The Politics and Future of Tax Reforms in Pakistan

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Context

Zardari Nawaz and AsfandyarThe Governor of Punjab province Salman Taseer was assassinated today in a posh Kohsar Market of Islamabad. According to media reports he was coming out of a restaurant after meeting a friend, when his bodyguard belonging to the Police Elite Force, sprayed him with bullets at a close range.

According to Pakistan’s fragile PPP led government, in the post flood situation the introduction of Reformed General Sales Tax (RGST), Income Tax Flood Surcharge and increase in Special Excise Duty, has become a necessity. Pakistan’s economy is worsening right at a time when the political setup itself is going through transition. Even if PPP led coalition collapses, any new setup that emerges, would still have the daunting task of dealing with Pakistan’s shaky economic situation. This article looks at the correlation between the worsening economic conditions to the nations international reputation, domestic security situation, and increasingly polarized politics.

Analysis

The Need For RGST

Pakistan desperately needs to increase its tax revenues by adopting a more wide-ranging, modern sales tax on products and services. The Sales Tax Act of 1990 was based on established value added taxation principles but due to revenue exigencies and political compromises, it became increasingly narrow-based and distorted, with ever-growing list of exemptions, multiplicity of rates, special regimes and a number of other deviations from the best international practices and concepts, making it more ineffective over time. Consequently, not only has the tax base of income and sales taxes been crumbling but insufficient data on the national economy has also proved to be a substantial obstacle in the implementation of a sound tax policy.

The PPP government has already stated that reforms in General Sales Tax has become inevitable in the post flood conditions. Apart from helping the government achieve the annual revenue target it has set for 2010-11, RGST would also generate resources for flood victims. The government had set a tax collection goal of 1667 billion rupees for the current fiscal year; however, following the devastating floods, it is believed that it would only be able to collect 1604 billion dollars.

To cover the shortfalls during the period of January 1, to June 30, 2011, according to an estimate reported in the media, rupees 30 billion were to be collected through the imposition of RGST, 40 billion from Flood Income Tax Surcharge, while Special Excise Duty was to produce around 12 billion.

If approved, the RGST will be implemented on commission-based agents, doctors, lawyers, engineers, financial services, courier services, advertisement services, customs, construction, edible products and other general goods. The new tax system is expected to generate 100 billion rupees in revenue.

It is believed that a failure to adopt the RGST will lead to a record budget deficit of 1.2 trillion rupees, which may force the government to borrow more than one trillion rupees from the domestic market to finance the deficit. In that case, the Central Bank of Pakistan may have to raise the interest rates by up to 2% in order to counterbalance the inflationary impact.

The government has already borrowed 200 billion rupees from the central bank for financing the budget deficit. Meanwhile, revenue collection during the first five months of the current financial year is already lagging behind the target by 76 billion rupees.

“The increasing gap between income and spending will shift almost the entire burden of financing on domestic sources,” a source said. The State Bank has admitted that the government borrowing to finance the budget deficit is fuelling inflation, causing interest rates to rise.

Officials of the Ministry of Finance claim that if the government fails to get the RGST approved from the National Assembly, it will result in the discontinuation of foreign aid including payments of the US Coalition Support Fund and funding from IMF that Pakistan desperately needs.

The IMF’s suspended bailout program for Pakistan still has two installments left that are worth 3.4 billion dollars. In face of the political challenges, IMF recently agreed to give Pakistan more time to carry out reforms.

Positions Of Different Political Parties On RGST

The Reformed General Sales Tax (RGST) was approved by Pakistan’s Senate Assembly on 26th November under controversial circumstances. In the post flood scenario, RGST has widened the rifts with in the Pakistan Peoples Party (PPP) alliance.

PPP is totally supportive of RGST and wants it to be approved at any cost. Opposition parties, public and civil societies, on the other hand, are against the bill, as they believe that RGST will almost double burden of ever-growing inflation rates on the poor.

Opposition, as well as some of the key alliance partners of the PPP-led government, opposed the imposition of the tax, while Pakistan Muslim League-Q members walked out of the House. The GST Reforms Bill was expected to be tabled in the National Assembly on 20th December for final approval but has been delayed due to parting previously of Jamiate Ulema-e-Islam-F, and now Muttahida Qaumi Movement (MQM), from the PPP led ruling coalition.

Recent negotiations between PPP and its key ally MQM over the implementation of RGST failed. MQM desires direct taxes to be imposed on the agricultural sector- a move that according to them can broaden the nation’s tax base, which currently stands at just 1.8 million or 1% of the total population.

“We will not support RGST even if we are killed” said Senator Abdul Khaliq Pirzada of MQM, indicating how serious the party is in attempts to block the imposition of RGST.

