Trend in key fiscal ratios

The consistent series of the GDP with one year, 2015-16, has been estimated and released by the PBS from 1999-2000 onwards. This now enables determination and comparison of the key fiscal ratios of Pakistan from 2001-02 to 2022-23. For example, the trend in the tax revenues-to-GDP ratio can now be identified.

The approach adopted is to determine the magnitude of a fiscal ratio during the tenure of a particular government, that is, in the first year and in the terminal year. Therefore, the chosen years are 2001-02, 2007-08, 2012-13, 2017-18, 2021-22 and 2022-23. Adequate information on public finances was not available prior to 2001-02. The fiscal ratios are derived with respect to the GDP.

The first key indicator is the trend in total tax revenues as percentage of GDP, including both federal and provincial taxes. Over the last two decades this ratio has fluctuated between 8 percent and 12 percent of the GDP. It was close to 8 percent of the GDP in 2001-02 and this year it is likely to be 9.3 percent of the GDP.

The trend is inverted U-shaped. The tax-to-GDP ratio rose steadily after 2001-02 and reached the peak of 11.4 percent of the GDP in 2017-18. Between 2012-13 and 2017-18 there was a big increase in the ratio of 2.6 percent of the GDP.

Thereafter, the tax-to-GDP ratio shows a clear declining trend and now stands at 9.3 percent of the GDP, with a fall of 2.1 percent of the GDP after 2017-18. In the absence of a withdrawal of the sales tax on petroleum products, it would have been close to 10 percent of the GDP, still significantly below the peak level attained in 2017-18.

There is need to recognize that one of the fundamental structural problems with the public finances of Pakistan is the low and declining tax-to-GDP ratio. It is low in comparison to other South Asian countries. India has an overall tax-to-GDP ratio of 17 percent, while it is close to 18 percent of the GDP in Nepal.

There is fortunately one positive development in the tax system of Pakistan. The share of the income tax has increased from 29% in total tax revenues to 36 percent in 2022-23. However, many of the withholding taxes in the income tax system are of an indirect nature.

Turning now to the changes in the level and composition of federal expenditures, there are some clearly visible trends. Total federal spending has ranged from 11 percent to 15 percent of the GDP. It was at the lowest level of 11.5 percent of the GDP in 2001-02 and reached the peak of 14.5 percent in 2007-08. It stands at 13.3 percent of the GDP in 2022-23.

There have been big long-term changes in the composition of federal expenditure. Current expenditure has been rising steadily as a percentage of the GDP. It has increased from 9.3 percent of the GDP in 2001-02 to 12.7 percent of the GDP in 2021-22. There is a small decline of 0.3 percent of the GDP in 2022-23.

The evidence points to the fact that the rising level of current expenditure has ‘squeezed out’ development spending so as to prevent big increases in the budget deficit. As such, the development expenditure by the federal government has contracted sharply from a peak of 3.3 percent of the GDP in 2007-08 and 2012-13 to less than 1 percent of the GDP in 2002-23. This is undoubtedly a very negative long-term development in public finances.

The lack of adequate development spending by the federal government is a big constraint to economic growth. Vitally needed infrastructure related to expansion of water resources, highways and power transmission and distribution are being greatly delayed in implementation.

Within federal current expenditure, there have also been major changes in composition. The largest head is debt servicing, and its share has increased from 44 percent in 2001-02 to 52 percent in 2022-23. The level has gone up during this period from 4.1 percent of the GDP to 6.5 percent of the GDP. This reflects not only the rising level of government debt but also the quantum jump in interest rates this year.

The other rising component of current expenditure is the outlay on subsidies and grants. Combined they had a share of 15 percent in 2001-02, which rose to a peak of 34 percent last year. This is attributable to the problems of cost recovery, especially in the power sector and the collection of loss-making SOEs. However, there is one positive development in the form of significantly larger outlays for social protection, especially for the Benazir Income Support Programme.

A perhaps surprising finding is the fall in defence spending as a percentage of GDP. It has declined from 2.5 percent of the GDP in 2001-02 to 2.2 percnet of the GDP in 2012-13. There was a peak at 2.6 percent of the GDP in 2017-18. Thereafter, it has fallen to 1.9 percent of the GDP in 2022-23. Even if military pensions are included in defence expenditure, it is still below 2.5 percent of the GDP. The level of military spending in India is somewhat higher at 2.7 percent of the GDP.

The next set of trends relates to the relative levels of spending by the federal and the provincial governments respectively. Following the liberal 7th NFC Award in favor of substantially larger transfers to the provincial governments, their share in public spending, both current and development, has increased. It was 25 percent in 2021-22, which rose to a peak of 39 percent in 2017-18. The share has declined to 31 percent in 2022-23, due to the extremely large jump in debt servicing by the federal government.

Within the total development spending in the country, the share of provincial governments has consistently been increasing. As highlighted above, there has been a squeezing out of development spending at the federal level because of the big increase in the burden of debt servicing. Consequently, while the share of provincial governments in total development spending was only 16 percent in 2001-02 it has now increased to 60 percent. This has augured well for education and health spending.

Finally, there is need to focus on the bottom line, that is, the size of the budget deficit and primary surplus/deficit as a percentage of the GDP. The consolidated budget deficit of the federal and provincial governments has been showing a sharply worsening trend. It was 4 percent of the GDP in 2001-02 and rose to 7.3 percent of the GDP in 2012-13. There was a significant fall to 5.8 percent of the GDP in 2017-18. Thereafter, it reached a peak of 7.9 percent of the GDP in 2021-22. There was a minor containment to 7.6 percent of the GDP in 2002-23.

A similar trend is visible in the primary surplus/deficit as percentage of the GDP. There was a small surplus in 2001-02. Thereafter, the budget books generally closed with primary deficits. It hit an all-time peak with a deficit of 3.4 percent of the GDP in 2012-13, followed by a big deficit of 3.1 percent of the GDP in 2021-22. This has come down to a deficit of 1.1 percent of the GDP in 2022-23.

Overall, the overriding conclusion is that the trends over the last two decades in key fiscal ratios have generally been negative. The tax-to-GDP ratio has fallen consistently, current expenditure, especially on debt servicing, has been rising while development spending, particularly by the federal government, has been falling as a percentage of the GDP, thereby limiting the growth rate of the economy.

Also, there has been a rising trend in the size of the budget deficit with respect to the GDP and primary deficits have been generated in most years. There is no doubt that major structural reforms are required in different areas of public finances in the country if the GDP growth rate is to be enhanced and inflation kept under control.

Copyright Business Recorder, 2023