Pakistan has accumulated huge external and domestic debt mostly as a result of borrowing to finance persistent budget deficit and external current account deficit. In the instant write-up, the writer has delved into the causes that have led to this worrisome situation, and has also proposed some remedial measures to improve the state of affairs.
Historically, Pakistan has been facing persistent fiscal deficits due to limited capacity for raising tax revenues as the actual tax collection is well below the potential. The total budget deficit sustained by Pakistan from July 2008 to March 2015 was Rs.8,000 billion whereas trade deficit during the same period stood at $130 billion. Thus the gap between public expenditure and revenue is quite large. And, in order to bridge this gap, the successive governments relied on external and domestic borrowings which resulted in accumulation of huge public debt. Notably, the public debt has increased from Rs 6,302 billion in July 2008 to Rs 11,074 billion in March 2015 — a massive growth of more than 75pc. This debt has crossed the threshold of 60pc o f GDP, which is not approved of by the economists and international financial institutions. In fact, too high public debt is considered detrimental to economic growth and development, particularly for a developing country like Pakistan.
An immediate cause of the persistent budget deficit is limited tax collection capacity in terms of human resource and desired level of skills to cope with considerable tax evasion of both direct and indirect taxes. Like many developing countries, Pakistan has been generating little tax revenues and has a moderately flat tax structure. Since tax-GDP ratio is less than 10pc, more than 60pc tax revenue is being collected from indirect taxes (sales tax, customs duty, federal excise duty, etc). Furthermore, income tax is a major direct tax levy in the country with more than 97pc share in the direct tax collection. But around 60pc income tax is collected through withholding taxes, which are overwhelmingly presumptive in nature and have the potential of assuming an indirect form of taxation. More than 12pc income tax collection is out of demand created through audits and examination of taxpayers’ records by the tax officials and less than 34pc income tax revenue comes from voluntary payments along with tax returns.
Culturally, the nation is found of spending beyond means whether it is a marriage ceremony or any other festival. It is also true with the routine matters of life. The private consumption expenditure in Pakistan has increased significantly over the years. For example, it increased from 14.4pc in 2006-07 to 20pc in 2007-08 and 30pc in 2008-09. On average, the private consumption expenditure recorded a growth of 20pc during the period 2009-10 to 2012-13.
It’s no less than a universal truth that massive household spending depicts extravagant lifestyle. Owing to excessive household spending, the private fixed investment — an important driver of economic growth and creation of employment — is lower than the desired level due to scant savings. On average, the private fixed investment increased by only 4pc during 2007-08 to 2011-12. There could be many other factors such as uncertainties in economic policies including taxation policies that have great bearing on the level and structure of investment in the country. Economic, historical and political factors, certainly, have deep influence on emergence and development of tax structure. But the culture might have strong influence on tax regime in the country, which is not generating sufficient tax revenues for balancing the government budgets.
Many cultural dimensions have strong influence on tax collection and tax structure in the country. One such dimension is trust. Here trust implies that people within the nation believe that everyone pays his/her due taxes. Second element is people’s confidence and trust in public institutions and the political system regarding fair and correct utilization of state exchequer for the maximization of public benefits.
Lack of trust and confidence among the people regarding fair and neutral taxation and correct spending of public funds leads to lower tax compliance. This is evident from the fact that less than 1pc of the total 180 million Pakistanis file their income tax returns. In view of widespread non-compliance of tax rules and regulations, the tax authorities have opted to secure tax revenues through minimum taxation schemes and other presumptive modes as these provide much broader base than taxes on businesses profits; though such schemes and presumptive taxes are not economically efficient and also tend to reduce progressivity of a tax regime.
Third cultural dimension could be the concerns of the people about fair distribution of tax burdens. If people start believing that tax burdens are not distributed among them fairly, the tax revenues will continue to tumble. Fair distribution of tax burden on horizontal grounds demands that the same income should be taxed at a uniform rate, even if generated from different sources. It implies that certain incomes, whether received from capital returns or from a salary, should be taxed at the same rate. In sharp contrast to this principle of good taxation, the taxpayers who fall within the minimum taxation scheme and/or presumptive taxation regime are not allowed any basic exemptions and the possibility that small taxpayers bear a relatively higher tax burden under such taxation measures could not be negated. Even same amount of income from different sources is taxed at different effective tax rates.
On the other hand, fair distribution of tax burden on vertical grounds demands that people with a greater ability to pay taxes should pay more so as to achieve the objective of redistribution of income essential for narrowing down income gap between the rich and the poor. However, with virtually no taxes on agricultural income, inherited property, wealth, gifts, etc., tax burden is highly skewed and the income inequality is on the rise in the country. The result is general unrest among the masses.