Pakistan and its massive tax problem

Rich Pakistanis pay next to nothing in tax, forcing government to rely on foreign assistance to prop up finances.

Readers may be familiar with an inspirational slogan of the American Revolution: “No taxation without representation”. It originating somewhere in the 1750-1760s and was a rallying call by people living in the Colonies, who resented the imposition of taxes by Britain since the levy was done without the expressed will of the people (of the Colonies).

In Pakistan, an arguably perverse view of this American proclamation has been in vogue for some time now: “No taxation with representation”, which means that rich Pakistanis, including a significant percentage of members of the National Assembly and provincial legislatures pay next to nothing in tax, forcing the government to rely on foreign assistance to prop up finances.

In the past, US Secretary of State Hillary Clinton said that Pakistan must tax its elite if it wants to continue receiving financial assistance and for this she came in for some heavy criticism in Pakistan. To quote what she said: “This is one of my pet peeves: countries that will not tax their elite but who expect us to come in and help them serve their people are just not going to get the kind of help from us that historically they may have…. Pakistan cannot have a tax-to-GDP rate of nine per cent when land owners and all the other elites do not pay anything or pay so little it’s laughable. And then when there’s a problem everybody expects the US and others to come in and help.”

British Prime Minister David Cameron also spoke on this point, recently, in interactions with Pakistani leaders and is reported to have said that aid increases were a hard sell when “too many of your richest people are getting away without paying much tax at all”. Clinton and Cameron live in societies where to quote Benjamin Franklin “The only things certain in life are death and taxes.”

Pakistan’s heavy dependence on foreign assistance impacts national sovereignty and has led to a ballooning debt-to-GDP ratio, which now stands at 30 per cent. This has meant that the largest chunk in the 2012-13 budget will be that of debt servicing. This becomes a drag on economic growth because resources are being used to finance what is essentially a purely non-productive item. Normally, low-income countries have tax-to-GDP ratios of 15-18 per cent. Middle-income countries have tax-to-GDP ratios ranging between 22-25 per cent, while the figure for high income countries is around 40 per cent. Quite clearly, Pakistan’s tax-to-GDP ratio needs to increase so that the burden of financing the deficit doesn’t lie on borrowing from foreign countries or foreign multilateral lending organisations. This, however, does not necessarily mean levying higher or punitive taxes, which can stifle growth but through fighting tax evasion and by making tax collection more efficient.

Equitable taxation is particularly important in a country where the rich-poor disconnect has been increasing over time. A 2010 study estimated that 32 per cent of Pakistan’s population of 180 million subsists below the poverty line. According to the most recent UN Human Development Index, 60.3 per cent live on an income of less than two dollars a day. One consequence of the yawning rich-poor gap is that it is exploited by extremists.

Pakistan’s rich have historically paid little of their share in taxes. It has been estimated that the landowning classes have been evading taxes to the tune of over $1.2 billion a year. While the number of national lawmakers from feudal families represented in the country’s feudal democracy appears to be shrinking primarily due to increased urbanisation, their financial clout seems undiminished. The average worth of a member of parliament is $900,000, with the richest member worth over $37 million, according to a recent study by the Pakistan Institute of Legislative Development and Transparency.

There are periodic reports in the media which give the impression that certain politicians, their wives and dependent children have amassed huge assets and which should require due scrutiny by tax authorities. These reports suggest further that the assets amassed by politicians, their wives and dependent children were either not subjected to scrutiny by various tax jurisdictions or are highly understated. There is a need for a correct valuation of the amassed assets of politicians, their wives and dependent children, as in its absence, the tax burden on existing tax payers is unfairly increased. Since the politicians are rich themselves and happily evading taxes, there is little will to change the system.

Exempting agriculture from taxation imposes a heavy burden on the rest of the economy and is one of the main reasons why there is usually a deficit between what the government collects in tax revenue and what it wants to spend in a budgeting year. Furthermore, given its tax-exempt status, transfers from other sectors of the economy to agriculture are commonplace. Also, since the government cannot seem to broaden the tax base by including agriculture in the tax net, the other option is to rely on indirect taxes. The problem with these are that they disproportionately affect the poor and less well-off, since they spend more on items like fuel and food as a percentage of income than more affluent people. This in turn further skews an already unequal distribution of income, and gives rise to arguments that instead of taxing the rich, the government is making life tougher for a section of the population that already lives a miserable existence. It would certainly be helpful, if external aid providers use their leverage with the Pakistani government, to insist that hitherto untaxed or under-taxed sectors be brought under the tax net.

An equitable national tax policy requires that everyone and every sector with a potential tax liability tax should be taxed. A tax must be perceived as fair and universal. Those who have little should pay little, but they should pay something, anything that displays a commitment to the nation and its goals. The politically and economically powerful elite must demonstrate their stake in society by carrying its share of the tax burden.

Published In The Express Tribune, June 7^th, 2012.