government has no choice.”

The IMF board is due to meet in mid-May to approve the fifth tranche — about $1.15 billion — of its loan to Pakistan.

Khan of the NUST Business School in Islamabad suggested the government should impose the VAT in the budget for the 2010/11 fiscal year, to be announced on June 9, but to implement it from July 1 next year. The government could use the time to educate the public, he said.

Editing by Robert Birsel and Miral Fahmy

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