THE government is justifiably ecstatic at the IMF’s, and now Standard & Poor’s and Moody’s, endorsement of its claims of having achieved a fair degree of macro-economic stability reflected in some key indicators. These include a lower budget deficit, a significant decline in the rate of inflation and the State Bank of Pakistan’s foreign exchange reserves crossing $12.5 billion. It hopes that these developments will change investor perception of the overall economic environment, stimulating private-sector investment and thereby economic activity and growth.

There has been little progress by way of long-postponed fundamental policy, institutional and governance reforms. These are not subjected to any serious debate and discussion in official circles. Islamabad also does not appear to be questioning itself on the quality of fiscal adjustment (signified by the budget deficit being reined in), which has been poor and unsustainable.

Neither is it questioning itself over the sustainability of the heavy, if not sole, dependence on additional external debt (some of it at interest rates that will be challenging to service) and one-time unsustainable grants from friends to augment foreign exchange reserve buffers and the deceleration in inflation that has resulted from the dramatic fortuitous fall in the international prices of oil and commodities.

That not much effort has gone into addressing these weaknesses has been highlighted by many analysts, notwithstanding the op-eds by poor apologists from the IMF defending their institution’s bank-rolling of the government’s unsustainable and patently silly measures to contain the fiscal deficit.

The complaints of the formal taxpaying sectors regarding the FBR’s treatment of them are worrying.

As an illustration of this point, what is one to make of the assertion that much success has been attained by way of fiscal discipline when this achievement has come from drastically curtailing the PSDP, not recognising and accounting for the energy sector’s circular debt and other liabilities sitting outside the books and by raising regulatory duties and slapping a hefty increase in GST on diesel? In other words, who knows what the real deficit is?

As regards the much-publicised beginning of the dismantling of the SRO regime, much remains to be done for the more politically difficult reforms. Moreover, what is somewhat amusing is the IMF’s declaration of victory on the commencement of this process. Its demand for withdrawing the SRO-granting powers of the executive in general, and the Federal Board of Revenue in particular, and for restoring parliament’s supremacy on granting tax-related concessions is rather touching.

Its proclaimed views on the subject run contrary to its silence when the same executive and FBR use the same powers to increase tax rates to achieve some magical budget deficit target agreed under the Fund programme. It seemingly does not like the executive granting exemptions but is quite happy, cheering from the sidelines, if new and higher taxes are imposed, no matter how ridiculous and unsustainable these measures may be.

Moreover, it is the same institution which scolds the State Bank if it lends directly to the government, but looks the other way when the bank lends close to Rs1 trillion to commercial banks, assisting them in making money and thereby also defending the lower interest rate that it had announced earlier. The market condition with respect to the level and potential growth in bank deposits would not have been able to support this lower interest rate but for the injection of such astronomical sums by the State Bank.

However, what is more worrying is the litany of complaints of the formal, organised, regular taxpaying sectors on the treatment meted out to them by the FBR. There is widespread disgruntlement regarding what they see as FBR excesses and high-handedness. They are protesting that the FBR has a hostile stance towards them and resorts to predatory taxes through an unending stream of multiple tax notices by different arms of the same agency for similar commercial activities and transactions, unlawful penalties levied by abusing discretionary powers, seizures of bank accounts, etc. All this while tax evaders and the urban informal sector continue to flourish and have a whale of a time.

The build-up of such an environment, even if it is only a perception about the harassment of tax authorities and the formal sector being squeezed, is affecting investor sentiment negatively constraining the expansion of production capacities. This is incentivising the growth of a mindset that is broadcasting the message of a painful lesson learnt, the need to shift from the formal sector — filing and paying taxes regularly — to the informal sector — avoiding registration of new enterprises — an outcome contrary to the objective of official policy.

The debate has also become ideological and political and not just about finding the right instrument. The other related accusation is that while local investors are being handled shabbily by the government foreign investors are being lured by all kinds of assurances and incentives. This has the potential of eroding middle-class support for the government.

In light of the discussion, the rational way forward would be broadening the tax base — partly through higher rates of withholding taxes for non-filers — and nabbing tax evaders using technology, discontinuing the issue of fresh Rs5,000 notes and using information embedded in the documentation systems already in place (eg CNICs in case of property ownerships, transactions in real estate and motor vehicles, etc).

This should be supplemented by legislation making benami transactions illegal, for equitable distribution of the tax burden instead of squeezing existing taxpayers, lowering formal tax rates; and establishing a light-touch tax environment so as not to kill the formal goose that lays the golden eggs. To this end, we need to make processes and institutional mechanisms that are not a source of harassment for existing taxpayers by addressing the unnecessary duplication of data bases and inconsistent legal and other treatments of similar types of taxes and by ensuring that GST on inputs paid by service providers is adjustable against their GST on outputs paid to provincial revenue authorities.

In a slow-growing economy, raising the tax-to-GDP ratio is much more difficult. The growth rate improvement will generate additional tax revenue to fund critical social and economic services which continue to suffer from issues of access and quality. Lest we forget, the key constraint today for resources for increasing government spending is the productive capacity of the economy.

The writer is a former governor of the State Bank of Pakistan.

Published in Dawn, May 26th, 2015

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