International Development CommitteeWritten evidence submitted by Dr Ehtisham Ahmad
Issues
Why is the tax/GDP ratio so low?
Implications of the low tax collections.
Role of DfID and governance conditions.
Links with the electoral process.
Why is the tax/GDP ratio so low and falling?
From 14% of GDP in mid-1980s to 9% of GDP today.
vs 17% in India and 19% in China for general government.
Unable to provide MDGs with less than 17% of GDP.
Some long-standing issues:
Government Of India Act of 1935; split bases (incomes, sales) between Center and States.
Opened up scope for “game play”, and created vested interests.
Weak and corrupt administrations.
Qamar-ul Islam, Tax Reform Commission 1985—cannot fix tax policy without fixing corrupt tax administration.
Mid-1980s: goal was to go from 14% tax/GDP ratio to 20%.
Attempt to implement efficient trade policies
High tariff barriers; and administrative regulations.
Spawned 60-year old inefficient “infant” industries.
1990s reform strategy to encourage efficiency by reducing tariffs and replacing by VAT/GST.
But the politicians were related to the owners of the infant industries…
Also recipient of financing for elections and more direct support for corrupt politicians.
Not interested in an efficient tax system and level playing field—Indian reforms of the 1990s not replicated in Pakistan.
Failure of the GST (another name for VAT!)
GST introduced in 1991 under duress, and implemented as a ‘production excise’—with “apacity prices”(that affect firm profits rather than being passed on to consumers); compensated by exemptions.
Both exemptions in GST, and capacity provisions, were to be removed (June 1994 structural benchmark, under 1993 ESAF;--incorrectly reported as being met; and again under 2008 IMF Program for end-2009—reported met, but again some economy with the truth).
Acceleration of export-promotion strategy under Musharraf, led to gutting the VAT (domestic zero-rating of all major sectors in 2003; suspension of audit—neither DFID nor World Bank objected).
Tax/GDP ratio declined to under 10% by 2008.
Proliferation of SROs—Statutory Regulation Orders, issued by FBR, overriding Parliament and legislation: designed to make friends and influence people.
Egregious SRO283/April 1, 2011—had 185 items; and catch all #185 that gave blanket authorization to issue SROs—leading to collapse of 2008 IMF program.
Tax administration reform, correctly supported by DFID
Tax Administration Reform Project (TARP) $135m co-financed by DFID.
Designed to implement “Shahid Husain Report” (2001)—functional administration using information from various sources.
Poorly supervised by World Bank Bank/DFID.
Did not follow the Shahid Husain report (reinventing the wheel).
Nobody noticed that audit had been suspended in 2004.
IT was in-house to automate existing procedures and processes; vs off-the-shelf.
Project termed “non-performing” by Bank in February 2008.
Functional administration had not even been initiated until 2009, with another DFID project.
But that too was half hearted and failed.
Tax reforms under 2008 IMF Program
Proposed by Zardari to Friends of Pakistan in NY, September 2009.
Formed basis for IMF program without conditions.
Arms length administration and removal of SRO powers (required under 2008 IMF program under the reformed VAT) strongly opposed by members of the administration and FBR staff.
Failure due to the interests of the administration to continue “making friends and influencing people”.
Habitual problem with IMF programs since 1991
Extent of rent seeking among high and mighty.
2011: 67% Parliamentarians and the President did not file tax returns (CDPI 2012) although average wealth of Parliamentarians was Rs 85 m (2009, approx $ 1 m)—President much richer.
Recent support by DFID/Bank to FBR attempt to expand the base by using 3rd Party information—but this excluded the Parliamentarians, and other powerful groups.
Critical exemptions: Agricultural incomes; foreign source income (suitcases full of $ flown to Dubai brought back through banking system --#111(4) 2001 Income tax ordinance—effective money laundering provision); plethora of SROs.
Plus amnesty—designed to “appease” well-to-do taxpayers.
What’s surprising is that any tax is collected at all—other than withholdings of salaried income.
Effects of the low tax collections—Basic facts
Need tax/GDP ratio of around 17–18% to meet MDGs.
Weakened state with nuclear weapons in dangerous neighbourhood.
Cannot run a diverse country of 180m with tax/GDP ratio of 9% and declining…
Imploding public services as well as law and order.
Nobel prize winner North’s “limited access society”—rent seeking to exclusion of masses becomes unstable.
Financing through borrowing from banking system imposes a tax on the poor, and crowds out investment and growth.
Does decentralization help?
National Finance Commission 2009—brought up provincial share of federal revenue pool from 50% to 58% on the assumption that the VAT reform would lead to a tax/GDP ratio of 15% by 2013.
To meet spending pressures at the provincial level.
But gap between expectations and reality: 3.7% of GDP today.
18th Amendment: All social spending devolved to provinces.
Now largely unfunded mandates.
Collapse of higher education—returned to centre but unable to take it up again.
Similar story on wide-area health care—polio epidemic.
Decline in public service delivery a fundamental cause of increasing discontent, polarization and turning to alternate/radical sources of welfare and justice.
Substantial weakening of the role of the state.
Role of DFID and governance issues—As seen in previous session on education…
Many programs well designed and delivered.
Makes a point vis a vis “best practice”, especially at micro level.
Rush to please government in office..
Rush to laud Musharraf decentralization to districts.
No more than a ruse to by-pass the political parties and national elections.
Why no objection to TARP until February 2008, when Musharraf was significantly weakened?
Why no protest when audit was suspended in 2004? Major sectors taken out of GST net (no objection from DFID, nor from IM,F nor from WB)?
Why the rush to support new initiatives like the tax amnesty? Clientelistic BISP designed to ensure re-election of Mr. Zardari?
Think of Mubarak and the Shah….if not Musharraf.
Preoccupation with “fads”
Better governance agenda: transparency in the sources and uses of government monies.
DFID Single-minded focus on MTEFs (not bad per se).
to the exclusion of proper classification and monitoring system (no idea about functional heads—education or health for general government—despite another $135 m World Bank project PIFRA/GFMIS).
No Treasury Single Account—at the time of the approach to the IMF in 2008, there were $10 bn in government bank accounts in commercial banks!! This number has grown.
Same story in Mubarak’s Egypt: same causes, effects to be seen!!
Inability to track the sources and uses of funds.
facilitates rent seeking and “unauthorized” spending.
including the use of development funds for the “re-election” of the party—or to build roads and power supplies to the PM’s home town (ie, making hay while the sun shines)!!
What could DFID do better?
Broad governance issues, decide on best practice.
albeit keeping Pakistani reality in mind; and
Institutional forms do not reflect what is really happening!!
Key governance issues important
stop cheating at all levels; and
both in generating revenues, as well as use of funds.
Insistence on the key policy and institutional measures—verified by independent bodies.
Do not back off from tax reforms.
Do not back off from tax reforms!!
Not in the interest of UK taxpayers.
Certainly not in the interest of the Pakistani masses.
Insist on proper conditionality in IMF programs.
Focus DFID-supported research in this area.
Links with election process
Important to keep to the electoral cycle.
Demands that tax cheats not be allowed to run seem reasonable.
Strong press and excellent work by the CPDI may well influence outcomes for the better.
If there is an issue-led campaign, people will turn out to vote without being “paid”.
February 2013