Growth and revenue collections

Low Gross Domestic Product (GDP) growth rate translates into lower tax collections according to basic economic theory. However in this country with low GDP growth tax revenue is rising. Is this because tax rates have increased? Or is this because the government has enhanced documentation through higher rates for non-filers relative to filers? Or is this because of some accounting jugglery?
Prior to responding to these queries the first order of business as it were is the credibility of the GDP growth rate itself. There is general skepticism about the growth rate calculated during the past three years with many an independent economist challenging the Pakistan Bureau of Statistics (PBS) data, under the administrative control of the Ministry of Finance. The reason is two-fold: (i) lack of rationalisation between the PBS data and those compiled by other government entities (to name a few Small and Household Manufacturing Survey, Labour Force Survey, Ministry of Food Security data) as well as industry sources known for compiling credible data (including Oil and Gas Development Corporation, Cotton Advisory Committee, All Pakistan Textiles Manufacturing Association); and (ii) what perhaps brought data manipulation to the forefront was the downward revision of the 2010-11 growth rate of over 4 percent in 2013-14 (the first year of the tenure of the Sharif administration) to under 4 percent that allowed the Finance Minister Ishaq Dar to maintain that growth during the first year of the Sharif administration surpassed the rate during the past six years.
The International Monetary Fund (IMF) in a report titled "unlocking Pakistan's revenue potential" released in August this year concluded that Pakistan's tax revenue is not responsive to growth given "the 5 percent GDP rate and the tax revenue elasticity estimated in the short and long term is slightly over 1 percent (1960 to 2015)". This low elasticity of tax revenue would have been better explained if the Fund had challenged the obviously doctored GDP growth rate itself. In defence of the Fund one must point out that the final review under the completed programme did point out the statistical discrepancy in the fiscal accounts (amounting to 0.7 percent of GDP in 2015/16) which "if reversed could entail pressure on this year's deficit". This no doubt prompted the wily Dar to request technical assistance from the Fund to further strengthen fiscal accounting.
The IMF study further argues that corporate tax and general sales tax have a higher elasticity relative to personal income tax or are more responsive to a higher GDP growth. In this context too the Fund perhaps overlooked one fact notably that the rise in tax collections under these heads was mainly attributable to a rate rise. General sales tax on all products was raised by one percentage point - 16 to 17 percent - that generated additional revenue of around 40 to 50 billion rupees per annum. In addition, the Finance Minister played fast and loose with the rate of tax on some petroleum products - raising it to as high as 33 percent, well above the 17 percent applicable on other items, when the margin between the budgeted and realised tax revenue widened; and lowered it as and when the margin declined. In addition, the rate of customs duty on imports too was raised last year - from 6.5 to 8.6 percent. These measures are hardly reflective of reforms in the tax structure and explain why the IMF report notes that general government debt is around 600 percent of tax revenue and reliance on borrowing (from domestic and external sources) continues to rise during the Sharif administration and that debt service payments remain significantly higher than development spending.
Federal tax collections increased from 1939 billion rupees in 2012-13, to 3104 billion rupees in 2015-16 - a rise of 60.28 percent in just three years. Instead of winning accolades the government has come under considerable criticism for three major reasons. Firstly, the rise in income tax is largely attributable to a rise in reliance on withholding taxes (accounting at present for 75 percent of total direct tax collections). However, while in the West withholding taxes are levied on income, for example on rent and income from shares, which justifies these taxes being labelled as direct, yet in Pakistan increasingly these taxes are imposed on consumer items/services and through making a distinction between filers and non filers. Taxes on consumer items and services are in the sales tax mode and hence should have been placed under the head of indirect taxes; in addition, the distinction between filers and non-filers at first glance would enhance documentation however the middle class, income of between 35,000 to 150,000 rupees per month (whose income tax is cut at source), cannot afford the services of an accountant that are required to file one's tax returns and are therefore paying the non-filer rate when they purchase say a motorbike.
Secondly, the IMF report noted that tax-to-GDP ratio has increased by over 60 percent during the Sharif administration to 12.4 percent however it adds that Pakistan's tax capacity (the maximum tax that can be collected by the government) is 22.3 percent only and tax effort (ratio of actual revenue and tax capacity) is 12.4 percent giving a gap of 10 percent of GDP in 2016. Disturbingly, the report does not mention that around 175 billion rupees higher tax revenue was realised by taking items that were previously under non-tax revenue into 'other taxes'. The reason they were placed under non tax revenue is because these were dedicated taxes for use by a particular sector alone for example Gas Infrastructure Development Cess projected at 145 billion rupees (in last year's budget as well as the current year's) and 35 billion rupees from Natural Gas Development Surcharge. Thus their placement under other taxes should have been pointed out by the Fund.
And finally, the tax collections each year are over-stated on two accounts: first, failure to clear refunds that is having a devastating impact on the country's exports, prompting the government to borrow more to meet its expenditure needs and secondly, through advance tax collections from large tax payers.
The foregoing explains why the twelfth and last mandatory quarterly review of the IMF used the same words as it did at the beginning of the programme notably the need for "fiscal consolidation" and to justify its own verdict of a successful programme completion with respect to the recently concluded 6.64 billion dollar Extended Fund facility the Fund added 'to stay the course'. The need therefore to reform the tax system and render it more equitable, fair and non anomalous and to stop accounting jugglery is not diminished subsequent to the three and a half years of Dar as the country's Finance Minister.