Pakistan’s fiscal dilemma

Governments have never been concerned with a judicious distribution of resources between the Centre and the federating units

The State Bank of Pakistan (SBP) in its Annual Report 2018-19—The State of Pakistan’s Economy has strongly criticised the provinces for what it called their “lack of institutional capacity,” giving rise to “lower revenue collection that contributed less to tax-to-GDP ratio and fiscal consolidation efforts”.

The report further noted that “an important agenda on fiscal reforms should be capacity building at the provincial authorities, which are responsible for mobilising revenue via the agriculture income tax, sales tax on services and property taxes, and carrying out crucial spending on important sectors like education, health, social spending and regional infrastructure”. It is observed in the report that even after nine years of the passage of the 18th Constitutional Amendment, “the provinces still seem to lack capacity to adequately assume these responsibilities”.

The following strong-worded criticism is made by the SBP about the performance of provinces:

“Their revenue efforts have been unimpressive to say the least, whereas their allocation on social development has been much less than what is required to bridge the existing service delivery gap. Therefore, it requires strong commitment from the provincial governments to support the fiscal consolidation efforts, bring the needed diversification in the revenue base, and gear themselves up to carry out effective public financial management to improve the quality of public spending”.

According to SBP’s report, the performance of provincial governments in general has not been impressive since the introduction of the 18th Amendment.

Though it was expected that over time, the provinces will enhance their capacity to collect taxes by modifying their institutional structures and reduce their dependence on federal transfers, these goals remain unfulfilled. The report further observes: “Despite the fact that all provinces have dedicated institutions to mobilize revenues, they are still overly reliant on federal transfers (both from the divisible pool as well as development loans and transfers)”.

The SBP observed that although the provinces are still maintaining multiple institutions to collect taxes (boards of revenue, Excise and Taxation Departments, and special new institutions for sales tax on services), they have failed “to put in place a workable strategy to improve collection” in respect of sales tax on the largest sector of Pakistan’s economy, i.e. services and income tax from the agriculture sector.

The SBP has suggested that “provincial authorities need to scale up their efforts in identifying their tax potential, devising adequate policies, and strengthening their capacities for implementation and collection”. SBP cited a very pertinent example that the provincial tax authorities since 2001 are responsible for collecting agriculture income tax, but till today have failed to devise a mechanism for its collection.

“Similarly, anecdotal evidence suggests,” the SBP says, that “there also exists a large potential for the collection of property income tax. If provincial authorities tap high-potential sectors, not only will they be able to reduce their dependence on the federal divisible pool, but will also diversify the revenue base across different sectors of the economy”.

For fiscal year 2018-19, the SBP appreciated the provinces for adhering to a better fiscal discipline as they cumulatively posted a surplus of Rs 190 billion, compared to a deficit of Rs 17.5 billion in fiscal year 2017-18. However, this surplus fell short of the target of Rs 285.6 billion.

While highlighting an unusual decline in revenue collection and steep rise in current expenditures, the SBP observed that it caused “deterioration in all major fiscal indicators” during FY 19. “The overall budget deficit during the year stood at a historic high of 8.9 percent of GDP, which was also in excess of the 4.9 percent target set in the Budget 2018-19”, it added. The logical outcome, the SBP says, was “worsening of the primary and revenue balances substantially, highlighting growing debt stress for the government and a shrinking space for the needed development expenditures”. The report further notes:

“Compared to a double-digit growth last year, tax revenues recorded a marginal growth of 0.1 percent in FY19. On the face of it, this was mainly an outcome of: (i) a decline in PSDP expenditures, which not only led to lower collection from withholding tax on contracts, but also affected revenue mobilisation from construction-allied industries; and (ii) court orders to substantially reduce the sales tax rate on major petroleum products and suspend the deduction of withholding tax on mobile phone top-ups. However, a deeper assessment holds responsible the country’s fragile revenue structure, characterized by narrow base and excessive reliance on few sources. Specifically, the entire decline in the single-largest revenue source for the government, i.e., sales tax, during FY19 was attributed to lower collections from petroleum; excluding this one item, the growth in sales tax collection rises to 7.2 percent. Similarly, heavy loss incurred by the SBP in the fourth quarter wiped out more than a third of overall non-tax revenues collected during the first three quarters. Taken together, the fiscal cost of the decline in revenues under these heads (petroleum and SBP profits), stood at 1.1 percent of GDP”.

It was noted with concern by the SBP that the revenue-led fiscal stress was reinforced by overall weak expenditure controls at both the federal and provincial levels.

The current spending of the federal government surged by a quarter in FY19 compared to last year, and also surpassed the targeted spending. Around 60 percent of the year-over-year (YoY) increase was due to mark-up payments, which was attributed to higher interest rates and the depreciation of the Pak rupee, it added.

The SBP in its report has failed to mention that in Pakistan, tax laws are meant only to fleece the poor for the luxuries of the rich. The privileged classes pay no taxes on their collossal incomes and wealth but the poor are subjected to all kinds of oppressive taxes. Adding insult to injury, they get nothing in return—and are deprived even of protection of their lives and property, what to speak of facilities like health, education, transport and housing.

It is a bitter reality that after the 7th NFC Award, both the federal government and the provinces failed to observe strict financial discipline. The monstrous size of government departments is causing colossal waste of resources. The governments are spending recklessly, a tendency that continues under civilian and military regimes alike.

In recent months, some economists and analysts have suggested that the 18th Amendment and 7th NFC Award are harming fiscal stability. This is also the underlying message of the SBP in its annual report. In Federation’s fiscal dismemberment, Mohammad Zubair Khan (Dawn July 09, 2018) claimed that “the imbalances triggered by the 7th NFC Award directly and indirectly contributed to a range of macroeconomic problems and turned out to be an unmitigated disaster for the Federation”.

Since 2009, the politicians sitting in parliaments — federal and provincials — and their economic managers have been following the 7th NFC Award — even in 2019 budget exercises by the federation and federating units, it was followed without taking into account results of the latest census.

It is thus clear that the federal and provincial governments have not been concerned with the fundamental issue of judicious and evenhanded distribution of resources between the Centre and the federating units to ensure prosperity for all. Balochistan should have exclusive right to levy sales tax on natural gas and Khyber Pakhtunkhwa on electricity produced there, just to mention two for illustration. These levies can make them rich. Their present share in sales tax from divisible pool is as low as 9 percent and 14 percent respectively. They have rich natural resources and wealth of oil, gas and electricity but due to low population get a smaller share for goods they produce. The same is the case with Sindh.

The performance of the provinces in collecting agricultural income tax has been appalling. After the 18th Amendment, right to levy inheritance tax, etc, is with the provinces but they are not ready to levy such taxes on the rich and mighty. This is a common issue both at the federal and provincial levels arising from absence of the political will to collect income tax from the rich — the meagre collection of agricultural income tax — less than Rs 2 billion by all provinces and Centre in fiscal year 2018-19 — is lamentable.

It is imperative that the right to levy tax on income, including agricultural income, should be given to the Centre. In return, the Centre should hand over sales tax on goods to the provinces. This would help the FBR collect Rs 5 trillion in income tax. By levying sales tax on goods and services to provinces would generate sufficient funds for their needs. This is the only way to achieve fiscal stabilisation in Pakistan.

The writers are visiting faculty at Lahore University of Management Sciences (LUMS)

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