The stake and its holders

Wednesday, January 21, 2015  – Dr Muhammad Yaqub – the News –

Every government gets lost in its own game of self-enrichment and political survival, and begins to engage in temporary fire-fighting in economic policy matters leading to worsening the underlying economic conditions. In an article in this newspaper (‘A fundamentally flawed fiscal policy’, January 6) I had highlighted some deep-rooted budgetary problems to which each government, including the present one, contributed.

In response, the finance ministry came out with a statement carried by this newspaper (‘From the Finance Division’, January 16) in which it seems to agree with the analysis in the article but complains that it “ignores the efforts the present government has been putting in the process of budget-making and allocation of resources” taking into consideration “the point of view of the stakeholders”, and also claims that the government was “open to any suggestions for further improvements”.

This follow-up article is devoted to a brief review of the ‘efforts’ of the present government in the fiscal area and suggestions for a major shift from temporary patchwork to fundamental fiscal reforms. It is hoped that due consideration will be given to these proposals by the government, which is “open to any suggestions” and claims to be committed to “a comprehensive agenda of reforms to reinvigorate the economy”.

First, the economic management team should overcome its egoistic impulses and accept that, in responding to the threat of external debt default and to finance the fiscal operations, the PML-N government has so far taken the easy route of external borrowing and begging, use of privatisation proceeds and reliance on domestic bank borrowing rather than the difficult road of real resource mobilisation through tax reforms.

Budget mismanagement is of course the mother of all economic ills and reduction in the budget deficit is essential to move the economy back to a path of sustained high rate of economic growth, moderation in the rate of inflation and balance of payments viability. The IMF made it a focal point of its present EFF arrangement, and the PML-N government committed to bring down the budget deficit. The problem is that the government has tried to meet the IMF conditionality by hook or by crook in order to have access to foreign loans rather than through fundamental fiscal reforms that could improve the long-term viability of the fiscal situation.

Instead of undertaking difficult structural fiscal policy reforms, the PML-N government engaged in an exercise of fiscal data manipulation, including dressing up revenue receipts, limiting releases of development expenditure and keeping several kinds of expenditure out of the recorded budget. That satisfied the IMF but the budget deficit will balloon up to higher levels once the IMF programme is over and data fudging comes to an end. A durable solution of budgetary problems lies in fundamental fiscal reforms on the following lines:

First, at present, the bulk of income originating from the agricultural, real-estate and service sectors is not covered by income tax, and a large underground economy does not even show up in GDP numbers. Our tax-to-GDP ratio is one of the lowest in the world and will become even worse if income earned in the underground economy is clubbed with recorded GDP. Similarly, about 65 percent of whatever revenue is collected comes from indirect taxes. This ratio will go up if account is taken of receipts that are included under income tax but are more in the nature of excise duties.

Second, income tax reforms would basically involve expanding and consolidating the tax base, reducing statutory tax rates and collecting income tax from the front door rather than from the back door of arbitrary withholding techniques. It is obvious that the services, real-estate and agriculture sectors should be brought into the direct tax net in one way or the other. The preferred course of action is to pass laws or amend the constitution to bring all income, including that from agriculture, into the net of the federal income tax. If that is not possible, then the provinces should agree to introduce an agricultural income tax having similar features as the federal income tax. Similarly, steps need to be taken to dismantle the underground economy and bring its operations in the open and in the direct tax net.

Third, all income tax concessions, exemptions and exclusions given to vested interest groups under one pretext or the other should be removed immediately and all avenues for escape from income taxation should be closed. Fourth, tax administration should be freed from political control, made professional and autonomous; steps should also be taken to reduce corruption and tax evasion.

Fifth, the business community’s resistance to documentation of the economy should be challenged so that the underground economy begins to shrink and all economic transactions are properly recorded and taxed. Sixth, except essential consumer goods, all goods and transactions should be subjected to a low rate VAT type consumption tax.

Seventh, all loss-making public sector enterprises should be included in the budget till such time as these enterprises are either sold to the private sector or reformed so as to run them on commercial basis to generate profits. Similarly, privatisation proceeds and rupee counterparts of foreign grants should be treated as financing items appearing below the line rather than ‘revenue’ items above the line. These steps will provide a more accurate measurement of public sector deficit and also be an essential first step towards the fiscal ‘transparency’ claimed by the Ministry of Finance. Transparency comes not by putting fiscal data on the website of the Ministry of Finance but by compiling and analysing it professionally and accurately.

Eighth, the banking system should not be held hostage to the fiscal needs of the government; it should be left to the SBP to regulate it so as to mobilise domestic savings to finance productive activities in the private sector. The provisions of the SBP Act should be respected and the SBP allowed to formulate and implement monetary policy mainly to control inflation and finance private economic activities.

Ninth, the government needs to embark on a comprehensive policy programme to reduce the existing trade gap and move the current account towards sustainable surplus in order to reduce dependence on foreign borrowing. While home remittances provide a welcome relief, the current account should incorporate a fundamentally improved trade account based on export expansion and import curtailment. To promote exports, the government should use the exchange rate policy to improve competitiveness and increase the share of value-added exports by adopting an export-led growth strategy.

Tenth, while large energy projects are welcome, there is a real need to contain the imperial impulses of the prime minister for building mega prestige projects such as multi-lane highways at the cost of better health, education and social welfare facilities for the majority of the people.

The above suggestions will be opposed by so-called ‘stakeholders’ consisting of the lobbying groups of landlords, various chambers of trade and industry and speculators, smugglers and underground operators because reforms on the above lines will directly hit their ‘rental incomes’. But the government should remember that the real ‘stakeholders’ are the people of Pakistan who expect prudent fiscal management and good economic governance by the government voted in by them.

The writer is a former governor of the State Bank of Pakistan. Email:

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