Informal affairs

While the federal government continues to boast rising tax revenues, the controversial strategy of using indirect taxes has received another unfavourable review. This time the criticism has come from the State Bank of Pakistan. The forced ‘broadening of the tax base’ – under IMF orders – has resulted in a decline in cash deposits in banks and an increase in currency circulation. This is according to the quarterly report by the SBP, which contrasts key figures from this year and the previous year to draw a rather bleak picture. Sure, tax collection has increased by over 10 percent, but the cost is the informalisation of the economy. The imposition of withholding tax resulted in a sharp increase in the purchase of prize bonds; to Rs94 billion from the Rs50 billion last year. The SBP seems to be saying that prize bonds might be used to conduct transactions instead of banking. The rise in bank deposits – Rs150 billion – is also low compared to the period between July 2015 and March 2016. The reason behind all this is simple: the 0.6 percent withholding tax on bank transactions, which exposed the government to the wrath of the trading community.

Experts had predicted that the outcome of such short-term measures would be an increase in the undocumented economy. Indirect taxes cannot be a long-term measure to secure the financial health of the country. While the finance secretary does not seem very worried about the negative data, there is an argument to be made for claims that people have been using cash and other mechanisms for trade since forever. It is banking that is the relatively new kid on the block. One must recall that it took a significant change in government policies towards banking in the late 1980s that made groups traditionally resistant to operating within the formal economy start using banks to store their wealth and conduct their businesses. The return to informal mechanisms of trade has clearly been faster and smoother than the government expected. The SBP has also criticised frequent changes in tax policy after the announcement of the annual budget. The use of regressive taxation measures, such as indirect and withholding taxes, indicates a failure to develop a long-term fiscal policy. Withholding taxes are 67 percent of all direct tax collection, a rather alarming number. The government must weigh the short-term benefit of withholding taxes against the long-term damage they cause to the process of formalising the economy. The SBP’s data must be considered seriously by policymakers to shift the focus of our tax policy to direct taxes.