Jun 032008

By Zafar-ul-Hassan Almas

The most stubborn failure of Pakistan’s macroeconomic and structural reforms during the last eight years has been the long-term failure of tax revenues to rise as a proportion of GDP and wasteful use of resources. Pakistan was successful in reducing fiscal deficit around 4 per cent or below mainly because of windfall gains of debt rescheduling, higher revenues on the back of rising imports and ending some tax exemptions. However, no serious effort was made to assess efficiency of spending or taxation decisions. The scope of the withholding tax regime was broadened and that also helped in augmenting revenue generating efforts.

Federal Board of Revenue (FBR) was in a false sense of self-praise that it has achieved the revenue targets every year. It was basically done by ending exemptions on basic items like fertiliser, food items, medicines etc. But real effort towards voluntary compliance was missing. No serious effort was made to bring under tax or not-taxed sectors in the tax net. Nothing has been done to improve documentation of the economy. Major portion of the economy is still undocumented and tax administration is as corrupt as it was.

The basic structure of the tax compliance and tax administration has remained nomadic and absurd. Even lax adherence to the rule of law in collecting funds due to the government in the shape of taxes is rule rather than exception. That’s the reason that Pakistan is collecting revenues well below its potential. Failure to mobilise adequate revenues has particularly hurt the development objectives, with adverse implications for efficient utilisation of resources. Because of weak tax administration is responsible for persistent reduction in tax rates (tax-to-GDP ratios) and generally sluggish economic activity. In this backdrop, it will not be surprising that tax revenues may fall short of the budget target by a wide margin. While the federal revenue shortfall will be partly made up by higher-than-budgeted bank borrowing, thereby igniting inflationary pressures in the economy, the fiscal position of the provinces will continue to be constrained, with adverse implications for priority expenditures.

While Pakistan succeeded in lowering the overall budget deficit from around 6.0 per cent of GDP by the end of the 1990s to around 4.0 per cent or below during the last five years, it has done so mainly through cuts in current expenditure and much higher-than-budgeted tax receipts in the same period. The hallmark of the last eight year legacy was poor governance of the highest order. The bureaucracy was riddled with menaces of posting of army personals in the civilian departments, extensions, contract employment based on cronyism and nepotism and that played havoc with good governance. The poor governance ultimately led to inefficient use of public funds, including on development projects outside the discipline of the budget and planning process; inadequate and wasteful public sector spending on physical and social infrastructure and poor monitoring and evaluation of public sector projects. This leads to a weakening of administrative capabilities of the government which encouraged extra-market forces to manoeuvre economic activity to their benefit. So the government spending was unable to reduce poverty or provide any relief to the general public or generate enough employment. The government’s business and its implementation seriously need a complete overhaul. During the past eight years the public sector spending grew with leaps and bounds but limited progress has been made in reducing non-productive public expenditures.

There is no denial of the fact that an efficient, effective and equitable tax system is the fundamental ingredient of good governance. Despite surpassing tax revenue targets in almost every budget in recent years, the tax-to-GDP ratio has stagnated or declined from its already lower level of less than 10 per cent. The main culprit being the overly complex and rigid tax system that covers very narrow tax base, an inequitable distribution of tax burden among various sectors of the economy, weak tax administration in-spite of huge investment in tax administration reforms, widespread and endemic tax evasion culture, and rapid growth of a tax-free informal sector in the economy. The Federal Board of Revenue (FBR) has suffered from profound institutional weaknesses emanating from poor skills, distortionary pay and perks structure, lack of adequate financial controls, excessive scope for discretion and rent seeking by individual staff, and lack of transparency in tax assessment and collection procedures.

In recent years, very little progress (for practical purposes) has been made in reforming the sales tax, income tax, and import tariffs. Significant amendments were made in the General Sales Tax (GST) law in June 1996, expanding the horizontal coverage at the manufacturing and import stages, removing excise-like features, and establishing a turnover threshold for registration. This was followed by introduction of compulsory GST registration of importers, wholesalers, and distributors; effective extension of GST to textiles and steel; improvements in refund procedures; and strengthening of collection. Notwithstanding these reforms documentation of large wholesale and retail trade is a far cry. The economic transactions are based on cash and without formal documentation. The sales tax is not levied on sale of property or many assets but it is imposed on a packet of tea or even other necessities. The sale and purchase of property is being done by influential people while necessities are dearer to the poor.

Pakistan economy needs more public resources to sustain growth momentum, increase spending on essential operations and maintenance, provision of basic social services, and public investment in high-priority projects and for this cause the tax-GDP ratio needs to be raised. In this regard, the government needs an autonomous, efficient and equitable tax administration with a well functioning Pakistan Revenue Authority. The current structure of tax administration is corruption prone because it is based on discretions, exemptions, abuse of authority, discrimination and distortions. We need to extend the GST and income tax base to more taxpayers, increase the yield of provincial agricultural tax by reducing exemptions, updating assessments, and raising the tax rates and more importantly we have to promote a tax payment culture where everyone, irrespective of his/her position/ or sector of origin of income, pays taxes.

With stagnant tax revenues, falling non-tax revenues, and deficit reduction through expenditure cuts like 2007-08 when development expenditure is likely to end at Rs390 billion down from the target of Rs545 billion is least desired option. The structure of public expenditures has deteriorated in recent years. The collective impact of defence and interest spending on the budget almost absorbs more than two-thirds of total budget outlay of the federation, and thus pre-empting nearly all federal tax revenues. In the case of the provinces, the bulk of expenditure is taken up by establishment costs (civil servants’ salaries, benefits, and pensions), interest payments, and subsidies. Development spending (previously the largest category) and other priority sectors are badly ignored. Expenditures on social services are still very low by international standards despite substantial increases in recent years. The waste and ineffectiveness of much public expenditure sharply reduce its effectiveness towards attaining development objective. During the current year, the government has made substantial cuts on development expenditures amidst rising current expenditures. The expenditure squeeze in the provinces has been even more severe than at the federal level, seriously affecting their development programs and their non-administrative expenditure. Further cuts would dangerously undermine the quality of public sector physical and social infrastructure.

The new Federal Budget is to be presented in a highly constrained fiscal environment, when Pakistan is faces stark choices in narrowing fiscal gaps without restraining social outcomes. The higher oil and commodity prices in the global market demands even more state intervention to provide social safety nets against more people are falling below poverty line. The reorientation of public expenditure must have a human face. The subsidies must be targeted to deserved and identified groups. There is an urgent need to spend more on: (a) irrigation, water resources and roads; (b) basic social services, especially quality enhancing expenditures; and, (c) public investment in high-priority development projects.

Source: The News, 1/6/2008

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