SUSTAINABLE economic performance is not possible without a strong domestic revenue base. Pakistan can no longer afford to ignore this fact, and will have to increase its tax revenue to support the development needs of its growing economy.

That was precisely the message the two-day conference on ‘Tax Policy Options’ for Pakistan held in Lahore sought to convey to all the stakeholders.

International Monetary Fund (IMF) Middle East Department director Masood Ahmed told the conference that Pakistan’s tax revenue performance was pretty near bottom by any international comparison.

Pakistan’s tax to GDP ratio declined to 9.6 per cent last fiscal, from around 13 per cent in the 1990s and the preceding decade. This is in spite of tax administration and policy reforms carried out in the past few years and an average GDP growth of around seven per cent in the five years to 2007.

Dr Hafiz Pasha blamed slackening of fiscal effort, falling tax rates, and exemptions for the poor revenue mobilisation. “In the same period India’s tax to GDP ratio increased by three per cent to 17 per cent.”

Other economies with comparable level of development to Pakistan mobilise tax revenues upto 18 per cent -- some up to 25 per cent of GDP.

Shaukat Tarin, the prime minister’s advisor on finance, blamed the low domestic revenue mobilisation for much of the current economic morass.

“It isn’t too difficult to establish that much of what is wrong with the economy essentially emanates from this low tax effort,” he underlined in his address.

For instance, he said, the perennial problem of fiscal deficit is a reflection of this deficiency. “The consequent accumulation of public debt and distortion it causes in the credit market by crowding out private investment eventually retards growth,” he noted.

The poor tax effort pervades the whole economic landscape and no reform effort to put the economy right, could succeed without putting the public finances on sound foundations.

“The high fiscal deficits are also the source for current account deficit of balance of payments and have a role in weakening the country’s external balance,” Tarin said.

Also, its weak resource base keeps the state from investing in the development of key social and infrastructure services to meet the requirements of a growing economy.

“The periodic economic instability and crises (as experienced by Pakistan) are the consequence of a weak domestic tax revenue base. The price of these crises is paid by the entire society,” noted Ahmed.

The government raised GST rate by one per cent to 16 per cent, increased excise duty on some services and levied regulatory duty on some luxury items by enhancing minimum tariff to 35 per cent in a bid to push revenue collection as a percentage of GDP.

But now the tax target of Rs1.25 trillion for 2009, up by 24 per cent from last year, appears difficult to achieve because of global and domestic economic slowdown. This is despite the 24 per cent growth in the tax revenue collection in the first five months of the current fiscal to November.

The IMF balance-of-payments support programme requires the government to raise the tax revenue target for the year to Rs1.36 trillion. But the government says it would revise the target up or down only after analysing December tax collection numbers. Dr Pasha said Pakistan had missed the opportunity of enhancing tax revenue as percentage of GDP during high growth years and is now facing the daunting task at a time when the domestic and global demand has been slipping.

Organised by the Federal Board of Revenue (FBR), the conference’s main objective was to identify tax policy and administrative framework to enhance domestic resource mobilisation in the context of the government’s tax reforms agenda.

The meeting was expected to help the government minimise the impact of economic slowdown on tax collection and lay down parameters and guidelines for sustainable increase in the tax base and enhance revenue generation according to the country’s potential on long-term basis.

The recent 23-month $7.6 billion balance-of-payments support extended by the IMF last month requires Islamabad to raise its tax to GDP ratio to 15 per cent over the next 5-7 years. Quite a formidable task, indeed.

“Resource mobilisation for development remains one of the most daunting challenges as we embark on a journey to revive the economy,” Tarin acknowledged.

But Ahmed believed if other countries could, then Pakistan should also be able to improve its tax to GDP ratio.

“Jordan pushed the ratio six per cent, Egypt by three per cent and the Philippines by two per cent in three years. Pakistan can also pull this off but it would have to restructure the tax regime as well to broaden the tax base. This also demands political commitment and ownership to go beyond reports and implement reforms,” observed Ahmed who said Pakistan’s long-term economic stability hinged on its ability to increase tax revenues.

Pakistan’s recent history shows that it had spent a lot of money to improve the tax policy regime and administration without gaining much from the effort. Also, a campaign launched to document the economy in the beginning of 2000s had to be given up because of political considerations.

Though the government was required under the previous IMF’s Poverty Reduction Growth Facility 2001-04 to enhance tax to GDP ratio to 14.3 per cent from 10.5 per cent, the government ended up with a reduced ratio of 10.3 per cent at the end of the programme. Thus, the objective of the institution of an equitable, broad-based, simpler and transparent tax system remains unrealised.

As Tarin said we need a broad-based tax system, which is administrated properly and is devised in a manner to encourage each and every Pakistani to share the burden.

A series of policy reversals, pointed out the advisor, had neutralised many gains of the effort undertaken in the recent past to modernise tax policy and reform tax administration along modern lines.

The country, therefore, continues to suffer from a very narrow base of fewer than two million taxpayers. This situation has forced the government to resort to higher tax rates and maintain a plethora of withholding and presumptive taxes that continue to burden the existing taxpayers.

Moreover, the exemptions estimated to be in the range of Rs300 to Rs500 billion, are eroding the small tax revenue base. The multiplicity of federal and provincial taxes also encourages evasion.

The situation, Tarin said, is complicated by the encouragement of a liberal trade regime, which saw tariffs being dismantled to their lowest possible and subsidies given to one set of industry or consumers at the expense of another taxpayer.

The dominance of indirect taxes, 62 per cent of total tax revenue or six per cent of GDP compared to direct taxes forming four per cent of GDP, in our total tax collection further makes the entire regime more inequitable, opaque, rigid, inefficient and investment unfriendly.

Any improvements in these areas will be useless unless the tax machinery is made responsive to the country’s revenue needs and the taxpayers’ sensitivities.

The advisor promised to eliminate subsidies as well as tax exemptions in order to make the tax regime equitable, just and transparent.

“We should basically have two taxes, income tax and consumption tax in value added mode, to simplify the tax regime and increase direct taxation. All presumptive taxes and withholding tax should go,” he said.

He said the government will tax all income no matter what its source. “Income is income, without regard to its origin,” he said, implying the government planned to tax agriculture, real estate, stock market, professionals and others whose income still remains outside the net.

But he didn’t give a timeframe for that. Many hope that some measures in this regard would be initiated in the next budget.

But the question still remains: will the tax policy and administration reforms pay off? If they didn’t in the past it does not mean they will not in the future. But to ensure the success of reforms and encourage a tax culture in the country the government will have to take drastic measures to curtail its non-productive spending.

Unless it controls and scales down its current expenditure, already doubled in last seven years, and diverts maximum resources to public development projects, it will not be able to convince people to pay taxes no matter how equitable and simple the tax regime is.