Forget tax increases, reduce spending

The public anger at Senate Chairman’s entitlements scratches only the surface of the public spending rut. Budget-making pins hopes on raising taxes to match spending. In the IMF programmes, too, the adjustment focuses on taxes. The result has been the opposite of what was expected. From 13.8% in the 1980s, the tax to GDP ratio declined to 13.4% in the 1990s, 10% in 2000s and to 9.6% in 2010s. It remained low in FY21 at 8.5% and 9.2% in FY22. The budgeted figure for FY23 was 9.6%, which had to be revised downwards to 8.5%. For FY24, the budgeted figure is 8.7%. It’s a wild goose chase. Let there be admission that our system can’t collect taxes already imposed, let alone new taxes. Let the taxes be as they are, which might encourage investment and growth and perhaps an automatic increase in taxes, as predictability increases incomes. As for a durable cure to the chronic fiscal deficit, the action lies on the expenditure side. In effect, this requires serious reform of the structure of federal government. Budgeting a fiscal deficit of 6.5% for the FY24 shows there is no political will to reform.

With some political will, the deficit can be minimised, even eliminated, by correcting the wrongs on the expenditure side. The largest expense, interest payments, is debt servicing at 6.9 % of GDP. This is larger than the fiscal deficit, implying that we will be borrowing all of this amount and more to survive. Nothing can be done immediately to reduce this burden. Luckily, 88% of the debt servicing is domestic. We owe it to ourselves and have the time to think of ways to dealing with it. Expenditure reduction will also reduce this burden. Foreign bilateral debt can be restructured, but is time consuming. The gain can be neutralised by the bad signalling about credit-worthiness. Defence is the second largest expense at 1.7% of GDP. It is more if pensions are added. Angels fear to tread here.

There is still a large room for manoeuvre. Grants and transfers are the third largest expenditure. At a time of grave economic and financial emergency, why should the federal government spend 1.4% of GDP in areas that no longer fall in its domain? At least 1% of GDP here can be slashed to reduce the deficit to 5.5%. Claiming 1.07% of GDP, development is the fourth largest expenditure. Financed entirely by borrowing, it is largely responsible for the rising debt servicing and fiscal deficit. Political parties take pride in increasing its size and criticise when in opposition. Growth is generated by fixed investment, which most development expenditure is not. Borrowing for spending that yields no return makes a net addition to debt burden. A large no of schemes is for provinces. A close scrutiny reveals that 1% of GDP can be made available to reduce fiscal deficit to 4.5%. Subsidies at 1% of GDP constitute the fifth largest item. Why should there be compensation for failure to compete? Getting rid of subsidies reduces fiscal deficit to 3.5%. The cost of running civil government is 0.7% of GDP. After the 18^th Amendment, the federal government needs only ten administrative divisions and 5-6 ministries costing 0.4% of GDP. Adjustment here scales down the deficit to 3.2%. State largesse of 2.2% of GDP as tax expenditures has no justification. Abolish these to achieve a deficit of 1% and the IMF will rush back, Dar or no Dar.

Concluding remarks at AERC/SPDC Seminar on State of Pakistan’s Economy and Federal Budget, Karachi University, June 20.

Published in The Express Tribune, June 23^rd, 2023.

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