Why ending big notes better than taxing salaried class?
The research head was of the view that the critically low foreign exchange reserves would not allow improvement in the rupee-dollar exchange rate. photo: file
Budget contours, aligned with the International Monetary Fund (IMF)’s preferences, were hastily approved recently to unlock funding. In other words, the government hopes to navigate through until the elections.
Among the various “decisive” measures undertaken, such as increased petroleum levy, pension reforms, property and juice taxes, fertiliser levies, and the withdrawal of remittance amnesty, the most controversial and unfair was the increase in taxes on the salaried class. Could this have been avoided?
While increased taxes on the middle class may seem fair as a direct tax, it is riddled with shortcomings. With a very low savings ratio, the taxed amount is likely to be part of the circular consumption economy, creating a multiplier effect.
An individual earning $2,000 per month equivalent in Pakistan fell under a 20% marginal tax rate in 2015. However, that has now been increased to a marginal tax rate of 35%.
People are already struggling due to the depreciation of the rupee, economic contraction, and the withdrawal of tax credits. The sense of disenfranchisement is now at its peak.
The question remains: why are individuals in untaxed service and agricultural sectors hardly taxed, despite earning similar amounts of money?
Electricians, retail shops, pharmacies, bakeries, cafes, restaurants, salons, beauty parlours, mobile shops, electronic sellers, toy shops, book stores, general stores, traders, landlords, intermediaries, lawyers, tutors, tailors, doctors, hospitals, and many others earn similar taxable incomes but conveniently escape the scrutiny of tax collectors.
What exactly is the benefit of working in the formal, documented sector when political leaders prioritise their vote banks? None. One possible solution to this problem is the demonetisation of currency notes. For the past four years, your author has argued, based on the outcomes of the experiment in a neighbouring country, that the benefits clearly outweigh the drawbacks.
A study by Harvard University concluded that demonetisation leads to long-term benefits, such as improved tax collection and increased savings ratio.
Another study by the IMF’s Roy & Rai highlights a short-term dip in industrial and economic activity when 86% of currency notes were removed from circulation, but this was accompanied by the introduction of two amnesties penalising undeclared assets.
The study suggests that the tax base widened, resulting in a tangible increase in income tax revenue. Of course, the short-term costs of demonetisation need careful consideration, such as ensuring the availability of cash at ATMs, catering to the rural population without banking facilities, providing alternative banking systems, maintaining business and industrial operations, reducing counterfeit and illegal funds, managing the transition from old to new notes, and promoting the long-term goal of digitising the economy and curbing the informal sector.
Over the medium term, benefits should be provided to move towards a cashless economy, starting with the elimination of Rs5,000 notes and imposing stricter documentation requirements for gold and dollar transactions.
Pakistan has a significant cash-based economy that is reluctant to become part of the formal system. Although we can envision financial experts adopting blockchain technology to track the movement of every rupee, ensuring taxation at the appropriate stage, the country currently teeters on the edge.
Undoubtedly, India’s digitisation and economic growth are not solely attributable to demonetisation, and Pakistan’s problems will not be solved by this measure alone. A smaller shock to economic activity during structural reforms can yield long-term benefits and help capture untaxed or low-taxed sectors.
Economic stability cannot be achieved by burdening the already taxed individuals. Employees would demand higher wages to offset the tax rates, making industries globally uncompetitive and disincentivising expansion and job creation.
The top 10 companies by market capitalisation in India pay an effective corporate tax rate of 25% or less, compared to Pakistan’s near 40% (higher for banks), acting as a clear barrier to growth.
Policymakers must recognise that the public sector cannot and should not create jobs for a population of a quarter billion. The only way to progress is by setting policies that encourage private sector growth, job creation, increased exports, tax revenue, waste reduction, import substitution, and value-added exports.
In such a Pakistan, we can bid farewell to the IMF with gratitude and fulfil the envisioned glory foreseen by Jinnah himself.
The writer is an independent economic analyst
Published in The Express Tribune, July 3rd, 2023.
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