The other key allies of the PPP led government-Awami National Party (ANP) and JUI-F have also opposed the enforcement of RGST.

According to JUI-F’s Maulana Muhammad Khan Sheerani, the implementation of RGST would create new opportunities for corruption, multiply the problems faced by the public and push the country in the direction of anarchy.

ANP’s Haji Adeel stated that his party would continue to oppose the bill until the government accepts their suggestions.

PML-N, Pakistan’s main opposition party, has claimed that it would oppose the RGST in the National Assembly. “The PML-N will strongly oppose the RGST in the National Assembly and it has also decided to contact the other political parties in this regard,” head of PML-N Nawaz Sharif stated at a meeting of his party’s Central Organizing Committee. According to him, the implementation of RGST is likely to cause price inflation and would directly affect the ordinary people.

The Future of Tax Collection, Extremism and Floods

Given strong resistance from prominent political parties and the general public, RGST is unlikely to gain approval of the masses or the National Assembly.

In the post flood environment, tax reform carry deep implications for the state of Pakistan. The economy was crippling even before the floods, as extremist activity dramatically reduced domestic and foreign investment. In the absence of law and order across the country, it is unrealistic to expect the business and economic activity to improve.

Furthermore, in the aftermath of the floods, a debate has emerged regarding where the resources for flood rehabilitation would come from. Million of rural citizens have lost their sources of livelihood and critical infrastructure also needs to be reconstructed. The discussion is also linked to matters of equity with in the tax system. The international community is one source of support, but even the friends of Pakistan have linked assistance to tax reform and generating significant funds from with in the country. A general perception has prevailed that the affluent class of the society is paying very little in tax.

An effective tax policy is linked to the ability of an average citizen to make a decent living. It assumes a reasonable balance between the tax obligation of an ordinary citizen and resources needed to maintain a decent living. Additionally, there should be some semblance of proportion between the prices of everyday items and the ability of people to purchase them. However, these balance do not exist in Pakistan, and this naturally has led to the increasing rate of corruptions. In addition to levying taxes, one of the states other primary function is to ensure law and order and provision of a business environment conducive for its citizens to prosper.

The above-mentioned imbalance has been complicated by another factor. The people who pay taxes are being taxed more, but the pool of tax payees is not growing. Additionally, politicians and the cream of the country are paying no or nominal taxes, as compared to their assets. This further erodes the credibility of the state to levy and collect taxes, and sets up a negative incentive for citizens fulfilling their tax obligations diligently.

Thus, who pays taxes and how much, is not only connected with the earning potential of an average citizen but also to how much it takes to make a decent living. To increase the revenues, the government cannot keep taxing the same people more or to repeatedly hike the prices of commonly used items, which disproportionately hits the lower strata income groups. The government would also have to consider cutting its own expenses and improving the taxpayer’s ability to pay more, and bringing more people into taxpaying bracket.

Extremism and floods have caused the above disequilibrium to spread from an individual level to inter-provincial scale. It has started to create tensions between different ethnicities and has complicated the politics of the federation. Or in other words, ones income level and assets are no longer the sole determinant of how much one should pay, provincial affiliation and race are becoming equally important.

Consider the case of Khyber Pakhtunkhwa province, whose industry and infrastructure has suffered disproportionately due to extremism, military operations, and recent flooding. In these circumstances, the citizens of the province cannot be reasonably expected to pay more taxes. This, in one way or the other, is going to complicate the politics of Awami National Party (ANP), or any political representation from the province.

On the other hand, Sind province is the economic center of Pakistan and it presents another scenario. The main constituents of the MQM political party hail from the city of Karachi, and they are primarily involved in the service oriented, manufacturing and trading businesses. However, PPP is popular in rural Sind, whose inhabitants are largely dependent on the agriculture sector to earn their living. So when MQM calls for imposing taxes on agriculture produce, it knows this would hurt the Zamindars of Sind and Punjab more than its own electorate. Similarly, when PPP led government decides to raise the price of fuel, it hurts the transporters and the urban dwellers as oppose to the landlords.

Ultimately, what this is leading to is a collision course between the agriculture based landlords and Zamindars, versus the elites originating from the urban Industrial and Servicing sector. While the rural populations feel cheated by landlords, the urban settlers are equally disillusioned at the hands of business class leadership and politicians.

As a result of the floods, the rural populations, which are dependent on agriculture sectors, have been harmed disproportionately more as compared to urban populations. On the other hand, extremism hurts the urban citizens and populations more than the rural one. The above dynamics would make the job of any politician extremely hard. It makes the question of: who should pay more to compensate for an economy suffering from extremism, and the people impacted by the devastating floods, an extremely challenging one.

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