For Pakistan, Khan’s FBR reform is the first step on a long road
The FBR has traditionally been responsible both for policymaking and for tax collection, but following the reform, the Pakistani tax authority will focus strictly on collecting taxes while a separate body will formulate the rules.
On November 9th, Pakistan's new prime minister Imran Khan implemented an important, and long overdue, item from his Pakistan Tehreek-e-Insaf (PTI) party manifesto: stripping the Federal Board of Revenue (FBR) of its power to make tax policy. The FBR has traditionally been responsible both for policymaking and for tax collection, but following the reform, the Pakistani tax authority will focus strictly on collecting taxes while a separate body will formulate the rules.
If the change produces a more disciplined and effective institution, it will come as a welcome development. The FBR's current structure has produced long delays in implementing key reforms. For example, the FBR is considerably behind schedule in introducing a track and trace system to fight the trade in illicit tobacco, even as tax revenue lost to the black market reportedly costs the government up to Rs 50 billion ($374.2 million USD) per year. The FBR was supposed to implement a track and trace scheme to stamp out the trade in contraband tobacco ten months ago, in line with a mandate from the World Health Organization (WHO) and its Framework Convention on Tobacco Control (FCTC). Instead, it has continually delayed the bidding process.
For a country like Pakistan, where a substantial informal economy makes it difficult to tax or even document many everyday transitions, a track and trace system for tobacco and other goods represents a critical tool for transparency. In their absence, Pakistan's Rs110 billion in cigarette tax revenue in 2015-16 fell to just Rs74 billion in 2016-17. Sadly, the FBR's inertia in this and other matters is nothing outside of the ordinary for Pakistan. The delays are typical of Pakistan's penchant for putting off finding solutions for chronic budgetary problems for another day.
A high bar for reform
While Khan has made the right noises about fiscal reform since winning office in July, the change to the FBR represents one of the first few concrete steps (along with establishing a new assets recovery office) he has taken to implement his budgetary promises. While the bureaucratic change to tax policymaking may have been straightforward enough, Khan's criticism of Pakistan's financial state during the campaign was all-encompassing. Among his most ambitious priorities: slashing government expenditure, tackling corruption at the highest level, and introducing revenue reforms to bring wealthy citizens into the tax net.
Khan was particularly critical of his country's reliance on outside lenders like the International Monetary Fund (IMF), with which Pakistan made its first bailout arrangement in 1988. Since then, every Pakistani government has had to call on the IMF for assistance, resulting in a total of 12 bailouts to date. Khan also criticized Pakistan's growing debt to Beijing, citing concerns about how the level of Chinese investment in the China-Pakistan Economic Corridor (CPEC) could destabilize Pakistan's economy further.
Back to old habits?
Less than three months later, the new prime minister has now officially reached out to the IMF for what will be Pakistan's thirteenth bailout. In the weeks prior, Khan actively solicited both Chinese and Saudi Arabian assistance to reduce the amount the country would have to borrow from the global "lender of last resort." At the start of the month, he touched down in the Chinese capital to meet with President Xi Jinping to discuss further loans, while in October, he announced Pakistan has secured $6 billion in aid from Saudi Arabia as part of a plan to borrow $12 billion from "friendly" nations to address Pakistan's urgent balance of payments crisis. Khan failed to secure immediate assistance from the Chinese, making the IMF bailout a matter of unavoidable necessity.
Pakistan's continual need for outside support is particularly galling because the root causes of its financial difficulties are readily apparent. In a country of 220 million people, less than 1% of the populace currently pays income taxes, while the wealthiest elites are effectively exempt. This arrangement puts undue pressure on Pakistan's poorest citizens to make up the difference, translating into a tax-to-GDP ratio of less than 10%. This puts Pakistan in the running with Bangladesh for the worst tax collection performance of any country in South Asia. In India, for example, the average ratio over the past ten years stands at 19.6%.
The true costs of borrowing
Khan suggested that the net would still be widened to catch wealthy Pakistanis, but many of the country's citizens are understandably suspicious. Successive governments have repeatedly promised to tax the rich, but implementing that proposition essentially requires convincing the elite to tax themselves.
This continual failure to reform and rationalize Pakistan's tax base carries real costs for the country. The fiscal crisis has caused the Pakistani rupee to fall 26% in value since December of last year. Meanwhile, literacy rates in the country are also on the decline, standing now at just 58%. Pakistan's outdated energy infrastructure means the national grid constantly faces the issue of load shedding and fails to keep up with peak energy demand, impacting both the general public and the national economy.
The government cannot make proper investments in education, healthcare or infrastructure – the key drivers of happiness and prosperity, as indicated by the Human Development Index (HDI) – without first getting its financial house in order. It must also be noted that, when the Pakistani government pursues stopgap borrowing to plug its budgetary gaps, Pakistanis pay the interest – be it through increased utility prices or the austerity measures demanded by the IMF in exchange for its assistance.
Reforming Pakistan's tax base to reduce the country's reliance on the IMF and wealthy foreign patrons promises to be a long, slow road. Imran Khan, after all, is hardly the first politician to promise financial stability to Pakistanis weary of corruption and their own government's ineffectiveness. Reforming the FBR is certainly a welcome start, but unless more sweeping reforms are introduced soon, this round of bailouts won't be the last.