A ‘boiling frog’ situation

Interest payments exceed govt’s tax revenues – a recipe for default, economic meltdown


RIZWAN RAWJI February 12, 2024
In yet another significant deterioration, the fixed rate debt reduced from 26% to just 22.6% of the domestic debt, increasing the interest rate risks. PHOTO: file

BRUSSELS:

Pakistan’s Rs38.8 trillion domestic and Rs24.1 trillion external debt mountain is a “boiling frog” phenomenon for the economy as higher deficits and ballooning debt servicing costs are unsustainable.

A boiling frog situation is one in which people fail to act on a potential problem that grows over time, causing it to become more severe until it eventually bubbles over.

A frog thrown in boiling water might jump out, but if the water comes to boil slowly, it’s too late by the time it notices it’s been cooked. The age-old metaphor could easily apply to Pakistan’s debt situation.

Net interest payments on debt already exceed the government’s total tax revenues, a recipe for a “disorderly” default and subsequently an economic meltdown.

Governments have two ways to generate revenues – taxation and borrowing. Year-on-year Pakistan has continuously failed in its tax collection and has, unfortunately, excelled in its capacity to borrow to no-end, thus falling into a non-ending debt trap.

Persistent fiscal imbalances lead to non-existent fiscal space for state building, further pushing the state into weakening trajectories. State building and fiscal capacity can only occur if the focus is on generating revenues through efficient tax collection over borrowing.

An ineffective tax policy and inefficient tax bureaucracy has kept Pakistan’s tax-to GDP ratio around 9% over the last several decades. Pakistan needs to increase revenue collection at all levels to improve the ratio to 20-25%.

Myopic revenue-thirsty governments have dodged tax reforms and embraced reckless borrowing, bringing the economy down to its knees.

The state’s focus should be on its ability to collect the maximum amount of tax revenue with the minimum amount of harm to the economy so as to achieve sustainable and robust economic growth. Resorting to excessive borrowing gives you the opposite results.

If Pakistan has to overcome the twin inter-related malaises of fiscal deficit and debt burden, then there is no other option but to dismantle the existing outdated and anti-growth tax system. A two-pronged tax reform agenda is the need of the hour:

One – replace/restructure the Federal Board of Revenue (FBR) with a national tax agency (NTA). Two – a total rationalisation of the tax system.

ReadDebt repayment

Replacing/restructuring the FBR with NTA is to ensure effective enforcement of tax laws both at federal and provincial levels. The country’s taxation system is complex and involves multiple agencies, which make the overall system inefficient.

The NTA with the mandate to impose a simple and harmonised tax code should be established to replace/restructure the FBR and all other federal tax authorities in the country.

It will be responsible for collecting taxes at the federal level with an active role of the National Tax Council (NTC). Provincial tax authorities will be similarly structured and streamlined to provide ease and simplicity to taxpayers.

The NTA will report to parliament through the minister of finance and the appointment of its chairman and members shall be through a public hearing by a joint committee of the National Assembly and the Senate.

It will not assume the role of a legislator and policymaker which under the constitution is the sole prerogative of the people of Pakistan through their elected representatives (Towards flat, low-rate, broad and predictable taxes – Bukhari and Haq, Prime 2020).

A total rationalisation of the tax system is to maximise tax revenues through voluntary compliance.

Pakistan, a country of 241 million inhabitants, has an extremely narrow tax base; currently at 10 million individuals, out of which 5 million are tax return filers and only 3 million actually pay any tax.

Exorbitant and punitive tax rates encourage tax evasion, avoidance and not to report taxable income. They also encourage taxpayers to seek exemptions, concessions, exclusions, credits, amnesties and write-offs.

The key to a good tax policy is a flat, low-rate, broad-based and predictable tax system. People in like circumstances should have similar tax burdens. The perception of fairness is the key to voluntary compliance but the relatively effortless implementation shouldn’t fool you. It will have massive beneficial consequences.

To broaden the tax base, from 10 million to 20 million individuals, the country should put in place a 10% flat-rate tax on all (unadjustable) gross incomes regardless of the source.

All individuals should be facilitated to file a simple income tax return, without a wealth tax statement and those earning below the taxable limit should be paid income support in the form of negative tax. A single-page return form should be available in English, Urdu and all regional languages that can even be submitted through a simple mobile app.

Historically, our elite are in favour of tax reform as long as it maintains their privileges. For a tax reform to be considered truly revolutionary, there needs to be a strong political will to resist the lobbies and bureaucracy that have helped sustain the current morass.

There is now consensus amongst all that unless and until we get out of this “boiling frog” situation, our economic miseries will not end and may eventually lead to a devastating end.

The writer is an economist and philanthropist based in Belgium

 

Published in The Express Tribune, February 12th, 2024.

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