High taxes don't work, reduce them
Tax
We may not all be supply-siders now, but the Keynesians are going to have to put their economics where their mouths are again. The tax hikes passed in Pakistan by the current government in the last two years have driven the economy into a depression that not even an Indus full of Prozac could fix. The only salve for Pakistan's fiscal insanity is some serious tax cut therapy.
Facing widening budget deficits, high unemployment and abysmal growth, the government with the blessing of the International Monetary Fund (IMF) in the last two fiscal budgets decided to tax everything that walks, crawls, runs, flies or stands still. Now, 12 months later, the tax-and-spend policies have worsened the economy than before the big tax binge.
It is time to wake up and realise that you cannot tax a country in prosperity. Taxes have some of the darndest consequences. But some tax effects are far from obvious to the layman and analyst alike.
For years, the effect of taxation in Pakistan was literally ignored as a factor determining state growth, employment, and output. Even today, we find an analytic vacuum when it comes to research on state tax policies.
If minuscule variations in the earth's environment can lead to dramatic evolutionary changes in the genetic structure of species, then surely tax changes can lead to profound variations in the organisation of finances among Pakistani businesses.
Incentives do matter and matter a lot. Pakistan desperately needs a complete about-face, a plan to accelerate tax cuts across the board, lowering the highest marginal personal tax rate, the corporate tax rate (including dividends), the sales tax rates on goods and services and lastly the federal excise duties and levies.
Of late, the government in its recent annual budget with the IMF blessing has introduced tariff reforms to be phased in over the next five years. A positive supply-side policy indeed, but is not a panacea for all economic ills.
It is only one element of tax cuts but not enough to pull the economy as a whole out of its morass into prosperity. Other heavy tax burdens on individuals and businesses need to be simultaneously addressed as well.
The answer to Pakistan's abysmal GDP growth rate and underperformance is a simple, straightforward set of supply-side economic policies. Pakistan needs to adopt pro-growth policies such as tax cuts, sound money, free trade, spending restraint, minimal regulations and privatisation; known as the six pillars of economic prosperity.
A total rationalisation of the tax system should be prioritised above all the six pillars of supply-side economic policies. There should be fewer taxes, where those taxes that are chosen to remain have low rates on broad tax bases.
Exemptions, deductions, exclusions, credits and write-offs should be kept to a bare minimum. Low tax rates provide the least incentives for people and businesses to evade, avoid or otherwise not report the taxable income.
Evidence shows that taxes which are inherently excessive are not paid. High tax rates inevitably put pressure on the taxpayer to withdraw his capital from productive business and invest in other non-productive assets.
The more taxes increase, the more they undermine the market economy. Every specific tax as well as a nation's whole tax system becomes self-defeating above a certain height of rates. Countries where supply-side economics were practiced, the real GDP growth has shown to be high and during anti-growth policies, the real GDP growth has shown to be low.
Unfortunately, Pakistan being subjugated by the umpteenth anti-growth IMF programmes centered on raising taxes and trying to balance budget at all costs to "stabilise" the economy, has never seen the way forward and never will.
If Pakistan's growth rate remains weak and fiscal conditions worsen, it will not see an easy path out of its problem.
The country's current economic model smells rotten, and whether or not the current government catches a whiff is still up in the air. Possibly the worst thing for decision makers is to plug their noses and pretend that all is well, or maybe, just maybe change course in fiscal planning and see the vision of supply-side ingenuity: if raising taxes doesn't work, try lowering them!
The writer is a philanthropist and an economist based in Belgium