Tax reform in a season of turmoil

It is true that RGST is unavoidable,even in these days of economic contraction, IMF or no IMF.

A besieged government has been forced by its creditors to enforce the ‘reformed general sales tax’ (RGST) to raise its tax-to-GDP ratio and have enough money devolved to the provinces to help an economy that is in the process of contraction but under high risk of inflation. The cabinet, on November 11, also gave concrete shape to an earlier warning by Finance Minister Hafeez Sheikh, that the well-to-do will have to be taxed to lessen the burden of compensations the government has to make to the flood-affected population. But the well-to-do also include salaried people who believe, and perhaps rightly so, that they already pay more than their fair share in tax.

Needless to say, the measures have been immediately opposed from within the ruling coalition and the powerful Punjab government. This is not a good augury for a state that is definitely in for a period of belt-tightening while resting in the oxygen tent of the IMF. Tragically, Pakistan’s resort to the IMF too has been politicised and a very ill-informed and isolationist rhetoric is being unleashed by TV commentators on the ‘slavery’ of the Fund which is ‘determined to destroy Pakistan’. The truth is that if Pakistan is not on the IMF roster no one will do business with it and it will not have enough dollars in the kitty to buy its imports.

The ongoing sugar crisis, ill-advisedly interfered with by the Lahore High Court and the Supreme Court in 2009, is still with us and being exacerbated by TV coverage showing people, who should be abstaining to bring the prices down, actually announcing ruefully that they are buying it at Rs110 per kilo as against the price of approximately Rs50 by the courts in 2009. Last time when the suo motu courts got the provinces to clamp down on the ‘sugar chain’, it caused the private sector trucking business to stop plying, which the state was simply in no position to replace.

Luckily, there are young people in the business programmes of TV channels saying that the RGST is unavoidable, IMF or no IMF. That is true, even in these days of massive economic contraction. The general sales tax (GST) had simply withered away as an efficient taxation tool with the passage of time. The taxation gap continued to linger and the tax-to-GDP ratio actually declined during its operation. There were exemptions in it that spared the agricultural sector — where income tax stayed uncollected because of the incapacity of the provinces — and the fast growing services sector was allowed a holiday.

This gradual failure of GST as a revenue collection device kept Pakistan’s retail sector out of the tax net; the economy remained unregistered and those not announcing their business to the Federal Bureau of Revenue were able to accumulate wealth that undermined the economy. Over the years the GST system was adversely affected by the ‘concessions’ that various powerful lobbies were able to extract from the government. And the system of refunds that came with it persisted in its malfunction and will now have to be massively reformed if the RGST is to succeed.

The RGST will target consumption, barring food and education, and therefore will fall on the well-to-do in the population. It will be collected at various stages and at each stage the seller will charge ‘output tax’ from the consumer on the value of supply of goods or services and will deduct the ‘input tax’ he has paid earlier on a monthly basis. At each stage, the economy will become ‘registered’ and this will make it easy for the state to impose a better system of collection in the future. The retail sector, which is out of the tax net altogether, will thus become a source of revenue, even if this will not happen fully in the first year because of the exemption given under the present RGST to a large segment of it.

The RGST will net an extra Rs200 billion, but the government is in dire straits for the post-flood subsidy it wants to give to the flood-affected. Another Rs70 billion is targeted through a 10 per cent tax for six months on those who earn over Rs300,000 annually. As per the conditionalities it has agreed with the IMF on, not subsidising oil and gas — and removing the old subsidy gap — the government is also ratcheting up petrol prices. If you count all the money the government wants to squeeze out of an economy being made to contract with high interest rates, it looks like a bombshell that the people won’t survive.

Even if the economist tells you that the RGST is not going to hit the poor and the middle class, the scenario is tailor-made for the politics of toppling governments in Pakistan. The most ominous reaction has predictably come from the MQM, whose leader Altaf Hussain has put on the war paint on the RGST and has warned that his party will campaign against it. If Karachi doesn’t pay up — and segments of the economy there are already protesting the tax — then Sindh will have less revenue to work with and the centre will come under pressure. Luckily, the MQM boycott of the RGST can be watered down with political concessions that the party would like to receive.

The revolt of the PML-N is also in high gear in parliament. And despite Nawaz Sharif’s low-tone aggression the party seems to be gearing up for a mid-term change of government, with its leader in the National Assembly Chaudhry Nisar Ali Khan saying ‘removal’ is possible even if the army doesn’t intervene. Punjab Chief Minister Shahbaz Sharif has raised the standard of revolt against the petrol price hike, hoping that unrest among the transporters and the common man will strengthen his hand. He could actually be responding to yet another move by the PPP and the PML-Q to deprive him of his majority in the Punjab Assembly after the 18th Amendment has made it impossible for PML-Q rebels to bail him out.

Nowhere in the Third World does economic discipline sit well with democratic politics, unless it is leveraged with some mixture of authoritarianism, as happened in Indonesia, where the army stands behind the elected government. In Pakistan, we have an army that has not yet been sensitised to the economy.

Published in The Express Tribune, November 12^th, 2010.