Government of Pakistan is currently trying to introduce a RGST, a reformed General Sales Tax. One can’t help but think that as so much of energy is being put into reforming tax system and increase revenue. Government may be exhausting its political capital but yet be missing a trick.
The primary reason why the government has been made to introduce this RGST is because of IMF’s pressure. It may be recalled that in 2008, when the country was about to default on its loans, the GoP decided to renegotiate with the IMF to get some loans, which would allow it to balance its budget. As a consequence of that loan agreement, the treasury was expected to ensure an increase in revenue, which would then lead to paying back the loan with interest.
Pakistan is regarded as one of the most tax evading countries in the world. Simple fact is, it is easier and cheaper not to pay tax than to pay. The system is contrived in such a way that millions of rupees in profits are hidden and protected. Many of the tax evaders are small and medium enterprise, that numerically are in millions. Larger corporations are not free from blame either. While most of them are happy to deduct tax of their employees from source, who in turn, having no other choice, never forget to mention this contribution to the nation. But large corporations too “invest” their profits into subsidiaries and projects that seem to have no returns – but give out many benefits to those involved.
Conveniently, these organisations are mostly related to directors, large shareholders and such. Because of such and even less palatable schemes of tax evasion, treasury introduced a regressive tax in form of General Sales Tax. This taxes affects both rich and poor equally, on whatever they buy. Notwithstanding tax evasion involved here as well, this has proven to be more easier and so far more successful way of tax collection in Pakistan. It is no surprise then that we are being pushed into reforming this GST, to get more revenue, at expense of the people.
I say this because, and this is uncontroversial, GST affects poor more than the rich – thus the term regressive tax. If Rich spend more on something, due to it being taxed, they conversely shall have less leftover to spend on luxury items. Poor, who always have little and no savings, would have less to spend on much needed amenities. Thus the choice for them is between nutritious meal or clean attire.
Effectively RGST is going to increase the items that are subject to GST. An addition of 15-20% to price automatically causes 15-20% inflation. In Macro-economics, inflation is something that a government is duty-bound to curb. Increasing it by taxation is effectively an own goal. This lowers the purchasing power, devalues currency, causes opportunity cost for certain business, which affects many industries that are affected by decrease in sales.
RGST is at risk of increasing this further, and arguably it will only hurt the economy more – at least according to Keynesian economic. It is, according to neo-liberal economics, likely to however salvage some private parties, eventually. In long run, it is likely to help the business that weather this storm and can also allow them to exploit cheap labour that would come due to increased inflation. Supply and demand, if there is increasing unemployment, stagflation if you will, due to more and more companies going bust, there would be competition for jobs. This would let employer dictate the pay scales. However neo-liberal economics is ruthless in that it doesn’t take into account the social loss. Such a loss in lowering standards of living is not something pure capitalists care about!
Such is the predicament of a left leaning party, which is being made to introduce these measures. But it is arguable that a principled Leftist party would instead tax proportionally and progressively. The long term solution and way forward would be to tax on high pays and profits. But as argued above, the revenue collection is low. There is need for a fundamental change in the policing of the tax collection. This includes changing the higher echelon of Federal Board of Revenue.
Bringing in new recruits and re-training to current staff. It also includes bringing in independent accountability mechanism, especially that of an independent body, and also parliamentary accountability on the activities of the department. There is of course need to revise the current tax law, in that to seal the loopholes that exist in the current system and to make it more air-tight. This would initially cost more both in monetary and political terms, but the results would yield high dividends.
But why is there need for Pakistan to tax its citizens in first place? Fundamentally the answer you would get for this is; to maintain and possibly buoy credit- rating of Pakistan. If we default on our loan, we become a credit risk, our credit rating goes down and we get loans only at higher interest rate. It is at junctures like this one misses a visionary strong leadership at Islamabad. In the last three decades Pakistan has been ruled by for twenty years, or two-thirds of era, by Army chiefs who have had, to put mildly, catastrophic understanding of basic macro-economics and of international politics. This has led them to let others, primarily technocrats, control these domains. These then themselves have micro-economics credentials.
For example, the previous prime minister, whose credentials for office of Finance ministry was his position at Citi Bank. This Bank claims to be involved in many financial activities, but even they would agree those activities are not concerned with inflation, unemployment and such. A cursory look at list of Finance ministers of past three decades shows that, apart from Mr Shaikh and Burki, we have hardly had people at top who have grasp of macro economics. Those who have been experts, have had no grasp of politics, being technocrats.
Simply here is a difference between micro economics and macro economics- when a company defaults its creditors, it has to face legal actions, it has to face increased interest rates, has to find almost no other credit options and effectively faces ruin. When a country defaults, it depends! Some countries have, by pure brazen tactics and resolve, along with taking advantage of international politics, taken full advantage of their default. A country’s only form of credit is not only other countries, but it can also be international institutes like IMF. Further, governments can also raise revenue from their own citizens and finally also by selling assets.
In certain circumstances, default on loans such as bonds or foreign loans is actually a better decision because it allows you to free yourself from large debts. Increased inflation may allow for bonds to be of lesser value, and paying them then, at height of inflation along with a calculated default can go long way to lower the national debt. Default on singular but large debt is better.
Technocrats being only versed in economics would never conceive such a thing, a politician with financial background or advise would! Such a default then would allow you to use the freed up funds into something of national interest. Public infrastructure that would create returns, or organisations that would create jobs and revenue etc. Tactical default closes one door but opens another, these are the competitors of one who has just faced default. A default can also lead to national cohesion, which if propagated properly would initiate people to contribute and stand in with solidarity.
Nothing brings people together better than common threat and concern as long as there is a clearly defined goal in sight. Finally the paradox of the markets is that, once a default has occurred, after the initial mess and chaos, the markets begin to actually see the defaulting country in better light, especially if the country is seen to have a good financial history and has used justifiable reasons for default. This is because, once it is clear a default has occurred, and consequently the country has begun to invest into lucrative assets, that would yield more.
It is also clear that the government is now no longer aiming to default any time in future. They seem to have begun to balance the accounts and, with the large debt gone, have again begun to see green. Thus the markets begin to see the country in better light, ironically more than they had when the poor country was paying of large interest rates but taking the honourable road of ensuring no default occurs. But this is how markets work, and if you are in it, one needs to play its rules to one’s advantage. What of course markets are responding to quite favourably is the resolve and financial direction, twinned with political stability and resolve of people. These create a favourable impression, not only for the lenders but also investors who are always looking for untapped investments.
Pakistan then if is adamant on increasing its taxes, it must do it with a long term strategy. This strategy must be based on the left of centre ideals of progressive taxation, efficient public services, good tax collection and well maintained balance books, even if this includes taking some hard decisions. Any change, especially on the neo-liberal proposals, would only leave a sour taste in mouth and question mark to leftist credentials of PPP.