Wearing new shoes on budget day is an interesting tradition among Canadian ministers of finance. Some say that new shoes are meant to convey a new beginning. One finance minister wore second-hand shoes to underscore the living standards of ordinary families. Another finance minister wore re-soled shoes to reflect fiscal prudence and economic hard times. One minister wore ice skating shoes and crash helmet to convey that the economic recovery was on thin ice.
Perhaps Finance Minister Dar may wish to start this tradition in Pakistan. So what kind of shoes should he wear while presenting the 2016 budget? Many would suggest that he should start his speech wearing re-soled shoes, and midway during the speech change to skating shoes and crash helmet. I would recommend that he wear the Cheetah brand of local sneakers, and present a budget that embraces boldness and abandons meekness.
For too long has Pakistan pursued timid and ‘tweaking on the margin’ policies in almost every sphere. In the last three or so decades the world has moved at a rapid pace, while we generally remained stuck in the old and traditional way of managing our economy. The living standards of many countries that lagged behind us in the 1980s have leapt far ahead of us now.
High global growth and prosperity, the hallmark of the last few decades, are now a phenomenon of the past. In the next decade, global growth outlook is bleak. The crisis in Europe, Middle East and Latin America will dampen growth for years. The slowdown in China’s growth is also a dark cloud on the horizon.
Given this scenario, the only option for Pakistan to accelerate growth is to abandon the policies of status quo and tweaking on the margin. A quarter century back, Prime Minister Nawaz Sharif put in place a very ambitious and bold economic reform agenda. This time around, his government has been meek in pursuing pro-growth reforms, and its skewed development priorities will not be of much help in generating growth or employment. Thus, if the prime minister and Minister Dar want to leave another lasting legacy of pro-growth economic reforms, the upcoming budget is a good vehicle to initiate the following bold reforms.
First, a ‘growth first, taxes latter’ policy. This they can do by announcing the following tax cuts: (i) over the next 2-3 years, reduction of sales tax to 10 percent and corporate income tax to 20 percent; (ii) for all greenfield projects anywhere in Pakistan in the manufacturing, agriculture, and services sectors, imposition of corporate income tax only after sponsors have fully recovered their equity; (iii) withdrawing all taxes on imported and domestically produced agriculture inputs to increase profitability of farmers, until such time that global commodity prices increase to levels that provide farmers reasonable returns.
Second, to raise profitability of exports to reverse the trend of Pakistan losing share of global export markets by abandoning the foolish overvalued exchange rate policy, and ensuring that all taxes on inputs and electricity are fully refunded.
Third, in conjunction with the provinces, initiate a comprehensive programme to reduce the ‘cost of doing business’, thereby improving Pakistan’s competitiveness . Actions need to be taken so that customer service in key agencies is transformed, and hounding of businesses by government functionaries is dramatically reduced.
Getting tax officials off the backs of taxpaying businessmen, will go a long way in lowering the cost of doing business. Until such time as the tax administration is fundamentally transformed, all coercive and audit powers of tax officials should be suspended for tax filers. The goal should be to curb discretionary and coercive practices of tax officials, such as frivolous and backdated notices; unjustified assessments; seizure of bank accounts. For the next few years, the entire focus of the tax machinery should be on chasing non-filers and auditing filers with zero returns.
The tax cuts proposed above will lead to substantial reduction in tax collection. Given the stagnating economy, accelerating growth is far more important than raising taxes. Also, at present, money in the hands of the private sector will have far higher returns to the economy than money in the hands of an inefficient and wasteful state. In addition, lower tax collections by federal government would encourage overdue reform – force the provincial governments to increase provincial taxes.
The reduced tax flows can be managed and made up by increase of fiscal deficit by 1.5- 2 percentage points, for the next 2-3 years. Such a temporary increase would not be damaging to the long term fiscal position and growth prospects. There could also be ‘deep’ cuts in wasteful current and low priority development expenditures. Or a onetime super tax , say 10 percent, on market value of shares. With the market capitalisation increasing by Rs4 trillion in three years, a few hundred billion of this wealth should be taxed away. We could also dramatically increase the withholding tax rates for non-filers and impose high presumptive income and sales tax (equal to, say, 100 percent of the electricity/gas bills) on all non-filing medium-large commercial and industrial users of energy. All unjustified subsidies could also be eliminated.
This budget should also start a national debate on the fundamental overhaul of tax and expenditure management in the next 3-5 years. The key expenditure reform goals should be limiting federal government expenditures to debt service, national security and foreign affairs, Supreme court etc. The goals should also include the financing of mega projects of national importance, collectively by all provinces and the federal government. As well as making public debt limit part of the constitution, and linking the limit to tax collection; shifting responsibility to provincial governments for providing all household level subsidies; and making district governments fully responsible for delivering education, health, water, public transport, agriculture services, policing and judicial services within the district.
The medium goals in respect of taxation would be first of all, redistribution of taxation responsibility between the three tiers of government in line with the above suggested expenditure mandate, with significant level of tax collection by the district governments. The latter would ensure that citizens clearly see the link between expenditures and taxes. Traders and businessmen will be more amenable to be in tax net when they see their taxes being spent on schools and hospitals used by them and their families, rather than schools and hospitals in some other district or province. Second, levying federal income tax on agriculture and third, transformation of the tax administration, including rewriting and simplification of tax laws.
This government’s term will end in two years. This budget is the last chance for the prime minister and the finance minister to take meaningful steps to accelerate growth within their term of office, and to leave a legacy of a sound and efficient tax and expenditure management system. They would be well advised to listen to their instincts, not the ‘status quo’ officials. And to indicate their preferences by wearing Cheetah sneakers on budget day.
The writer is a former operations adviser at the World Bank.