The following article has been published in the renowned “Blue Chip” journal as an exclusive Op-Ed on Economy in its 11th Anniversary Edition published in July 2015.
Online Version Link: Blue Chip Article on Economy
Budget, Taxation and Reforms
By: Omer Zaheer Meer
There were many positive indicators announced by the honorable finance minister, Mr. Ishaq Dar in his latest budget speech. The first one was the growth rate of 4.24% in 2014-15. Despite missing the target growth rate of 5.1% in last fiscal year, it is still a healthy sign when compared to the mere 3% from 2008 to 2013. The significant drop in inflation from 12% to 4.6% was also phenomenal. Fiscal deficit is expected to be brought down to the level of 5% of GDP from the previous level of 5.5%. However, all these were largely due to the significant reduction in global oil prices and the resulting deflation effects rather than the structural reforms and/or economic policies of the policy makers.
Furthermore, the foreign remittances to Pakistan showed an extravagant increase of 16.14%, which is the highest in the region and should be exceptional by any standards. However it would warrant further examination into the origins of the funds as the controversial law sanctioning no tax or questions about origins on foreign remittances has long made the foreign remittances route a heaven for money laundering and legitimizing black money. While legitimate foreign remittances are a great support for developing economies like Pakistan’s, the use of the above mentioned law for legalizing the black money actually costs more to the economy in terms of the lost revenue and the impact of black businesses on related industries.
In view of the above, it was rational to expect the shortcomings to be addressed in the budget including structural reforms in the taxation system pursuing a progressive regime, introduction of economic reforms and improvements in controversial laws hampering the economy. Whether that was the case is examined below along-with some recommendations
As for the reforms in the taxation system, the proportion of indirect and direct taxes has not changed substantially. This alone though is not sufficient as indirect taxes lead to a regressive system where not only are the rich and poor paying equal amount but unequal proportion of their incomes as taxes but it also causes inflation. This results in higher production costs, which leads to declining exports due to the loss of cost competitiveness and missed opportunities.
The government, in its defence points out to the existing trust deficit between the taxpayer and the taxmen which has created a tax avoidance culture in Pakistan. However there is a reason that all developed economies rely more on direct taxes to negate the disadvantages of indirect taxes which far outweigh the benefits to the national exchequer. The approach of using indirect taxes to fill-up government’s coffers has serious negative ramifications.
To make this clear, take the example of fuel. Upto 30% had been routinely charged as an indirect tax on every liter compared to only 13% in the USA. There are several types of indirect taxes levied within Pakistan including customs duty, sales tax, federal excise duty, petroleum levy, gas infrastructure cess, natural gas surcharge, e.t.c. All this focus on indirect taxation leads to inflationary pressures in the economy as increased prices translates into increased cost of production, services and living. The resulting impacts are hyper-inflationary in nature as there is a multiplicative rather than an additive element in the inflation passed-on at every level.
Furthermore the pay-rises are not proportionate to inflation. Only a 7.5% increase has been proposed in the federal budget. This forces people towards unfair means or rely on expensive credit in order to make their ends meet. Similarly finance requirements of businesses also increase. The resulting hyper-inflationary environment and decreased purchasing power leads to higher interest rates which negatively impacts the businesses as many otherwise viable projects become non-feasible. The declining business output results in lower employment opportunities which coupled with the limited money-supply puts recessionary pressures on the market. This ultimately results in the devaluation of the currency which in turn translates into increased foreign debt. As a result, financing costs of the foreign debts increases leading to a higher proportion of GDP being spent on debt financing. All this combined with hyper-inflation drags the already weak economy further back in Pakistan’s case.
It is therefore recommended that the policy makers should seriously consider pursuing a progressive tax regime where wealthy segments of the society are taxed more. Moreover large landowners and the various exempt sectors must be brought within the tax-net and the revenues raised should be utilized to subsidize the weaker segments of society and to support reforms. For example, it’s been suggested to the authorities before that the agriculture sector should be taxed at a reasonable rate, 5%-7% for landowners with holdings over 12.5 acres and the revenue raised should be used to subsidize the water and electricity for the agriculture sector. This would enhance the yield and therefore the GDP. To summarize, the proportion of direct taxes should be increased and reliance on indirect taxes should be minimized. While some exemptions have been withdrawn in the finance bill which is commendable, more needs to be done in this regard.
