PAKISTAN’S overall fiscal deficit has been brought down from 5.4 per cent of GDP in 1999-00 to 3.3 per cent of GDP in 2003-04. It is considered to be an outcome of “prudent fiscal policy.” While Pakistan’s fiscal policy juggled the pressures on it to reduce import taxes and substitute them with sales and direct taxes, the equity of the taxation structure may have been further eroded.

With an inability to tax agricultural incomes directly and to ensure tax compliance by all, the taxation structure remains both horizontally and vertically inequitous to begin with. To increase sales tax is to make the taxation structure more regressive and thereby more inequitous. Since comparisons are usually made by policy makers with other countries and regions, a closer look might be in order.

In 2003, India’s deficit as a percentage of GDP was higher at -4.3 per cent. Its revenue as a percentage of GDP at 11.6 per cent was lower than Pakistan’s at 14.6 per cent in 2003. Even though India’s expenditure as a percentage of GDP was also lower than Pakistan’s, India’s deficit-to-GDP ratio was higher. In 2003, India’s total debt as a percentage of GDP was 64.5 per cent and was lower than Pakistan’s at 74.7 per cent in the same year. However, India’s interest payment as a percentage of its revenues was 37.1 per cent. This was higher than Pakistan’s at 33.9 per cent in 2003.

So, India’s large economy is nowhere near the 17 per cent tax-to-GDP ratio claimed to be the average for developing countries (in Pakistan Economy Survey 2003-04) that Pakistan must also achieve somehow irrespective of the progressivity or otherwise of the taxation structure and irrespective of the tax incidence.

While tax-to-GDP ratio must certainly go up and people must pay their taxes, the issue of who bears how much of the taxation burden remains crucial to building a socio-economically just society. Earning kudos for having the tax-to-GDP ratio jacked up by burdening the existing tax payers more and more is neither fair nor would it make a reduced fiscal deficit sustainable. A crucial variable left out of the sustainability calculations for fiscal deficit is the people’s perception vis-à-vis horizontal and vertical tax equity.

Against the same backdrop of emphasis on higher tax-to-GDP ratios regardless, it is said that the tax-to-GDP ratio of industrialized countries is 30 per cent. It is worrisome when it is stated thus in Pakistan Economic Survey lest some might begin to believe that a higher tax-to-GDP ratio will mean that we are industrialized. For, converse may not be true. That is, an industrial country may have a high tax-to-GDP ratio but a high tax-to-GDP ratio may not necessarily mean that a country is industrialized merely by jacking up this ratio.

The USA had a revenue-to-GDP ratio of only 17.4 per cent in 2003. And, while UK had a revenue-to-GDP ratio of 36 per cent, both USA and UK had deficit-to-GDP ratios of -3.7 per cent each. So, fiscal deficit reduction is not a mere function of tax-to-GDP but also of expenditures-to-GDP. Canada with a 20.0 per cent revenue-to-GDP ratio in 2003 showed a surplus of 1.4 per cent of GDP in the same year. And, Greece with a 46.5 per cent revenue-to-GDP ratio in 2003 had a deficit-to-GDP ratio of -1.1 in the same year. Singapore, on the other hand, had a 4.8 percent surplus-to-GDP ratio in 2003 with only 22.2 per cent revenue-to-GDP ratio in the same year.

The upshot of the above review ought to be that instead of benchmarking other countries’ tax-to-GDP ratios and deficit-to-GDP ratios in isolation since a causal relationship between these two variables is difficult to establish as other factors are not constant in real life, one needs to determine what the same should be for own country in the interest of a combination of efficiency and equity.

What is a good tax-to-GDP ratio for one country may not be the same for another country as is seen above which is why regional averages may carry little meaning, if at all. Averages for various parts of the world only help us in defending some of our tough decisions for existing tax payers when true guidance requires a holistic view of fiscal policy criteria in other countries that is not done yet. It is, therefore, important to ascertain the factors and forces that drive our fiscal decisions.

Since Pakistan came under IFIs’ pressure to liberalize, the share of custom duty in total tax revenues has been brought down from 45 per cent of total tax revenues in 1990-91 to 17.1 per cent in 2003-04. This loss in tax revenue was then compensated partly by increase in sales tax whose share of total tax revenue went up from 14.4 per cent in 1990-91 to 33.7 per cent in 1999-00 to 42.8 per cent in 2003-04.

