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December 14, 2010

Reform and resistance


December 14, 2010

The writer is a former envoy to the US and the UK, and a former editor of The News.
The firestorm over the government’s intent to reform the general sales tax is a result of several factors: resistance from those who will be affected or documented, official prevarication, partisan posturing and opposition grandstanding. It also reflects genuine public fears about price rises in an environment of great economic distress.
The debate on mobilising resources is a welcome development in a country characterised by the absence of a tax culture. But the heat generated in this debate has made the outcome of this critical reform effort rather uncertain.
The test of the government’s resolve to stay the course will come after the Muharram holidays when the bill passed by the Senate Finance Committee is considered by the counterpart body in the National Assembly before being voted upon in the House.
More is at stake than just an economic measure announced by the PPP-led coalition. The reformed GST is a test of the government’s capacity to get anything of consequence done. If political will is expressed in action rather than in words enforcing this reform will be an important benchmark. Failure to assert that will and galvanise parliamentary support to secure the measure can adversely affect both the government’s credibility and a fragile economic recovery.
The RGST has also become a measure of the country’s ability to honour its international commitments. It will demonstrate to varied donors whether Pakistan’s own taxpayers can be mobilised when their nations’ taxpayers are repeatedly asked to bail out Islamabad.
Delay over promulgating the RGST and inability to meet other performance criteria have already made the programme with the IMF inoperative. This state of limbo cannot end without meeting commitments among which the RGST was Islamabad’s own proposal to address its chronic revenue shortfall.
Mobilising additional resources is in

any case a national imperative urged by Pakistan’s precarious public finances and the fragile state of its economy. A country unable to tax cannot secure its economic future. Without raising external revenue dependence the growing debt burden cannot be reduced. Nor can badly needed social and physical infrastructure be financed and essential services delivered.
Government borrowing from the central bank to finance the domestic and external deficits is now at a record high – Rs3 billion a day in recent weeks and averaging 1.7 billion daily since July. This injects a powerful inflationary impulse into the economy and imposes the most pernicious tax on the poor: high prices.
Ten years ago a task force established to recommend tax reform put it starkly: “Pakistan’s fiscal crisis is deep… taxes are insufficient for debt service and defence. If the tax to GDP ratio does not increase significantly Pakistan cannot be governed effectively, essential public services cannot be delivered and high inflation is inevitable. Reform of the tax administration is the single most important economic task for the government.”
This holds even truer today. But a mindset that presumes that the world will come to Pakistan’s financial rescue and obviate the pain of internal reform persists among many in the government and beyond, including the business community. This evasion of responsibility is not new but its implications are graver than those in the past.
The RGST is being resisted on many grounds. Predictably the stiffest resistance comes from those who do not want to subject themselves to documentation and a potential exposure to income tax down the road. It comes from those who fear that the reformed regime will make it harder for them to escape paying tax or collude to evade taxation.
While a GST has been in place for around two decades the proposed reform removes hundreds of exemptions and replaces its multiple rates by a lower single rate. This helps to mitigate the regressive nature of an indirect tax. Setting a threshold also means those below this will be exempt which will include small retailers. Exemptions on food, education, health services and medicines inject some progressivity to the tax.
The reform aims to add new taxpayers by expanding the net to those previously exempted as well as the five ‘zero-rated’ sectors including textiles that were not subject before to GST on domestic sales.
Opposition to the RGST has been orchestrated as much by special interests and their political allies as by leaders leveraging public anxiety for partisan benefit. Even some of the PPP’s coalition partners have stridently opposed the tax while continuing to remain in the government – hoping perhaps to extract a political price for their support.
This does not mean there are no grounds for public concern about the reform’s knock-on inflationary effects. But these may be overstated. Moving to a standard rate should logically reduce taxes and hence prices across a range of commodities. That public worry persists makes it even more necessary for the relevant authorities to check any exploitation of the new regime.
The furor over the tax does however raise important questions. Could the government have approached the reform differently and articulated its objectives in a manner that mobilised wider support to trump the anticipated resistance?
One view is that official procrastination and wavering over the past six months sent mixed signals about government resolve and allowed an air of uncertainty to build up. Had the government gone ahead with the RGST announcement in July rather than wait till November it may have avoided a situation in which vested interests and lobbies had ample time to coalesce and mount their opposition.
This otherwise persuasive argument overlooks the dynamics unleashed by the National Finance Commission award of December 2009. As the provinces have to cede to the centre the responsibility to collect the services component of the RGST, consensus was first needed at the interprovincial level otherwise the effort would have collapsed.
If there was a missed opportunity it was during negotiations for the NFC award, which tilted the balance of resource distribution in favour of the provincial governments. It was then that provinces could have been asked to commit to a reciprocal obligation to support revenue-raising efforts.
Then there is the question of packaging the RGST. Had the RGST been accompanied by or wrapped in progressive tax measures such as on wealth, gift and inheritance, it would have taken the sting out of the criticism of its regressiveness, marked a move towards a more equitable regime and helped to mute opposition.
This would also have served to blunt the self-serving case being made by some politicians who have been insisting that instead of the RGST other taxes should be enforced. Had the RGST been packaged differently these alibis to oppose it would have been unavailable obliging such leaders to take a clear position on tax reform rather than to fudge it. Demands for alternate resource mobilisation would be more convincing if they called for these taxes to supplement rather than supplant the RGST.
Some have argued more plausibly that the government proceeded without sufficient preparation when the experience of countries undertaking similar reforms shows that campaigns to educate people usually start more than a year in advance of such measures.
Instead of owning and aggressively campaigning for the RGST the top political leadership remained invisible, leaving it to Finance Minister Abdul Hafeez Shaikh to wage this battle on all fronts. Presumably the prime minister and his cabinet had more important demands on their time.
While the finance minister has been an able and credible spokesman for reform, his political principals have yet to pitch in and expend political capital to ensure that the proposed measure overcomes the opposition at hand.
This unsure and hesitant approach seems to characterise the PPP-led coalition’s style of governance in general. But the government must know that its authority would weaken if it were unable to push through with a measure that is badly needed. This will reinforce the widespread perception of the government as one that rules but does not govern.

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