IMF, taxation and fiscal sustainability

Pakistan needs to transform its taxation. The focus should be on documenting the economy

IMF, taxation and  fiscal sustainability


he coalition led by Pakistan Muslim League-Nawaz (PMLN) now holds sway both at the federal level and in the Punjab. While boasting a clear majority in the Punjab, the PMLN has forged alliances with other parties in the National Assembly and the Provincial Assembly of Balochistan. Maryam Nawaz Sharif has been appointed as the Punjab’s first woman chief minister. Against the backdrop of Pakistan’s current economic woes, the PMLN faces a daunting challenge.

Tasked with extricating the country from its financial morass and charting a course towards economic recovery, the government must navigate rough and bumpy terrain. As Pakistan grapples with economic uncertainty, the onus is squarely on the PMLN to devise and execute robust strategies aimed at revitalising the economy and reinstating fiscal equilibrium. Amidst these formidable obstacles, the government’s capacity to surmount these challenges will be pivotal in shaping its legacy and steering Pakistan’s economic trajectory.

While Prime Minister Shahbaz Sharif has unveiled his cabinet and assigned portfolios to the ministers, the past two weeks have not witnessed any breakthroughs or policy announcements aimed at steering the external affairs towards a more prudent trajectory. In the present climate, characterised by the necessity for astute diplomacy to strengthen ties with friendly nations and navigate complex multilateral and bilateral relationships, the absence of substantive policy initiatives is significant.

Particularly striking is the appointment of a chartered accountant as foreign minister. The decision raises questions about the government’s approach to handling foreign affairs. As Pakistan contends with geopolitical challenges and strives to assert its position on the global stage, the appointment of a seasoned diplomat had seemed a strategic imperative. The current situation underscores the critical need for strategic foresight and diplomatic acumen in charting Pakistan’s foreign policy course and safeguarding its interests.

The trajectory of Pakistan’s economic prosperity is intricately tied to the formulation and execution of a prudent foreign policy. In recent years, the country’s reliance on the IMF has increased. Lack of effective policy reforms and systemic governance challenges have precipitated a trend wherein Pakistan finds itself increasingly reliant on external borrowing, thereby straying from the path of self-reliance.

Consequently, economic policies have fallen under the purview of institutions like the IMF. Some of the bilateral lenders too have made their support conditional on adherence to the IMF directives. This pattern has persisted in recent years, heightening the country’s susceptibility to external influence and eroding its autonomy in economic decision making. Pakistan’s recent experience with the IMF has been fraught with challenges, beginning with a failure to fulfill the obligations outlined in the 39-month $6 billion Extended Fund Facility programme signed on July 3, 2019.

The conditions imposed under this programme not only exacerbated inflationary pressures but also necessitated adjustments in the policy rate. While the government’s inability to enact substantive policy reforms played a role in this setback, the primary focus remained on meeting immediate fiscal requirements by adhering to prescribed action items.

Particularly striking is the appointment of a chartered accountant as foreign minister. The decision raises questions about the government’s approach to handling foreign affairs. 

Following the premature conclusion of the EFF, Pakistan sought recourse to a short-term 9-month $3 billion Standby Agreement signed on July 12, 2023. This shift in approach underlined the complexities inherent in meeting the intricacies of IMF engagements and the challenges posed by the evolving economic situation.

The SBA has apparently progressed steadily, now reaching its final phase, with the staff-level conclusion of the second and final review. The timely initiation and successful conclusion of the second review, originally scheduled for March 15th, reflected the efforts of all stakeholders. Leveraging the proactive measures undertaken by the caretaker government, the Ministry of Finance held an optimistic outlook. This has rekindled the hope that it could serve as a steppingstone towards a more comprehensive EFF programme, potentially featuring an augmented financial allocation.

However, the condition imposed by the IMF are bound to add further misery for the common man. The new government has reached an agreement with the IMF to implement contingency measures if the monthly cumulative tax revenue of the Federal Board of Revenue falls short of the projected targets. Should the shortfall reach 1.5 percent in the second quarter, 0.5 percent in the third quarter, or 0.1 percent in the fourth quarter, the government will initiate one or more of the pre-approved contingency measures outlined in the programme.

The contingency measures reported in the media encompass a range of strategies aimed at bolstering tax revenue collection and mitigating fiscal deficits. These include: (i) increasing the sales tax rate for textiles and leathers tier-1 from the reduced rate of 15 percent to the standard rate of 18 percent, with an anticipated monthly additional collection of Rs 1 billion; (ii) implementation of Federal Excise Duty of Rs 5 per kilogram on sugar, expected to generate a monthly collection of Rs 8 billion; (iii) augmenting the advance income tax on the import of machinery by 1 percent, with an expected monthly collection of Rs2 billion; (iv) elevating the advance income tax on the import of raw materials by industrial undertakings by 0.5 percent, aimed at generating a monthly collection of Rs 2 billion; (v) increasing the advance income tax on the import of raw materials by commercial importers by 1 percent, with an anticipated monthly collection of Rs1 billion; (vi) raising the withholding tax on supplies by 1 percent, projected to yield a monthly collection of Rs 1 billion; (vii) enhancing the withholding tax on services by 1 percent, expected to result in a monthly collection of Rs 1.5 billion and (viii) increasing the withholding tax on contracts by 1 percent, aimed at achieving a monthly collection of Rs 1.5 billion.

These measures represent a proactive approach by the government to address potential revenue shortfalls and uphold fiscal stability, aligning with broader efforts to strengthen Pakistan’s economic resilience and sustainability. However, these conventional increases in taxes on sectors already paying taxes are based on an orthodox approach and may prove counterproductive.

As Pakistan transitions under a new government, a critical reassessment of the country’s tax system is imperative. Leveraging modern technological advancements, the government must undertake a comprehensive review aimed at imposing taxes on previously untaxed or inadequately taxed sectors of the economy.

Pakistan needs to transform its taxation. The focus should be on documenting the economy, making everyone liable to discharge the legal obligation of filing a tax return and paying the due taxes. This should be achieved by devising and implementing innovative tax policies, coupled with technological solutions, which can streamline tax collection processes and ensure greater compliance across various economic sectors. Such a pragmatic approach is essential for fostering economic growth, promoting fairness in taxation and achieving fiscal sustainability in Pakistan’s evolving economic growth.

Dr Ikramul Haq, an advocate of the Supreme Court and writer, is an adjunct faculty at Lahore University of Management Sciences.

Abdul Rauf Shakoori is a corporate lawyer based in the USA

IMF, taxation and fiscal sustainability