Fiscal Policy Of Pakistan 5h2p1x

Fiscal policy: Fiscal policy refers to use of government taxes and its spending to influence the economy. Through this policy government adjusts its spending level and tax rates to monitor the economy. It is formed by federal government (Ministry of Finance). John Maynard Keynes (1883–1946) believed economic performance could be enhanced by adjusting tax rates and government spending. When the government has to take decisions on the goods and services it purchases, distribution of the transfer payments, or collection of taxes, it is likely said to be engaged in fiscal policy. The major roles of fiscal policy are to  improve unemployment rates  control inflation  stabilize business cycles  Influence interest rates in an effort to control the economy

Stances of fiscal policy The three main stances of fiscal policy are described as: 

Neutral fiscal policy is usually undertaken when an economy is in equilibrium. In this situation overall the budget outcome has a neutral effect on the level of economic activity and Government spending is fully funded by tax revenue.

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Expansionary fiscal policy occurs when government spending exceeding tax revenue, and is usually undertaken during recessions.

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Contractionary fiscal policy occurs when government spending is lesser than tax revenue, and is usually undertaken to pay down government debt.

Methods of funding Governments spend money on a wide range of things, from the military to services like education and healthcare, as well as transfer payments such as welfare benefits. This expenditure can be funded through different ways:

 Taxation  Seigniorage, the benefit from printing money  Borrowing money from the public or from abroad  Consumption of fiscal reserves

Fiscal Structure Pakistan’s fiscal system is categorized by a weak tax base and an inequitable tax collection, combined with structural rigidities on the expenditure side. The following points underscore the vulnerability associated with Pakistan’s public finances.  Pakistan’s tax efforts had not attained its targets and remained poor its reflection could be seen in tax-to-GDP ratio that is amongst the lowest in the region. This structural weakness is due to low compliance, widespread exemptions, low coverage, and lack of audit etc that directly s for low tax-to GDP ratio. Despite robust economic growth since 2003, the tax-to-GDP ratio has actually declined to under 9.5%  Manufacturing sector held around 18% share in value addition but tax collection was highest from this sector. While share of agriculture in tax revenues is estimated at only 1.2% being s for 23% of value-addition in the economy. On the other hand Services held 53% in of contribution to total value-addition and it s for approximately 26% of tax revenue. The bulk of tax revenue is collected from industry, particularly from large scale manufacturing, which provides almost 63% of the annual collection.

Sectors

Value addition

Tax revenue

Agriculture

23.3%

1.2%

Services

52.6%

25.6%

Manufacturing

17.6%

61.0%

Other

6.5%

12.2%

Sectoral share in value addition and tax revenue

 Tax-to-GDP ratio fell from 11.1 percent in 2007-08 to 9.3 percent in 2012-13. Provincial tax collection stagnated at around 0.5 percent of GDP. FBR tax-to-GDP ratio actually fell from 10.3 percent in 2007-08 to 8.5 percent in 2012-13. Pakistan yields one of the world’s lowest tax-toGDP ratios (ranks 115th out of 179 countries). The tax istration and structure are planned to be reformed to contribute adjustment to the tune of 0.7 percentage points each year by reforming existing tax system.

 Tax gap is almost half of the actual tax collection. The reforms are aimed at de-politicizing the recruitment, transfer/ postings in the FBR which must be based upon merit.

 The tax department noted that the target for 2012-13 was fixed on the basis of Rs. 1,952 billion to be collected by end of June 2012-13 but actually the collection for the year 2012-13 ended up at Rs. 1,883 billion. Thus, from the beginning of FY 2012-13 the base was eroded by Rs 69 billion.

 Deficit: On average, deficit was 6% of GDP during the decade of 1970s. It was 7.6% of GDP in 1980s. During the year 2001-02, it has again sured 7% of GDP. For the sustainability of deficit several revenue measures were introduced in the successive budgets, along with reduction in development expenditures, however, all in vain. Budget deficit in Pakistan has varied between 5.4 to 8.7% of GDP during last two decades. Now government is trying to cut down the subsidies and struggling for improvement in tax collection process but still it is 5.4% in 2011-12 and is projected at 6.5 % of GDP for end 2012-13.  Public Debt: Pakistan’s public debt stood at Rs. 12,024 billion as of March 31, 2012. During first nine months of current fiscal year, total public debt ed an increase of Rs. 1,315 billion which includes Rs. 391 billion consolidated by the Government into public debt against outstanding previous year’s subsidies related to food and energy sectors. Public debt as a percent of GDP stood at 58.2 percent by end-March 2012. At the end of March 2012, servicing of the public debt stood at Rs.720.3 billion against the budget amount of Rs. 1034.2 billion. A major cause of this increased debt is year by year high deficit.  Reserves:Pakistan’s foreign exchange reserves reached to $ 16.5 billion at the end-April 2012 compared to $ 17.0 billion at end-April 2011. The exchange rate averaged at Rs. 85.50/US$ during July-April 2010-11, whereas it averaged at Rs. 88.55/US$ during JulyApril 2011-12. The Pak Rupee depreciated by 3.4 percent during July-April 2011-12 over the depreciation of 2.2 percent in July-April 2010-11 period.

