Taxation, growth negatively correlated: survey

ISLAMABAD: International and national evidence points out that taxation and growth are negatively correlated, says a survey.

“It is time Pakistan took this seriously and changed the adjustment and growth model. If Pakistan thinks it through and can develop a good policy, the country can negotiate better with its international partners. Our growth is our responsibility and we should not follow anyone else’s model,” the Pakistan Institute of Development Economics (PIDE) survey said.

It said time after time, Pakistanis are often called “tax cheats” by their government and are embarrassed by donors at various forums. The depressing stats that only 1pc of the population pays income tax is mentioned whenever Pakistan’s taxation revenue is discussed. But is it true? Do we only pay such minimal taxes? The country has no tax-free goods or services.

The survey said that the Federal Board of Revenue (FBR) in its pre-COVID-19 time was celebrating higher tax revenue collection but all without generating new income. Instead, the taxes on utilities like energy prices went up by 20-30pc, further tightening the grip on the income of the country, which was already struggling with double-digit inflation. The list of indirect taxes in Pakistan is long. According to a recent article, Pakistan’s 96 million mobile phone users and 82m internet users are paying advance, adjustable income taxes of 12.5pc, all without the data that how many of them are eligible for taxable income.

The survey said the solution everyone seems to suggest is “progressive taxation”, but one enlightening example of progressive taxation is South Africa, where such a rate is the highest in the world and is still the country with highest income inequality.

The question remains: is it solely the problem of tax evasion (which is true for Pakistan to some extent like rest of the world) or the issue of incompetent and complicated tax policy, public trust issues, frequently changing SROs [statutory regulatory orders], poor taxation education and lack of research and development in the tax department?

Frequently, the survey said, Pakistan is advised by donors to increase taxation for two basic reasons: To allow for more resource collection for the government to finance development; and the citizenship and ownership in the country would increase if we adopt a western welfare model with social security nets.

While on the face of it, the survey said, these objectives are laudable. However, these arguments miss some fundamental points. First, Pakistan does not have a competent state that will use the increased revenues wisely. Some, including Haque (2017 and 2020), argue that the state is wasteful and incompetent. The state keeps wasting resources on poorly thought projects, building official housing and other low return or negative return projects (Haque et al. 2020).

Second, the survey said, high taxation is required to return the debt accumulated by the government. Instead of building checks on the government’s capacity to acquire debt and sign poorly planned contracts such as Reko Diq and Karkey cases, Pakistanis are told these mistakes have to be paid by more taxes.

Third, Pakistan is asked to copy the western social safety nets and welfare state while it stands at the stage of development without growth. This “isomorphic mimicry” merely stretches Pakistan’s already poor administration capacity to reduce growth and require more and more taxes – a vicious cycle. Rather than following the Haque proposition and reforming the state for efficiency, people are told to finance the inefficient state (Haque, 2017 and 2020). Our top priority in a series of International Monetary Fund (IMF) programmes has been to increase taxation, the survey noted.

It argued that higher taxation should be stopped and explored the literature on taxation and growth conducted based on both national and international studies.

The survey said Saqib et al. (2014), Azeem et al. (2013), Atif et al. (2013) and Siddiqui (2010) confirm the negative effect of taxation on real per capita GDP. Madni (2014) discovers that both direct and indirect taxes were causing inflation to increase in Pakistan. Ahmed et al. (2010) runs a micro-simulation analysis for tax reform in the country and concludes that almost simulations of increasing the tax rate in Pakistan result in a decrease in investment levels, reduced consumption, and an increase in poverty. Ahmad et al. (2018) analyses the impact on indirect taxation in the country for time series data (1974-2010) and confirms the negative effect of indirect taxation on growth. The study declares that 1pc increase in indirect taxes reduces growth by 1.68 percent.

Analysing the cross-sectional and time-series data for 1970-1997, Lea and Gordon (2005) visualised the effect of taxation on growth and concluded that corporate tax was negatively related to growth for all seventeen nations. In case the tax was reduced by 10pc, it could increase the growth rate by 1.1pc. A study by Pami, et al. (2000) identifies the negative effect of income tax on GDP where exports taxes were also identified as negative and significant. Dackehag and Hansson (2012) used fixed-effect regression for 25 Organisation for Economic Co-operation and Development (OECD) countries from 1970 to 2010, finding that both income and corporate taxes were negatively affecting economic growth in the OECD region.

Abdioglu et al. (2016) examines the relationship between corporate income taxes and foreign direct investment level in OECD countries and found that FDI increases significantly followed by tax rate reductions in the region. The study concludes that countries that reduced their tax rates attracted higher levels of FDIs. Djankov et al. (2011) in an investigation of 85 countries discovered a large negative effect of corporate income tax on aggregate investment, FDI and entrepreneurship.