A NUMBER of worrying developments are playing out on the economic front. The government has sounded the retreat on documentation of the economy, and announced amnesty schemes to attract ‘black’ money into the economy — yet again.

By punishing honest taxpayers and rewarding dishonest ones, the government has unwittingly reinforced the incentive for Pakistanis to remain outside the tax net. As in the past, the unintended consequences of this move will be:

1) By introducing tax holidays, it will legally reduce the pool of taxpayers the Federal Board of Revenue can tax, at a time when it is under tremendous pressure to increase tax revenue.

2) It will incentivise taxpayers in the formal economy to ‘informalise’ and avoid the discriminatory costs of a high tax and regulatory burden being imposed on them, while large chunks of the economy operate profitably — and easily — outside the tax net.

The combination of the two unintended consequences will force the FBR to resort to what I have termed ‘predatory taxation’ — which will reinforce the vicious downward spiral on the tax side.

The government’s return to its ‘basic instincts’ of neither taxing the political leadership nor its constituencies will have yet another unintended consequence: it will fuel inflation.

Since 2008, Pakistan has been experiencing high inflation which has been unprecedented in its severity as well as its prolonged duration. Cumulatively, the price level as measured by the GDP deflator has risen 104pc compounded in the past six years, with food prices having risen 130pc.

This is the most sustained increase in prices in Pakistan’s history. Inflation of this magnitude for such a period of time, leading to sluggish or negative real growth in wages, has adverse consequences for large parts of the population and has imposed substantial economic as well as social costs. These costs have been summarised in an excellent article recently by Dr Muhammad Yaqub, the former governor of the State Bank of Pakistan.

Despite the devastating consequences of high inflation in Pakistan, successive governments in Islamabad have failed to understand — or even tried to comprehend, as evidenced by the PML-N’s lame excuses for the spurt in prices in the recent debate in the National Assembly — the nature of inflation and its sources.

Inflation is a complex interplay of a number of external, institutional, structural and policy variables. Nonetheless, one predominant factor is excessive money creation, caused by the failure to collect taxes combined with a failure to rein in government spending.

As pointed out by Dr Yaqub, and repeatedly by the State Bank over the past many years, it is no coincidence that the longest period of high inflation in Pakistan has coincided with one of the weakest fiscal performances in Pakistan’s history.

Since 2008, the fiscal deficit has averaged 7.2pc of GDP each year. Tax collection as a percentage of GDP has averaged a paltry 9pc, sinking to 8.2pc in 2012-13. In one of the poorest performances in the country’s recent history, tax collection increased by around 3pc last year — less than half of inflation — with the FBR managing to ‘capture’ only 30pc of nominal GDP growth.

To be fair, however, with a rampant, and now growing, SRO culture, the failure to collect taxes should be laid less at the doorstep of the FBR than its political masters — first in the PPP government, and now its successor PML-N set-up.

As a direct result of the failure to collect needed tax revenue — that too in the form of direct income tax rather than via indirect taxes that burden the poor — the government has borrowed a mammoth Rs6,880 billion domestically. A large part of this is from the State Bank, with the central bank ‘printing’ a mountain of cash for the government’s deficit financing during this period.

The ‘money’ channel to inflation works in a number of ways. These include the following:

• The phenomenon of too-much-money-chasing-too-few-goods;

• By leading to speculation in commodities when the central bank resorts to a policy of ‘easy money’ and artificially low interest rates (usually negative in real terms);

• By the de-basing of the exchange rate via an expansion of the monetary base;

The weakness of the rupee adds significantly to inflationary pressure in the economy since it affects the price of petroleum products, among other imported inputs. The price of furnace oil determines the generation cost of electricity, and a combination of international prices and rupee depreciation puts upward pressure on tariffs.

The price of diesel impacts transportation costs, which is a key component of food prices. It is not surprising, therefore, that the prices of non-perishable food commodities, which are generally transported over longer distances, have risen more than those of perishable ones in the past few years.

Another important channel by which the weak fiscal performance of the government transmits directly into inflationary pressure in the economy is via the taxation of petroleum products. As seen recently, the government failed to pass on a sharp fall in international oil prices to domestic consumers simply because it was earning ‘windfall’ revenues.

Higher inflation for 180 million Pakistanis appears to be an acceptable trade-off for the government as long as its key constituencies, traders and businesses, are spared taxation.

However, despite the fiscal and monetary underpinning to inflation, there are other factors at work that are not insignificant. These shall be explored in a future article.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.