Political economy of the VAT

Negotiations on value-added tax (VAT) on services between the federal government and that of Sindh have broken down. Any other end would have been surprising. Most federal constitutions were prepared without due regard to the economics and politics of the appropriate level of government for collecting various taxes. In Pakistan it was always presumed that the federal government would collect all the major taxes and would apportion the receipts vertically as well as horizontally in accordance with the marginally changing NFC awards.

This time round, a consensus NFC report left no doubt that the levy and collection of taxes on the sale of services fell in the provincial domain. The federal finance bureaucracy, which effectively runs the NFC shows, issued a notification which completely blacked out this important aspect of the 7th NFC award. It was done with the same impunity as in the issuance of Statutory Regulatory Orders circumventing the original intent of the legislature. However, the rights conscious provinces not only had the notification suitably amended, but the legislators acted with rare togetherness in the Parliamentary Committee on Constitutional Reform (PCCR).

Before the 18th amendment, entry 49 of the Federal Legislative List Part I in the Fourth Schedule of the constitution, reads as follows: “Taxes on the sales and purchases of goods imported, exported, produced, manufactured or consumed.” It implied that services were not on the Federal List. It has now been amended by adding at the end the explicit declaration: “except sales tax on services.” As a matter of fact, sales tax is the old “bikri tax” given to the centre by the provinces to meet its deficit in the early years of independence. In the original 1973 Constitution, entry 49 only mentioned “taxes on sales and purchases.” Goods found a specific mention only after the 5th amendment in 1976.

Today the general sales tax (GST) is the largest revenue spinner and hence the scramble for it. However, this was not always the case. In 1990-91 for instance, when the GST in VAT mould was introduced, customs was the largest source of revenue, followed by excise duty and income tax. Over time, the GST has more than compensated for the reduction of average tariff from 65 to around 5 per cent. In theory, VAT is the most efficient indirect tax. As developing economies come up against strong vested interests in realising the full potential of direct taxation such as income tax, VAT is also seen as an effective means to enlarge the tax base. But the progression of GST into a fully-fledged VAT has been hampered by the lack of political will. Instead of taking time to prepare consumers, producers and traders for a tax which requires extensive documentation, the finance bureaucracy is using the IMF conditionality to steamroll the opposition, which this time also includes the provinces.

The opposition of the provinces, overtly by Sindh and covertly by the Punjab, is qualitatively different from the businesspersons. The provinces are upholding the constitution. The question is: did those negotiating the deal with the IMF take into account the rights of the provinces before agreeing to this conditionality? Or did they just arrogantly assume, as always, that they will ride roughshod. Some notion of ‘economic national interest’, known only to the finance establishment, has always prevailed in Block Q of the Secretariat. But now the provinces have asserted. Provincial autonomy is the central argument of the 18th amendment. Will this have to give in to the imposition of a tax which works best without provincial boundaries? Here is another challenge to the supremacy of the parliament and the upholders of the constitution.

Published in the Express Tribune, May 14th, 2010.