May 25 - 31, 2009

The budget for the fiscal year 2009-10 is due to be announced within a few weeks. Economic Managers of the country, as a result of talks with IMF for release of next tranche, have almost finalized their main targets for the next year envisaging an expenditure of over Rs3trillion, debt-servicing Rs 751billions, defense expenditure Rs380billion, development expenditure of Rs616billions and tax revenue of Rs1.8trillion.

Details of these targets and the methodology to achieve these targets especially the revenue generation are discussed in the relevant circles these days almost round the clock to give a final shape to the budget. 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.

The policy makers seeking to reform tax structure must comprehend that a misguided tax reform would do more harm than good to the 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 weak tax structure.

If we look at Pakistan's present tax structure in international perspective, we would know that already it has narrow tax base with tax evasions. It caused lower tax to GDP ratio, which has 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.

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, that how much exploitation of present sectors of tax-base can be made is not a difficult riddle.

There is a consensus amongst the independent economists that in our efforts to raise the national revenue and the tax to GDP ratio we do not bother to focus on untaxed and exempted areas. For instance, Agriculture Sector of our economy accounts for 22% of our GDP. Agriculture sector accounts for 22 per cent to GDP but contributing in tax revenue only 1 per cent. In a given structure, it is the biggest sector in terms 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 dampness in present circumstances. Just focusing on indirect taxes will not give revenue recovery over the long run.

In the past the promises of bringing Agriculture sector in to the 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 want us to improve tax revenue, and it is not their issue, if it is done by increasing tax more on indirect sources on already well-exploited sectors or to take some superficial measures on administration level for reducing the numbers of tax evaders. The raise in revenue is a prime issue and solution of economic problems but economic stabilization 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.

According to experts by bringing income from agriculture into tax net at the existing rates of income tax we can raise over Rs300billion annually. Real estate sector, capital markets, and professional services sectors are other areas from where, according to experts, about Rs500billion can be raised annually. These measures would be fully justified on moral grounds. Well there is a rampant corruption in our tax departments, which are abetting in tax evasions of over Rs3 to 400 billion annually, according to experts.

If we do not take these measures then we will have to resort to the loans from external sources to meet the estimated expenditure in the next financial year because adding to the burden to those already paying taxes would not be an easy task. Under the prevailing conditions, what we need is to take decision entailing for the long-term economic productivity, otherwise we will get to a stage where debt service payments will wipe out everything else.