Public Finance (MPA405)

Dr. Khurrum S. Mughal

Fiscal and Monetary Policy

Economic Survey of Pakistan 2013-14

• Public debt stock reached at Rs.15,534 billion at the end of March, 2014, representing an increase of Rs.1,168 billion or 8 percent higher with that of last fiscal year.

• The primary source of increase in public debt during first nine months of current fiscal year was domestic debt that stood at Rs.10,823 billion representing an increase of 14 percent over end June 2013.

2. Public Debt

• External debt posed at Rs. 4,711 billion by end March, 2014, representing a decrease of Rs.138 billion as compared to end June 2013. This decline in external debt during first nine months of current fiscal year is mainly attributed to net repayments and appreciation of Pak Rupee against US Dollar.

• Government took following measures to effectively manage its public debt during first nine months of current fiscal year:

Cont…

1. Developed its first Medium Term Debt Management Strategy (2014-18) to take informed financing decisions based on the evaluation of cost-risk tradeoffs.

2. Trading of government debt instruments was launched to broaden the investor base

and have a liquid government securities market.

Cont…

3. Pakistan successfully tapped international capital markets after a gap of 7 years and raised US$ 2 billion against the initial expectations of US$ 500 million. This transaction represented the largest ever international bond offering for Pakistan.

4. With increased external inflows, the government was able to reduce the pressure on domestic resources while strengthening the foreign exchange reserves vis-à-vis improving exchange rate parity which also contributed towards reduction in public external debt.

Cont…

• Public debt servicing was Rs.1,155 billion during July-March, 2013-14, against the annual target of Rs.1,561 billion, thereby, consumed nearly 47 percent of total revenues. .

Cont…

• Long standing structural issues posed multiple challenges for monetary management in Pakistan, however, current fiscal year witnessed significant improvement on account of contained government borrowings, increase in foreign exchange reserves and improvement in credit to private sector.

• Moreover, entering into 3-year arrangement under the Extended Fund Facility (EFF) with IMF, successful launch of Pakistan Sovereign Bonds worth $ 2.0 billion and auction of 3G/4G license during 2013-14, are major developments, which will further support the financial and external sector.

3. Money and Credit

• During the first half of current fiscal year, SBP reversed its policy stance from accommodative to tight policy to contained inflation to single digit, as the rate was increased by cumulative 100 bps, staggered in two stages of 50 bps each.

• However, SBP adopted a cautious stance by maintaining the policy rate at 10.0 percent in latest monetary policy announced on 16th May, 2014, keeping in view the risks of inflationary pressures.

• Broad Money (M2) witnessed an expansion of 7.3 percent during July-9th May, 2013-14, against the growth of 10.3 percent in the comparable period last year.

Cont…

• Net Foreign Assets improved and reached to Rs. 236.9 billion during July-9th May, 2013-14 as compared to a net contraction of Rs. 181.4 billion last year.

• Within the banking system, government retired Rs.10.5 billion to SBP against a borrowing of Rs. 416.8 billion in the same period last year.

Cont…

• The government borrowing from the banking system for budgetary support and commodity operations reduced to Rs.199.6 billion during July-9th May, 2013-14, against Rs. 992.9 billion in the comparable period last year.

• Significant decline in government borrowing from the banking system due to contained borrowing for budgetary support is largely a reflection of improved fiscal accounts.

• On the other hand government has borrowed only Rs. 275.2 billion from Scheduled banks during July- 9th May, 2013-14, against the borrowing of Rs. 659.0 billion last year.

Cont…

• Pakistan equity market, the KSE was one of the best performing stock markets in 2013. During this period the KSE-100 Index gained 49% and closed at 25,260 levels by end of December, 2013.

• The KSE-100 Index improved by 45.2 percent , a gain of 8,998 points since 11th of May, 2013, General Elections and taking control of the PML(N) government till end-April, 2014.

• However, since 1st July-2013, the KSE 100 index increased by 7,907 points from 21,006 to 28,913 level (37.6 percent gain) till end April, 2014. This reflects the restoration of the confidence of the investors.

4. Capital Markets

• Other reasons for outstanding performance of Karachi Stock Exchange includes better economic growth’s estimates, improvement in industrial growth, reduction in load shedding, robust growth in remittances, single digit inflation and decline in the fiscal deficit etc.

• Pakistan Stock Markets has out performed during 2013-14 (July-April) among Global Stock Markets and remained at top of the list in percent gain (37.6 percent) surpassing China, India, Tokyo, Hong Kong, UK and USA markets.

Cont…

• Small and Medium Enterprises (SMEs) plays vital role in the development of a country. SMEs are considered to be an important segment of the economy as they have the potential to create the economic as well as social growth.

• It is therefore essential to minimize the constraints and to provide a conducive environment for the growth and development of SMEs.

Cont…

15

TAX REFORMSIN PAKISTAN

Five Key Questions– Was there any pressure for tax reforms?– What was the process of tax reforms?– What Happened? How was the structure of

tax system changed?– What impact did the reform have on the

goals of revenue adequacy, economic efficiency, equity, and capacity to effectively administer the new tax laws? and

– What general lessons can be distilled from country’s tax reform experience.

