Much has been written in Pakistan on the merits and demerits of the Reformed General Sales Tax (RGST). The government led by its fourth economic manager Dr Hafeez Sheikh is spending a considerable amount of time and energy defending it and challenging the assertions of those opposed to it.
Few opposed to RGST have, however, been convinced by Dr Sheikh's rationale; instead the government is employing the usual carrot and stick approach to win support from its coalition partners.
The carrot in the form of ERRA chairmanship led to the PML (Q) walking out of the Senate during the recommendatory vote which strengthened the government's hand. Another carrot was offered to the JUI (F) in the form of Chairmanship of the Islamic Ideology Council. However, this did not work as the government rather foolishly and in violation of the constitution, appointed Maulana Sherani not for three years, but 'till further orders'. The stick applied to the ANP through what is alleged as a massive clean-up operation in Karachi worked as the carrot was the promise that all those without charge would be released. The carrot extended to the MQM is not yet ripe enough and negotiations are ongoing between the PPP resident MQM expert Rehman Malik and the MQM stalwarts.
It is not yet clear if the government will succeed in keeping its coalition intact and pass the tax bill in the national assembly as individual politicians of different political parties are giving contradictory signals. As matters stand today the PML (N), MQM and JUI (F) have expressed their commitment to oppose the bill in the Assembly and there are reports that there are many PML (Q) members angered because of the party decision to walk out during the Senate meeting who may also vote against the bill. However, notwithstanding the murky realm of our politics it is relevant to highlight the theoretical merits/demerits of the Value Added Tax (VAT), as well as its positive and negative features in practical terms. The existing GST in Pakistan, it must be noted, is levied in the VAT mode and hence Dr Sheikh's contention that the RGST is not a new tax is just as valid as the argument by those opposed to it stating that widening such a tax to include 700 more items is tantamount to a new tax on these products.
One irrefutable economic fact largely ignored needs to be highlighted: any tax, including a tax on consumption, distorts what would have happened without it. In effect, some one has to pay the price. It could be the buyer who is no longer able to purchase a particular commodity - a buyer who is likely to belong to the lower middle/middle income group rather than the rich. It may be the manufacturer whose sales would decline with obvious repercussions on national output, and employment opportunities. Theoretically though VAT discourages consumption rather than production, or in other words those who purchase more of the taxed commodity would pay more tax. Be that as it may, VAT is considered a superior tax not because it does not distort incentives to invest or save because it does, but because it does so less than other forms of taxes.
Whichever industry/income group loses out with VAT implementation the government will be better off as its tax income would rise. However economic theory argues forcefully that a tax would have merit only if the consequent loss suffered by a sector/group/consumer is more than offset by what the government gains - a gain not evaluated on the basis of a reduction in the budget deficit, as being argued by the Finance Minister, but how productively the enhanced income is used by the government. And this is a source of concern for all, given the range and depth of the financial scandals in this country in the last two years alone, ranging from appointments in state-owned entities of incompetent, unqualified and corrupt people which has already resulted in losses in billions of dollars to the almost routine flouting of public procurement rules to the refusal of the government to tax farm income, which would include three-fourths of the 100 plus Cabinet, including the Prime Minister as well as the income/interest earned on savings banked abroad which would include Dr Sheikh as well as his former boss Musharraf.
The recent comments by Dr Hafeez Sheikh where he reportedly acknowledged the corruption in the Federal Board of Revenue (FBR) merely adds further fuel to the fire of public concern. Dr Sheikh's decision to give low priority to development expenditure, a slash of 50 percent is on the cards for development expenditure post-floods coupled with his inability to reduce government profligacy does not portend well for the increased tax collections subsequent to VAT implementation being used productively. And his statement that he would focus on eliminating corruption in the FBR after the RGST is levied would hardly ease pervasive public concerns. The government is aware that initially revenue from VAT would be lower than expected because it is difficult and costly to administer and collect. And in the case of Pakistan may well provide opportunities to the corruption-ridden FBR to further individual fortunes till such a time as Dr Sheikh turns his attention towards plugging this rather visible sieve.
The Opposition charge is that VAT is inflationary. The government says no, premised on theory, (yes) say its opponents based on local as well as international business patterns. Pakistani businessmen/wholesalers/retailers, like their counterparts in other countries, seize any opportunity to raise prices, and the introduction of VAT certainly offers them an opportunity. To forestall this happening, the government would need to implement temporary price controls to ensure that there is no increase in the cost of living.
Some economists even suggest a reduction in income tax, which would allow take home pay to rise and offset any price increase. Pakistani governments have been unable to control price rises and continue to resist strengthening the Competition Commission of Pakistan due to pressure from vested interests; with respect to reducing income tax as an alternative measure to guarantee the success of the VAT Dr Sheikh has increased its levy on the salaried class as part of his post-flood revenue generating technique.
What has not been debated much in Pakistan is the fact that VAT favours capital-intensive, as opposed to labour-intensive firms, since the ratio of value-added to the selling price is greater for the former. Needless to add, the capital-intensive firms are easily outnumbered by labour-intensive firms in this country.
Dr Sheikh also maintains that the RGST, unlike its parent GST, would be uniform on all products/services taxed, rendering it more equitable. Those opposed to this claim point out several VAT slabs (ranging from two to four) in countries which are implementing this tax. Thus for example cigarettes have a higher VAT rate than other products in most countries.
VAT is being implemented in several countries, developed and developing alike, but as we in Pakistan continue to draw comparisons with the United States and India it is relevant to note their approach to this tax. The US does not impose a VAT, while most states have a sales tax that is charged to the end buyer alone. Nancy Pelosi, the former House Speaker, did state in October of last year that a new national VAT is on the cards to increase federal revenues but a day later the US Treasury Secretary stated that the President did not support a VAT.
India introduced VAT from April Fool's day 2005. Of the 18 states, eight did not introduce VAT. OECD in 2008 quoted Chanchal Kumar Sharma's views on VAT: "political compulsions have led the government to propose an imperfect model of VAT... Although the implementation of the broad-based federal VAT system has been considered as the most desirable consumption tax for India since the early 1990s, such a reform would involve serious problems for the finances of regional governments. In addition, implementing the VAT in India in the context of current economic reforms would have paradoxical dimensions for Indian federalism.
On the one hand economic reforms have led to decentralisation of expenditure responsibilities, which in turn demands more decentralization of revenue raising power if fiscal accountability is to be maintained. On the other hand, implementing VAT (to make India a single integrated market) would lead to revenue losses for the States and reduce their autonomy indicating greater centralisation." These concerns are just as valid in Pakistan and remain a source of concern given the National Finance Commission award as well as the passage of the eighteenth amendment.
I personally oppose the VAT in Pakistan at the present time for many reasons but mainly because I, like the majority of the people of this country, experience a severe trust deficit due to: (i) the divergence between what the government promises in terms of social and physical infrastructure and what it has delivered or the productivity that is likely to be generated by the revenue collected, (ii) the leakages to the system through corruption in the FBR, (iii) the leakages through corruption in state-owned entities that include outright corruption as well as using SOEs as recruitment centers for party loyalists, thereby exacerbating their losses, (iv) failure to reduce current expenditure through either slashing the 100 plus ministers/advisors or delaying the 50 percent pay rise to bureaucrats post-floods, (v) the inability of Pakistani governments to check profiteering that retailer/wholesaler may impose under the garb of VAT, (vi) refusal to tax the net income of rich landlords, and (vi) the refusal to tax those who have savings abroad/work abroad but hold Pakistani passports.