Book 12361248 fiscal imperatives in pakistans economic development by m munir qureshi (1) by emque

M. Muneer Qureshi

FISCAL IMPERATIVES IN PAKISTAN’S ECONOMIC DEVELOPMENT

"THE MISD OF MAN IS CAPABLE OF ANYTHING BECAUSE EVERYT'H ING IS IN IT-ALL THE PAST AN13 ALL T H E FUTURE"

JOSEPH CONRAD

FISCAL IMPERATIVES IN PAKISTAN'S ECONOMIC DEVELOPMENT

PROGRESSIVE PUBLISHERS ZAILDAR PARK, ICCHRA LAHORE PAKISTAN

- -

ISBN 969 8064 04 4

First Edition February, 1989

XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX

Price: Rs. 250.00

Published by S. Raza Mehdi, Progressive Publishers, Zailditr Park, Ichhra, Lahore-16, Pakistan Printed in Pakistan by Sh. Zafar Mehdi, at Fisco Press (PVT) Ltd. Zaildar Park, Ichhra, Lahore-16 Pakistan. Phone. 411142

Contents

PART I Preface The taxation of Income: its conceptual basis Tax rate structure Taxation structure

Base Broadening: a leading issue in tax reform The Taxation of Business Profits-. realignment of tax burdens among different business entities The tiixatiy of agricultural incomerationale and alternative approaches Tax legislation in developing countries

The design of tax incentives An appraisal of the scheme of fiscal incentives incorporated in the Pakistan Income Tax Code

Law and procedure controlling the taxation of self assessed income in Pakistan The political dimension in taxation Controlling tax evasion The parallel economy-an overview The economics of inflation PART I1 The economics of growthSome important lessons drawn from the historical experiences of nations Sources LIST OF TABLES Pakistanconsolidated govt. finances Pakistanconsolidated govt. finances: an analysis Central govt. "current revenue" in selected third world countries & comparison with the N.I.C's Central govt. expenditure in selected third world countries & comparison with the N.I.C's Comparative burden of direct taxes on agricultural & non agricultural incomes Land utilization statistics-Pakistan

Distribution of cropped areaPakistan Area, production & yield per hectare of major cash crops in the main growing countries Area, production & yield per hectare of major cereal crops in the main growing countries Area of crops covered by ground Plant protection measures-Pakistan Pakistan's position in various cropsan international comparison Money & interest rate in selected third world countries & the N.I.C's Macroeconomic performance of forty one developing countries grouped by trade orientation Change in export prices and in the terms of trade of the countries of the third world Origin & destination of manufactured exports of selected third world countries. Pakistan in the third world-comparative data for selected countries Saving, investment & the current account balance---selectedcountries External public debt & debt service ratio of selected third world countries & the N.I.C's The distribution of income in Pakistan

26 5

20. I

Population growth in the third worldselectetl countries

21.

Education in the third worldselected countries - comparison with the N,I.C's

22.

Economic structure of selected third world countries compared with the N.I.C's

23.

Structure of manufacturing in selected third world countries and the N.I.C's

I I

277

Preface

That the road t o economic development can be long and arduous is made dramatically evident by the apparent futility of the growth effort for the great majority of the third worlds plethora of desperately poor countries that litter the economic scene in a disarray that is a poignant reminder of the daunting odds that have not been overcome. In the post world war two era, only communist China and South Korea-among the "major "developing countries-have been able t o break away from the stranglehold of the antigrowth forces and move on t o self sustained growth. Much of their success is relatable t o a candid willingness t o come t o grips with reality and t o learn from the historical experience of other countries. They have shown time and again that when it comes to making hard choices they will not be found lacking. Indeed, the ability to identify the right alternate -- or the right set of alternatescoupled with sustained, determined effort, is a key feature of their success story. Their saga-and that of others that honestly strive t o follow in their wake-forms part of the inspiration for this book. Effective resource mobilization is an obvious starting point for any program of economic development. Many of the hard choices we have referred t o above, have t o be made here. That maximizing revenues - and keeping expenditures within tolerable limits - is a none too easy exercise is one important lesson that emerges from the experience of most countries. The author has made an effort t o focus critically on the direct

