Let provinces tax on their own

Should provinces lower the rates of GST on services? That’s a question mostly answered with a resounding ‘no’ by a few leading public economists in Pakistan. An oft cited argument so goes that if provinces lower their rates of GST on services, it will result in a kind of a price war and thereby negatively impact provincial tax revenues, and therefore competition over tax rates among provinces to attract mobile tax bases should be avoided because it will be a race to the bottom.

While there is surely a need for better coordination among provinces, the (tax) rate race to the bottom should not necessarily be construed as a foregone conclusion. First the Laffer Curve argument that holds true for corporate tax rate also holds for GST on services. If provincial economies grow, so will the overall tax collection.

Second, there are many other factors aside from taxes that influence business decision making. These include factor mobility or lack thereof, cost of factor inputs, market size within province, proximity to market and/or factor inputs, and overall business and economic environment prevailing in the province.

Surely all the four provinces offer various strengths, weakness, opportunities and threats on these factors. You can’t expect a telecom company to relocate its headquarters to Quetta because Baluchistan is offering lowest GST on services – not anytime in the foreseeable future at least given Baluchistan’s socio-economic indicators. Nor can ports & terminal businesses be moved to Lahore or Peshawar.

Third, provinces’ dependence on few big sectors is gradually going down. As a proxy, look at Sindh’s data. There are four big heads under which GST on services is collected: telecom, banks, insurance, and ports & terminal. By FY16, their combined contribution to Sindh’s GST on services had come down to nearly 45 percent from nearly 80 percent a few years ago – and during that period their total collection kept on growing.

That shows growth in tax collection from other sectors – and for many of those sectors geographic mobility is rather inelastic to taxes. In fact, a lot of service sectors are closely related to markets. For instance, GST on wedding halls: people will not have their wedding in another province, nor will wedding halls business move to another province because of tax rates.

The bottom line being if provinces want to lower the rates on GST, then so be it. Let businesses and consumers reap its fruits.

Lower tax rates may as well at least partially reduce the disincentives for businesses to come into at the tax net, and thereby help expand the tax base.

Once the tax base expands, there will be enough of pie for everyone to enjoy without racing to the bottom.