Tax, state building and governance are intertwined

Taxes are essential for sustainable development and governance. The state spends funds generated from taxes on education, public transport, healthcare and other social benefits. A sound tax system has been shown to have a linear relationship with good governance. All international organisations including the IMF, the World Bank and the United Nations share a standard definition of governance that includes the rule of law, a participatory democracy, equity and accountability.

State building and governance have been at the heart of the tax reforms adopted by several countries. Usually called the “tax bargain” or “fiscal contract”, citizens pay taxes in exchange for facilities their government provides them such as law and order, water and sewerage, judicial services, etc. Governments ensure that people are provided with services for which they are taxed. However, tax collection has never been an easy task, especially in countries with a trust deficit between the state and its people. If the general impression is that the state misuses taxpayers’ money, people will shy away from parting with their hard-earned wealth.

Rational people will choose not to pay and would instead seek a private service than pay taxes. Therefore, to ensure that people pay taxes for the sake of collective social and economic good, the state would have to do the following: educate taxpayers on the importance of paying taxes; develop a transparent tax system; build a high level of trust between the state and citizens; ensure adequate trust in the integrity of the system; and organise taxpayers politically.

Taxation improves governance in four ways, as follows:

One, by developing a shared interest in economic growth. When a government is dependent on taxes, it also strives to bring prosperity in taxpayers’ lives, which in turn brings economic growth. For example, the government’s increased spending on health and education improves labour quality, which later becomes the cause of improved economic output. In a similar vein, increasing public expenditure on the development of roads, communications, etc helps reduce the production cost of private goods, raising private sector investment and profitability.

Two, by developing state apparatus. When the state depends on taxes, it builds complex bureaucratic infrastructure for tax collection. This may lead to a broader development in public administration.

Three, by building a system of accountability and responsiveness. People who pay taxes become political stakeholders and assume the responsibility to question the government on matters of public interest.

And four, by creating a responsible nation. Taxpayers should share the responsibility of economic development with the state. This relationship can only transpire when the state enters into a two-way relationship with its people, especially on using the taxpayers’ money where it belongs.

Pakistan is a classic example of a state with no visible tax bargain or financial contract with its citizens. That explains the situation of our tax system, which is highly inequitable and has been developed such that it favours the rich and fleeces the poor. A meagre 9.58% of the GDP is collected in tax each year — one of the lowest rates in the world. Moreover, politicians and, by extension, governments have also been accused of misallocation of public resources in the bid to play to the gallery or get voters’ confidence to stay in power. Spending public money on unproductive projects or goods and services slows down the economic prospect of a country.

In the event of low tax collection, the state is left with the option to reach out to the lenders of last resort — the donor organisations, the international lending organisations, or the country’s central bank. However, if the government borrows extensively — especially from banks — to finance its expenditure, it crowds out the private sector thus reducing private investment.

Pakistan’s national debt stands at 88% of the GDP. During his visit to Pakistan in 2011, then British Prime Minister David Cameron warned Pakistan of not getting paid if it did not improve its tax system because the taxpayers in the UK asked their government the reason of spending 650 million pounds in a country where only a few people pay tax.

The PTI government had vowed to break the begging bowl, especially the one extended to the IMF. Imran Khan had gone so far as to say that he would commit suicide instead of stretching out his hands in front of the IMF for a loan. Unfortunately, to the utter chagrin of its voters, the PTI government was not prepared to take the bull of Pakistan’s economy by the horn. The party’s justification that it lacked clarity about the state of economic disorder has just been a lame excuse. Even almost four years down the road, the economic situation is throwing down the gauntlet on us, and we have no option but to surrender to external sources of income.

People will not pay taxes because the state wants them to do that. The taxpayer will be motivated to give money to the government only when a better tax system is built on the principles of equity, fairness, inclusivity and reciprocity.

Published in The Express Tribune, November 11^th, 2021.

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