THE failure to manage the much talked about fiscal consolidation — a key to ensuring macro-economic stability — has eventually forced the ministry of finance to take up the issue of taxing incomes in agricultural and services sectors to tide over growing financial difficulties.

Interestingly, the issue has been raised at a time when the new elected government is about to be set up both in the centre and the provinces. It is perhaps for the first time that tax on agriculture income has been “proposed” by the ministry of finance despite the fact that this is a provincial levy and cannot be made a federal subject. Earlier, the officials had been talking about the importance of taxing farm incomes privately but never raised the issue on record..

Both the agriculture and the services sectors are under-taxed though they together account for over three-quarters of the GDP. The provinces collect less than Rs1 billion from tax on farm incomes while agriculture has a share of about 22-23 per cent in national income. The lion’s share of the overall tax revenue is contributed by the consumer followed by the manufacturing sector. The taxation system is too narrowly based and high rates of indirect taxes are a burden on the consumers.

About a year ago, Chairman, Federal Board of Revenue Abdullah Yousuf gave a presentation to President Musharraf, seeking authority to levy tax on farm incomes. The president agreed to the proposal, but no action was taken. Eventually the president succumbed to the pressure of the landed gentry of former ruling party PML (Q) to postpone the move .

But a new official report — Fiscal Policy Statement 2007-08 — finalised by the Debt Policy Coordination Office (DPCO) ministry of finance on January 31, 2008 calls for expanding taxation gradually into the agricultural and services sectors for bringing better yields, and reducing tax evasion.

It may be recalled that former Prime Minister Zulfiquar Ali Bhutto had federalised tax collection on farm income with the proviso that the tax receipts would be deposited directly to the account of the province from which these revenues are raised. This was a departure from the arrangements prescribed for the National Finance Commission Award, where tax receipts go to the national exchequer and are distributed among the provinces on the basis of population.

The report of the ministry of finance warns that a loose fiscal policy can lead to higher inflation, higher interest rates and crowding out of private investment, all of which can hamper growth and poverty reduction efforts.

As private sector savings are often low in developing countries, a sound fiscal policy can play a central role in mobilising resources by raising revenue and reducing less productive spending.

“We must increase our revenues without hurting the growth momentum. It is the government’s intention to undertake major tax reforms to improve the tax-to-GDP ratio, expand tax-payer base, increase tax compliance and make tax administration more efficient”, it said.

While referring to tax on agricultural income, it also says that government should move to a taxation system that is based on moderate rates and wider base through rationalisation of exemptions. Despite recent reforms, it concedes, that tax effort remained modest owing to the failure to address various structural problems.

The report reveals some important structural shifts in patterns of revenue and expenditure. On the revenue side, it says, that the tax-to-GDP or revenue-to-GDP ratio exhibits a secular decline over the last one and half decade. On the expenditure side, total expenditure and its components also exhibit a secular decline as percentage of GDP.

The improvement in revenue side should not be limited to federal government alone. The provincial governments will have to do much more to enhance the provincial tax-to-GDP ratio from the current stagnant level of 0.5 per cent to at least 1.0 per cent of GDP in the medium-term.

The report said that the government should make continuous efforts to widen the tax base, reduce exemptions, provide incentives and concession wherever required, reduce multiplicity of tax rates, lower tax rates, shift the incidence of tax burden from production to consumption, move away from the excessive reliance on manufacturing and taxing all value-additions including services. It should overcome the culture of tax avoidance and evasion and establish effective and efficient tax system.

The official report is unsure whether the government could achieve its four per cent GDP fiscal deficit target (Rs399 billion) set for 2007-08. The government projected a revenue surplus of Rs98 billion or just less than one per cent of GDP. The primary balance for the year is projected to be the deficit by Rs39 billion or 0.3 per cent of the GDP. The latest trends indicate that the fiscal deficit may be close to six per cent this year.

Development expenditure has been budgeted at Rs546.5 billion or 5.5 per cent of GDP for the year 2007-08.”Operational shortfall in development expenditure is anticipated at Rs50 billion. Therefore, development expenditure is targeted at Rs496 billion or five per cent of the GDP”, the report said.

The total expenditure at the end of the first quarter of the current fiscal year stood at Rs470.8 billion or 4.7 per cent of GDP. Current expenditure amounted to a total of Rs340 billion or 3.4 per cent of GDP. The two sub-components of current expenditure i.e. interest payments and defence spending amounted to 1.1 per cent and 0.6 per cent of GDP respectively. Development spending from July-September 2007 amounted to Rs129.9 billion or 1.3 per cent of GDP.

The consolidated public expenditure jumped sharply due to strong increase in both current and development expenditure. The exceptional 89.5 per cent year-on-Year (YoY) increase in the development spending should be partially encouraging as it translates into an improvement in the country’s infrastructure and human capital resources.

Defence expenditures saw a surge of 26.3 per cent in the first quarter of 2007-08. This perhaps reflects greater engagement of armed forces to maintain the law and order situation in parts of NWFP and tribal areas. Health and education expenditures witnessed a welcome increase of 24.1 per cent and 34.8 per cent respectively. Also, the impact of large subsidies extended to various sectors, such as fertilisers (DAP), food (wheat) and energy (particularly diesel) contributed to a rise in current expenditure, the report said.