Need for a balanced revenue-sharing framework

One of the key demands of the IMF is to increase the tax-to-GDP ratio to 13-14 percent by the end of the upcoming programme and to boost FBR tax revenues by over 30 percent in the next fiscal year.

Generating more revenue to lower the fiscal deficit is essential. However, both the IMF and Pakistani authorities are not emphasizing enough the need for provinces and cities to contribute their fair share of revenue.

Pakistan’s total fiscal revenues, including those from both provincial and federal levels, averaged 12 percent of GDP over the last five years.

Within this, the federal share is 10.6 percent of GDP, while the provincial contribution is a mere 1 percent of GDP. This excessive reliance on federal revenue needs to be reconsidered.

In India, the overall tax-to-GDP ratio is around 18 percent, with about one-third (6 percent of GDP) contributed by states and cities.

The federal tax collection in India is not significantly higher than in Pakistan. To progress, Pakistan must increase revenue contributions from provinces and cities.

Most of the easily collectible taxes, such as land and municipal taxes, GST on services, and agricultural income tax, fall outside the federal domain.

However, provinces have little incentive to impose new taxes, as they are the main beneficiaries of growth in FBR taxes. If the FBR increases its taxes by 30 percent next year, 57.5 percent of the additional revenue would go directly to the provinces, allowing them to increase their expenditures by 30 percent.

Political parties might publicly criticize higher federal taxes, but privately they celebrate the additional revenue, which allows them more room to fund development and people-friendly schemes.

The federal government’s biggest expenditure is debt servicing, expected to be around 8 percent of GDP in FY24, with provinces having no share in this responsibility.

Nonetheless, 57.5 percent of tax revenue from holders of domestic debt and other interest-linked savings instruments is passed on to the provinces, enabling them to spend more freely when interest rates are high.

Listed banks contributed Rs947 billion (Rs580 billion in income tax and Rs367 billion in withholding tax on profit paid on deposits) in FBR taxes in 2023, about 10 percent of FBR revenues.

Additionally, non-banking fixed income instruments are taxed. A significant reason for the 30 percent growth in FBR revenues in 1HFY24 is the higher tax on interest income, including banking income.

This situation creates a spending spree for provinces and their chief ministers. The federal finance team is constantly worried, while the provincial finance ministers show no signs of stress.

The question is whether the country can afford this. The answer is plain and simple no.

The IMF framework does not address this anomaly. All the IMF’s KPIs are set for the federal government and the central bank.

There is nothing for the provinces beyond MOUs to provide a certain surplus, which cannot be used by the federal government anyway.

It is not fair to demand this of the IMF, as its basic mandate is to ensure balance of payments so that the country remains current on its external obligations.

The IMF deals with the federal government and naturally asks them to maintain fiscal discipline to ensure balance of payment sustainability.

The IMF is not here to reform Pakistan. The responsibility lies with the state organs, including the federal and provincial governments. The current framework is unsustainable. Provincial governments must have an incentive to raise additional revenues for the spending they wish to undertake. For that to happen, they must have an adequate share in expenditure. Without this change, achieving a 13-14 percent tax-to-GDP ratio will remain a pipe dream.

Copyright Business Recorder, 2024