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January 6, 2015

A fundamentally flawed fiscal policy


January 6, 2015


The countries in the Far East, which were way behind us in economic and social developments up to the 1960s, have by now developed to a stage where they are the envy of our country. Even Bangladesh, which was considered to be a basket case and an economic drag when it was a part of Pakistan, seems to be marching ahead of us.
Pakistan is rich in natural and human resources but is being left behind by other countries in the region. The public is at a loss to understand what is ailing the country. In a nutshell, an insincere and ineffective leadership has failed to exploit the full potential of the country and has instead dragged it towards the inglorious status of a failing state.
Specifically in the economic field, the main factor for the country’s poor performance is fiscal mismanagement year after year by successive governments in the last three-four decades. Notwithstanding the self-congratulatory and boastful speeches of a succession of finance ministers while presenting budgets, and endorsement of fiscal policy programmes of almost all the governments by the IMF, the public should be aware that fiscal mismanagement is in fact the mother of all economic ills in Pakistan.
Fiscal mismanagement has adversely affected not only allocation of resources and rate of economic growth, price stability and distribution of income but also directly negatively impacted the lives of ordinary people. On the expenditure side, wasteful and inefficient use of resources for the benefit of the rich and powerful, combined with corruption and pilferage of national wealth for self-enrichment by the ruling elite have been responsible for inadequate funding for the health, education and social welfare sectors leaving the vast majority of the population proverbially out in the cold. On the revenue side, exclusions, deductions and exemptions in taxation given to the vested interest groups and the ruling class have kept tax revenue way below the potential, and the incidence of

whatever taxes have been collected has fallen heavily on the poor.
The high level of public sector expenditure accompanied by a low level of tax revenue as a percentage of GDP forced successive governments to fill the gap by excessive domestic and foreign borrowing. With the passage of time, the servicing of the mounting public debt has become a part of the problem entrapping the government in a vicious circle.
Despite the fact that every government kept a part of the expenditure hidden behind the reported fiscal statistics, the officially consolidated expenditure of the federal and provincial governments averaged about 20 percent of GDP in the last five years, fluctuating in a narrow range of 19 to 21 percent of GDP depending upon the extent to which expenditure was kept out of the published fiscal statistics.
On the taxation side, the total tax revenue of the federal and provincial governments in the last five years averaged about 9.8 percent of GDP with the year-to-year fluctuations between the lowest 9.3 percent of GDP and the highest 10.1 percent. Moreover, about 65 percent of the total tax revenue was derived from indirect taxes which are regressive in their impact and have a direct bearing on the rate of inflation. Notwithstanding data manipulation, there was an average annual gap of over 10 percent of GDP between the recorded consolidated expenditure of the federal and provincial governments and their tax receipts.
A part of this gap was covered with what is called non-tax revenue which averaged about 3.5 percent of GDP in the last five years with wide year-to-year fluctuations ranging from 2.6 percent of GDP to 4.2 percent. About one half of the non-tax revenue is the profits of the SBP and ‘defence’ receipts as recorded in the federal budget.
But we all know that the SBP is a non-profit organisation and its huge profits do not represent any commercial activities. What has happened is that the government has engaged in massive borrowing from the SBP in the last five years on which it pays interest. That interest income is ploughed back as non-tax revenue in the form of profit transfers by the SBP to the federal government. These profits will not exist if successive governments had not indulged in excessive borrowing from the SBP as a substitute for tax effort.
It may be added that government borrowing from the SBP amounts to implicit taxation of the poor through inflation the bulk of whose burden falls on the poor and the small savers. The defence forces are not a revenue collecting agency, and the ‘defence’ receipts perhaps represent a part of the Coalition Support Fund of the US government that are shown in non-tax revenue. Both SBP profits and defence receipts are temporary and reversible and will create further fiscal difficulties once they dry up.
Even if we take nontax revenue at its face value and merge it with tax revenue, an average annual gap of 6.5 percent of GDP between total expenditure of the federal and provincial governments and their total revenue remained uncovered. The gap becomes bigger if adjustments are made for unrecorded expenditure of the public sector and windfall/ nonrecurring receipts – such as foreign grants and privatisation proceeds – recorded above the line in fiscal statistics. Unfortunately, fiscal data manipulation has been taken to a new ‘art’ form by the PML-N government which has engaged in ‘accounting engineering’ much more aggressively in preparing and presenting the budgetary statistics to make them look better on paper.
For example, the budget deficit for FY13 – the last year of the PPP-led government – was blown up to 8.2 percent of GDP by including the payments of circular debt at the last moment. In FY14, the circular debt was kept out of the budget, and with some additional accounting trickery the budget deficit was shown to have declined to 5.5 percent of GDP. In reality, the budget deficits as a percentage of GDP prepared on a comparable basis are much closer to each other in FY13 and FY14.The underlying budgetary situation has become worse in FY15 but is being covered up by not fully passing on to the consumers the fall in international prices of oil and levying a 30 percent higher sales tax on petroleum products and holding back the release of development funds.
In the period ahead, the mega infrastructure projects of questionable economic value inaugurated by the prime minister will add billions of rupees on the expenditure side. The war against terrorism is bound to increase defence expenditure. No structural reforms are in sight to reduce the flow of circular debt or contain the losses of the public sector enterprises. The overwhelming influence of the landed aristocracy and rich businessmen on the government is certain to stop it from undertaking fiscal reforms to include agricultural income in the tax net, introduce documentation to create a framework for catching the tax thieves in the business community and expanding the direct tax base or to adopt sound taxation principles to promote horizontal and vertical equity and elasticity in taxation.
A government that has decided to seek advice in the fiscal area from the lobbying groups of business community and politicians belonging to the landed aristocracy in preparing the budget for FY16 will continue to indulge in fiscal mismanagement with all its adverse consequences for the economy and the people.
The writer is a former governor of the State Bank of Pakistan.
Email: [email protected]




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