 Inflation: Inflation has always been the one of major problems of Pakistan. Historically we can examine the trend of inflation, say, during 1973-1980; rate of inflation remained high at an average of 14.3 percent. During 1980s the economy experienced a comparatively moderate rate of inflation averaged at 7.2 percent per annum. But in the 90s it increased again having an average of around 10 percent per annum. In fact, fiscal sector indicators also moved in the same direction during the sub-periods mentioned earlier. Inflation is still in double digits (10.8), even more than target of 9.5%. Another matter to b noticed that, Pak Rupee depreciated by 3.4 percent during July-April 2011-12 over the depreciation of 2.2 percent in July-April 2010-11 period.

Taxation structure and trends Macroeconomic stability depends to a large extent upon fiscal consolidation, particularly in the context of emerging economies. Generating sufficient government revenues for provision of public goods and deg progressive tax structures which address both efficiency and equity considerations are indeed challenging tasks. Our analysis should start with a brief description of how the tax structure has evolved since the early years. The country, with customs duties on imports and exports of cotton and jute as the principal source of revenue started with a tax to GDP ratio of four per cent. By the end of the 1960s, with rapid industrialization, tax to GDP ratio rose to 6.4 per cent, with excise duties as the major revenue source. Income tax, due to tax holidays to promote investment, as well as sales tax taken over from the provincial governments since 1951, did not show buoyancy. It was the decade of excise duties. There was a quantum jump in tax to GDP ratio during the 1970s (14 per cent by 1979-80) mainly due to an increase of four percent of GDP in customs duties as well as phasing out of tax holidays. The period from 1970s-1980s referred as decade of custom duties. Since the early 1990s, tax to GDP ratio has remained stagnant, with decline in the share of customs duties being offset by improved performance of income and sales tax and it was decade of income and sale taxes.

Tax to GDP ratio averaged at 13.2 per cent during the 1990s and at 10.6 per cent during the period 2000– 07. Adjusting for the effect of re-basing of GDP in 2000-01 after a long interval of 20 years, it is evident that tax to GDP ratio has remained broadly unchanged. A comparison with tax revenue levels in developing countries reveals a relatively low level of fiscal effort Countries in a similar income bracket as Pakistan have an average tax to GDP ratio of 20 per cent. The analysis of how major taxes have fared in relation to economic growth depicts that direct tax to GDP ratio has improved from 1.85 in 1989–90 to 3.8 per cent in 2006-07. However, it is still much lower than the developing countries standard of around seven per cent. As a percentage of GDP, indirect taxes as a whole have declined from 12.4 of GDP in 1989-90 to 5.9 in 2006-07, and within indirect taxes, customs duties came down from 5.7 to 1.5 per cent, sales tax moved up from 2.2 to 3.6 per cent, and excise duties declined from 2.2 to 0.8 per cent. The share of direct taxes in total taxes has increased from 18 to 39.4 per cent in 2006-07, while the share of indirect taxes declined from 82 to 60.6 per cent during the same period. Even within indirect taxes, the structure has changed profoundly, with the share of customs duties declining from 45 of total tax collection and 55 per cent of indirect taxes in 1990-91 to 15.6 and 25.8 per cent respectively. The share of sales tax increased sharply from 14.4 to 36.5 per cent of total taxes and from 17.6 to 60.3 per cent of indirect taxes during the same period. Central excise as a tax is being phased out; its share in total taxes and indirect taxes has gone down from 22.5 and 27.5 per cent in 1990-91 to 8.4 and 13.9 per cent respectively during the same period. This represents a structural shift in the composition of taxes on of reforms, which were initiated since the early 1990s and vigorously pursued from 2000 onwards. The base of taxation is rightly moving from trade and investment to income and consumption. However, though the share of income and sales tax has increased, yet the quantum of increase is not so strong as to offset the reduction in customs and excise duties. The incremental tax effort should, therefore, focus on income and sales tax, which would not only enhance the revenue yield but also contribute to a more balanced, equitable and buoyant tax system.

Fiscal policy rules A rule-based fiscal policy has generally been associated with improved fiscal performance and debt sustainability. A prolonged commitment to fiscal discipline may stem from a rule-based fiscal policy.

