Sunday, 7 July 2013

Austerity Pakistan 1: Should Tax/GDP ratio be our top priority?

Austerity Pakistan 1



Should Tax/GDP ratio be our top priority?

Decades of fund involvement has changed the economic narrative permanently in Pakistan. Before IMF involvement we used to talk of growth and investment; now everyone talks only of TAX/GDP ratio as if that will solve all problems of Pakistan. There was a time when national policy not only built institutions for economic growth such as the Planning Commission and governance infrastructure, government also engaged in developing social infrastructure through agencies such as Bureau of National Reconstruction (libraries) and National Film Development corporation.

Now the national conversation seems to be dominated by the IMF requirement of ambitious fiscal targets based on increased tax collection and arbitrary expenditure cuts. Growth, employment and development are almost forgotten subjects. Even development donors such as World Bank, Asian Development Bank, DFID and USAID have nothing for growth and development. Succumbing to IMF pressure, these agencies push only for revenue collection and severe fiscal correction. The little development work that they do is now social protection and some health and education.

We have been bitten by the bug of austerity without realizing it. The whole world has now recognized the harmful effects of the policies of austerity while we continue to follow them. In this series, I will examine the harmful effects of austerity in Pakistan. We should all review these policies and change our narrative from austerity to growth.

Let us begin with an examination of the proposition that there can be no development without increasing our tax/GDP ratio.

  1. It is said that out tax/GDP ratio is 9% of GDP which by international standards is very low. To justify their proposition, they point to selected countries with a higher tax GDP ratio without establishing the basis for a comparison. Are they implying all countries should have the same tax/GDP ratio? But just examine the advanced countries: US 27%, UK 39%, Sweden 46%, and Germany 41%. Does this mean US should increase taxes to 46%? Yet the US wants to lower taxes. Let us face it there is no theory that tells us that all tax/GDP ratios should be the same. Those who use this argument on the media should be reminded of this simple truth.
  2. If we want to compare our tax performance to anyone, perhaps we should go back in history and see how the advanced countries did when they were at our level of development. In 1901 the US and UK had a per-capita income of about $4500 and $3700 respectively. Their tax/GDP ratios were 7% and 10% respectively. Through most of the first world war UK tax GDP ratio remained in the low teens. Pakistan has a per capita income of around $1000; should we really be aiming for OECD tax rates?
  3. Why then has our focus been on tax-GDP ratio for the last few decades and not on growth. What if our tax GDP ratio went up to about 15% would that mean higher growth more employment for people. All over the world people associate a tax-cut as a policy instrument for stimulating growth. Only in Pakistan will a tax increase stimulate growth. For some strange reason investors will invest more, workers will work harder, savers will save more to pay higher taxes. This strange theory prevails only in the minds of media commentators in Pakistan—commentators too lazy to go beyond simplistic donor propositions. This theory belies all received wisdom as well as empirical evidence: taxes take from production not increase it.
  4. There is also another belief that if we get more revenues the government will spend the money wisely and judiciously giving us more public goods like education, health and infrastructure. Let us recall that in 2002 we got a rescheduling which did allow us to generate ample fiscal space to do all these good things. Where did we end up? With a humungous energy deficit, bankrupt PSEs, failing education systems, deteriorating law and order situation. Did we make the societal investments for public goods? NO! Why then do we hold on to the assumption that more revenues will automatically increase welfare through better public good generation.
  5. Another theory that donors love to put forward is that when people pay taxes they have (or will have) more control over governance. The fee-paying theory of revenue is not cognizant of literature. The Sheriff of Nottingham despite continuously increasing taxes gave no representation to people.
  6. This brings us to the heart of the problem. Taxes follow a social contract and a certain need for creating public goods. That is why through history, sovereign's power to tax has been severely curbed through parliaments and popular vote. Kings and governments had to prove a need to tax through identifying clear public welfare programs that the tax was going to finance. This was at the heart of enlightenment thinking. Now it seems we do not need to show what our taxes are used for. Without regard to public welfare we have to give the government more money to reach a target of 15% of GDP without questioning where the target came from.
  7. People everywhere in Pakistan are asking what are my taxes used for? “What are my taxes used for? I get no public service, yet pay high taxes. Why?” is a frequent lament. People are intuitively in line with enlightenment thinking. Surprisingly donor philosophy remains anti enlightenment forcing all Pakistanis to pay more regardless of the quality and quantity of public service. Remember no one claps when the Sheriff of Nottingham raises his tax collection because everyone knows he is collecting for his own welfare.
  8. International observers have benchmarked our poor governance and failed public service delivery mechanisms every which way. Should we hand such a system more revenues? Surprisingly that has become the mantra. What has the system done very well when they had more money in their hands. They engaged in poor quality projects that did not deliver a social return. They also engaged in self-dealing maximizing their own perks, plots and welfare schemes. They created unnecessary and unprofitable public sector enterprises.
  9. When I raise this argument with donors they point to the need to raise taxes to meet with the variety of donor initiatives that they want in the country, ranging from social protection to money-laundering to environment. So we should tax our people more to follow agendas determined in some dark corridor where we had no say.

Growth is about productivity, investment, jobs and opportunity. Educated kids without jobs and opportunity remain unemployed and potentially a destabilizing force in society. I do not understand why serious people think growth will happen with an increase in revenues? It is a spurious argument and we should not take it seriously.

Taxes and revenues should be increased in line with what enlightenment has taught us. Our governance system needs reform to make it responsive to people's needs and to develop its capacity for public service delivery and for public policy. Reform will also remove the mechanisms of rentseeking such as perks and plots and align public servants incentives with public service delivery. When people see a responsive and capable public sector, their willingness to pay will increase.


To me it seems that public service delivery reform must come before revenue collection. Why have we got it wrong?