Fiscnl Impernrives in Pakistan's Econornic Development

taxation of income as a source of revenue for the public exchequer. The system in vogue in Pakistan in terms of the legislation in force is examined indepth and areas where reform is called for are identified. Besides the taxation of income the author has also made explorations in related areas such as the parallel economy and inflation. Lastly, an effort is made t o draw on the historical experiences of other countries that have achieved successes in their quest for economic development - both in the free world and the regimented controlled economies. It is hoped that a workable amalgam from their variegated policy prescriptions can be seen t o emerge t o be put t o use by the powers that be in the third worlds corridors of authority. The author is indebted t o his colleagues an.d friends especially Mr. Mazhar F. Shirazi, Coordinator, Data Processing Center, Income Tax Department, Lahore - f o r the assistance and encouragement so graciously given without wh.ich it would have been difficult t o complete the project in time. The author is also heavily indebted t o those who laid the basis for his studies in economics. Here, Mr. Amir Nawaz Khan, - Aitchison College, Lahore, 1961-63 - Professors Hamid Yarnin Dar, Muhammad Rashid and Fiza ur Rahman, - all at Government College, Lahore in 1963-67- must find special mention. On thq home front. the commendable patience with which the authors wife and children put up with the many months of computer assisted distraction - the book was composed o n an " Amstrad " computer - cannot go unrecognized. The authors greatest debt however is t o his parents -- who made everything possible.

1st January, 1989 Gulberg, Lahore.

MUNIR QURESHI

The taxation of Income: its conceptual basis

A system set up t o generate revenue by levying taxation o n income can be evaluated o n the basis of specific criteria. The more important of these may be stated as follows: a.

Whether the system is "fair" in terms of treatment accorded t o people deriving income and "similarly placed" with regard t o quantum of income realized 2nd whether the system is capable of reasonable differentiat,ion, according t o their ability t o pay between persons in different economic circumstances;

Whether the system is economically efficient in terms of the quantum of revenue generated and he costs of raising the revenue. These costs are not only the costs of tax administration but also the extra blurden that is required t o be borne insofar as a tax on i l ~ c o n ~isean addition t o the other costs that arise from the process in which the income is generated. "Efficiency" is also relatable t o the impact that taxation of income has on investment flows. What needs t o be seen here particularly, is whether the taxation of incorne directs investment into channels that may not be the most productive. Without coming t o grips with the more esoteric aspects

of the subject, it is possible to achieve a consensus with regard t o the core meaning of "fairness" in taxation i.e. equal

Fiscol Itnpero fives in Pakistan 's Econofrlic L)eveloptr~cnr

treatment of similarly situated persons and reasonable differentiation, according t o their ability t o pay, between persons in different circumstances. The problem now would be t o state the characteristics that are relevant t'or defining similarity o r differences in circumstances. The great majority of those who have looked into the matter in any depth would agree that the most relevant characteristic here is the taxpayers (together with that of his dependents) total income - or total consumption. Coming t o the "ability t o pay" principle, there would also appear t o be general agreement that a tax levied on income ought t o be "progressive" with regard t o different levels (or slabs) of income. Thus people fortunately placed t o enjoy higher absolute amounts o f income would be required t o pay a relatively higher amount of their income as tax vis-a-viz those not so fortunately placed. Hopefully, over time, such an arrangement would reduce the gap between those who have more and those who have less. Coming t o the "efficiency" criteria, ''supp1:v side" economists regard taxes as inherently inefficient because they weaken incentives and reduce production. Mainstream economists are more sceptical about t h e effects o n total activity. They tend t o distinguish between taxes and t o judge a tax's efficiency o r inefficiency by its influences on methods of production and the composition of consumption.. An inefficient tax system may unnecessarily increase production cost or result in a pattern of output and con sump ti or^ that yields less satisfaction t o consumers than that obtained from another pattern producible at the same cost. For example, taxation is held t o be inefficient if it causes firms t o use eit.her more or less capital t o produce a given output than they otherwise would use. This is so because either overuse or underuse of capital will increase production cost per unit. Any t a x system that allows the effective rate of tax t o deviate markedly over broad categories of investment will cause investment decisions t o be based o n tax cc~nsiderations instead of economic productivity. The social costs of such tax related distortions can be enormous. They divert resources from their most productive use - those with t h e highest rate of return before taxes - into uses that are less productive but

TABLE 1 PAKISTAN - CONSOLIDATED GOVERNMENT FINANCES

194960 1960-61 1965-66 1972-73 --

A -

GROSS RECEIPTS

1422

4778

-534

-138

10830

16938

REVENUE RECEIPTS receipts non tax

-tax

SURPLUS O F AUTNOMOUS BODIES CAPITAL RECEIPTS

- surplus o n revenue account (if any)

- external finances (Net) '-domestic n o n bank financing -public sector surplus EXPENDITURE

- current -development OVERALL POSITION

1304

-1259

Source: Govenunent of Pakistan Economic Survey (Various Issues)

