The writer is special adviser to the Jang Group/Geo and a former envoy to the US and the UK. In his budget speech Finance Minister Ishaq Dar declared that his government had “inherited a broken economy”. The main reason for this is that the country’s tax system is broken. The failure to generate domestic resources is a major factor for the country’s economic stagnation and why the economy is in the critical ward today. Tax collection is in a shambles. This crisis is also spawning or contributing to a number of other, inter-related crises – mounting and unsustainable public debt, high inflation, deteriorating public services, eroding physical infrastructure, low level of spending on education and health and lack of power-sector investment at a time when energy shortages are crippling economic activity and inhibiting growth. In 2001, a task force set up to reform the tax system held out a stark warning: “Pakistan’s fiscal crisis is deep. Taxes are insufficient for debt service and defence. If the tax to GDP ratio does not increase significantly Pakistan cannot be governed effectively, essential public services cannot be delivered and high inflation is inevitable. Reform of the tax administration is the single most important economic task for the government”. This counsel has long been ignored. The failure to mobilise tax revenue to meet the country’s financing requirements is at the heart of its chronic fiscal crisis. There is no tax culture in the country. Its absence is attributable to several factors: weak political will, an inequitous and narrowly-based tax regime rampant with abuse, exclusion from the tax net of large swaths of the economy, half-hearted reform efforts, poor delivery of public services and the ability of powerful economic and political lobbies to thwart even modest tax-collection measures. The failure on the part of successive administrations to raise revenue can also be explained in terms of a privilegentsia that refuses to pay tax and opposes taxation, using increasingly dubious pretexts to preserve its economic and political power. This failure has driven Pakistan into a state of perpetual financial crises. These have been temporarily and periodically ‘resolved’ either by excessive domestic borrowing – with all its deleterious consequences – and/or bailouts from abroad. The latter have often been strategic payoffs for foreign policy behaviour or predicated on Islamabad’s promise of economic reform. The record shows that such promises are forgotten as soon as frontloaded tranches are received from multilateral lenders. The availability of significant flows of external assistance has long acted as a disincentive for tax reform. With these and other capital inflows now drying up, this so-called ‘fallback option’ to fill the fiscal gap may no longer be available. State bank and commercial bank borrowing has also served as ‘substitute’ for taxation, but at great cost to the economy – ‘crowding out’ the private sector, inhibiting growth, as well as imposing a ‘tax’ on the poor who are unable to hedge against inflation. Excessive borrowing has saddled the country with record public debt – 64 percent of GDP. The previous government earned the dubious distinction of borrowing more during its tenure than the previous 60 years put together. For over a decade now debt servicing and subsidies have exceeded total federal and provincial development spending. Interest payments have also surpassed defence as the single largest item of budgetary expenditure. The crisis in tax revenues is evident from the dismal statistics. Tax as a percentage of GDP fell to nine percent in the past decade from around 11 percent in the 1990s. And it has remained stubbornly static – among the lowest in the world. The number of income-tax payers has actually dropped from one percent of the population to 0.92 percent in the past five years. In 2011, 3.1 million people were registered with tax authorities and had national tax numbers (NTNs). Yet only half or 1.5 million of them actually filed returns. This fact is even more telling when set against data from the 2011 household survey that calculated the number of people who earned enough to pay tax. Only 17 percent of 4.5 million taxable Pakistanis – one in six – are verifiable taxpayers. The rest do not pay income tax. A more fundamental issue is the large swath of the formal economy that remains untaxed. Agriculture accounts for around 21 percent of GDP and employs 45 percent of the labour force. But it yields little more than one per cent of total revenue. The service sector, which now contributes the largest share to GDP – around 50 percent – contributes just 16 percent to revenue. Of over a million taxable retail outlets only about 160,000 are registered. Of these less than 28,000 paid tax last year. This means that at least 70 percent of the formal economy is untaxed, lightly taxed or non-compliant. If the informal, undocumented economy is factored in, an even larger proportion of the economy is outside the tax net. Not only is the present tax regime narrowly based, it is also inequitous, putting a heavier burden by way of indirect taxes on those least able to bear it, while offering the rich and powerful ‘legal’ escape routes. The ‘SRO regime’ is a spectacular example of this. Statutory regulatory orders are administrative instruments through which ad hoc exemptions and waivers are handed out. Successive governments have used these to grant exemptions and concessions to special interests, individuals and sectors. This translates into billions in lost tax revenue. Last year the National Assembly’s Public Accounts Committee was told that Rs650 billion worth of exemptions and tax waivers were given in the previous four years alone. This regime fosters the worst form of cronyism and upends the very notion of a level playing field. An unfair tax system is an important reason for low revenue collection and poor compliance. Relatively high rates of tax are imposed on a narrow band of people and a few sectors. The corporate sector for example is the highest contributor (62 percent) to direct tax revenue. But non-compliance in corporate income tax is also high at 58 percent. Systemic weaknesses in tax administration have produced major ‘leakages’. The 2001 task force found that 50 percent of due taxes never reach the treasury, illustrating the power of the rich to defeat the law. Others estimate that the equivalent of $3 billion raised annually in revenue never makes it to the exchequer because of collusion between the tax authorities and powerful groups. The lack of provincial tax effort has compounded the revenue crisis. Provinces make little or no effort to raise tax revenue, from agriculture, services and property that lies in their jurisdiction. At less than 0.5 percent of GDP, provincial revenue funds only a modest part of their spending and instead encourages fiscal recklessness. The transfer of much greater federally collected tax resources to the provinces under the 7th National Finance Commission award was welcomed as a much overdue exercise in fiscal devolution. But failure to think through the fiscal consequences, evolve clear rules and elicit provincial commitment to increase revenue now confronts the country with the spectre of enduring federal budget deficits driven by fiscal indiscipline by the provinces. Who, if any one, will mitigate these serious risks to the country’s financial stability? To extricate the economy from this fiscal mess and generate the means for the country’s economic progress, Pakistan’s leaders have to bite the tax bullet. Without revamping and broadening the tax regime, ending exemptions and loopholes, bringing untaxed sectors into the revenue net and ensuring that provinces substantially increase their revenue, the country cannot chart a way out of a growing fiscal crisis, overcome economic stagnation and reverse the deterioration in public service delivery. This is the test that awaits the PML-N government and its finance minister who raised expectations by announcing that “the culture of exemptions and concessions must end”. Its persistence would certainly leave the economy broken. By Dr Maleeha Lodhi
Posted on: Mon, 22 Jul 2013 05:00:15 +0000
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