Redoing the revenue and expenditure policy

Published: April 9, 2012

A big debate needs to be initiated to reconstruct the fiscal social contract to decide how taxes and expenditures should be allocated in the country.

Weak fiscal structure is one of the major policy areas Pakistan seriously needs to concentrate on to strengthen its public finances. This was recommended by the International Monetary Fund (IMF) in its country report released in February 2012. IMF’s advice is not misplaced, especially in the context of the yawning fiscal deficit and low tax-to-GDP ratio. The fiscal deficit of Pakistan has widened to the unsustainable limit of 6.6% of the GDP whereas tax revenues constitute only 9-10% of the GDP, one of the lowest in the world.

Tax evasion is widespread. You will hardly come across a person in Pakistan who believes that tax collection is fair, or that he should pay due taxes for a larger purpose of state building, or that he can associate himself with the benefits dished out by the state in return of taxes paid by him due to perceived horizontal and vertical inequities of the taxation system. Thus, there is general unwillingness to pay taxes in Pakistan.

Due to low revenue collections, large fiscal deficits are hard to finance and the hammer of austerity always falls on the development budget. As pointed out by the IMF report, the budgetary management simply means containment of investment spending and borrowing from the banks. It will almost be impossible to reinvigorate the weak fiscal structure unless a consensus is reached through renegotiation of the fiscal social contract among all the stakeholders for domestic revenue generation and its spending. Currently, the social fiscal contract, if it at all exists, is very weak due to a palpable absence of any relation between the revenue raising and spending preferences.

The revenue collection and public spending patterns are clearly determined by the vested interests of such groups and not the collective benefit of the citizenry at large. Consequently, the powerful and the rich do not pay due taxes.

In order to reconstruct such a contract, we need to answer three basic questions. First, what will be the major sources of revenue to reduce: fiscal deficit, aid, borrowing or domestic revenue mobilisation? Second, what will be the priority areas of spending (butter versus guns tradeoff)? Third, how will it be ensured that the allocated budget is properly spent on priority areas and value of money is returned to the tax payers (control of corruption and good governance)?

For domestic revenue mobilization, issue of horizontal and vertical inequities need to be addressed. Taxation of the sectors of the economy which are still out of the tax net should become part of the debate while reconstructing a fresh fiscal social contract. Taxation of land value improvements, and simplified taxation schemes for small businesses operating in informal sector can be some of the potential areas for broad basing of taxation. Broadening of tax base will not only enhance revenue but also contribute towards state building.

In order to reduce tax evasion and large tax gap, improving the quality of tax bureaucracy is another area deserving major focus of the government. The efficiency of public bureaucracy is determined by the fact as to how effectively it collects taxes and detects tax evaders. The empirical literature recognises the quality of tax bureaucracy as one of the major determinants for tax revenue.

Second ingredient of the social fiscal contract relates to the spending priorities. It is what the economists call “butter versus guns tradeoff.” According to IMF country report, subsidies especially electricity subsidies and interest payments consume almost half of the government’s revenues while security spending uses up another quarter. The portfolio of expenditures in our case has got two salient features: first, most of the revenue is consumed by non-developmental budget like interest payments and defence. Second, whatever is left is consumed by wasteful expenditures. Thus very little budget is allocated for sectors like education and health etc. Resultantly, large population of the country is not direct beneficiary of the fiscal choices. While negotiating the social fiscal contract, we need to resolve, once for all, whether we should secure ourselves through guns or by investing in our people.

Third question relates to the control of corruption and good governance. It is a matter of common observation that whatever little is allocated for the human and infrastructure development does not reach the intended targets. According to the IMF report “patronage, weak management, poor service delivery and other governance issues have created fertile ground for rent-seeking and corruption in Pakistan”.

The point is that in order to fully tap the economic potential of the country, we need to reconstruct a fresh fiscal social contract by seeking answers to the above questions. A big debate needs to be initiated to reconstruct the fiscal social contract to decide how taxes and expenditures should be allocated in the country. Taxation and expenditure decisions should not be based on the preferences of the particular interests. All the stakeholders, irrespective of their political, ethnic and religious affiliations, should come forward to steer the country out of the economic morass.

The writer is a graduate from Columbia University with a degree in Economic Policy Management.

Published in The Express Tribune, April 9th, 2012.

on Twitter, become a fan on Facebook

Reader Comments (1)

  • Meekal Ahmed
    Apr 9, 2012 - 3:22PM

    This is good but treads on well-worn ground. Your points are well understood as are the solutions. To state the obvious, it is all about political will. Without that, no amount of good articles and sensible solutions, will change anything. We will just muddle-through as we have done for 64 years.

    Recommend

More in Business