Fiscal lmpera n'ves itr Pah-isfank Ecotro fnicDevelopmetr r

yield higher after tax returns. The result is re'duced initial output, lower productivity and sluggish economic growth. When tax rules cause investors t o select projec1t.s that yield less and t o give u p projects that yield more, then, the economy as a whole loses. and its loss can be quantified in terms of the extra return that would have followed the selection of the more efficient project - and which is not now available. There is t o be sure, the counter argument that given the imperatives of capital formation and promotion of balanced economic development in the country, distortions In investment i.e, a deliberate deviation from what the dictates of market forces would indicate, are all too often necessary and developing countries might have no option o n the matter. It is argued in: this context that the capital base of most developing countries is so deficient and so localized is the existing pattern of industrial development that only by offering a range of fiscal incentives can investment be attracted in projects that though necessary from the economic standpoint may not; promise returns (atleast in the short run or the immediate future) as high as others that may not be so necessary in terms of acquiring economic potential. Furthermore, investo:rs may never move t o the far flung regions of a country unless a package of incentives is offered, the net effect of which is t o make the investment. attractive. To be fair, developing countries certainly need t o build up an industrial base and also t o achieve a degree of balanced regional development if the aspirations of t h e less developed regions are t,o be satisfied and if regional integration is to be promoted.

The F,esource Imperative : Does the Existing Tax System Yield Enough Revenue In order t o fuel the engine of growth effect'ively, adequate resources are necessary. This would appear t o be so obvious as t o require no emphasis. However, in the real world t h e generation of adequate resources in most developing countries is an area of acute and persisting concern for the fiscal agencies charged with conceiving and executing development projects.

The Taxation of Income :its concephral hasis

It must not be forgotten that besides the very real demands of economic development the sheer expenditure of running the government machinery has spiralled and itself imposes a considerable burden o n the exchequer. Non development expenditure other than the cost of administration-especially expenditures t o fund the military establishment-add t o the strains on government resources. In developing countries the defence establishment typically dwarfs most organizations in the country. Given the clout its spokesmen wield, its "will t o power" ensures a steady flow of resources t o it. The increasing cost of military hardware on the international market, (quite natural in view of the diverse competing demands),escalates costs and has been responsible for dramatic increases in defence spending in recent years. The government expects its fiscal agencies t o devise ways and means of realizing the required revenue. Taxation measures, both direct and indirect, yield p a r t . of the domestic resource component. The latter is ofcourse the more significant in most developing countries. This however is far from an ideal situation. Indirect levies create a regressive burden that does not augur well in alleviating and mitigating the social tensions and cleavages that fester in the body politiqthreatening t o upset the precarious equalibrium that keeps the economy going. That the direct tax component of the resource base is quite unable t o make an effective contribution is dramatically evident from the ever increasing size of the budget deficit. This indicates that the tax system suffers from much more than structural deficiencies. Huge deficits in 'the resource availability position, stretching into t h e indefinite future, are certain unless effective legislative action is taken t o restructure the tax system so as t o broaden its b&e significantly and t o give it the capability t o bring within its ambit rr~ostof the taxable income generated. An innovative approach is necessary because for reasons that are obvious, resort to generation of additional revenue by increasing the tax burden of existing taxpayers is neither feasible nor expendient. Also, t h e development expenditure will have t o be augmented t o accelerate the pace of economic development as there is little possibility of significantly decreasing the non-development; expenditure, ncnnoiglltr

t h ~ nn t A n f n n n n anrl ~ l A m i n i c t r n t i n n

TABLE 2 PAKISTAN CONSOLIDATED GOVERNMENT FINANCES - AN ANALYSIS

INCOME TAX AS % OF: -total tax revenue Total revenue G.N.P. G,D.P.

TOTAL REVENUES A S % O F G.N.P.

14.0

14.6

15.2

15.6

14.96

14.74

Source: Government o f Pakistan E m n o m l c S w e y (Various)