While Pakistan’s taxes on goods and services as a percentage of total revenue were 32 per cent in 2003, comparable figures for India were 33 per cent, UK’s at 32 per cent, Canada’s at 17 per cent,, Germany’s at 22 per cent, Malaysia’s at 21 per cent, and USA’s only 4 per cent in the same year. This shows that there is no one benchmark that needs to be attained in terms of sales tax-to-revenue ratio. For, this ratio varies from country to country even within the same part of the world.

Sales tax-to-revenue ratio cannot even be linked to direct tax-to-revenue ratio. For, while both USA and Canada enjoyed a direct taxes-to-total revenue ratio at slightly above 50 per cent in 2003, Canada’s taxes on goods and services were 17 per cent of total revenues compared to only 4 per cent for the USA in the same year. And, Germany’s taxes on goods and services were 22 per cent of total revenue in 2003 which were comparable to Malaysia’s 21 per cent in the same year.

However, the share of direct taxes as a percentage of total revenue was as high as 47 per cent in 2003 for Malaysia as compared to only 16 per cent for Germany in the same year. And, while Pakistan may justify its 32 per cent taxes on goods and services in 2003 on the basis of India’s at 33 per cent in the same year, India’s direct taxes were 33 per cent of total revenues in 2003 compared to Pakistan’s at 19 per cent in the same year.

So, would Pakistan try to squeeze its existing tax payers more to increase its direct taxes or would it increase its sales tax more to compensate for lower direct taxes? And, if such decisions are driven by what the ratios are for other countries, then India’s taxes on international trade as a percentage of total revenue at 15 per cent in 2003 must be noted as compared to Pakistan’s at 9 per cent in the same year. This shows that India did not lower trade barriers as fast as Pakistan did even though India’s direct taxes contribute a significant share to total revenues.

So, what got us in trouble to begin with was a very rapid reduction in custom duties from 45 per cent of total tax revenue in 1990-91 to 17.8 per cent in 1999-00. Since then, this share has fluctuated after dropping to its lowest at 11.8 per cent in 2001-02 and going back up to 17.1 per cent by 2003-04.

At the same time, while the share of sales tax increased steadily, that of direct taxes as a percentage of total tax revenue after increasing to 35.8 per cent in 1998-99 decreased to 31.8 per cent in 2000-01, then increased to 35.3 per cent in 2001-02 following which it dropped back to 31.6 per cent in 2003-04 virtually showing the limits to which existing tax paying segments can be squeezed further.

The share of direct taxes and customs duties almost appear to have moved in sync since 1999-00 showing the ability to which each can be stretched further. The decision to drop the proposal of further duty reduction to 20 per from 25 per cent (Dawn, 5-5-05) appears to be in order.

The proposals that are being considered, however, include completely abolishing the central excise that contributed 8.6 per cent to total tax revenue in 2003-04, corporate tax cuts, and relief to salaried classes.

Since custom duties are not to go up any more, it is the sales tax that will be enforced further. Since sales tax is regressive, it will disproportionately burden the lower income groups. And, since it is a tax on consumption, one wonders if it will increase savings in our society that is not only conspicuously consumptive but where consumption is facilitated by credit schemes without which a lot of industrial wheels will not be easy to turn.

Unless all segments of the economy including agriculture are taxed directly, the taxation structure will remain inequitous thereby making tax compliance that much more difficult as people will not only resent and thereby try to evade their tax burden but will also view greater reliance on regressive sales tax as unjust.

Due to the above limits on taxation, the tax-to-GDP ratio actually declined from 11.5 per cent in 2002-03 to 11.0 per cent in 2003-04. With defence-to-GDP ratio pretty much the same at 3.3 per cent, it was reduction primarily in interest payments that contributed significantly to overall fiscal deficit reduction by 0.4 percentage points to 3.3 per cent of GDP in 2003-04. Interest payments declined from 5.6 per cent of GDP in 2001-02 to 3.7 per cent in 2003-04. In Pakistan Economic Survey 2003-04, it is admitted candidly that this can be attributed to a sharp decline in interest rates and prudent debt management.

While reliance on external financing was reduced to Rs14.4 billion in 2003-04 from Rs113 billion in 2002-03, reliance on domestic financing went up from Rs67.6 billion in 2002-03 to Rs163 billion in 2003-04.

While real interest payments will remain a function of interest rates, inflation rate, and exchange rates; how much more can sources of financing be juggled with to keep expenditures and thereby fiscal deficits low? It is productive capacity and distributive justice that need to be enhanced if budgets are to graduate beyond a mere paper exercise!