Will Is All

The new government likely to take office in the coming days will face enormous economic challenges. How it will balance its income with expenditures will be the first challenge it will have to grapple with. The obvious strategy is to bridge the widening gap between revenues and expenditures, which is possible in either of the two ways: by enhancing revenue collection or by cutting down expenditures. There are problems in both these areas.
As far as revenue collection is concerned, the tax-to-GDP ratio stays stagnant around nine percent despite all the efforts made so far to change the situation. In terms of tax-to-GDP ratio Pakistan falls in those countries that lie at the tail end of the list. What is more alarming is that this situation continuously resists any change for the better. The major reasons for this status quo are: stagnant economic growth, lack of political will, and low capacity of the tax machinery. It is significant that the new government can make a difference in all these areas.
The key to putting economic growth on the path to recovery is to first identify, and then focus on, the most binding constraints to growth. It is imperative that a focused attempt is made to remove the most important constraints rather than making a diffused effort in many areas and wasting resources in the process. For all practical purposes four constraints are inhibiting economic growth in Pakistan – the energy crisis, low investor confidence, poor governance and bad macroeconomic environment.
The energy crisis has crippled the economic and social lives of the people. The manufacturing sector has suffered the most due to the power shortage. The industrial units that had to be shut down as a result also rendered a large number of people jobless. Exports did not witness any remarkable increase mainly due to supply-side constraints. So the resolution of energy crisis is one of the biggest challenges the new government will be facing. Unless this crisis is taken care of on a war footing, it will not be possible to revive the economy.
A multi-pronged strategy will be required. Taking care of the circular debt problem, restructuring power companies, and resolving the tariff issue should be some of the major planks of such a strategy. Seemingly circular debt constitutes the core problem but the monster, in reality, is hydra-headed. It is less known that even if the gap between demand and supply of electricity is completely bridged, the distribution system in place does not have the capacity to carry the load to the consumers. Distribution lines have outlived their use and are currently incapable to transmit the requisite electricity load.
This dimension of the problem is often overlooked and requires investment worth billions of dollars. Given the current state of the economy, this does not seem to be possible with domestic investment. How the new government lures in foreign investment to tackle the issue will determine, among other things, its success or failure in dealing with the energy crisis.
But bringing foreign investment into Pakistan requires serious efforts towards restorating the badly-shaken confidence of investors. Despite high potential of returns (consistently high interest rates in the past couple of years), even domestic investors have been reluctant to invest in Pakistan. They either did not bring their savings into Pakistan or invested them elsewhere. It is an open secret that a number of manufacturing concerns shifted their capital to Bangladesh. Partly this capital flight is connected to the energy crisis but other factors like bad law and order situation, poor governance and corruption are also equally responsible for low investor confidence and stagnant economic growth.
Pick up any international report and you will find Pakistan near the bottom of ranking by governance indicators. For example, according to the Global Competitiveness Report 2012-13 Pakistan stands at 116 among a total of 185 nations as far as protection of property rights is concerned. On favouritism of officials in government decision making, Pakistan is at number 129, poorer even when compared to Sri Lanka and India.
The same is the case with other governance indicators like waste of government expenditures, irregular payments and bribes, provision of public services, and efficiency of legal frameworks for settling disputes where Pakistan fares badly compared to countries with the same income levels. Besides poor governance, weak macroeconomic indicators like rising public debt, huge fiscal deficit, and low savings etc have crowded out private sector investment, fuelled inflation and badly damaged investor confidence.
One of the macroeconomic indicators that need attention first and foremost is the huge fiscal deficit. With a view to minimise fiscal deficit, it is essential that either more revenues are mobilised or expenditures are curtailed. There are two options to mobilise additional revenues: borrowing from the IMF or mobilising domestic revenue through new taxation measures and capacity building of the tax administration.
Several economists have suggested that the IMF should be approached to avert the impending danger to the balance of payments. Given the current economic meltdown, IMF conditionalities are likely to further exacerbate the situation. For instance cutting state spending, controlling inflation through reducing private credit and interest rate increases as generally advised by IMF are bound to dampen economic growth further. Even if the IMF agrees to grant a loan – which is not certain – its conditionalities may be hard to digest. The IMF’s micromanagement of domestic economy subsequent to the loan may leave little scope for the government to manage and revive it.
The second option is to go for domestic revenue mobilisation, which requires strong political will. Generally, blame for low tax collection is shifted entirely to the tax machinery and the complexity of laws and procedures. This may be partly true but it does not tell the whole story. Despite the fact that we have heavily relied on self-assessment schemes in the past, tax revenues have not witnessed any appreciable increase to bring an improvement in tax-to-GDP ratio.
Can a tax official enter any business premises in Liberty Market of Lahore? Can professionals like lawyers and doctors be subjected to tax? Can tax officials enforce tax provisions against the biggest tax defaulters? Probably not. It is the lack of political will wrapped inside self-assessment that is the biggest impediment to domestic revenue mobilisation.
Tax thieves use the SRO culture to shield themselves against tax laws; this SRO culture is used as an umbrella also for corruption and discretionary powers of tax officials. Pick up the tax record of any business concern, there is more than enough chance that it will show losses going over years. However, a little investigation will reveal that the wealth of its owners has multiplied many times as evidenced from their property and newly-established business concerns. If they have been incurring losses, how has it been possible for them to multiply their wealth and businesses?
The level of political will in the new government will determine how far it succeeds in raising tax-to-GDP ratio, currently one of the lowest in the region. An honest and efficient tax administration liable to accountability and capable of enforcing tax laws against the big fish will show the real political will of the new government.