No, not TERF. But also,not entirely unrelated to the very relevant debate that is taking place in the country as the Central Bank bid farewell to its contentious subsidized temporary financing scheme offered during Covid. The red flags being raised on TERF are on the efficacy of the scheme, but can easily be applied to schemes similar to it. As such, the absence of any monitoring&evaluation mechanism in place that would preferably collect relevant data and ensure targets are being metwhile a scheme is active (granted, targets and goals were actually set prior) or a detailed impact assessment after the scheme has reached the finish line. But most of all perhaps, the biggest red flag is the missing policy design that should precede any large-scale scheme a government offersthat will benefit a select few disproportionately as all others pay full fare. Keen readers can now glean what the “T” word we must address next- it’s taxes. More specifically, taxes forgone, or tax revenue not collected.
As described by the World Bank, foregone revenue is “the tax revenue loss resulting from those preferential provisions of the law that provide certain taxpayers/class of taxpayers or certain sectors with concessions that are not available to other taxpayers or sectors and that results in the collection of fewer tax revenues than would be collected under the basic tax structure.“Here are some startling statistics for the uninitiated.
Last year, taxes forgone—an indirect subsidy of sorts—was estimated by the FBR to beroughly 36 percent of the taxes that the agencyactually did collectthrough income tax, sales tax and custom duties. At a time when the economy is so detrimentally cash-starved—burdened with a mountain of debt it must pay back (74% of GDP in FY22) and doesn’t have the money to, all the while grappling with the flimsy tax coverage that stands at or below10 percent of the GDP, leaning heavily onto indirect tax (64% of all tax receipts) because direct tax is apparently so hard to collect for FBR—the economy is leaking billions in taxes(it could potentially collect) by way of allowances, rebates, credits, exemptions,exclusions, and reduction in rates. Meanwhile, development spending is on the chopping block, declining over the years. Spending on development in fact is the opportunity cost of subsequent governments offering tax concessions to some interest groups.
For the year FY2021-22, forgone taxes were Rs2239 billion, as estimated by the FBR. During that year, the agency collected Rs 6148billion in federal taxes. These taxes grew 21 percent from the previous year, but taxes forgone are estimated to have grown by a whopping 49 percent during this time. The CAGR of the former since the year 2012 when this data became available is about 12 percent compared to the CAGR of taxes forgone of 23 percent. Revenues are not growing fast enough by any measure, but they are also growing slower than the speed of tax concessions being doled out. Suppose in FY22, all these taxes were collected, FBR taxes would immediately grow from 9 percent to 13 percent of the GDP—much closer to the desired target of 15 percent which is the minimum level of tax revenue considered necessary to support long-term economic growth (per IMF). Important to note here that Pakistan has never reached this unelusive target.
Tax concessions (and subsidies) are not a phenomenon exclusive to Pakistan. The global average for revenue foregone over the past three decades has persisted between 3 percent and 5 percent of the GDP (for East-Asia, its 3%-4%, for U.S, it’s 7%). In contrast, Pakistan’s 10-year average is around 1.9 percent of GDP. Evidently, governments around the world are doling out tax incentives as a tool to steer their economies toward investment and growth. Surely, Pakistan needs both, and direly too.
Except that, Pakistan goes into billions of rupees in tax expenditure completely blind. Tax incentive policies require a set of principles that need to be followed, a clear policy objective/goal in place that has qualifications that firms must meet aimed to incentivize specific behaviors (such as increase in investment into R&D, or grow exports by x% etc.), said objective must be backed by research with estimates of expected benefits and costs. What’s easily forgettable here is that while tax incentives are focused on a specific target audience and hence, concentrated among some interest groups, the costs of it are distributed amongst all taxpayers. Therefore, assessment should consider the distributional impact of each tax incentive.
This is a legacy problem for Pakistan—a legacy of poor ill-conceived policies. If there is a tax incentive in place, and it’s going to a certain group, there needs to be a detailed assessment done on its impact. Tax and relevant authorities must collect relevant, periodic data to track performances which can then be used to inform future policy decisions. Aside from distorting tax systems, such incentives can also distort economic activity—higher investment in doomed sectors that may never become competitive without the incentive in place; a classic misallocation of resources.
Yes, tax expenditures are popular around the world but they are also controversial for this very reason—they are often not effective in reaching their stated goals and can lead to adverse outcomes such as exacerbating inequality, tax evasion, windfall profits for some and running out of business for others, or the revenue authority forced to raise basic tax rates to meet their revenue targets. So far, its tick, tick, tick and tick when it comes to adverse outcomes and deafening silence on any evidence that would truly legitimize atax scheme, or incentive program.
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