ISLAMABAD: Taxation policy has to be complemented by other macroeconomic policies as it is just a small component of the big pie. Going forward, Pakistan has to implement massive public investment programmes to steer the economy to a higher growth trajectory.
This has been suggested in an economic analysis titled ‘Structural Reforms to Boost Economic Growth’ compiled by two Senior officials Umar Wahid and Zafar ul Hassan Almas in Federal Board of Revenue (FBR) for the first quarter July-September period of this fiscal year 2013-14.
Recently, a working paper of the International Monetary Fund after analysing a sample of 107 countries and 79 episodes of public debt reduction driven by discretionary fiscal adjustments during 1980–2012 showed that expenditure-based, front-loaded fiscal adjustments can dampen growth when there are credit supply restrictions.
Contrary to this, fiscal adjustments that are gradual and rely on a mix of revenue and expenditure measures can support output expansion while reducing public debt. The paper also concluded that protecting public investment is critical for medium-term growth, as is the implementation of supply-side, productivity-enhancing reforms.
In the light of this paper if we look into the design of the IMF-backed stabilisation programme of Pakistan, the inclusive growth is at the centre stage of the programme. This programme is unique in a sense that it not only tried to endogamies the economic growth but also make it more inclusive. Another important component of this program is to enhance the effectiveness of social protection by guaranteeing budgetary allocations. This programme is trying to distribute the burden of adjustment evenly on both tax and expenditure reforms.
The adjustment burden of expenditure is mainly placed at phasing out unproductive and untargeted subsidies. The fiscal deficit of the last five years is higher by 2.6 percent over average deficit of 2000-07 and 1.7 percentage points were contributed by rise in subsidies alone. The current expenditure was higher by 2 percentage points which implies that only 0.3 percentage points came from other components of current expenditure. The tax-to-gross domestic product (GDP) ratio had declined by 0.1 percentage points in this period
The positive thing is that rise in fiscal deficit also came from increase in development expenditure by 0.4 percentage points. The development expenditure had borne the brunt of adjustment in the aftermath of the Stand-by Arrangement, 2008 which proved counter-productive. Pakistan is facing large infrastructure gaps and developmental needs and in this backdrop slashing development spending constrains the country’s growth potential. The government has rightly realised that the growth enhancing expenditures has to be raised so that job creating potential of the economy may not be jeopardised and thus to transform the economy by scaling up investment in infrastructure and human capital.
Public investment has a high economic and social rate of return and is highly complementary toward private sector investment.
Resources needed to finance public investment are not adequately available as fiscal space remains constrained by rigidities in the structure of the current spending and the government embarked upon a plan to put burden on taxation.
Fiscal adjustment remained the key problem area for the last five years as the fiscal deficit averaged 6.6 percent of GDP per annum. Half hearted reforms in tax administration and policy, power sector, restructuring public sector enterprises and governance remained major bottlenecks towards fiscal situation. Tax and expenditure slippages and problems in financing the deficit remained the hallmark of fiscal situation and as a result:
Tax-to-GDP ratio fell from 11.1 percent in 2007-08 to 9.3 percent in 2012-13. Provincial tax collection stagnated at around 0.5 percent of GDP. FBR tax-to-GDP ratio actually fell from 10.3 percent in 2007-08 to 8.5 percent in 2012-13. Pakistan yields one of the world’s lowest tax-to-GDP ratios (ranks 115th out of 179 countries). The tax administration and structure are planned to be reformed to contribute adjustment to the tune of 0.7 percentage points each year by reforming existing tax system. With lopsided structure, almost one-fourth of the entire tax collection or more than 25 percent comes from POL at various stages. In customs tariff, 54 percent of tariff lines have different tariff rates for different importers through SROs. Around 86 percent of tariff lines are affected by an SRO in one way or the other and 44 percent of the value of imports affected by SROs. Multiple rates are applied on sales tax–(0, 5.0 percent, 7.0 percent, 16 percent, 19.5 percent, and 3.0 percent additional tax on commercial importers). Effective sales tax rate is 3.6 percent which is very low because of exemptions, and huge input adjustments. Tax gap is almost half of the actual tax collection. The reforms are aimed at de-politicising the recruitment, transfer/ postings in the FBR which must be based upon merit. This will enhance administrative efficiency. Another area of concern remained the tracking of non-filers who enjoy decent living and huge ability to pay. This is weakening the overall writ of the government and institutional degeneration in the country which has also impacted the functional and operational efficiency of the country in recent past and efforts are underway to make FBR a vibrant organisation. However, FBR alone could not make headway in boosting revenues substantially unless it is not equipped with effective legislation. The structure and the legal framework governing the taxation need to be reviewed by the parliament. The international best practices, technology and political will could play an important role in restructuring the taxation environment. The SRO culture has detrimental effect on competitive environment and nurturing entrepreneurship. This is retarding economic growth and by bringing those in normal tariff lines could help enable to raise revenues. Taxation policy has to be complemented by other macroeconomic policies as it is just a small component of the big pie.
Going forward, Pakistan has to implement massive public investment programs to steer the economy to a higher growth trajectory. The government has to review its development framework as well to ensure that resources contributed by the people of Pakistan are not spent in non-productive projects. Increasing public investment will not be sufficient for the increased well being of the common man as the country faces important capacity constraints. A solid public investment framework has to be in place to ensure that projects selected are aligned to the present government’s priorities and are efficiently evaluated and selected based on their value for money assessment. A proper accountability framework for making the bureaucracy responsible should also be put in place to avoid unnecessary delays in project completion and wrong appraisal.
By increasing the efficiency of public investment over time, it is possible to yield higher economic returns which may increase the growth dividend for a given level of investment spending, or alternatively achieve the same growth dividend with reduced reliance on new tax revenue or borrowing. Social sector need substantial resources in the years to come to improve our social indicators compatible with peer countries. A high growth trajectory would require adequate investments financed through a high rate of domestic savings. Historically, savings rate in Pakistan has been low and consequently the country has to depend on foreign inflows to finance its growth and development needs. Increasing the national savings in order to finance the investment needs will be critical for putting Pakistan back on the high growth trajectory in the long-term. In order to channelise investment in key sub-sub sectors having the potential to lift the economy from a low growth equilibrium, it is important to sequence and prioritize the public sector investments to crowd in private investment and bolster economic growth.
The structural reforms under the IMF programme (both pertaining to expenditure or revenues) should be implemented in holistic form and piecemeal approach will not work as has been proved in the past. The economic growth has to be boosted to around 7.0 percent in the medium-term and tax policy will enhance the much needed allocative efficiency of factors of production. The expenditure policy should also support growth enhancing efforts.
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