Agricultural Income Tax in Pakistan: Time to Impose

Introduction

Sometime back, I wrote a piece in The News, one of the leading English newspapers in Pakistan (Get Agrarian), about the need for carrying out comprehensive agrarian reforms as opposed to limited distributive land reforms, advocated by some advocacy groups, to transform the political economy of Pakistan’s agriculture. While emphasizing the need to have clarity of mind about the above-mentioned two interrelated but distinct concepts, I mentioned the need for the imposition of a tax on the income derived from agriculture, which is presently exempt from this fiscal measure.

Some of the readers have questioned my suggestion on the plea that agriculture is already overtaxed and that it will be a disincentive to levy any further tax on a sector that has a lot of potential to become the engine of growth. The looming threat of food security has been quoted as another reason for not imposing the tax on agricultural income. This article is a response to these observations and objections

Factual Position

Under the 1973 Constitution of Pakistan, it is the responsibility of the respective provinces to tax agricultural incomes, which have been defined in Section 41 of the Income Tax Ordinance as “any rent or revenue from the land... which is used for agricultural purposes”. Under the Ordinance, even rental incomes derived from agriculture are exempt from taxation because the legislation defines agricultural income in a very broad manner.

It will be interesting to note that this exemption is available to farmers in most countries, developed as well as developing, for a variety of reasons. Historically, farmers in developed countries had enjoyed this exemption from modern income tax laws because they were subject to land tax. They have continued to be exempt as agriculture now contributes less than 5 per cent to the gross domestic product (GDP) of these countries, and now it is not cost-effective to do so.

In developing countries, this sector has been kept untaxed because of the colonial hangover and the power and prestige enjoyed by the landed aristocracy in these countries. Now their biggest supporters are the newly emerging class of urban industrial landlords, who have purchased vast tracts of agricultural land to escape taxation

Arguments

The usual arguments given by pro-farmer advocacy groups for not imposing a tax on agricultural incomes do not have solid grounds. One of their off-the-cuff arguments is the so-called over-taxation of the agriculture sector. According to this argument, advanced by the opponents of agricultural income tax, the agricultural sector of Pakistan is already overtaxed because the bulk of Pakistan’s fiscal taxation is based on indirect taxation, and 60 per cent of Pakistan's population, by being rural dwellers, contributes large resources to the national exchequer in the form of this indirect taxation.

Related to the above is the so-called terms of trade argument. According to the proponents of this line of reasoning, the industrial sector charges exorbitant prices for the goods it sells to farmers, while agricultural commodities, on the other hand, seldom fetch handsome prices for the farming community.

Counter Arguments

Frankly, both arguments, over-taxation of the agrarian sector and adverse agricultural terms of trade have a lot of factual validity and historical truth but cannot be used as a logical argument for exempting the rich farmers from the imposition of tax on their income. Payment of tax is not a collective responsibility, rather, it is the individual income earner who is assessed to be taxed or not based on his annual income crossing the threshold, not the sector as a whole, which determines the tax liability. Basic principles are the same for everyone; all those earning equal incomes should be treated equally, irrespective of the source of income. No one should be allowed to take refuge under the garb of over-taxation of a community as a whole.

Farmers must lobby for the rationalization of prices of agricultural inputs, industrial products, and public goods but should not give an excuse to rich landowners to escape taxation on this plea. Over the last few years, the agricultural terms of trade have improved a lot, and the ruthless squeezing of the peasants with due process of law has been eliminated, although farmers are still subject to the vagaries of nature, governmental neglect, inadequate access to banking finance, and other difficulties. In any case, the poor farmers will be exempt from agricultural income tax.

Interestingly, PML-N’s manifesto is silent about agricultural taxation, although the dominant urban industrialist lobby is a very vocal advocate of this tax. There are several reasons for this calculated silence. Firstly, it is a constitutional issue. Agriculture, being a provincial subject, reinforced after the 18th Amendment in the constitution, can be taxed only by the provinces, and I have my doubts whether the federal government will be in a position to force the provinces to legislate on such a sensitive issue.

Secondly, it is a political issue. None of the provincial legislatures has the guts or the will to initiate any legislation regarding the levying of income taxes on their incomes. Provincial governments haven’t been collecting agricultural income tax, although legislation was promulgated at the provincial level way back in 2000/01 to tax agricultural incomes from this source due to a lack of political will. It has become such an emotional issue for the farmers that even those who will not be affected at all by the imposition of tax on rich landlords vehemently oppose it.

Apart from the absence of political commitment, it is a lack of a proper policy framework and the inadequate wherewithal of the taxation institutions that are delaying the imposition of tax on agricultural incomes. How will the tax be imposed? As a capacity tax on land that has already been there for centuries? As a tax on the incomes of the farmers, none of whom keep a record of their income and expenditure? Even the military regime could not document the urban merchants, but they were expecting the farmers to keep the record! Who will collect the tax?

The traditional land revenue authorities or the urban middle-class income tax officers? All these questions have not been properly thrashed out, either by the policymakers or by the advocacy groups demanding the imposition of an agricultural tax.

What to do?

Let me put up a draft plan of action that could be the starting point to impose an agricultural income tax without creating many difficulties for the farmers by observing the classical canons of taxation-equity, efficiency, and growth.

1. Amend the income tax ordinance and bring income derived from agriculture on par with income earned from any other legal source for the imposition of tax on all, repeat all, incomes derived from any legal source. Certain other sectors also enjoy this immunity.
2. For the next ten years, provincial governments are advised to utilize the existing revenue structure as an institutional mechanism for the assessment and collection of agricultural income tax
3. Every year, the district collector of the district would announce per acre rates for leasing agricultural land for tax assessment on the same basis as they do to levy stamp duty on the sale/purchase of land. For this purpose, they can rely on the information provided by their revenue staff, which is fairly accurate
4. Based on this information, the district collector will assess the tax to be recovered from landowners after allowing the usual exemption. For example, if the land lease rates for a district in Punjab or Sindh are assessed to be Rs. 25, 000 per acre per year, anyone owning ten acres or less of land will not pay any tax at all because his income is below the threshold of taxable income. For convenience's sake, we should not distinguish between land under crops or orchards.
5. Only the owners of the land whose notional lease amount is above the taxable threshold will pay the tax. If he has given his land to tenants on fixed rate or a cost-sharing basis, then he will decide the issue of sharing the tax burden with their tenants the way they do for other costs
6. It will replace the land revenue/usher but will not affect the water rates, which are user charges and not a tax on income

I understand most farmers will be disturbed at the thought of paying taxes on their agricultural incomes, but they should read the writing on the wall and get ready for this eventuality. My advice to them is to think logically and act rationally. Ground realities have changed, and time is not on their side.