Progressive fiscal policy

The Managing Director, Kristalina Georgieva, of the IMF (International Monetary Fund) has said recently in the context of Pakistan that ‘there is a need for collecting higher taxes from the rich and giving subsidies directly only to those people who are poor’.

This is, no doubt, the basic principle of a progressive and redistributive fiscal policy. Unfortunately, in the presence of state capture by the elite in Pakistan the overall incidence of the tax system has been regressive in nature while pro-poor subsidies and cash transfers account for a relatively small portion of the budgetary outlay by the federal government. These benefits should ideally play the primary role in the redistributive process in the country.

Recent research at the BNU Center for Policy Research has quantified the incidence of federal taxes in Pakistan in 2020-21. The results of the tax burden by quintile are presented in Table 1.

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                                 Table 1
                     Share of Incidence of Taxes by Quintile
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                        Highest
                        1        2        3        4        Lowest    Total
                                                            5
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Income Tax              64.0     15.5     7.5      7.4      5.6       100.0
Indirect Taxes          42.6     21.3     15.7     11.9     8.5       100.0
Total Taxes             49.9     19.1     12.9     10.2     7.9       100.0
Share in Household      51.5     19.8     12.8     9.6      6.3       100.0
Income (Adjusted)*
Relative Incidence      0.969    0.964    1.008    1.062    1.254     1.000
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*For misreporting
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The perhaps not so surprising finding is that the overall burden of taxes is regressive. The relative incidence is measured for each income quintile as the share of taxes paid to share in household income. It is below unity, at 0.969, for the top quintile and rises to 1.254 in the case of the bottom quintile.

The reforms in direct taxes which could be implemented to increase progressivity have been highlighted by this writer in an earlier article*. The direct tax-to-GDP ratio was 3% of the GDP in 2020-21 and is likely to rise to 3.5% of the GDP this year. However, the UNDP Human Development Report for 2020/21 on Pakistan has quantified that the ‘true’ potential of income tax revenues is close to 6% of the GDP. An increase of 2.5% of the GDP in direct tax revenues could add over Rs 2000 billion to FBR total tax collections, raising them thereby by over one fourth.

Turning to subsidies and transfers to the poor in Pakistan, these are primarily of two types. The first is cash transfers through the Benazir Income Support Program (BISP). This has been increased recently by Rs 40 billion and will now include a total transfer of Rs 400 billion in 2022-23. The second type is in the form primarily of the electricity price differential subsidy for small consumers. The cost of various pro-poor interventions in the federal budget of 2022-23 is given in Table 2.

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                 Table 2
Budget Pro-Poor Interventions in 2022-03
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                              Allocation
                            (Billion Rs)
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BISP Cash Transfers                  400
Power PDS                            240
Subsidy to Gas Consumers              36
Others (PASSCO, USC, etc)             28
Total                                704
% Of GDP                             0.9
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The total direct interventions for the poor in the federal budget of 2022-23 are likely to cost just over Rs 700 billion, equivalent to 0.9% of the GDP. They account for only 7% of total federal current expenditure.

The fundamental question is whether this is enough to effectively tackle poverty. The incidence of poverty is likely to rise above 40% of the population this year due to the fall in the agricultural output by the floods and extremely high rates of inflation in food prices due to resulting supply shortages. Further, because of rising industrial unemployment due to restrictions on import of inputs and cost-push inflation arising from the big increases in administered prices of energy and petroleum products.

There is need to estimate the ‘poverty gap’ in the country to identify the quantum of support required. The latest poverty line estimates, based on the cost of basic needs approach, by the Planning Commission, was Rs 3,758 per adult equivalent per month as of 2018-19. A typical household in the lower two income quintiles, consisting largely of the poor, had a size of 5.7adult equivalents in the last Household Integrated Economic Survey by the PBS (Pakistan Bureau of Statistics) in 2018-19. This implies that the household minimum income level had to be Rs 21,420 per month to graduate out of poverty in 2018-19.

The household poverty line is likely to have gone up substantially since 2018-19 due particularly to the high rate of inflation in food prices. Accordingly, the latest estimate of the poverty line for a typical lower income household is estimated at Rs 40,200 per month.

The projection of actual income from 2018-19 to 2022-23 is Rs 29,700 per month, based on the cumulative increase in wages of semi-skilled and unskilled workers. Therefore, the average monthly poverty gap per household is Rs 10,500. As compared to this, The BISP transfers Rs 7,000 per quarter to a poor household. This is equivalent to 22% of the required amount for a poor family. Also, the coverage is limited to 7 million households when the actual number is over 13 million households.

Estimates are that with over 40% of the population below the poverty line and the average estimated poverty gap in income per household, the national poverty gap for the poor households in the country is Rs 1,510 billion. This gap is 215% of the size of the pro-poor interventions in the budget and equivalent to an absolute gap of over Rs 800 billion.

The bottom line is that the direct subsidies and cash transfers will have to be at least twice as large as is the case currently. The appropriate progressive fiscal policy in the budget for 2023-24 will be the introduction of direct tax proposals, as highlighted in an earlier article*, to yield up to Rs 800 billion to be used for providing relief to the poor. This will enable the effective tackling of poverty in the country. Progressive fiscal reforms should be included in the IMF programme if it continues up to June 2023.

*‘Strategy for Resource Mobilization’ 7th February 2023.

Copyright Business Recorder, 2023