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Wanted: A Solid Tax Base in Pakistan

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Wanted: A Solid Tax Base in Pakistan

The new government must confront an old problem.

Wanted: A Solid Tax Base in Pakistan
Credit: Facebook/Imran Khan Official

While Pakistan has a new government under Imran Khan, but it also has the same old currency and balance of payments crises that will take more than a changing of the political guard to fix.

The populist premier started off his tenure promising to root out corruption and trim government spending. Unless he pursues deeper structural changes, however, Khan won’t have any more luck than his successors in extricating Pakistan from its addiction to foreign loans and its interminable cycle of economic crisis.

The new prime minister’s starting hand is not an enviable one. The Pakistani government is struggling to come to grips with plunging foreign exchange reserves. Pakistan currently has only $9.9 billion in foreign reserves on hand, not enough to cover even two months’ worth of imports.

Coming into office, Khan’s first decision centered on whether to turn to the International Monetary Fund (IMF) or the Chinese government for emergency relief to stave off a default. Chinese-backed “Belt and Road” infrastructure projects are, of course, a major reason Pakistan has a balance of payments crisis in the first place. It now appears Islamabad is leaning towards its 13th IMF bailout in the past four decades and has invited an IMF team to visit before the end of September.

That assistance will bring with it austerity measures, which almost certainly means Khan’s campaign promise of Islamic welfare state will fall by the wayside for the time being.

As the Pakistani public is well aware of by now, crisis interventions by outside donors are no more than a stopgap solution to what has become a chronic problem: Pakistan, for all intents and purposes, does not have a tax base. Only about 1 percent of the population pays income tax. According to an IMF working paper authored by Serhan Cevik in 2016, Pakistan had a “tax revenue gap” equivalent to 10 percent of national GDP (or roughly $28 billion in 2016) and could potentially double its tax revenue-to-GDP ratio.

While not even high-income countries manage to collect the full total of their potential tax revenues, the paper pointed out that Pakistan’s collection rate falls “significantly below” even countries of comparable circumstances. Not much has changed in the last two years. Pakistan’s Federal Board of Revenue confessed this past June that it would miss its original revenue collection target for the 2017-2018 fiscal year by 162 billion rupees ($1.32 billion).

Until it builds an adequate tax base, Pakistan’s fiscal stability will continue to rely on outside donors. In other words: there won’t be any fiscal stability.

Fortunately, Khan’s government is well aware that it needs to get itself on sounder financial footing. The new prime minister, holding true to the populist tone of his campaign, has called for the rich to start paying taxes and said the country will begin an austerity drive to reduce debt. He started off that campaign by selling his office’s fleet of bulletproof cars and forsaking the prime minister’s residence to instead live in a small three-bedroom house with only two servants, as opposed to the 524 normally assigned to a sitting premier. He also vowed to introduce a package of reforms to enhance tax collection and broaden the tax base.

What kinds of reforms could help Islamabad get its financial house in order? One important step would be to get Khan’s fellow political and business elites, who are notorious for tax dodging, to follow his more positive example. In 2011, journalist Umar Cheema found 70 percent of Pakistan’s parliamentarians failed to file income tax returns. Cheema’s reporting spurred transparency-minded reforms that cut into this percentage, but the country has also repeatedly resorted to amnesty schemes to make up some of the shortfalls. The most recent such program came earlier this year.

Another key approach is to appeal to the 7.6 million Pakistanis working or studying abroad, whom Imran Khan has seized upon as a major potential source of outside funds even beyond the billions in remittances they send back home. Khan said in his post-election speech that “Our greatest asset is our overseas Pakistanis. We will invite them into the country and we will give them an opportunity to invest here.” He is not exaggerating. Remittances are Pakistan’s second-largest source of foreign currency after exports. In July alone, overseas Pakistani workers sent $1.9 billion in remittances to family and friends back home.

Other ideas – such as higher taxes on cigarettes – illustrate how the government can kill multiple birds with one stone. Pakistan’s Health Ministry supports raising tobacco taxes to reduce smoking rates. Even though smoking and its complications kill 108,000 Pakistanis each year, the Pakistani finance division made the bizarre decision to effectively cut tax rates on tobacco products last year — though it has since realized its mistake. Just this week, a Senate commission demanded a report from the Federal Board of Revenue (FBR) on those lost revenues.

Pakistan’s Senate has also pushed for a tracking system to fight the illicit tobacco trade, responsible for billions lost in tax revenue. Pakistan formally ratified the WHO’s Protocol to Eliminate Illicit Trade in Tobacco Products in June and is required to implement a “track and trace” program that combats the illegal tobacco trade. While disagreement over the government’s standards for companies bidding to create an electronic tracking system has delayed implementation, tobacco tax evasion costs the government hundreds of millions of dollars a year.

All of these solutions are just parts of a much larger puzzle, but they represent one of several options available for raising revenue. Pakistan will need to pursue a range of measures simultaneously to dig itself out of its perennial hole. Many of these measures, including cracking down on tax evasion and illegal tobacco products, can be accomplished more easily by the use of innovative new technologies. The most important ingredient, however, will be diligent and forward-thinking policymaking.

Anthony Kleven is an economic risk consultant. The views expressed here are his own.