15.79

15.00

15.47

15.60

The Taxation of Income : Its conceptual hsfs

Budgetary deficits pose a greater problem for developing countries than they d o for the developed. The rc?ason for this is that the underdeveloped country has an underdeveloped economy. The economic structure is as yet impel*fectly formed. The linkages - both inter and intra sectoral exist only in a rudimentary form. The capacity of the economy t o bear shocks is poor because it cannot transmit the initial shock. The consequential action that would follow as a matter of course (responsive reaction) in a more developed econoiny is missing in the developing economy. Much of the inherent rigidity is allied with rigidities in data transmission. Since information in not transmitted effectively between and within :sectors,;, decisions cannot b e taken in time nor can the complexion of a situation be properly perceived if decisions are taken in a void-as so frequently happens in developing countries, these turn out t o be whimsical and capricious. Another complicating factor of great significance here is the operation of the parallel economy. Considering its large relative magnitude vis-a-vis its counterpart in the developed country, it represents an area of operation that impacts significantly on the regular economy. The parallel economy permeates the regular economy so that it interferes with its operations. Its large absolute size removes a large segment of the national economy from the jurisdiction of the fiscal authorities. Thus official policy stops short of the boundaries of the parallel economy. This happens so frequently and in such diverse areas that the overall result of the interference is t o confuse and obstruct official policy. Thus effective control of the regular economy too becorr~esproblematic. As the great crash of '87 so dramatically showed, the trouble making potential of recurring budget deficits can be much more than what is immediately perceived. This is because in a free economy government competes for available savings in the economy alongwith the other economic sectors. The government, t o be able t o attract available investible funds, must offer an attractive rate of return (interest). When the government, year after year, indicates an increasing need t o mobilize the available savings, there is bound t o be an upward pressure o n interest rates. A sudden increase in the size of thc deficit o r an increase in government expenditure o n a significant scale that heightens the significance of t h e existing deficit insofar as government would appear now t o be compelled t o offer extraordinary inducement - in t h e shape of higher in-

Fiscnl Impem tives in Pakistan 's Economic Developmen r

terest ofcourse - so as t o be able t o attract the loanable funds in the economy, can provoke an economic destabilization by drawing funds away from their existing deployment in order t o be in a position t o place these funds at the governments disposal where they are expected to fetch a much higher rate of interest. It is thus this "expectation"of a significantly higher rate o f return that can provoke destabilization in the economy. The fickle nature of man is brought out vividly in d o c k market gyrations provoked by nothing more concrete than rumours based o n truths, halftruths and nonsense. Tax Reform:

If one is t o think rationally about tax reform it is irnperative that one have in mind an ideal tax system against which proposals can b e evaluated. Without such an ideal, one cannot decide whether any proposed change is an improvement. Unfortunately, people disagree strenuously about what the ideal tax system should look like. Many think that the tax system should be used t o influence private economic and social choices. Many others hold that frequent use of the tax system t o change private incentives will lead t o inequity and unintended distort io ns. Disagreements o n t h e nature of the ideal tax system extend t o beyond the question of the systems purpose. They also encompass the most fundamental issue for levying taxes: what is the best way t o measure an individuals ability t o pay? Some hold that annual income (measured as the sum of consumption plus additions t o net worth over the year) best measures ability to pay taxes. Others claim that income measured over many years o r that annual consumption expenditures are better measures. This section examines many of t h e issues about which tax reformers disagree and provides the necessary background t o evaluate tax reform proposals. The issues raised here are important because it is really not possible t o think straight about tax policy options without a thorough understanding of the objectives sought in a desirable system.

FLrcol Impemtiws in Pakistan's EcononriC Development

"Fairness' In a Tax System All taxes constitute a burden that people have to bear as the tax levy has the force of law and is enforceable if necessary, through coercion. The acceptability of a system of' taxation is determined largely by the peoples perception of its fairness i.e. how t h e system treats people placed in more or less similar curcumstances. If the system is so structured that it is neutral in its imposition between persons who are placed in identical economic circumstance than it can be said that we have a fair system i.e. the system does not have a bias towards; one o r the other category of persons.

1 j I I

If t h e condition of fairness is violated, people will be treated inequitably and what is very significant, incentives will be created to base economic decisions on tax considerations rather than o n true economic gain. The critical issue however is how to determine when people are placed in equal economic circumstances. It would be useful in this context to divide the issue of fairness into a number of pertinent questions:

- What flows best measure ability t o pay? - Over what period should these flows be measured and taxed? I

- Should taxes be levied only o n actual transactions or also on accruals? -

How does inflation interact with the tax system'?

- What kind of savings impact on aggregate econqmic activity and in what manner? - What factors are pertinent in assuring improved taxpayer compliance? Ability t o Pay Fairness requires that those with t h e same ability to pay should pay t h e same tax. The question however arises as t o what should be t h e basis for determining the relative ability to pay of different taxpayers.

