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Pakistan Budget 2009-10 and IMF conditionalities

We need to take decisions to achieve long-term economic sustainability, otherwise
we will get to a stage where debt servicing payments will wipe out everything else

The budget for the fiscal 2009-10 is due to be announced in June this year. It remained a question whether the resolution of annual budget is to gain political mileage or to reveal an economic action plans for next year? This question becomes much relevant in upcoming budget in view the garb of economic restructuring plan of IMF for Pakistan. Budget document presents the government action plan of priority and allocation of funds and the question that confronts us is ‘how to strength the policy that should not undermine the sovereignty on decision making functions of the country. There should be priority on the national issues and allocation of funds for various key sectors and the role and extent of IFIs. Critics are fast to note that this budget is no exception, at present, just after the approval of second tranche of $800 million of $7.6 billion loan of IMF.

budget-2009-10lMeasuring the implementation of IMF conditions is not straightforward. Presently, the government’s central challenge in this first budget would be putting downwards pressure on inflation, reducing fiscal deficit and increase tax to GDP ratio. It is apprehended that if the target of fiscal deficit which is core area of IMF’s medicine to poor state is not materialised by the government, then the future trenches after June 30, 2009 under 23 months Standby Arrangement loan of $7.6 billion may be delayed.

Keeping in view the shortfall of the projected revenue for current financial year, it is unlikely that such reduction in deficit can be achieved. As a result of talks with IMF for next tranche, other targets such as expenditure of Rs3.064 trillion, debt servicing Rs751 billion, defence expenditure Rs380 billion, development expenditure Rs616 billion and tax revenue of Rs1.879 trillion is already fixed for next financial year. So fixing up these macro targets already tuned the budget of 2009-2010, barring a miracle any way.

Since 1998, Pakistan had a long and difficult relationship with the IMF and it remained concerned with macro economic issues of Pakistan, which naturally gives leverages to influence the monetary policies and budgets. As per agreement with the IMF we are under obligation for a new value-added tax laws for full implementation. This new VAT system will replace the existing general sales tax (GST) regime. From a macroeconomic perspective, a particular area of interest for policy makers is whether the existing overall tax to GDP ratio is appropriate, and whether the existing composition of tax revenue is viable. For the past three decades, IMF’s favorite policy advice area is tax reforms, now with great emphasis on the value added tax (VAT). Under the given tax structure it is believed that it will be regressive and put more burden on poorer than rich classes of any country.

Though it is also be considered as most efficient way of raising revenue but we should be mindful that it would be also at risk of evasion and tricks may be lesser but still. There is a potential chance that under VAT sales is underreported, ghost traders can evade VAT as other taxes, unregistered groups will be beneficiary, and VAT with a relatively high registration threshold will exclude smaller businesses for which this is likely to be more of a risk. If this tax is not charged at the borders, then there is a brighter chance form accumulation of profits by importers without any tax. It will also increase administrative cost of the tax collection. The policy makers seeking to reform tax structure must comprehend that a misguided tax reform would do more harm than good to the general public. Rationale of VAT must have some merit for replacing a sales tax or excise duty, it will improve the horizontal equity of the sales tax and replacing a corporate profits tax with a VAT will make revenues more stable but with the caution that what works with Europe, may not work with other states keeping in view the week tax structure. Unlike sales tax VAT often may not be itemised on retail receipts, leaving a smaller room for consumers to know that they are paying VAT. Since it is passed through to consumers like a sales tax, replacing a corporate profits-tax with a VAT, will make already-unfair tax systems even more regressive to consumers.

If we look at Pakistan’s present tax structure in international perspective, we would know that already it has narrow tax base while having tax evasions too. It caused lower tax to GDP ratio which is now declined to 9.5 per cent which in 1980s and 1990s remained at 12 and 13 per cent respectively. It is lower even in the region where average is about 15 per cent to GDP. In EU it is ranging between 24 to 44 per cent. Now the authorities in Pakistan targeted its raise to 15-18 per cent through tax reforms in coming 5 years. A revised target of 1 trillion is already set for the next financial year by Federal Board of Revenue. What we need is to link our tax base with our per capita income which is also lowest in the region. Keeping this fact in view, how much exploitation of present sectors of tax-base can be made, is not a difficult riddle. Naturally we need to enhance the tax net base, though there is stronger view that existing bases should be exploited, which will easily generate 400 to 500 billion rupees, but this takes a whole restructuring of the tax system. It is also said that if potential in the existing tax base gets exploited, Pakistan will easily be able to generate Rs300 to Rs400 billion and can generate revenues of over Rs100 -150 billion if tax exemption is revisited but it would need an investment in restructuring of the tax system to work, for already exploited areas. The tax area would enhance capacity through investment in traditional tax sectors.

Agriculture sector accounts for 22 per cent to GDP but contributing in tax revenue only 1 per cent. In given structure it is the biggest sector of tax evasion, as often the income of non-agriculture can be exposed as agriculture income which substantially increases non-formal sectors of economy. Agriculture tax will give a financial cushion immediately to tax gap in present circumstances. Just focusing on indirect taxes will not give revenue recovery in the long run. In the past the promises of brining Agriculture sector in to tax net have been made but did not work. Now it has been warned by IMF that there is no escape, if Pakistan wants to continue with IMF program, it has to go for agriculture tax. The IFIs surely wants us to improve tax revenue, and it is not their issue, if it is done by increasing tax more on indirect source on already well exploited sectors or to take some superficial measures on administration level for reducing the tax evaders. The raise in revenue is a prime issue and solution of economic problems but economic stabilisation needs equality and distributive justice. There is a trade off. It needs a stronger governance and fiscal policy. A regressive tax reduces the purchasing power of the consumers and ultimately negatively affecting the taxes revenue even as a direct source.

Pakistan would need $12 billion constantly for next few years to meet revenue gap and if we keep on relying on foreign aid then debt is an efficient tool and mechanism of effective control by IFIs. Therefore, the question should not be how IMF’s lens sees this budget and how much the capacity of prioritising the issues is edged but what we need is to enhance the economic productivity capacity for tax revenue as we cannot continue borrowing and borrowing. What we need is to take decisions entailing for the long-term economic productivity otherwise, we will get to a stage where debt service payments will wipe out everything else. There will be no exception to tough decision whether in this up coming budget or many to come afterwards.

Source: The News International, 18-May-09

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