[Tax reforms in Developing Countriesby Prof Wayne Thirsk (1997)]

16

Intellectual Foundationsof Tax Reforms

• Tax Reform Process needs to be analyzed within the normative framework of Optimal Theory of Taxation [Newbery and Stern (1987)];– For any revenue objective, the optimal tax reform

strives to balance vertical equity gains against tax-induced losses in the efficiency of resource allocation;

– In other words a pattern of tax rates on different tax bases that minimizes the efficiency cost of taxation;

– Non-uniform taxation to ensure equity and efficiency objectives – higher tax rates on commodities and resources that have inelastic supply or demand and vice versa.

17

18

Inadequate Resource Mobilization

The Pressure for Tax Reform• The resources generated through tax and

non-tax sources are insufficient to meet growing expenditure needs;

• The performance of international trade sector to provide support for fiscal imbalances is generally weak – continuous trade and current account deficit;

• Reliance on external sources of finance (either bilateral or multilateral) exposes the economy to additional risks and increases its vulnerability.

19

Inadequate Resource Mobilization

Some of the Reasons

• Modest Tax Effort – Stagnant and low Tax/GDP Ratio – developed economies have tax/GDP ratios in the range of 30% to 40%, developing economies in the range of 15% to 25%, and less developed economies below 15%;

• The Performance of sub-national governments is less than satisfactory;

• Fuel surcharges as a source of revenue – big question mark;

• Complexity of Tax Laws, Rules and Procedures makes it difficult for the taxpayers to exactly know their tax obligations;

• Domination of international trade and production related taxes curbing investment and economic activity

(continued)

20

Inadequate Resource Mobilization

Some of the Reasons• Reliance on Indirect Taxes leading to regressive

tax system and excess burden on final consumers;

• Narrow tax base due to exemptions and concessions;

• High tax rates and other distortions enticing tax evasion and tax avoidance;

• Primitive and antiquated tax administration – persisting with manual record keeping with limited IT support ;

• No scientific approach to handle tax matters – until recently virtually no research on critical areas such as tax incidence, enterprise taxation, tax-gap on sectoral basis etc.; and

• No respect for the taxpayers.

21

Tax Policy & Administration(Prior to Reforms)

o Major emphasis of tax policy during 1970s and most of 1980s was on increasing tax rates;

o Tax was levied on ‘easy to tax’ areas – for example at production stage (excise) and at import stage (customs);

o High protective barriers through tariff and para-tariffs (infant industry argument);

o Extremely high corporate rates – discrimination between different types of corporations.

o Complexity of Laws & Procedures and arbitrariness in their application; Manual record keeping; Complete assessment and examination; Cylindrical tax administration setup.

22

Winds of Change• Somewhere in 1980s there was a realization that the

tax system needs restructuring and reforms. Since then, different Task Forces and Research Groups were constituted and their contribution has resulted into following valuable studies/reports:

– Report by the National Taxation Reform Commission (1986);

– Report by the Resource Mobilization and Tax Reforms Commission (1994);

– Report on Income Tax Reforms (2001);– Several Reports by the Task Force on Reform of Tax

Administration (2001);– Strategy and Priorities for Tax and Customs

Administration Reform (2001)– The Strategy Document on Tax Reform (2001)– Pakistan: A Preliminary Assessment of the Federal Tax

System (2006) and– Tax Policy in Pakistan: An Assessment of Major Taxes and

Options for Reform (2008)

23

What did they Say?• Report by the National Taxation Reform

Commission (1986);– ‘The rates of direct taxes too high, tax laws

complicated and procedures inconvenient for the taxpayers, harassment of taxpayers by the tax collectors quite common, complaints of corruption against tax collectors in abundance, the bulk of indirect taxes derived from the lower middle income groups, lack of public confidence in the system, customs tariff excessively biased towards revenue, rates of custom duty high leading to mis-declaration and smuggling’

24

What did they Say?• Report by the Resource Mobilization and

Tax Reforms Commission (1994);– ‘The rates of taxes too high, withholding

tax rates need rationalization, too many pending appeals and huge burden of litigation, orders are harsh and arbitrary, lack of transparency, no incentive for record keeping, tax education program not working, no research and policy planning, too many exemptions and narrow sales tax base’

25

What did they Say?• Report on Income Tax Reforms (2001);

– Purpose: To revise income tax law and move the system in the direction of uniformity of tax treatment, reducing dependence on withholding taxes, reviewing the appellate hierarchy and consolidating, simplifying and redrafting the statue.

– Corner stones of new policy: universal self-assessment, no immunity from audit, efficient audit arrangement, and documentation.

– Wide-ranging recommendations on rate structure, threshold, minimizing tax exemptions, and compulsory record keeping.

