CAN taxation accelerate poverty? The answer is yes, though the orchestrated claims about the purpose of taxation are diagonally opposite. The truth is that what taxation may ultimately lead to depends on the taxation structure, tax incentives that encourage economic expansion on stable bases and, finally, welfare-oriented productive use of tax revenue. Governments that err in these areas, especially in spending tax revenue, accelerate rather than contain poverty.

During the 1990s, Pakistan registered modest growth. Yet, poverty kept rising. No one realized that, given its flawed fiscal policy, the state was gobbling up the bulk of the GDP growth. Worse still, the federal government kept siphoning off provincial taxes into the NFC pool which was, by far, the cardinal policy error. Obtaining a fair share from the NFC is now the provinces’ biggest dilemma. Rising poverty is therefore blamed squarely on the federal government.

Expecting politicians to legislate on taxation measures that can channel the benefits of growth to filter down to the poorest classes may be overoptimistic. That this reality continues to bedevil Pakistan (in spite of the GDP rise registered during 2002-04) was pinpointed by Kunio Senga, ADB Director General, who voiced his concerns about government’s inability to channel the benefits of the increased wealth (that this growth represented) down to low income groups. One major indicator thereof was the failure to stimulate job-oriented sectors – a view also shared by WB’s Praful Patel.

What Patel and Senga overlook is that agriculture sector that elects an over-whelming majority of legislators remains the least taxed while city-dwellers, businesses and industry continue to be lumbered with evermore direct and indirect taxes.

Late Dr Mahboob-ul-Haq had to pay dearly for his cardinal sin of trying to levy a tax on agricultural income. His fate discouraged change seekers among the policy-makers, and Pakistan’s taxation structure remained flawed. Pakistan now enjoys an odd distinction: direct taxes make the lowest contribution (27 per cent) to tax revenue; bulk of it (68 per cent) comes from indirect taxes including GST, CED, Import Duty, municipal levies, etc. All essential goods and services provided by state enterprises (fossil fuels, natural gas, transport, civic services, electricity) include surcharges that are, in effect, indirect taxes. With them added on, the share of indirect taxes rises to a staggering 76 per cent of the tax revenue.

Indirect taxes and surcharges are a short-cut to accelerating poverty because low income groups end up spending bulk of their incomes on paying them while for those placed in higher income brackets these levies form progressively lower proportions of income.

According to SPDC, the richest 10 per cent pay less than 10 per cent of their incomes in indirect taxes but these taxes account for over 16 per cent of the incomes of the poorest 10 per cent, which is an enormous proportion of the income of the low paid.

Recent studies reveal that the lowest income bracket has drifted down to Rs1,800 to 2,200 per month – well below government estimated per capital income of $630. The impact of rising inflation (finally accepted by the government) will further reduce real incomes of 32 per cent of Pakistan’s population living below poverty line. It will accelerate poverty dramatically unless the tax structure is rationalized by reducing indirect taxes.

Pakistan’s energy prices are among the highest in the region, courtesy the surcharges. Given the escalating oil price, the surcharges (built-in as a percentage of fuel import price) will steadily erode industry competitiveness. SBP too has finally recommended to the government that tax on agriculture should replace the surcharges included in fuel prices.

Resort to indirect taxation was the easy option; it facilitated tax collection at source without caring about who bore how much of its impact. For decades, CBR’s, World Bank and IMF-backed policy remained focused on cutting fiscal deficit ignoring the developing negative trends and the need for change in the taxation structure to ameliorate the sufferings of nearly a third of Pakistan’s population.

That this policy is flawed has been proved by the experience of EU states. None of them (especially Germany and France – its strongest members) believes any longer that fiscal deficits be contained at the expense of accelerating poverty (via unemployment). But successive Pakistani governments couldn’t convince WB and IMF about the need for living with higher fiscal deficits for a while to bridge the yawning gaps in social services.

Steadily, these gaps pushed more Pakistanis below the poverty line. Governments also failed to highlight to WB and IMF the contradiction in simultaneously containing fiscal deficit and lowering trade barriers because it meant cutting down on vitally needed development expenditure, pushed up unemployment and aggravated the law and order situation that eventually made Pakistan a basket case in the context of security.

Meanwhile, increasing revenue through direct taxes that involved hard choices in expanding the taxpayer base, devising fair taxation bases and organizing a credible collection system remained on the backburner. In fact, corporate income tax was lowered during a period when sector profitability grew substantially spurred by low borrowing costs whose impact was borne by millions of small savers. Corporations did not pass the benefit back by lowering product prices.

This is not to belittle recent CBR efforts but they aren’t enough because the taxpayer base remains below one per cent of the population. Mind boggling speculation in real estate, stocks, precious metals, commodities, food grain, and even automobiles, points to enormous un-taxed wealth and the potential for generating revenue there from. Either CBR can’t (although most Pakistanis can) see this or is unwittingly siding with the rich and the powerful. Neither perception strengthens the image of the CBR.

News that duty on imported cars is being cut shows how wrong CBR can be. What the common man wants is cheap and efficient public transport – overhead or surface railway – in cities that are bursting at the seams due to enormous migration from rural areas.

Productive use of tax revenue can induce honest tax payment. Taxpayers detest solutions that favour one class at the expense of another; they want lasting solutions to inadequacies in health, education, transport, electricity, water and sewerage, lower judiciary and policing — systems that went from bad to worse killing the incentive for paying taxes. This vicious circle, that keeps fiscal deficits high, must be broken to finally break the begging bowl.

For visible improvement, the logical route would be local governments because, unlike federal or provincial governments, the taxpayer can access them and hold them accountable.

Reforming the system requires a fresh mindset (not the one entrenched in CBR for decades). It would involve an enormous though not impossible effort to clear the backlog accumulated over decades of stereotyped fiscal budgeting that prioritized collecting taxes, not the productive use thereof. Besides reforming the flawed taxation structure, the ceremonial accountability of tax revenue spenders by the CBR also needs thorough revamping.