The Taxation oflncome : its conceptual basts

This question has been hotly debated over the years. The debate ranges over two dimensions: t h e object t o be measuredincome o r consumption - and the period over which the object should be measured - t h e so called accounting period. Income Vs Consumption Many economists hold that consumption is a better base for direct personal taxation. They hold that justice requires that taxes be apportioned on the basis of what 'people withdraw from the pool of resources (consumption) instead of what they contribute t o it (earnings plus t h e return t o savings). They argue that consumption can be measured far more reliably and simply than income. It is also argued that corisumption is a more stable tax base because household consumption varies less than household income. Each of these propositons is debatable, but consumption in our view is simply not an accurate measure of each persons ability t o pay or of total economic capacity. Ac~:umulations of wealth confer valuable economic and social benefits to their owners even if the wealth :s not consumed.. Accordingly, wealth accumulations should be incorporated into any measure of ability t o pay. Unlike a consumption tax, a tax on income can reach accumulations of wealth that are not actually consumed during the accounting period. For these reasons we hold that income is the proper object by which t o measure ability t o pay. Having chosen income as the object of taxation, one must devise rules for taxing it. Income can be measured in two ways: as an outflow and as an inflow. As an inflow, income equals the sum of earnings plus returns to capital, including changes in the value of assets. As an outflow, income equals the sum of expenditures incurred plus additions t o ..net worth. These two definitions are equivalent to each other - rupees coming in equal rupees going out or retained. The number of rupees in the tax base is the same in either case.

TABLE 4 CENTRAL GOVERNMENT EXPENDlTURE IN SELECTED THIRD WORLD COUNTRIES k COMPARISON WITH T H E N. 1.c.'~.

5% O F T O T A L EXPENDITURE

Housing. Amenitlen. Defence

Educdbn

Ecooamle Senna

y$gGF

OIbR

Totd erpemitlure ( % o f GNP)

OIIRU m . u V 1 ~ dcrldt ( % o f GNP)

PAKISTAN NIGERIA BANGLANDESH INDONESIA INDIA PHILLIPINES THAILAND TURKEY EGYW

s KOREA* SINGAPORE

sourcw: Wodd Bank World Development Reporis- 1981. G m w t h 01 p o p u l d b n . u r b . n l d b q t h e h n p e m t l r s o f defence haw all contributed t o a tma. So h m w b t h e d r h o n t h e exchequar t h a t e m r e n t revenues b u d y r u f t k e to mes( c-t to t h e L d a a l o p m t n t fund'.

anp a r . l t i o n in l e r c b o f rrondew10Dmerrt.l

go=rnment e r p m i l e x p m d f u r e r c q u l r e m c n t . leadog UtUc (or notblas u 111) t o pu o n

TABLE 4-A NON DEVELOPMENT EXPENDITURE IN PAKISTAN AS A % OF TOTAL EXPENDITURE

Period

(%)

The steady increase in "non development" expenditures is related to con62 tinueing high commitments for the defence establishment and escalating 8 5 administrative expenses. The latter are related t o increased population levels 58 and the greater role that the state has come to play in the "management" 62 of the economy. Public utilities are some of the biggest employers in the 68.5 country and all are state run. The increased structural complexity of the 72 politico-economic format is also responsible for the increase in the cost 73 of administering the country. 64

The faxation of Income :its conceptual basis

The Accounting Period: Income can be measured and taxed over a day, a week, a month, a year, or a period as long as the taxpayc?rs life. The usual measurement period is twelve months. Furldamentally however, there is no logical reason why a particular astronomical regularity should be enshrined in the tax law. T o be sure, there may be practical as well as historical reasons for choosing one income definition and accounting period over the other. Inflows rather than outflows may better conform with conventional views as t o what income really is. Similarly, there may b e practical and historical reasons for treating equally individuals who have the same one year income but not the same multi year or lifetime income. The main point here is that one can favour income over consumption as the measure of ability t o pay without necessaril!i favouring a single year as the best accounting period for determining equally situated taxpayers. Accrual o r Realization: The income tax rests on the concept that ann1.1al income, when measured as an inflow, includes changes in the value of assets. For practical reasons however, most personal income is not taxed when it accrues t o the benefits of the ta.xpayer but only when it is realized, generally in a market transaction. This conflict between the definition of income in concept and its measurement in practice is responsible for much inequity, inefficiency and complexity in the current tax law. For example, capital gains and losses o n assets for which no objective market price is available can only be estimated crudely and laboriously. Gains and losses o n assets such as stocks traded o n registered exchanges are easily counted and could be easily taxed when they accrue. But taxing some assets one way and some another would create unfair distinctions among assets and among taxpayers. Instead, current law taxes only realized capital gains o n certain classes of assets, thus abandoning the principle that annual economic income should be taxed. As a result, a different set of unfair distinctions is created: taxpayers with accrued but unrealized capital gains pay significantly less .tax. than d o others with realized gains, ,ltL,..mL

thn-

n n n n n m - n annnmoc ~ w o iAontioal

I 'iscal Jmpemh'ws in Pakistarl 's Economic Development

I -i

Why should capital gains be taxed the same whether or not they are realized? Because it is not necessary t o realize a capital gain in order t o spend it. If one pledges the appreciated asset as security on a loan,one can spend the proceeds of the loan and even deduct the interest payments on the loan, thus reducing current tax liabilities. As long as the asset continues t o appreciate by an amount atleast equal to the after tax interest cost, one can quite literally, have ones cake and eat it too. Inflation: Proper measurement of income requires the valuation of all quantities in real terms, that is, with full adjustments for inflation. If such adjustments are not made, inflation changes both the tax base and tax rates.

