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Plugging leaks, poking holes

Who will pay for Pakistans state?

Dec 8th 2012 | ISLAMABAD |From the print edition

PAKISTANS national poet, Muhammad Iqbal, believed the subcontinents Muslims needed tounite if they were to prosper. Without a strong sense of nationhood, he wrote, mountainsbecome straw and are blown away in the wind.

Poetry and taxes do not often mix. But those melancholy lines grace an analysis of Pakistansfiscal plight by Ehtisham Ahmad of the London School of Economics. The countrys tax

revenues have collapsed. Its debt is almost certainly unsustainable without outside help. And yetPakistan does not pull together. Textile lobbies, the urban gentry, traders and agriculturists, allpoint to the other and say: Tax that group first, but do not tax me, Mr Ahmad writes.

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The tax authorities can identify a mere 768,000 individuals who paid income tax last year. Evenfewerjust 270,000have paid something in each of the past three years. That is one reasonwhy Pakistans tax revenues amounted to only 9.1% of GDP in the latest fiscal year, one of thelowest ratios in the world (see chart). These are exceedingly narrow shoulders on which to rest anuclear-armed state of 180m people. The culture of cheating starts at the top. Most members ofparliament, many of them conspicuously affluent, do not file tax returns.

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In the months before an election, due by May, the government of President Asif Zardari of thePakistan Peoples Party (PPP) is proposing a controversial remedy: an amnesty for evaders. Theywill be invited to wipe the slate clean with a one-off payment of only 40,000 rupees ($400). Thegovernment says it is a quick way to resuscitate the public finances and expand the tax net. Itscritics see the amnesty as a boon for politically connected crooks.

The scheme is the brainchild of Pakistans tax chief, Ali Hakeem, head of the Federal Board ofRevenue (FBR) since July. His computer boffins have spent the past few months trawling datanot to find out how much people earn, but rather to unearth their spending patterns and lifestyles.The FBR has come up with 1,700 variables that predict a persons tax liability. Some clues areobvious, such as foreign travel, owning a house in a posh neighbourhood and big-ticketpurchases such as cars. Others are ingenious. It turns out that having a weapons licence is anexcellent indicator of wealth. The FBRs analysis also shows that married men are richer thansingle men. Men with two wives are richer still. However, men with four wives (the maximumallowed to Muslims in Pakistan) are often poorer than those who have only one.

Many people escape paying taxes by simply bribing the tax inspectors who call on them, MrHakeem admits. We want the computers to be the enforcers, he says. The exercise hasidentified around 3m people who should be paying tax. Under the plan, these people will beserved notice and given 75 days to comply or they will face punishment.

But if the FBR can identify the dodgers, why can it not pursue them for the full amount theyowe? The tax board says it wants to use its new data fast, before a possible change ofgovernment jeopardises the scheme. There is no time to calculate the evaders full liabilities.

Mr Hakeem believes the system is so rotten that, in effect, it offers an amnesty to almosteveryone anyway. But cynics worry that the oily businessmen and back-room fixers who have

prospered over the past four years of PPP government will use the scheme to legitimise their ill-gotten gains. It is a way of laundering your money, says Hafeez Pasha, a former financeminister.

Amnesties, which have failed in Pakistan in the past, create perverse incentives. They alienatetaxpayers otherwise disposed to being honest, who may decide to stop filing and wait for thenext such offer. At best, the amnesty will bring in another 0.5% of GDP in revenue, Mr Ahmadsuggests. At worst, revenues may fall.

Both Mr Pasha and Mr Ahmad argue that more fundamental reform is required. Many people failto pay taxes because they are not legally obliged to do so. Agriculture is exempt from federalincome tax, largely because parliamentarians are either large landowners or dependent on ruralvotes.

Mr Hakeems board has the power to exempt products through regulatory orders without theapproval of parliament. One such order, dated April Fools Day, 2011, made a mockery of thecountrys sales tax, imposing a 0% rate on 184 items, including carpets, buttons and the willowwood from which cricket bats are madeas well as any other goods as may be specified. Mr

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Hakeems number-crunching may help plug some leaks in Pakistans tax bucket. But his boardhas already poked hundreds of legal holes in it.

Pakistan promised to abolish loopholes in 2008 as one of the conditions for a generous IMF loanof $11.5 billion. Yet it failed to do so. It also promised to remove the tax boards discretionary

power to create loopholes. But punching holes in the tax code is a handy way to win friends andinfluence people, Mr Ahmad says.

A low tax take breeds problems. People who might otherwise pay their taxes wonder whatservices they will get in return. Federal revenues are swallowed up by debt servicing, defencespending and power subsidies, with no room for much-needed spending on health, education orwelfare. A constitutional amendment passed in 2010 gave the provinces clearer responsibility forsuch programmes. But the provinces lack a reliable tax base of their own. In the latest fiscal year,Pakistan spared only 0.3% of GDP for health.

Despite such miserliness, Pakistans budget deficit still exceeded 8% of GDP last year. The

government has bridged the gap by borrowing from the central bank and the banking system(which itself borrows heavily from the central bank). This has crowded out private borrowingand ushered in inflation, projected by the IMF to return to double-digit rates by the middle ofnext year.

Fundamental tax reform will always upset one powerful constituency or another, whether it bethe landed gentry, farmers, traders or industrialists. Without reform Pakistan courts economicdisaster, a financial crisis that might blow the precarious economy away like straw. That wouldupset everybody. But Pakistans ruling elites assume that such a crisis will always be avertedwith help from international donors. And, says Mr Ahmad, they are probably right.