26

What did they Say?• Task Force on Tax Administration (2001);The report has five

volumes and covers finer details of the system to offer new insight for undertaking comprehensive reforms. Briefly the report recommended that:– The Organizational Structure of CBR and its field offices need

fundamental changes, especially it encouraged creating separate slots for Member (Audit) and Member (Legal) within CBR,

– There should be an improvement in the design of human resource management system, revision is desired in recruitment, training, compensation, evaluation and promotion system and salaries to aligned with market rates

– There should be maximum autonomy to the tax administration,

– Internal Audit Divisions be setup at Collectorates,– Regional Collectors be established, and– Taxpayers Assistance Units be setup to streamline the contact

between taxpayers and tax officials.– The annual revenue targets should be realistic,– The report also required automation of the system to ensure

quick data retrieval and use.

27

Tax Policy & Administration(The Process of Reforms)

o Reduced tax rates to minimize tax evasion and allow market forces to work;

o Switch from tax on ‘production and investment’ to tax on ‘consumption and income’ – for example GST in VAT mode and reduced reliance on excise duties;

o Substantial rationalization and reduction of tariff and complete elimination of para-tariffs, (reduction in anti-export bias);

o Examples of Para-Tariff customs surcharges; additional charges; internal taxes and charges levied on imports; and decreed customs valuation

o Gradual reduction in corporate rates to make investment internationally competitive.

o Undertake wide-ranging reforms related to tax administration and system and procedures

28

Finer DetailsRelated to Reforms

Three Areas1. Tax Policy Reforms

2. Tax Administration Reforms3. Reforms in Systems &

Procedures

29

Tax Policy Reformsrelated to

tax rates and basic threshold level– Transition from ST to GST

• Zero-rating concept and Multiple Rate Structure

– Decision to Rationalize and Reduce Tariff• Resolving Issue of Tariff Peaks and Escalation

– Decision to reduce reliance on Excise Duties– Change the composition of Direct Taxes – rate

reduction and broadening of base

30

Reforms Related to Tax Administration & Procedures

• In an effort to improve efficiency of workforce, the reforms in the area of tax administration took the following shape:– Transformation of FBR and Field Offices on Functional Lines

and Reorganization field offices into two streams dealing with internal and international trade taxes

– Simplification of Laws, Procedures, and Return Forms– Implementation of Self-assessment Scheme– Alternate Dispute Resolution System and Reduction in the

Litigation Burden– Automation of Business Processes– HR Initiatives

31

OUTCOME OF REFORMS

Impact Analysis?

• It is rather easy to find out what happened and why but not easy to evaluate the success or merit of a particular tax reform episode. Many reasons for that:– Success or failure has to be judged on the basis of trade-

offs made between competing objectives (equity vs efficiency or administrative simplicity vs fairness)

– Lack of precision in measuring the impact of reforms (partial equilibrium vs general equilibrium analysis on the basis of available data)

– More than one approaches to measuring tax incidence and the efficiency benefits

32

33

Escalation in Revenue Receipts

(Easier Part)• In the legacy system it took CBR forty two years to

collect the first Rs. 100 billion (1947-48 to 1989-90);

• Within next five years, this amount was doubled and crossed Rs. 200 billion in 1994-95;

• Another seven years, the collection crossed Rs. 400 billion in 2001-02;

• Further five years and the collection crossed Rs. 800 billion mark in 2006-07; and

• FBR crossed the historic one trillion rupees mark in 2007-08.

• Concern about absolute vs Relative Increase.

34

Tax Structure of Pakistan:Significant Change in the Tax Mix during 1990-91 & 2006-

07; not only between direct and indirect taxes but also within indirect taxes

1990-91

DT, 18.0FED, 20.9

CD, 45.7GST, 15.4

2006-07

DT, 39.3

CD, 15.6

GST, 36.5

FED, 8.5

35

Recent Performance of FBR

Legend => BE: Budget Estimate; RE: Revised Estimate; C: Collection

0

200

400

600

800

1000

120019

90-9

1

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-00

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

BE RE C

Recent Evaluation• The efficiency costs of tax system to the economy

continue to be high• Frequent changes in tax legislation have made the overall

tax structure incoherent and tax base narrow• Significant horizontal inequities – similar income receives

dissimilar tax treatment, issue further complicated by shoddy enforcement – compliant taxpayers bear the maximum burden, non-compliant taxpayers go scot-free;

• Tax system remains overly complex due to preferential treatment, exemptions, and ad hoc changes in tax structure;

• Tax administration remains weak – tax reliance on easy to tax handles rather than innovative thinking and application.

36

37

CHALLENGES ANDCONSTRAINTS

• The major challenges are:1. Ownership (or lack of it) of REFORMS2. Policy Reversals – inconsistency of policies3. Lack of political will to address the issue of

low Tax/GDP Ratio in relation to comparable economies;o Mismatch between Sectoral Contribution in GDP

and Taxes;o Low Contribution of Sub-national Governments

4. Low Level of Compliance;o Deliberate inaction to understand tax base

5. Large Underground and Informal Economy; and

6. Absence of Tax Culture.