September issue 2018
The Tax Reform Challenge
‘Tax reform’ is the favourite buzz-word of every political party when out of power. But it is easier said than done, once a party is in the driving seat.
Pakistan has failed miserably in maintaining any pro-people fiscal policy and administration. The country’s tax-to-GDP ratio trails at less than 11 per cent. The present tax collection of Rs. 4,000 billion falls short by at least Rs. 3,000-4,000 billion. The PTI has formed a government at the centre for the first time and has resolved to undertake the kind of reforms that have never been introduced in the past 71 years and voters’ expectations are high.
Throughout its history, Pakistan has witnessed more than 10 Tax Reform Commissions. All such Commissions, by and large, were made up of educated personnel who were experts in their respective fields. All the reports they produced were well-drafted and recommended the relevant reform measures. Despite the reasonable theoretical work, the situation on the ground has remained unchanged. On the contrary, it has, of late, worsened and turned into a disaster-like scenario. How the government will bring about a change for the better remains to be seen.
Fiscal policy is an integral part of the country’s overall economic policy. Pakistan as a state, especially after 1970, has been run without any medium or long-term economic plan. Policy decisions on economic affairs have been made on a short-term, election-to-election basis. Decisions are filled with political expediencies and determined by the politics of the vote bank. Fiscal policy and administration is the biggest victim of any such ad-hoc approach.
The approach that the PTI government chooses to adopt will be a clear indicator of whether it will be able to deliver on this front. Will it come up with a medium- and long-term framework in the shape of an integrated ‘Five-year,’ ‘Twenty-year’ or ‘Fifty-year’ institutionalised economic plan? If it is filled with the useless ‘visions’ and ‘missions’ as has been the case in the past, then that would only demonstrate a continuation of the status quo. There is a widespread expectation of a more constructive approach.
Policy measures that are part of an integrated economic plan designed to provide a solution to both the fiscal and current account deficit, coupled with steps for the sustainable growth of domestic industry and employment, will be the first sign of any meaningful reform. Fiscal and current account deficits are closely related in every economy. In Pakistan, however, it has been observed that the current account mismanagement leads to serious crises after every decade.
The year 2018 is no exception. The current account mismanagement in Pakistan, unlike many other countries of the world, is mostly driven by fiscal policy. In this country, fiscal policies are designed and managed in a manner that creates a non-level playing field for local industries. It encourages the import of goods and services in every practical sense and after a decade or so, the country ends up in serious current account crises.
There are many practical and theoretical answers in support of the policies adopted. But Pakistan, as a state without an adequate industrial and employment base, has erroneously adopted the follies of the ‘market economy,’ ignoring certain ground realities such as bringing the house in order with respect to industrialisation, value addition and employment. This has been amply demonstrated by all the fiscal policy measures adopted over a very long period of time.
The process has, however, intensified after 1990. The result is a consumer-oriented society, in which only a minor percentage – seven to ten per cent – of the total population benefits. The segment of society that has benefited from these policies is the politically and socially-connected elite. The biggest challenge for this government will be to take on these sections of society that have been prospering at the cost of the majority. As things currently stand, this is a huge task, as there will be resistance from various quarters against any substantial change in the status quo.
Any policy measure that eliminates discrimination against the domestic industry will directly affect the quantity of imports in the country. Since a substantial part of the tax-collection comes from imports, all policy decisions will have to be weighed with reference to the negative and positive affects on tax collection and the financial risk that the state will be able to bear on that count.
The government must adopt far-reaching, corrective reforms and effectively communicate to the people that any rupee increase in tax revenue, without a consideration of the fundamentals, is a mere illusion. There are, however, limited choices. It has been observed that over time, the state has lost its writ in the matter of tax collection, especially taxing people on a net income basis. Tax collection is heavily reliant on indirect taxes and indirect taxes disguised as direct taxes, arranged by way of withholding taxes on necessities like natural gas, electricity, mobile phones and so on. The other major issue is the collection of tax at the import stage on consumable items. It has been observed that the government’s writ is gradually receding. There are actual and implied threats of non-cooperation against any drive for transparency in economic activities.
On the administrative side, the problem is even more severe. At present, the tax administration is conjunctive with other civil services, in hiring, educating, training and remunerating employees. This colonial legacy cannot continue. There is a need to introduce a separate line of service – a ‘Pakistan Revenue Service’ if you will – that caters to its own hiring, educating, training, and remuneration system. This process will, again, face immense resistance and the success – or failure – of the new government will depend on its will and power to withstand that pressure.
The tax reform process to be undertaken will have to be gauged on the following benchmarks:
1. Coordination and integration with an overall economic plan for the next 50 years.
2. Resolving the adverse inter-relationship between fiscal and current account deficits.
3. Promoting the documentation of economic transactions.
4. Providing a level playing field to domestic industry against imported products.
5. Relying on income-based taxation and documentation of all assets at appropriate costs.
6. The formation of a Policy Board for Fiscal Affairs and its complete segregation from the administrative side of things.
7. The formation of the Pakistan Revenue Service.
If the government is able to deliver on these points, Pakistani society will be in the forefront of reform. All this must, eventually, lead to the promotion of domestic industry, employment growth and an equity in income distribution.
Syed Shabbar Zaidi is a former president of the Institute of Chartered Accountants of Pakistan and a Senior Partner at A.F. Ferguson and Co.