A simple example shows how inflation distorts the tax base. A person who sells corporate stock at a profit will pay tax on the purchase and sale, price differential. If the general price level rose faster than the price of the stock, so that the proceeds from the sale buy less than did the funds used t o acquire the stock, the same tax will still be due. In this situation taxable income has little or no relation to economic income and taxpayers in the same real economic circumstances may pay widely different taxes; thus the interaction of the tax system with inflation undermines equity - and is also the root cause of serious misallocation of resources. Depreciation and Inventory Costs: Deductions for depreciation are based on historic costs if no adjustments are made for inflatiop. If depreciable lives

reflect useful lives and prices are stable, depreciation deductions based on historic cost lead t o an accurate measure of income; and if firms set the same amounts aside in depreciation reserves, they will build up a pool of funds sufficient to replace assets as they wear out. If prices increase, however, deductions fall short of replacement costs; the greater the rate of inflation, the greater the shortfall.

Th? Taxation o f l n c o m e ' i ~ 'corrceprrrol hosi(

true economic depreciation. This accelerated depreciation is also invariably higher than the inflation rate. The measure is designed principally as a fiscal incentive t o encourage businesses t o make investment in new plant and machinery ahd to make replacement of worne out and obsolete plant at the right time. Interest Income and Expense: Inflation also causes mismeasurement of real interest income and expense. During inflation, interest payments compensate lenders not only for the use of their funds but also for the decline in the purchasing power of their funds over the life of the loan. The real income of thc lender is the interest received (or accrued) less the decline in the real value of the loan principal outstanding. Similarly, the real interest expense of the borrower is the interest paid, less the fall in the real value of the outstanding loan. Ideally, it ought t o be provided that the real value of the loan on which interest arises (as income or expense for the lender or borrower as the case may be) be worked out adjusting fully for the prevalent inflation rate and then to calculate interest with reference to this "adjusted" value. Practically, however, implementation of this adjustment would be cumbersome and would strain the resources of both taxpayers and administration. Distortions of Consumption and Saving: The taxation of capital income at any positive rate reduces the spending opportunities of people who wish t o consume in the future by a larger fraction than it does the spending opportunities of people who wish t o consume income as it is earned. A tax on capital income thus distorts personal decisions about when t o consume. The variation in tax rates among assets also distorts household decisions about which assets t o hold. In the pursuit of tax advantages, individuals may buy assets'that are l e s productive (in other words, do not have as high a before tax rate of re&..",\

":,I.:,.

,."

lr.er

1;,..,,;,4

+hnn wn,,lJ n+hPrw;90

hP ,gPCirPlhlP

I'isral l m p e m d w s In Pakistan's Economic Development

Some advocates of expenditure type taxes claim that deferring taxes o n all asset income until it is actually used would increase household saving. This is also a major argument against the annual income tax. While it is generally correct t o say that tax changes can appreciably increase household saving and that such an increase can contribute modestly t o economic growth, however if we wish t o increase savings at the national level there are more powerful and direct means of achieving this goal. The increase in national savings from tax inducements t o encourage household saving would be small relative t o the increase in national saving that could be achieved by fiscal policies t o reduce the deficit or create a surplus. National saving is the sum of saving by households, business and (government. While household savings are positive, the federal government may be dissaving. Even if tax changes boost household saving, the effect on national saving world be small compared with the direct and certain effects of eliminat.ing the federal deficit. Tax policy as it impacts o n capital acquisitions can have significant implications for savings. At the micro level, household savings have a variety of motivating factors. It cannot be denied however, that a desire t o acquire long lived (durable) assets mainly for their income yielding poteniial on a recurring basis, is at the root of most such acquisitions. The amount that an individual chooses t o set apart for investment in such long lived assets in the future will be determined,to a very significant degree, by the individuals pcirception of the worth of such assets t o him - in the future when the acquisition is planned. If he perceives that the acquisition will entail a financial burden other than the cost price,the usefulness o r worth of the asset t o him would stand discounted to the extent of the extra burden involved. One of the reasons that people are prepared t o sacrifice consumption in the present for consumption in the future in t h e shape of long lived assets is that such assets are expected t o appreciate in value over time. This "gain" makes it "worthwhile" for the investor t o postpone present consumption. However it is this gain that also attracts the attention of the taxman. Tax law generally incorporates some sort of special provisions t o tax this gain. Usually the gain is taxed as it is realized ~enerallyin a market transaction. As has been shown

