Reforming Pakistan’s Tax System for Economic Growth

Taxation policy and economic growth has a long-standing connection, according to GDSI Managing Director Pauric Brophy.

Economic growth is driven by an assortment of economic, institutional, political, and social factors. Taxation is one of the few public policy areas that can produce a direct and immediate effect on the economic, institutional, and political landscape of a country and taxation is proven to be one of the most important influencers of social behaviour.

Pakistan has a population of approximately 200 million people, less than 1% of whom are registered to pay income tax. Since independence from British rule in 1947 the country has undergone cycles of civilian and military leadership, which have been accompanied by unstable economic and taxation policies. In 2018 Imran Khan’s Tehreek-e-Insaf party (PTI) took office with a manifesto to prioritise job creation, to reform tax collection systems and to bring an end to Government corruption. Since their election, the party has devalued the rupee, imposed new taxes, and sought a $6bn bailout from the International Monetary Fund (IMF), its 13th IMF bailout since 1980.

In late 2019, the World Bank pledged $400 million to Pakistan Raises Revenue (PRR) ‘to create a sustainable increase in Pakistan’s domestic tax revenue’. (DFID) has also taken a long-term interest in supporting tax reforms in Pakistan, with a series of initiatives designed to support the Federal Board of Revenue (FBR) in the country. “Creating fiscal space through revenue mobilization is critical to reduce the country’s budget deficit, enabling the people of Pakistan to benefit from better public investments and services,” said Illango Patchamuthu, World Bank Country Director for Pakistan.

Pakistan has adapted several tax reform policies such as broadening the tax base by including the agriculture sector, reducing exemptions, and revising property valuations. Additionally, the country has made efforts to improve its tax collection policies by enforcing and incentivising compliance through accelerated appeals and refunds. According to the UN, Pakistan’s inflation remains extremely vulnerable to fuel price fluctuations and weather conditions, as is the case for most countries in the region. Pakistan faces a fiscal and balance of payments crisis as GDP growth for 2020 was forecast at 2 per cent prior to the global pandemic. However, while existing challenges such as fuel price fluctuations and weather conditions continue to face Pakistan, the effects of the COVID-19 pandemic and the consequent global financial crisis deeply threatens its efforts to promote economic growth.

The economic challenges facing Pakistan can be explained by many complex factors. These same factors can also help to explain Pakistan’s weakness in collecting tax revenue. Institutional weaknesses in the tax collection system, a narrow tax base, a large informal economy, poor enforcement mechanisms and a reticence to take policy decisions for fear of social destabilisation are all factors that can explain both poor economic performance and poor tax collection capacity in Pakistan.

Given the direct impact that it can have on the economic health of a nation, it is surprising in some respects that greater donor attention has not been given to tax policy. In the case of Pakistan, however, much interesting work in the tax area has been funded by DFID and the World Bank. Leading Pakistani and international experts have been providing high quality advice on the legal, institutional, and public relations aspects of tax reform. Some of this advice has focused on some complex institutional aspects of tax reform such as the motivations and performance of tax inspectors. Others have focused more directly on removing anomalies and loopholes in the tax code.

Overall, this experience has shown that the greatest short-term impact can be achieved in those cases where the reform does not require large adjustments in institutional capacity or culture. In this context, a steady program of incremental reforms is more likely to gain political and civil acceptance than high profile, paradigm-shifting proposals that promise transformational improvements in tax collection performance.

In practice, this is likely to require a long-term effort to digitise the tax affairs of the nation (especially in the area of tax collection), better use of digital information, a gradual targeting of specific economic sectors that are remaining in the informal economy despite being profitable, a gradual adjustment of the tax code so as to ensure that the system is seen to be progressive and fair and a greater effort to inform the public about the way that taxes are being spent for public good.

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