International experience suggests that countries, which have adopted well-designed fiscal rules and implemented them effectively, have garnered important credibility gains and achieved higher economic growth. Fiscal rules aim to prevent governments from taking short-sighted measures in the light of election cycles and competing demands from special interest groups, by binding policymakers to a fiscally prudent path. Pakistan has experienced serious macroeconomic imbalances in the 1990s mainly on of its fiscal profligacy (budget deficit as percentage of the GDP has averaged almost 7.0 percent per annum), and has accordingly paid a heavy price in of slower economic growth, rising debt burden, and the rise in poverty. A rule-based fiscal framework was prepared in 2002-03 and enshrined in the Fiscal Responsibility and Debt Limitation (FRDL) Act 2005, and was ed by parliament in June 2005.

The purpose of the Act was to inject fiscal discipline in the country. This Act ensures responsible and able fiscal management by all governments, the present and the future, and would encourage informed public debate about fiscal policy. It requires the government to be transparent about its short and long-term fiscal intentions and imposes high standards of fiscal disclosure.

There are five keystones of the law.

1. Firstly, starting from July 2003 (2003-04), Pakistan’s public debt would not be more than 60 percent of the GDP by end June 2013 (2012-13). In other words, Pakistan’s public debt had to be reduced from 75 percent to 60 percent of the GDP in ten years.

2. Every year the government would reduce public debt by at least 2.5 percentage points of the GDP during the ten year period.

3. Revenue deficit would be eliminated by 2007-08 and a surplus would be maintained thereafter.

4. The government would not provide guarantee to the borrowings of the Public Sector Enterprises (PSEs) by more than two percentage points of the GDP in a given year.

5. Social sector and poverty-related expenditures would not be less than 4.5 percent of the GDP for any given year, and the expenditure on education and health would be doubled in of percentage of the GDP in ten years This law binds the government to pursue a sound and disciplined fiscal policy.

From 2003-04 to 2006-07, the law performed very well. Public debt declined from 75 percent to 55 percent of the GDP during the period. However, most of the critical elements of the law have been violated in the last four years. In particular, public debt, instead of declining, has increased to 60 percent of the GDP and revenue deficit continues to prevail. None of the of parliament has ever raised the issue of violation in the House and Pakistan’s economy continues to suffer.

Deficiencies in taxation system : According to the study conducted by The Network to check level of tax compliance in Pakistan, the weak areas in taxation system are:  Taxpayer has trust deficit  lack of tax compliance culture in a society  lack of tax education  lack of effective complaint redress mechanism in tax system

 Malpractices of tax istration.

Policy Recommendations Fiscal Policy Pakistan covers the fiscal deficit by issuing notes and borrowing from private sector. This leads to major problems in the economy. Fiscal deficit can only be reduced by reduction of excessive expenditure by government or increasing the level of government revenue.

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Firstly there is a need of privatization in the economy, as many publically owned enterprises are creating huge losses and these corporations should be privatized. And the process of privatization should be done on merit and it should create perfect competition. Selling the publically owned enterprises will create revenue for the government; this will help government in short run to reduce some amount of fiscal deficit.

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Secondly, it will also halt the amount that government spends to cover the losses of these enterprises. Then there are other benefits of creating perfect competition among the privatized firms through a regulatory body. This will increase efficiency, as in perfect competition greater efficiency leads to higher profits and the firm does not have monopolistic power, so there won’t be any firm which will charge higher price.

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Other policy is to reduce non-developmental expenditure, as it creates demand pressure on the economy. By reducing this non-development expenditure, demand pressure will decrease and increasing the developmental expenditure, more job opportunities can be created. This will increase the employment level in Pakistan and it will create better environment for the private owners to take part in investment. As the economy is suffering from higher unemployment rate, this is will reduce the unemployment rate.

Another aspect of reducing fiscal deficit is to increase the tax revenue. In Pakistan, taxation structure is not performing properly. There is corruption and influence of elites on the system which causes increase in indirect taxes and major revenue is completed through indirect taxes. There is a need to reduce the indirect taxes, as it causes the price level to increase. Reducing indirect taxes will mean reduction of regressive taxation system in Pakistan. There is a need of proper and transparent taxation system in Pakistan which will increase revenue generated from direct taxes. Main tax should on the income of the public, which is considered to be progressive tax. Rich should be taxed more and poor should pay less tax. Wealth tax should be re-introduced in the economy. And landowners in Pakistan are not paying the amount of tax that they should be paying for earning the profits. Landowners should be taxed on the profits it earns from selling the agricultural products in the market. There is a need to make Federal Board of Revenue completely autonomous which will ensure that tax is collected in transparent way.

goverernment should increase the ratio of direct taxes, more taxes from rich and less from poor. There should be proper allocation of these revenues. Sustain trade balance is also key to remove fiscal deficit. Government official like parliamentarians should reduce their expenditure as much as they can. More than 50% revenues utilized on these expenditures and it increase fiscal deficit.

