CUTTING WASTE OR LEVYING TAXES?
By A. B. Shahid

[This article first appeared in Business Recorder on June 01, 2010]

The fact that while budget-makers do the unenviable job of levying taxes, they can't ensure their optimal use results in missing the targets set in the budgets. But the budget-makers must accept part of the blame there for. In December 2004, the Ministry of Finance (the budget-maker) committed to the World Bank that it will undertake a 5-year Tax Administration Reform Programme (TARP), and received $100 million for completing this job.

The aim was to increase documentation, and through that, raise the tax-to-GDP ratio on a credible and non-disruptive basis. But very little was done in this context rendering controversial the levy of the VAT. Missing the budgetary targets was blamed on the apathy of the FoDP, though the cause was blatant resource waste. As for the FoDP view about the capacity and integrity of our institutions, it was spelled out (most undiplomatically) by the terms of the Kerry-Lugar law; Senator Kerry darkened it further via his latest demands for tightening the pre-conditions for disbursement of aid under that law.

To assess the consequences of rejection of the VAT regime (expected to provide over 50 percent of the fresh taxes) and to avoid missing the budgetary targets yet again, it was prudent to delay the budget to ascertain the extent to which the VAT regime could be enforced so that the proposed taxes appeared realistic. But speed - the killer - is being prioritised over prudence, which raises serious doubts about the regime's intentions.

Instead, rumours are that two versions of the budget - one with, and the other without VAT. This implies doubling the budget-making workload. If two versions of the budget are what the Finance Ministry has opted for, while it must be commended for the extra effort, the work overload is bound to dilute the focus and quality - both critical ingredients - of the budget.

Indications thereof are that the budget projections assume the GDP to grow by 4.5 percent and inflation to fall to 8 percent from its current level of 13.26 percent; some hope given the current global and domestic scenario! Rumours are that the GDP figures of FY09 have been 'revised' to portray higher growth in FY10 and lend credence to the projected GDP and tax revenue growth in FY11.

Irrespective of who insists on it - WB or the IMF - imposing the VAT regime is risky given the kind of groundwork done by the FBR. This move (instead of containing resource waste) may fail and force higher government borrowing, which already stands at 60 percent of the GDP, and interest payments thereon consume over 40 percent of the tax revenue.

That the sovereign debt of many countries now exceeds their GDP is a flawed defence for higher debt. Unlike Pakistan, most of such countries have a credible record of generating the repayment capacity, not seeking debt restructuring. Besides, these countries are aggressively cutting their current expenditure.

Recently, Spain's parliament resolved to cut the salaries of its speaker and members, as well as judges, mayors and municipal officials by 10 percent. Parliamentarians, receiving additional benefits for their roles as legislative officers and party spokespersons took a 12 percent cut. We heard nothing of the sort in Pakistan, and the much-publicised 'austerity plan' too hasn't been implemented.

People accuse the incumbent regime of gross mismanagement - allegations corroborated by none other than Pakistan's Auditor General. In South Asia, the IMF quiet rightly pointed a finger at Pakistan for minimal public disclosures about the use of tax revenue but, pitifully, the same IMF insists on additional taxation, neither stricter state accountability nor austerity, and in the process appears to side with an unpopular regime.

According to the latest budget estimates, the projected total tax revenue is Rs 1,667bn implying an increase to the tune of Rs 287bn over its target of Rs 1,380 set for FY10. But fresh taxes (disclosed thus far) amount to only Rs 132bn net of relief worth Rs 5bn. Where will the remaining Rs 155bn come from, is yet unclear.

In this backdrop, levying fresh taxes can't appear credible unless the budget justifies them by guaranteeing their efficient use in activities that deliver collective benefits, especially for the under-privileged. Ironically, until FY10, in the tax revenue, direct taxes that align tax incidence with ability-to-pay accounted for 39 percent and indirect taxes that impact all taxpayers regardless of their ability-to-pay accounted for 61 percent.

This tax mix may worsen after imposition of the VAT because in the proposed taxes (Rs 132bn), the share of indirect taxes is 66 percent (VAT Rs 70bn and Federal Excise Duty Rs 17bn). Yet, the budget-makers promise a 'pro-poor' budget, and that the VAT (at 15 percent) will add just 2 percent to inflation - a gross under-estimate. What they also don't admit is that this move will push up the already crippling bank lending rates.

The IMF's report on Middle East, North Africa and Pakistan opines that, although out of the danger zone, countries in these regions must increase the competitiveness of their economies and rapidly cut unemployment. Pakistan can do so only by cutting the cost of doing business, impliedly, by containing inflation, reducing interest rates, reducing power supply cuts, levying minimum taxes, and focusing on improving tax collection.

Latest reports suggest that fresh taxes also include hikes in WHT on banking transactions, excise duty on locally produced electrical appliances, and presumptive tax on goods transport. Discouraging documentation, undermining import substitution, and increasing the cost of doing business is hardly worth the insignificant benefits these taxes may yield.

The projected VAT contribution is one-fifth of the revenue (Rs 323bn) wasted in FY09 courtesy 'irregularities' in federal offices. The irregularities increased further in FY10. Remember the flawed tenders, frauds in custom duty and sales tax collection, and losses of PSML, PIA, PR, WAPDA and the rest. The question is "should resources be saved by cutting waste and corruption, or raised afresh by levying more taxes during a recession?" During the past two years, parliamentary conduct did not manifest fiscal responsibility (as per the bill passed in 2005); the coming budget must insist on it and implementation of the 'austerity plan' latest by December 2010. [Courtesy Business Recorder]

Regards