The Taxation of Income :Its conceptual basis

separately, in terms of economic power the fact of realization of suah capital gain is not material. In other words it is not necessary for the holder of such capital assets that have gained in value to dispose off the asset in the marketplace to be able to exercise the increase in their economic power resulting from the gain in value of the asset. The holder can thus put up the appreciated asset as collateral and use the resources thus acquired while at this same he retains possession of the asset - the classic case of having one's cake and eating it too. In any case the individual would not like to see this gain eroded through a tax levy. If the tax statute incorporates provisions that make it known to the individual now that any gain that the asset he proposes t o acquire tomorrow is likely to be heavily reduced by its taxation then depending on how prohibitive he perceives the tax levy to be, saving for such an asset will lose its normal attractiveness to him. Depending on how broad the coverage of capital gains taxation is, such taxation can actually reduce the quantum of savings of individuals. What is of significance here is that the reverse of the situation outlined above is just as valid in terms of its incentive effect on the individuals proclivity to save. This means that if existing burdens are reduced or done away with, the worth of the acquisition of 'such assets freed of financial burdens will be enhanced and provided the incentive feature here is pronounced enough it is actually possible that the individual will be goaded into saving more presently so as to be able to acquire the asset in the future. In this way therefore an increase in individual (household) savings is possible. While household savings are undoubtedly of much significance, at the national (Macro) level the level of aggregate savings in the economy are not likely t o be automatically increased by all areas involved (government, businees and households) as a result of incentive legislation of the type out.lined above. Thus it is quite likely that while households save more, the government could be dissaving - as happens ever so often resulting in escalating budget deficits. Looking t o the ever increasing size of budget deficits, it is clear that meaningful reductions in these deficits aimed ultimately at doing away with them altogether would have a much more significant impact as .far. as national savings are concerned. An imaginative policy geared t o eff~rtioo rnnhilization of revenues

1,'isccll Impemtives in Pakistan's Economic Devclopnrc~rr

across the full range of the economic spectrum coupled with rationalization of expenditures - again at the national level is what is really required if economic policy is ever t o have a perceptible impact towards betterment of the state of the economy. The tax system should be designed t o be fair, conducive t o the efficient use of resources and easy t o administer. Any increase in saving would be a positive but minor bonus from reforms that should be adopted only if whollv justified for these other, more important reasons. Compliance and Administration: Tax laws are not self enforcing. Taxpayers must go t o the trouble and expense of calculating how much they owe. The government must spend part of the proceeds of the tax t o collect it and t o enforce it. Despite the efforts of a professional staff of tax administrators in the Deptt. of Income Tax, taxpayers illegally evade a good part of the taxes they owe. Also, they go t o enormous trouble and expense rearranging their affairs legally t o avoid taxes. Tax reform holds out hope of improving compliance through two separate routes-reducing marginal rates and simplifying the system. Simplification in turn takes two forms: "legal simplification" which would ease taxpayer comprehension, compliance and administration and "transactional simplification" which is the reduction of the number and complexity of transactions undertaken t o avoid taxes. Improving Compliance The key t o improving compliance and enforcement .is a combination of lower marginal tax rates and ilnderst,andable rules. For a given amount of revenue, the only way t o hold down marginal tax rates is t o broaden the tax base. In theory, economic power flows from a "persons" (i.e. individual, AOP, Firm, Company etc) command over economic "material". It follows therefore that the greater a persons income the greater would be the command over economic matnrinl

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The Taxation of Income : its concepmal bast:

son. At the same time it should be quite clear that income as a mere receipt cannot be t h e only determinant of economic power for if such power is symbolized by a persons command over economic material then in order t o be 1ogic:ally consistent we have got t o acknowledge the periodic accretion in market value of assets as also bestowing on the owner of such assets, economic power that is equivalent t o that bestowed by the receipt of an income. That this must be so is apparent from the fact that this accretion in value is a realizable value because the asset can be disposed off (sold) in the market o r can be put up as collateral for securing a loan. In either. case resources (money) become available t o the owner of this asset to acquire available economic material, be it factors of production, raw material, or finished products. For all practiciill purposes an ideal tax law would treat both the recipient of income and the owner of a "valuable" asset with escalating periodic market worth in identical fashion. However much of real life is a far cry from the ideal - and tax laws are notorious in keeping their distance from this ideal.

