“Believing things which we know to be untrue, and then, when we are finally proven wrong, impudently twisting the facts so as to show that we were right.”
– George Orwell.
IMF thumbs-up, some feel-good reports (a recent one by Daniel Runde) and government’s usual rhetoric aside, the fact remains that the economy for most Pakistanis is not performing. What the recent budget should have done was to set the stage in the country for growth along with social equity. Clearly this has not happened. As national competitiveness and subsequently manufacturing falters, jobs are fast evaporating in a demography where urbanisation is taking place at an extremely fast pace (to reach 50% by year 2050) and where nearly 200,000 jobs are required annually to accommodate a young population attaining employable age each successive year. Given such a situation, for any thinking and caring government the most important aspects of its economy ought to be a real move towards comprehensive social support for the public at large and shoring up of its home industry to spur job creation. And no one argues this better than the Cambridge economist, Amartya Sen, by stressing in his various works on South Asia that whereas “poverty can be partially alleviated through relief; but it can ‘only’ be eliminated through creation of jobs and equitable growth in economies such as of India and Pakistan.” The problem though, often seen, is that economic managers invariably forget that growth is not merely a statistic and it actually needs to be flesh and blood if it is to truly mean anything other than a few extra numerals in an economic report. If there are no jobs and if there are no opportunities for talent, the economy is only the crackle of a paper tiger – Our leadership also seems to be falling in this very trap. For Pakistan’s progress to be meaningful it has to primarily accommodate public welfare, both by facilitating the domestic private investment in industry to generate mass employment and by prioritising state’s revenue towards health, education, basic amenities and small housing over fancy infrastructure showboat projects.
Instead, we witness a false sense of optimism being promoted by the government quarters on the state of the Pakistan economy, which if not checked can have larger long-term negative implications. First, complacency can set in and the much awaited economic reforms, necessary to correct the underlying malaise of the economy, will once again be put on the back burner. Second, once the present geo-strategic cum military need of Pakistan tapers off (as has invariably happened in the past) and when this low commodity price cycle begins to reverse, we will yet again find ourselves at point zero, confronted by our age old problems of poverty, inequity and unemployment. More to the present, this illusion unnecessarily raises expectations on exaggeratedly enhanced revenue generation by the government. As it is, today the whole tax collection drive by the government is rather poorly crafted and causing more pain than joy for all stakeholders. The fact of the matter is that while every successive Pakistani government keeps on moaning about the low tax to GDP ratio, the taxpayers on the other hand keep reminding their leaders on the need for serious reforms in our tax system in order to seek meaningful progress in tax collection. It is only natural and to be expected that people go to a great length to avoid paying tax or rather staying out of the ‘tax-net’.
One popular trick in the Middle Ages was to become a monk; these days, shell companies in the Caribbean are a more common retreat in the West and in an environment like ours a simple avoidance to become a part of the documented sector is considered to be the best option! Point being that it is really up to governments to create an environment and a culture that induces people to pay their fair share of taxes. For example, the value added-added tax allows firms to deduct tax paid on inputs from their sales-tax bill, in effect performing a duty on behalf of the government to police their respective suppliers; in return they and not the evaders face the brunt in shape of coercive audits and penalties; now who would want to be a part of it? And then this whole meaningless business of first collecting a tax and then refunding it to the exporters where invariably the government collects less and pays more! Why not make it zero-rated as in the past? Last but not least, in taxation, the government’s undue emphasis has been on indirect taxation instead of endeavouring to broaden the tax base. The General Sales Tax (GST) is the main vehicle of indirect taxation being used at home. The share of sales tax in our overall tax collection was recorded at 44% in FY14, overriding the share of direct taxation, which stood at 39% in FY14. Currently charged at 17%, the rate is too high when compared with both neighbours and competitors; only Turkey has a higher rate at 18%. However, in Turkey there exists a reduced rate of VAT (Value Added Tax) of 8% and 1% on essential items including foodstuffs, textile products, etc. In fact these very focused cum sector-specific measures have been mainly instrumental in Turkey’s attainment of a tax to GDP ratio of 20.38%, which is almost double that of Pakistan at 10.93%. It is interesting to note that Taiwan and Thailand charge only 5% and 7% sales tax and have tax to GDP of 12% and 16% respectively. Also, Malaysia that charges sales tax at 10% has tax to GDP ratio of 16.10%, and this despite applying a reduced sales tax rate of 5% on essential food items.
Clearly Pakistan needs to dwell on the taxation models of these comparable nations in order to improve its taxation strategy. Also, some promising new research in behavioural economics can give the government yet another tool for boosting tax payment: the psychological nudge. Economists have long understood that psychology matters in tax systems. Studies repeatedly find that tax gaps are much smaller than one would predict given the rarity of audits and the benefits of underpayment. Many taxpayers are motivated by more than just pecuniary concerns. Feelings of patriotism and civic duty ease the pain of paying tax (or dodging them less attractive). Guilt, or the perceived moral cost of violating social norms, also seems to enter the equation. A recent working paper from ‘America’s National Bureau of Economics Research’, documents experiments conducted by economists from Imperial College in London and University of Chicago, with the British government, and explains how a government chooses to spend the tax it collects, plays heavily on the emotions of the taxpayers. The less return the taxpayers feel they are getting for their money, the more likely they are to avoid paying. Also, if taxpayers discover that the government’s priorities are more out of step with their preferences than they had previously believed, collections may fall. Rings a bell?
Lastly, to our mounting debt: Post 2008 Euro-zone experience tells us alarming stories on hardships that high borrowings can bring about on people of an indebted country with the main lesson of the global financial crisis being about how poorly planned borrowings and more so, poorly planned spending of those borrowed funds, can render even developed and emerging economies virtually bankrupt. More importantly, it has rekindled the debate on a longstanding conundrum of economics: when is a country bankrupt? At what point are government debts simply too great to bear? Unlike for companies, there is no clean answer for countries. From Adam Smith (in his Wealth of Nations) to modern day Kenneth Rogoff (in his This Time is Different), economists are unanimous on the point that there are likely to be “multiple equilibria” points for dangerous debt levels. In the canonical model, if a country’s fundamentals are sufficiently strong, it is at no risk of debt crisis, and if the fundamentals are sufficiently weak, it is almost certain to happen. And this, ‘weak fundamentals’, is precisely where we also need to be careful. Economic Growth – the simplest solution to excessive debts – cannot be conjured up by magic, and often proves stubbornly elusive when it is needed most. And no one knows this better than the Turks. Back in the 2000s, it was only through concentrating on the ‘basics of the economy’ by their then Economic/Finance Minister; Kemal Dervis that Ankara was able to pull back from the brink. The sooner we also realise this Economics-101 lesson, the better!
The writer is an entrepreneur and economic analyst.
Economy: Looming Challenges | Dr Kamal Monnoo