Fiscal mess - straighten the priorities

Budget-making is in the process. This one is a tough budget to make. Covid-19 demands stimulus; but the fiscal deficit is already too high. The government is asking for no new taxes and demanding stimulus for industries and vulnerable. The government wants higher PSDP spending to generate employment. The IMF has its own tax target and is rightly pushing for managing deficit.
The Ministry of Finance is trying to create a balance to satisfy all the stakeholders. That won't be easy. To-date, six to seven different versions of budget have been drafted, and nothing is finalized yet. The problem is not short-term. It is time to think long-term for a new fiscal normal. The current state of affairs cannot sustain perpetually. The way debt servicing to fiscal revenues is growing, the day is not far when the government would effectively default on its domestic debt.
The government has to raise revenues and cut expenditures. All the stakeholders have to bring hands on the table. The numbers show that it's not possible without military volunteering to join in austerity and revenue generation. Provinces have to contribute too. The federal government alone cannot do much. The debate has to go beyond repercussions of the 18th Amendment and the 7th NFC award.
Any new taxes may not be optimal. Informal sector is not ready to pay. Higher tax incidence on non-filers, barring property, numerous amnesty schemes, and all failed to bring untaxed into the net. Both carrots and sticks are not working. There is an issue in social contract. There is a mistrust between state stakeholders and taxpayers. Additional taxes will further chock the formal sector.
However, that does not mean that the tax burden is too high on the economy. For example, India's economy contributed 17.1% of GDP in taxes last year versus Pakistan's five-year average of 12.1%. But there are economies doing fine at low tax to GDP ratio - such as Bangladesh's (11.4%), Indonesia's (11.5%) and Malaysia's (13.6%).
The catch is in managing deficit. If an economy controls its expenditure, low tax to GDP works. There is literature supporting that low tax burden is good for developing economies to move up the ladder. But for economies having higher expenditure, tax collection must grow.
For example, Indian expenditure to GDP at 24% last year is higher than Pakistan's 21.6%. India's economy has similarities to Pakistan's in terms of higher military spending and inefficiencies in government affairs. But these are compensated by higher taxes.
On the other hand, other economies cited above with low tax to GDP ratios have contained their spending. They do not have hostile borders and public service delivery efficiency is better. If Pakistan wants to operate on that model of low taxes, she will have to forgo government fat and more importantly need to rethink defence spending. Pakistan simply cannot have best of both the worlds.
Some say non-tax revenues have potential. Yes, they do; but there is limit to government selling its assets. That can delay the inevitable; but eventually recurring revenues and expenditures have to be managed. Nonetheless, unlocking government lands can raise good chunk of revenues. For instance, take land of cantonment back and optimally use this and other federal and provincial government lands. These can be leased to private sector for securing regular stream (through rent) or one-offs through outright selling. Plus, the federal government has to get rid of loss-making PSEs and should work on improving dividends from others. For that circular debt has to be resolved. Electricity distribution companies need to be passed on to provinces for better efficiency.
The sustainable way is to increase the tax revenues. Higher taxes are required to meet military expenditure and feed government inefficiencies. Status quo cannot continue. There is some room in bringing untaxed into the net. That can be done by improving tax collection machinery to collect taxes from those who don't pay their due share. Easier said than done. Mistrust is both ways.
The other option is to bring discipline in expenditure. Both Pakistan and India have higher spending on military. Indian military spending in terms of GDP is reduced from 2.7% in 2010 to 2.4% in 2019. On the flip, Pakistan's spending has increased from 2.5% of GDP to 3.0% in the same time. The military pension in Pakistan is in addition to it - pension liabilities are higher than all other federal government general expenditure (including salaries and other running expense).
Having said that, there is a rationale for higher defence spending. Pakistan has a hostile neighbour. Plus, Indian economy's size is 10 times of Pakistan's; but Pakistan cannot have military size one-tenth of India. If as a nation, we want higher spending on defence, then we should pay taxes for that. Anyhow, military needs to rethink to bring efficiency within. One way is to curb non-combat military expenditure. The numbers say that room for austerity is much higher in military than what the federal government can offer.
Some say that higher provinces' share is creating a debt crisis. That is true. The debt servicing significantly increased after the 7th NFC award. But debt servicing is still less than India's - in 2019, India spent 5.6% of GDP on interest payment as against Pakistan's 5.4%. Last year was an exception for Pakistan due to high rates. Debt servicing averaged at 4.4% of GDP in 2015-18.
Higher debt and its servicing do not reduce the provinces' need for social spending. Education, health, environment, agriculture etc are provincial subjects. Over 44% of kids in Pakistan are out of school. Health indictors are no different. Agriculture needs direct subsidies as support price mechanism creates economic rents and distortions.
There is surely a need to improve the service delivery at provincial level; but social spending is ought to increase. It is a collective decision of the nation on where to cut the expenditure. Do we need fat in government and military machinery or should spend on improving social indictors? Do we need to give stimulus to private sector for much-needed economic growth and employment or increase the tax burden on existing payers to further suppress the economy?