PAKISTAN’S national poet, Muhammad Iqbal, believed the subcontinent’s Muslims needed to unite if they were to prosper. Without a strong sense of nationhood, he wrote, “mountains become straw and are blown away in the wind”.
Poetry and taxes do not often mix. But those melancholy lines grace an analysis of Pakistan’s fiscal plight by Ehtisham Ahmad of the London School of Economics. The country’s tax revenues have collapsed. Its debt is almost certainly unsustainable without outside help. And yet Pakistan does not pull together. “Textile lobbies, the urban gentry, traders and agriculturists, all point to the other and say: Tax that group first, but do not tax me,” Mr Ahmad writes.
The tax authorities can identify a mere 768,000 individuals who paid income tax last year. Even fewer—just 270,000—have paid something in each of the past three years. That is one reason why Pakistan’s tax revenues amounted to only 9.1% of GDP in the latest fiscal year, one of the lowest ratios in the world (see chart). These are exceedingly narrow shoulders on which to rest a nuclear-armed state of 180m people. The culture of cheating starts at the top. Most members of parliament, many of them conspicuously affluent, do not file tax returns.
In the months before an election, due by May, the government of President Asif Zardari of the Pakistan Peoples Party (PPP) is proposing a controversial remedy: an amnesty for evaders. They will be invited to wipe the slate clean with a one-off payment of only 40,000 rupees ($400). The government says it is a quick way to resuscitate the public finances and expand the tax net. Its critics see the amnesty as a boon for politically connected crooks.
The scheme is the brainchild of Pakistan’s tax chief, Ali Hakeem, head of the Federal Board of Revenue (FBR) since July. His computer boffins have spent the past few months trawling data—not to find out how much people earn, but rather to unearth their spending patterns and lifestyles. The FBR has come up with 1,700 variables that predict a person’s tax liability. Some clues are obvious, such as foreign travel, owning a house in a posh neighbourhood and big-ticket purchases such as cars. Others are ingenious. It turns out that having a weapons licence is an excellent indicator of wealth. The FBR’s analysis also shows that married men are richer than single men. Men with two wives are richer still. However, men with four wives (the maximum allowed to Muslims in Pakistan) are often poorer than those who have only one.
Many people escape paying taxes by simply bribing the tax inspectors who call on them, Mr Hakeem admits. “We want the computers to be the enforcers,” he says. The exercise has identified around 3m people who should be paying tax. Under the plan, these people will be served notice and given 75 days to comply or they will face punishment.
But if the FBR can identify the dodgers, why can it not pursue them for the full amount they owe? The tax board says it wants to use its new data fast, before a possible change of government jeopardises the scheme. There is no time to calculate the evaders’ full liabilities.
Mr Hakeem believes the system is so rotten that, in effect, it offers an amnesty to almost everyone anyway. But cynics worry that the oily businessmen and back-room fixers who have prospered over the past four years of PPP government will use the scheme to legitimise their ill-gotten gains. It is “a way of laundering your money”, says Hafeez Pasha, a former finance minister.
Amnesties, which have failed in Pakistan in the past, create perverse incentives. They alienate taxpayers otherwise disposed to being honest, who may decide to stop filing and wait for the next such offer. At best, the amnesty will bring in another 0.5% of GDP in revenue, Mr Ahmad suggests. At worst, revenues may fall.
Both Mr Pasha and Mr Ahmad argue that more fundamental reform is required. Many people fail to pay taxes because they are not legally obliged to do so. Agriculture is exempt from federal income tax, largely because parliamentarians are either large landowners or dependent on rural votes.
Mr Hakeem’s board has the power to exempt products through regulatory orders without the approval of parliament. One such order, dated April Fool’s Day, 2011, made a mockery of the country’s sales tax, imposing a 0% rate on 184 items, including carpets, buttons and the willow wood from which cricket bats are made—as well as “any other goods as may be specified”. Mr Hakeem’s number-crunching may help plug some leaks in Pakistan’s tax bucket. But his board has already poked hundreds of legal holes in it.
Pakistan promised to abolish loopholes in 2008 as one of the conditions for a generous IMF loan of $11.5 billion. Yet it failed to do so. It also promised to remove the tax board’s discretionary power to create loopholes. But punching holes in the tax code is a handy way to “win friends and influence people”, Mr Ahmad says.
A low tax take breeds problems. People who might otherwise pay their taxes wonder what services they will get in return. Federal revenues are swallowed up by debt servicing, defence spending and power subsidies, with no room for much-needed spending on health, education or welfare. A constitutional amendment passed in 2010 gave the provinces clearer responsibility for such programmes. But the provinces lack a reliable tax base of their own. In the latest fiscal year, Pakistan spared only 0.3% of GDP for health.
Despite such miserliness, Pakistan’s budget deficit still exceeded 8% of GDP last year. The government has bridged the gap by borrowing from the central bank and the banking system (which itself borrows heavily from the central bank). This has crowded out private borrowing and ushered in inflation, projected by the IMF to return to double-digit rates by the middle of next year.
Fundamental tax reform will always upset one powerful constituency or another, whether it be the landed gentry, farmers, traders or industrialists. Without reform Pakistan courts economic disaster, a financial crisis that might blow the precarious economy away like straw. That would upset everybody. But Pakistan’s ruling elites assume that such a crisis will always be averted with help from international donors. And, says Mr Ahmad, “they are probably right.”
Courtesy: The Economist