Agriculture tax: Expect meagre yields

KARACHI: At over one-fifth of the GDP, agriculture is the single largest segment of the economy that is almost entirely untaxed. So the desire to levy taxes, at least on the surface, seems like a good idea. However, a more careful examination shows that it is unlikely to yield any meaningful revenues and will only serve to slow down growth in the sector that is responsible for the employment of nearly half of the country’s workforce.

Several analysts and economists have made the argument against taxing agriculture, mostly on the grounds that the government controls all input prices as well as the price of the final product. Yet that, unto itself is not a good enough argument and one that can be especially easily countered by the fact that the energy industry faces similar constraints and does not have even remotely close to the same level of tax protections.

There are, however, other arguments against the tax. And those arguments get to the successes and failures that lie at the heart of Pakistan’s agricultural policy, particularly the land reforms policies that have been so favoured by the both sides of the political spectrum. Before imposing a tax on the sector as means of trying to break the illusory economic power of the aristocratic landed elite, it would be prudent to examine the strengths and weaknesses of agriculture in Pakistan and then determine whether or not such a tax is a wise choice.

Land reforms: part of the problem, not the solution

Land reforms have been proposed almost since the very beginning of Pakistan’s existence. The idea behind the reforms was that land holdings in Pakistan are highly concentrated in the hands of only a few families and in order to alleviate the gross income inequalities in the rural areas, the government should place a limit on how much land a single individual can own.

Such reforms began in the 1960s under the Ayub Khan administration and continued under the premiership of Zulfikar Ali Bhutto. To say that they were a colossal failure would be a gross understatement. Land holdings throughout Pakistan continue to remain as concentrated as ever. The rural aristocracy simply changed the legal ownership of their land to that of their tenants while retaining complete effective control.

Not only did the land reforms fail in achieving their stated objectives, but they have also ensured that any agricultural income tax levied on Pakistani farmers will not be likely to yield substantial revenues. Agriculture is not a very profitable enterprise. Anecdotal evidence suggests that the most profitable farms yield between 5% and 15% in terms of a net margin.

To take the example of cotton, according to some farmers in Sindh, an average acre of land cultivated yields about Rs10,000 in income (after netting out all expenses). If a person had 1,000 acres under their ownership, that would yield a substantial amount in terms of tax, given that the person’s net income would be Rs10 million. However, according to the Agricultural Survey of Pakistan 2000, about 79% of all farmland is 50 acres or below in size (on paper, at least). That means that the average annual net income comes to around Rs500,000 or less.

Given the fact that very few farms in Pakistan are corporatized, any tax on agricultural income will have to be the same as that levied on personal income. At personal income tax levels, the federal government would only be able to get between 0.25% and 3.5% in agricultural income taxes. The government could try taxing at the corporate rate of 35% but that still means exempting corporations below Rs7.5 million in net income, likely to be the overwhelming majority of farms.

While it would be difficult to determine the precise amount of tax that the government could expect from levying an agricultural income tax, it should be clear from the above back-of-the-napkin mathematics that it is not likely to be a substantial amount.

Inefficiency

Pakistan’s agricultural productivity is amongst the most inefficient amongst large developing economies. According to the Economic Survey of Pakistan 2010, compared to the world average, Pakistan is 21% less efficient in wheat, 27% less efficient in sugarcane, and 19% less efficient in rice. Those averages hide the fact that Pakistan is much further behind the world’s top producers, with productivity levels of China and Egypt ranging from two to three times higher than those of Pakistan.

One of the major reasons for low productivity is the fact that Pakistan’s farmers have lower levels of fertiliser and pesticide inputs, which lowers yields. In addition, the irrigation system in the Indus plains – dependent as it is on mud-lined canals – is also relatively inefficient, resulting in lower water availability in many parts of the country.

Given these extreme levels of inefficiency, and given the fact that Pakistan has the sixth largest population in the world to feed, it is imperative that the agricultural sector invest in more use of fertilisers and better irrigation equipment. That, however, requires substantial amounts of money which most small farmers do not have.

Yet a more efficient agricultural sector means substantially higher incomes for approximately 45% of the work force. The most effective poverty alleviation scheme that the government can run, therefore, would be to promote investment in increasing the productivity levels in agriculture. A continuation of the income tax exemption would be a good start, but more needs to be done.

The solution: Corporatise, Corporatise, Corporatise

One of the biggest obstacles that the agricultural sector faces with respect to raising productivity is the difficulty in raising capital. Banks remain unwilling to lend owing to the scattered legal paperwork of landholdings, meaning that even the largest landholder in Pakistan is officially treated like a group of tiny landholders, since that is the legal status of their land.

A solution to the problem: encourage the rural aristocracy to corporatise their farms, turning their legally scattered holdings into a unified, corporate entity with their tenants as minority shareholders. This then makes dealing with banks, as well as raising other forms of capital such as equity through a stock market listing, much easier. It has the advantage of allowing the government to then begin taxing a larger, more efficient, more productive and more profitable agricultural sector at the much higher corporate income tax rate.

Taxing the agricultural sector is not a bad idea and should be supported in principle. But given the current state of the sector, it is probably best to sort out some of its most pressing difficulties rather than pushing through another ideologically-motivated policy that creates more problems than it solves.

Published in the Express Tribune, June 14^th, 2010.