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Fiscal priorities

April 05, 2013

WHAT can the caretaker administration do to bring much-needed sanity to the fiscal framework?

With a backdrop of a record budget deficit of around 10 per cent of GDP staring us in the face, the near-collapse of the energy sector as well as of most public-sector enterprises (PSEs), the more-than-doubling of public debt, and the Federal Board of Revenue (FBR) struggling to prevent a meltdown in tax collection, the situation on the public finances front is far grimmer than most people realise.

It is clear that nothing short of deep institutional as well as structural reform is required to correct, where and to the extent possible, the damage done to Pakistan’s economy and finances by successive governments in the recent past. These reform moves would include restructuring the FBR, setting up a permanent tax reforms commission to unify and bring coherence to the tax effort of the centre and the provinces, restructuring the size and performance incentives of government, improving governance of the energy sector, providing a framework for the restructuring of PSEs etc.

Such a sweeping reconstruction of Pakistan’s economy is beyond the scope of the caretaker government. With its limited mandate — and fast-disappearing tenure, especially for a yet-to-be-nominated finance minister — is there any balm that can be applied in the caretaker’s triage?

Mindful of what can and cannot be done by an interim government, I would suggest the following priorities with regard to the economy for the next 36 days: 1. Kill the proposed tax amnesty scheme: Given the developing urgency on the revenue front, and the FBR’s rising desperation, the caretaker government may be convinced into approving a notoriously bad idea. I intend to write separately on why the FBR’s proposed scheme can be a “near-fatal” blow to Pakistan’s tax collection effort, but many of the country’s best tax and legal minds have already made their views known. Broadly, the arguments against the tax amnesty are as follows: — It “institutionalises” moral hazard i.e. it will encourage behaviour it seeks to avoid.

By raising the white flag of surrender to tax defaulters and delinquents — even with the incredible “goldmine” in its possession in the form of data from the National Database Registration Authority on 3.2 million elite citizens with affluent lifestyles who are not on the tax register — the FBR is reinforcing the perception of a lack of credibility and ability on its part to collect taxes from those who choose to stay outside the tax net.

Amnesties of this nature work best when the threat of subsequent enforcement action is credible. If this is the state of the FBR that there are 3.2 million people outside the tax net operating under its nose, so to speak, that it has identified with addresses, name of spouse(s) and children, bank account details etc., but cannot send a tax notice to and is instead forced to offer a blanket amnesty at the rate of a paltry Rs40,000, why should anyone take it seriously?

And that too when it is unclear if a “business-friendly” elected government may choose to soften, or do away with completely, the penal terms for non-compliance that the FBR has placed in the amnesty proposal.

The FBR’s priorities are misplaced. It should seek to meaningfully and credibly improve its processes, procedures and personnel to enhance tax revenue in a sustainable manner.

— Amnesties have been tried many times before, with no success Starting with Dr Mahbub ul Haq’s somewhat twisted efforts in the 1980s to “whiten” black money through the issuance of bearer bonds, to previous six or seven tax amnesty schemes since the 1990s, Pakistan’s tax problem has grown rather than been resolved. The size of Pakistan’s thriving informal economy and the continued abysmal tax-GDP ratio are testimony to the disastrous failure of short-term gimmickry replacing a serious reform effort.

The supposed trade-off between approving the amnesty scheme or levying additional taxes is a false one. The choice before the FBR is to get its act together — and bring non-payers whose details it possesses into the tax net.

2. Book the “losses”: An equally important priority should be to recognise (in the accounting sense) the fiscal and quasi-fiscal costs of the actions taken by the previous government over and above the budget approved by parliament. This would be important for at least two reasons.

One, it will give the incoming government a clear sense of how much it has to “provide for” in subsequent budgets for recapitalisation costs, or for power-sector subsidies, for example. My guesstimate is that these un-booked fiscal and quasi-fiscal costs are substantial, quite possibly in the range of 3pc to 5pc of GDP. As I have noted previously, the exact magnitude can only be unearthed by professional forensic accounting.

Second, it will provide, to an extent, some much-needed operating space to the incoming government by establishing a base-line of the fiscal situation it inherited. This exercise will have greater credibility if conducted by a non-political interim set-up.

Since the caretaker government cannot prepare next year’s budget, as it is not in its remit to establish the fiscal envelope or the expenditure and tax priorities of the next government, or negotiate with the IMF or institute any wide-ranging economic reform, its focus will perforce have to be on fiscal housekeeping — and on stopping a bad piece of legislation in its tracks. If it can achieve these somewhat modest tasks in the stipulated time, it should credit itself with a job well done.

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