LARGE FISCAL DEFICIT; TOO BAD FOR THE ECONOMY
SHAMSUL GHANI (email@example.com)
May 26 - June 01, 2008
Since growing economies need new investment money every year, controlled fiscal deficit, possibly in the range of 1.5 to 2.5 per cent, may be considered desirable for a nation's economic development. Pakistan faces an undesirable situation when its fiscal deficit for the year 2007-08 appears to have reached a threatening level of more than six per cent (some say even more) as against the government target of 4.2 per cent. In this backdrop, State Bank of Pakistan's revised budget deficit target of 5.2 per cent - based on country's economic performance for the first six months ñ seems outlandish. During the first six months, the total revenue collection stood at Rs.625 billion in the face of an annual target of Rs.1,475 billion. What is more disappointing is the fact that total expenditure for the same period posted a figure of Rs.982 billion. The large deficit of Rs.357 billion represents 3.6 per cent of the GDP. Major portion of this deficit has been financed through State Bank borrowings thereby putting strain on State Bank's liquidity. The State Bank, in turn, might be forced to raise money through country's banking system.
As a measure to minimize the deficit, the Rs.520 billion Public Sector Development Program (PSDP) has already been slashed by Rs.70 billion. A further cut is also on the card. The on-going development projects will continue till completion, the projects that were ready to take off have been put on the hold. The new finance managers have arranged from the lending agencies assistance to the extent of $2.5 billion to meet the fiscal deficit. These window dressing measures may leave a bad taste in few mouths, yet these are the ground realities.
We are a nation that consumes more than what it produces. Our government are the people that spend more than what they earn. The major part of government earnings is contributed by the tax revenue system which, in our case, is not very efficient. The deficiency of our fiscal system can be traced to the faulty tax structure we passively stick to even after the passage of decades. The low tax to GDP ratio of around 10 per cent continues to haunt us since long. The narrow tax base, the undue and unfair concessions allowed to the feudals and elite classes either out of subservience or as a result of coercion, the meaningless multiplicity of taxes, the regressive tax regime and unfair tax rates and the system's failure to introduce the element of dynamism are the maladies that have firmly stood in the way of tax reforms.
Over dependence on indirect taxes that are easily passed on to the final consumer results in low consumer spending and is therefore anti development in consequence. It also creates serious economic disparities that hinder the overall growth process. In our case, the indirect taxes account for approximately 60 per cent of the total revenues. The infamous GST is the highest revenue contributor in the list of indirect taxes. Our indirect tax to GDP ratio is 6 per cent while the direct tax to GDP ratio is 4 per cent. In most of the East Asian economies, this is the other way round, that is direct tax to GDP ratio is higher.
Multiple taxes and high rates encourage tax evasion. To broaden the tax base, the number of taxes will have to be reduced to the bare minimum coupled with the slashing of rates to make them realistic and acceptable to the new tax payers. Our economy's informal sector is quite large in size. It can be brought into the tax net by offering certain incentives. This will not only broaden the tax base but will also reduce our dependence on indirect taxes.
Much is being said about taxing the agriculture and service sectors. While the unprecedented growth of the service sector offers an opportunity to widen the tax base, taxing of agriculture sector seems a distant possibility. Sources say that President Musharraf had agreed, last year, to tax agriculture. Now, after his capitulation, who is going to take up this issue? Perhaps none. May be some one tries to find a link between his present position and his resolve to tax agriculture sector.
In our ambition to raise revenue from country's stock exchanges, we must not commit the folly of introducing capital gain tax (CGT) on stock exchange operations. This will be highly counter productive. It will be much better to take the stock big wigs in confidence and give them a reasonable revenue target which they will definitely achieve through capital value tax (CVT) either through increased trading volume or through adjustment in the CVT rate. The proposal, said to be initiated by the SECP, carries little sense. Similar attempts in the past are known to have produced disastrous effect on stock market operations. We, in the present situation when the economy is already in shambles, can not take the risk of sending shock waves through the stock market. Standard and Poor and Moodys' have already reduced our ratings. Stock market shake-up will only add to the country's economic woes
Besides controlling non-development expenditure, government borrowing from the banking system should also be curtailed as it results in higher interest charges. During the first half of the current fiscal year, the domestic interest charges increased from Rs.156 billion in FY 2007 to Rs.238 billion in FY 2008. The increase in domestic interest charges was to the extent of 53 per cent as against 18 per cent on account of foreign interest charges.
With the recent change in the country's leadership coupled with the resigning and induction of finance ministers, we can not expect the economic managers to produce an excellent budget document. We can, however, expect them to give due thought to the burning economic issues. The policy framework for the coming years should aim at keeping the budget deficit within the desirable limits. The budget making is not rocket science. What is required is the will to act and the resolve to implement government policies. The policies should be based on realistic grounds carrying promise to create an equitable financial system with a focus on the uplift and well-being of the poor in particular and the entire society in general.