Taxation problems

The major problems the economy of Pakistan is facing in recent years are macroeconomic imbalances and sluggishness of the economy. The whole burden lies on the shoulders of vulnerable class in the form of high food and non-food prices and low level of income. Moreover, the macroeconomic policies of the government badly ruin the lower class of the society.
The structure of taxation is the most controversial issue in developing countries, including Pakistan. The focal source of revenue generation in Pakistan is indirect taxes. However, the economy has seen a gradual shift from indirect taxes towards direct taxes. In 2010-11 the share of indirect taxes in total tax revenue decreased to 60.05 percent from 84.01 percent in 1990-91. Over the years, the burden of taxation lies mostly on poor class of society.
The economy mostly relies on sales taxes instead of customs and excise duties. Sales taxes as a percentage of tax revenue increased from 13 percent in 1990-91 to 37 percent in 2010-11. The step taken by the government to implement the flood tax may have serious implications, if the burden of this tax lies more on consumers because it may reduce aggregate demand and output.
According to Zaidi (2003) "Lack of prudent fiscal policy can adversely affect price stability, balance of payment constraints, essential government investment in economic and social infrastructure, and thereby pose a threat to growth prospects".
Pakistan's economy always faces difficulties in raising its tax-to-GDP ratio. The tax revenues as a percentage of GDP fell from 14.0 percent by 1980-81 to 12.7 percent in 1990-91 and fell further to 10.7 percent by 2001-02. In 2008-09 the tax-to-GDP ratio was 11.3 percent, while it further fell to 9 percent of GDP in 2010-11. On average, the tax-GDP ratio is 11.5 percent over the period of 1990-91 to 2010-11. A number of factors have been responsible for the shortfall of tax revenue.
First; the quality of tax administration is very poor. There is poor documentation of taxpayers, and the chances of tax aversion are very high; second, the tax base is very narrow. Agriculture income tax is always debatable in Pakistan. Some economists and policy makers argue that tax net should be widened to include agriculture income, whereas, instead of tax imposed on agriculture inputs, it should be subsidised; and third, the allocation of government resources is not transparent in Pakistan. Development expenditures always contribute to high level of income and employment and hence the source of tax revenue.
Debt overhanging is one of the biggest problems faced by the developing countries including Pakistan that is primarily due to higher budget deficits. Unless fiscal deficits are financed through grants, it would result in rising public debt. To finance the escalating budget deficit the government relies mostly on domestic sources.
However, domestic borrowing is not sufficient to fulfil the resource gap, and the tax machinery is lax. The government is not able to increase the tax-to-GDP ratio and to widen its tax base. The other option is "inflation tax". But, realistically, keeping in view the consumer prices in Pakistan, it is not possible to increase it further. Therefore, the last option to finance budget deficit is external sources. There are also two options for the government when it goes for external borrowing.
The one is to get loans from international market and the other is to get loans from the International Monetary Fund (IMF). But, as the debt-to-GDP ratio of Pakistan is much greater than the requirement of international market so we have to get loans from the IMF. We bear the economic as well as social cost due to these loans. The IMF offers loans with strict restrictions on economic policies. The grant of loan is usually offered on a condition that the budget deficit should not be more than 4% of GDP, which becomes difficult to maintain due to the interest payments of that very loan.
Under these circumstances, the targeted deficit cannot be maintained but by reducing development expenditures. Over the years the development expenditures as percentage of GDP is showing a declining trend. Furthermore, external borrowing crowd out future domestic demand because the external borrowing must be financed through substantial reduction in trade gap.
In such a state of affairs, when the growth process of the economy is inundated, the burden lays on the shoulders of government to keep its budget deficit in the narrow band of 3 to 4 percent of GDP. Behind this limit the unsustainable budget deficit could have undesirable macroeconomic costs and the government's macroeconomic objectives such as low inflation and high economic growth might be in jeopardy.
If the government is able to reduce its budget deficit, eventually it would get rid of the vicious circle of debt overhanging problem, because the debt-to-GDP ratio would increase only if the fiscal deficit as a percentage of GDP exceeds the real GDP growth rate. However, the reduction in budget deficit must be due to reduction in the public expenditure rather than an increase in resource mobilisation.
(The authors are respectively Lecturer in Economics at University of Swat, Assistant Professor at University of Swat and Assistant Professor in Ghalib University Hirat, Afghanistan)