ISLAMABAD: Persistent low fiscal revenue is one of the drivers of Pakistan’s recurrent budget shortfall, as total revenue collection has been falling over time, with fiscal year 2018–22 average at 12.5 per cent of GDP, down from fiscal year 2013–17 average of 13.2 per cent, says the World Bank.
The Bank in its latest report “Pakistan Public Expenditure Review 2023”, noted that Pakistan’s total revenue collection averaged 12.8 per cent of GDP over the past decade, substantially lower than the South Asian average of 19.6 per cent. Tax revenue collection, which averaged at 10.3 per cent of GDP over the past decade, is also low.
The report noted that Pakistan’s tax system is complex, has a narrow tax base, and high tax rates. The tax system has numerous special provisions, concessional rates, exemptions and, to some extent, unorthodox approaches to tax policy.
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Many of these policy choices were implemented to balance the provision of fiscal support to certain groups or industries with the need to maintain a minimum level of revenue collection. This has resulted in a system with many vested interests and has come at the cost of economic efficiency and the ability to sustainably raise revenue to a level that can finance Pakistan’s spending needs.
To raise more revenue in a sustainable manner, the tax system needs to be simplified, the tax base broadened, and the burden on compliant taxpayers concurrently reduced, the Bank recommended.
Estimates show that past efforts to broaden the tax base have not resulted in tangible outcomes: in fiscal year 2022, Pakistan lost a total of 2.6 per cent of GDP to tax concessions, 0.2 percentage points more than in fiscal year 2020. Pakistan annually lost an average of 26, 18, and 30 per cent of sales tax, income tax, and custom duty revenue potential, respectively, between fiscal year 2020 and fiscal year 2022, it added.
The sales tax base is narrow with multiple exemptions, concessionary rates, and zero ratings, all contributing to low revenue efficiency. The sales tax base definition is narrow, with multiple exemptions being permitted.
In addition to exemptions, the sales tax system also allows for concessionary rates below the standard 18 per cent for select products and sectors. Pakistan also allows certain domestic supplies to be zero-rated under the sales tax, which further narrows the tax base. The fractionalized design of the sales tax has resulted in low revenue efficiency.
A VAT gap analysis, conducted with reference to fiscal year 2019 GDP, reveals that concessionary tax rates, exemptions, and zero-ratings for non-exported products cost Pakistan 15 per cent of its revenue potential.
The personal income tax is complex, which allows for income shifting, and contains multiple provisions that narrow its base. Tax-free allowances, tax brackets, and tax rates differ significantly between salaried individuals and other taxpayers, which risks generating economic distortions and creating opportunities for tax avoidance through income shifting.
The income tax exemption threshold is set sub-optimally high, leaving formally employed salaried individuals outside of the tax net.
At the same time, the threshold for the top income tax bracket for salaried individuals is also very high and is likely to only capture a very limited number of taxpayers.
The corporate income tax (CIT) is complex and features numerous preferential schemes. CIT rates differentiate between three different regimes, with different tax rates and special provisions applying to standard companies, small firms, and small and medium-sized enterprises in the manufacturing sector.
These differentiations generate incentives for firms to split or stay small. Similarly, Pakistan provides certain firms access to a simplified turnover tax regime, which is both financially lucrative for the firms and reduces incentives for them to invest in accounting, business formalisation, and growth.
The CIT regime also provides for various tax incentives. These include outright tax holidays, reduced rates, credits, and exemptions granted by sector, investment type, and location.
The report noted that Pakistan’s fiscal deficit has been persistently large and growing, posing risks to fiscal and debt sustainability. In fiscal year 2022, Pakistan’s general government deficit stood at 7.9 per cent of GDP, matching that in fiscal year 2019, to be the largest in more than 22 years.
In addition to being persistently high, averaging at 6.2 per cent of GDP over the past decade, the deficit has also been growing, with the post 2010 annual average being 50 per cent larger than its pre-2010 average.
The large recurrent budget shortfalls have led to a rapid accumulation of public debt, which reached 78.0 per cent of GDP in fiscal year 2022, slightly lower than the record high of 81.1 per cent of GDP in fiscal year 2020.
Accordingly, both the deficit and debt levels are in breach of the fiscal rules stipulated by the Fiscal Responsibility and Debt Limitation Act (FRDLA). As a result of the large debt stock, interest payments at 4.7 per cent of GDP account for over one-third of its total federal expenditure in fiscal year 2022.
The Debt Sustainability Analysis (DSA) projections show that the debt stock is expected to remain above the FRDLA threshold in the medium term under all scenarios examined.
DSA also reveals that Pakistan’s public debt stock is vulnerable to exchange rate shocks. Given Pakistan’s volatile macroeconomic environment, these shocks not only drive up the public debt levels but also constrain fiscal space by increasing debt servicing costs.
In fiscal year 2022, combined federal and provincial expenditure stood just above Rs 13 trillion, around 19.7 per cent of GDP, with the federal government accounting for about two-thirds at 13.5 per cent of GDP.
While these levels are not high by international standards, the spending pattern is strikingly rigid, with almost 70 per cent of total spending per year being allocated to pre-committed areas such as interest payments, transfers and subsidies, and payments to public sector staff. These levels are higher than that of regional peers.
Consolidated development spending in Pakistan stood at 2.5 per cent of GDP in fiscal year 2022, of which the federal government contributed about 84 per cent.
These levels are very modest and lower than that of regional peers; India’s general government capital spending in fiscal year 2021 stood at 6.7 per cent of GDP.
Low levels of investment have been a driving factor to Pakistan’s recurrent boom–bust cycles and has contributed to low growth in productivity, potential output, and employment.
Copyright Business Recorder, 2023
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