Also some structural reforms in the taxation system can go a long way to assist the authorities in meeting their revenue targets. One good step is the current budgetary proposal to allow computerized national identity card (CNIC) number to be used as the National Tax Number (NTN). However the proposal for using the CNIC number as Sales Tax Registration Number (STRN) for all citizens has been ignored. Together both these steps could not only make it extremely easy for any Pakistani to start a business having the requisite tax registrations and thereby promoting a culture of entrepreneurship but would also help broaden the tiny existing tax base as the number of filers and ultimately taxpayers are forecasted to increase with the increasing documented nature of the businesses.
Another key reform could have been to decrease the tax rates to make it more feasible to pay taxes with stringent penalties and cost of avoidance acting as a deterrent. The increase in the tax base would more than compensate for the loss from lower rates. Currently Pakistan has one of the lowest tax bases and tax-to-GDP ratios in the region. If implemented this proposal can turn this around and increase them both substantially.
In addition, to restore the faith of the taxpayers a multi-dimensional tax reforms agenda which has been constantly recommended by this writer must be implemented, where:
- Taxpayers are encouraged and incentivized for paying taxes.
- Taxpayers are facilitated by making the process easier and fairer, focusing on maximum automation in order to stem out corruption.
- Instead of increasing the tax rates the tax net is constantly widened.
- More focus is given to direct taxation.
- Meaningful tax rebates and reliefs are introduced for the less able sections of the society.
- A system of proportionate taxation is adopted with more affluent contributing more to the treasury.
- Certain exempt sectors are brought into the tax-net (subsidies can be given for assisting any under-pressure areas/products).
- Tax rebates and incentives are introduced to encourage foreign/local investments in key sectors with tax-breaks for transfer of technology, e.t.c. as may be required in a particular sector.
- Tax money is actually spent on public welfare and infrastructure projects, which will improve the spending capacity and the business environment in Pakistan.
- The massive corruption in public contracts/projects, now routinely in the range of 40-50% of tender values, is eradicated for better and efficient use of public money through revamping the pay and accountability structures.
Similarly the controversial law allowing foreign remittances to be brought to Pakistan without having to declare the source of origin or pay any taxes has more disadvantages than the benefits it brings. Let’s elaborate this further. As mentioned before, Pakistan saw an increase of 16.14% in foreign remittances from $12.89 billion to $ 14.97 billion in the last fiscal year. What’s interesting is that the remittances in the entire region have seen a much humble growth. Also, the work profile and the resultant pay scales of ex-pats Pakistanis have not been changed drastically. Furthermore, the inflation and cost of living has actually declined for the relatives of ex-pat Pakistanis as per the figures revealed by the finance ministry. Considering all this and the various studies conducted in the past, it can be safely said that a huge chunk of the foreign exchange remittances are actually the black money laundered and then brought back to legitimize the funds and that too tax-free. Now infamous model Ayan Ali is a case in point. We don’t know for sure how many Ayans are currently doing what she was caught for. It is therefore high time that the finance ministry officials give this a serious thought and atleast consider introducing checks about origins of finances to control and curtail the illegal economy hampering Pakistan’s economic development rather than actually assist it for some short-term gains at the cost of longer-term losses.
Pakistan has been blessed with all kinds of terrains and weathers, fertile lands, valuable natural resources, a high proportion of population been young and hardworking with cheap labor availability. A fairer system of taxation coupled with some key reforms culminating into a fairer economic policy can provide the necessary environment to harness the economic potential of Pakistan.
The key reforms outlined above, if properly implemented with a focus to rely on and develop indigenous capabilities, can resolve the current enigma facing the treasury. With the above actually implemented, there is no reason, why Pakistan cannot stand on its own feet and become an economic hub not only for the region but the whole world. Let us hope that our representatives give this all a serious thought while passing the amendments to the federal budget.
The author is Director of the think-tank “Millat Thinkers’ Forum”. He is a leading economist, CFA Charterholder, experienced fellow Chartered Certified Accountant and anti-money laundering expert with international exposure who can be reached on Twitter and www.myMFB.com @OmerZaheerMeer or email@example.com