Pakistan continuously relies on foreign and domestic loaning to finance deficit. This will contribute to budget deficit of the country again as $10.3 billion reserved for debt servicing in year 2010-11. Means Pakistan is raising debt to repay debt, while its positive impact on overall economy is not ed. So reliance on foreign financing should be avoided through generating domestic resources Then there should policies to create incentives for greater number of exports from Pakistan. In recent past, exports of Pakistan have increased but not to the same level of imports. Proper policies should be made to increase the level of production by domestic firms and to increase the efficiency of production. Subsidies should be given on importing the machinery for better production rather than taxing the imports. There shouldn’t any tax levied for producing goods for exporting. As the soil of Pakistan is better for agricultural, incentives should be given the increase the production of agricultural products, so that it can be exported to other countries and more revenue can be generated for the economy. Pakistan also requires foreign direct investment to increase its revenues. The multinational companies should be given incentives to increase foreign direct investment in Pakistan by creating a clean and favorable environment. This will bring foreign currency in the country and it can be used to reduce the gap of imbalanced trade. In Pakistan there is a huge need to spend higher amount of money on human capital. Education expenditure has been around 2 or 3 percent of GDP. High investment in human capital can lead to productive and efficient work force which will increase productivity. Minimum expenditure on education should be 5 or 6 percent. There should higher expenditure on secondary or tertiary educational institutes so that Pakistan better work force. And there is a need for increased amount of expenditure on health sector as well, as healthy labor force will in turn give better productivity rate.

Moreover in case of the agriculture reforms, across the rural and urban areas to improve the dreadful malnutrition situation, it is vigorous that the government should move their care to encouraging farming of food crops appropriate to original environments instead of cash collecting and receiving foreign exchange by agricultural trades. It is a need of time to offer the rural poor more access to land and the requisite services to assist them come to be viable farmers, attaining “food sovereignty” will stay an mysterious goal, and the grassroots in our republic will endure to practice hunger, its associated health problems, and various forms of social disturbance.

Suggestions:

The majority of political leaders last year failed to submit any income tax returns despite lecturing citizens on the need to improve revenue collection in a country with a yawning financial deficit.

Fiscal strictness should be imposed by curtailing all unnecessary expenditures of the government. The total expenditure was Rs. 1874 billion in year 2007-08 which has increased to Rs. 3259 billion in 2010-11. This continuous increase in expenditure is unjustifiedat all if we look at miserable performances of the various government departments. Reduction in cabinetsize is the first step towards this. Austerity measures should be adopted by all at all levels. • The study, published by the Centre for Investigative Reporting in Pakistan, found that only 20 of 55 cabinet ministers had filed returns, while 49 senators of 104 paid income tax. militarisation in south Asian states has come at the cost of the health and education sectors. egion's countries spend billions of dollars on arms and ammunition despite 40% of the world's poor living in South Asia.

tax rates on urban immovable property in the main cities of Pakistan are kept low because ownership is concentrated among the elites

The top eight public sector organizations alone incur annual losses of more than 250 billion rupees, an amount higher than Pakistan’s development budget. These loss incurring Public sector enterprises should be privatized or their expenditures should be controlled, except an improved, rationalizedand updatedprogram is launched Economy’s overall growth and development in the form of improvement in GDP growth will definitely leaves positive economic affects. It also helps in reducing the fiscal deficit. Political stability, maintenance of rule of law, transparency, general security etc will encourage domestic and foreign investors. Improved business conditions, solution to the current energy crises are important in improving productivity and growth in the economy

 Change the general perceptions of citizens which are negative to tax culture in society.  There is a strong need to change knowledge aptitude and practices (KAP) of the tax payer to build a sound tax compliance culture in the society.

 Broadening of the tax base was intended to ensure the fair distribution of the tax burden among various sectors of the economy.  There are various segments of Economy, such as Agriculture, wholesalers, distributors and retailers, real estate, stock exchange, etc. which are not contributing towards the tax revenue in proportion to their contribution in Economy. There is a dire need to make necessary corrections in the tax system to have equitable distribution of tax incidence on all sectors of the Economy.  Typically traditional bureaucratic method for raising revenues is to increase the rate of tax and number of taxes which is always counterproductive and leads to tax evasion and makes the tax base shrink.  Wealth Tax was abolished in 2000 under the pressure of powerful who did not want to pay Wealth Tax on their properties and plots, despite of its rates were quite low. It is an important tool of a fiscal policy which endeavors to establish equitable economic justice. Due to rising trend of investment in non-productive sector like properties, it would be advisable to impose Wealth Tax on all immovable properties at a fixed rate to be paid at the time of purchase/transfer.