Towards a sound fiscal policy… Ehsan Malik

There are four essential elements of a sound fiscal regime. The first is to grow the income base from which tax revenue is derived. This is achieved by a well-aligned set of policies that incentivise investment, promote competition and legitimate profit-making, and encourage scale, efficiency, environmental and social responsibility, and high governance standards.

The policies should also help create jobs, generate exports, and reduce reliance on imports for goods and services that the country can produce competitively and without indefinite protection. The second is equitably distributing the tax burden, using smart technology to bring everyone with a taxable income into the tax base. The third is to levy taxes and duties at globally competitive rates. The fourth is to separate tax policy from tax collection and ensure that the latter has the necessary enforcement capability without creating harassment that discourages others from joining the tax base.

Pakistan’s fiscal regime lacks all four essential elements. Instead, we have a tax regime that discourages investment and wealth creation and extracts the maximum possible in a predatory manner from a narrow set of taxpayers. This discourages the formal sector and incentivises tax evasion. Pakistan’s tax rates and import tariffs are among Asia’s highest. Under the IMF programme, the government is unable to provide incentives for investment, reduce the disproportionate tax burden on the few taxpayers, or make tax rates globally competitive.

Until its efforts to broaden the tax base through digitalisation and by transforming the FBR start bearing fruit, the already taxed, including the salaried employees, will have to bear the brunt of the tax targets set without regard to the FBR’s capacity and capability to collect. A sound fiscal policy must be aligned with good industrial, investment, trade, labour, and environmental policies. It should support investment in sectors in which the country has a comparative advantage.

Before the recent budget, our export policy provided some fiscal incentives, which were withdrawn. The National Tariff Policy, however, is an excellent attempt to deploy tariffs as an instrument of trade rather than revenue generation. Currently, no incentives are provided to the private sector to promote environmental, social, and governance (ESG) practices. We need an integrated policy framework instead of the short-term, revenue-seeking, unsustainable taxation regime that we have today.

Policy consistency, continuity, and predictability provide investor confidence, while policy U-turns destroy it. Unfortunately, we see more of the latter because the FBR is forced to modify incentives and tax rates to achieve unrealistic tax collection targets. Combining policymaking and tax collection under the FBR also removes the incentive for it to expand the tax net. It is far easier to tax the already-taxed. Examples are the withdrawal of previous investment incentives and imposition of surcharges and super tax.

The transformation plans of the FBR include a heavy element of subjecting high taxpayers to special audits. In contrast, the principal target for the FBR should be tax collected from new taxpayers. This target, however, is unlikely to be achieved if existing taxpayers continue to be harassed and burdened with complex processes and their tax refunds are withheld for no good reason. Separating policymaking from tax collection, with key ministries and the private sector represented on the Policy Board, would encourage the continuity of a fiscal policy that promotes growth and equity.

The current tax system has several conceptual faults. Instead of taxing profit, it relies on taxing turnover as a proxy. Loss-making businesses are burdened with minimum taxes. The FBR treats the formal sector as unpaid tax collectors by obliging them to collect withholding taxes. Contrary to global practice, the tax regime discourages the formation of corporate groups by taxing dividends at multiple stages of the profit flow. This also thwarts the listing of new ventures on the PSX. Salaried employees pay one-and-a-half to three-and-a-half times the tax as compared to their Indian counterparts. As a result, many are moving abroad or to the informal sector.

The hasty imposition of the Capital Value Tax on declared overseas assets, which is contested and yields very little tax revenue, has resulted in people leaving the country, with some giving up their Pakistan passports. This does not augur well at a time when we are trying to attract FDI. Indiscriminate taxing of cellular connectivity, is impeding the growth of the knowledge economy. The faulty construct of tax on banks not achieving a 50 per cent advance to deposit ratio (ADR) is failing to broaden lending to the private sector, and is merely a tool to raise taxes.

Without leeway for their past, many small and medium-sized enterprises (SMEs) will remain outside the tax base, be denied bank credit, continue exploiting labour, and producing unsafe goods. We need a leap of courage to get them to join the tax base and meet the standards of the formal economy. Mindlessly pursuing a higher tax-to-GDP ratio is a hopeless effort without a sound and well-integrated fiscal policy that responds to the economy’s long-term needs instead of short-term, tick-in-the-box objectives that are currently pursued, with and without the IMF.

COURTEY