Tax rate structure

The tax liability of a person is determined by the rate structure in force in a particular period. The rates of tax are specified differently for each 'bracket' or slab of income. A 'constant marginal rate of tax' applies t o the income falling in a particular bracket. The constant marginal rate applies t o each addition to income within the particular slab. As income rises and a person moves out of the slab he was placed in previously the marginal rate of tax on the additional income (which takes him to a different 'high' slab) will be higher. Thus the marginal rates at succesively higher income brackets are higher than the marginal rates at lower income levels. The total tax one pays depends not only on the marginal rate applicable to the income bracket in which one falls, but also on the marginal rates applying to the lower levels of income, a well. Consequently, in order to be able to calculate the total tax liability, one must know the whole tax table. An important question of tax policy relate to the degree of 'progressivity' that ought to be built into Lhe tax system. We know that that tax system is 'progressive' in which the share of income paid in tax rises as the income rises above the minimum exemption limit. Now is it possible to structure a tax system in which the degree of progressivity incorported can be said to be 'socially optimal?" In the opinion of many experts in public finance it is not really practicable to structure such 'optimization' in a tax system. If an exercise is made the exploration would be purely theoretical. As Lewis points out,

Fiscal Ilnperahvrs in Pakistan's Economic Development

the determinants of tax rates, in practice, are more pragmatic and political. The importance of the 'marginal rate structure' in tax policy arises from the fact that the important alllncation decisions affected by taxation are made at the margin, where one compares the consequences of one action o r another on the after tax level of income. While high marginal rater; of tax for the higher levels of income having a progressive rate structure, it does not necessarily follow that high marginal rates of tax for the higher income slabs are 'ideal'. For one thing this could deter 'risk taking' by entrepreneurs both public as well as private. In a 'mixed economy' (typical in our times) risks will be taken if t h e anticipated profitability is high enough to justify the risky venture. One of the important factors that enter in an entrepreneurs assessment of the risk factor is the amount of tax he must pay at given income levels. The high the rate of tax t o which the venture would be subject lower its profitability. Obviously if the rate of tax appears to be prohibitive it would rule out an investment decision. Thus too much progression at the higher income levels might not be advisable if it were to put a brake o n risk taking. High marginal rates of tax at the higher income levels also provide a powerful incentive for tax evasion. P~tblicperception of what is a prohibitively high rate of tax is important in this context. Generally speaking in developing countries there is little 'tax consciousness' and in countries with a colonial background the negative attitudes vis a vis the central authority bred in the colonial period persist after independence. Also as governments in developing countries d o not have very many clearly defined 'welfare functions' the common man (usually illiterate o r at best semi literate) does not see a nexus between payment of tax and receipt of a benefit. The effect of all this in the aggregate is to condition the citizen negatively as far as payment of taxes is concerned. In t h e face of this reality it goes without saying that too high marginal rates of tax for increasing levels of income are sure t o provoke attempts at evasion. This is not t o say ofcourse that no attenapt ought to made to inject progressivity into the tax system. What is necessary however is a recognition of t he 'ecology' of taxation and t o structure tax rates keeping in mind the imperatives of the reality.

Tax m te Structure

The basic system of corporate income tax in Pakistan has been fairly stable over the years with an income tax of 30 % and a super tax of 30 % o n profits -- reduced t o 55 5% overall in 1983. Further relief was allowed for Public Coys in that the aggregate (income tax and super tax) rate was reduced from 50 % t o 40 % from assessment year 1986-87. Similarly, in the case of personal income tax, the maximum rate has been reduced from a high of 9 7 % in 1958 to 75 % from 1 9 6 1 through 1964, t o 7 0 % from 1965 through 1975, t o 6 0 % in 1 9 8 3 through 1985 and 45 % with effect from asstt year 1986-87. Also the lowest slab has been reduced from 10 % to 5 5%. Furthermore, dividend income of taxpayers (other than companies) from specified public companies has been totally exempted from any charge of income tax. While the trend towards reduced levels of taxation is a step in the right direction and what is very important government revenues have n o t fallen precipitously as many feared they would, given the deeply ingrained hibit of tax evasion (infact revenues have actually increased ( 1 9 7 9 8 0 onwards) the quantum of revenues generated in the aggregate are much less than what they would have been had base broa'dening: measures been taken simultaneously with the rate reduction. In the absence of the same revenues though much improved over the levels achieved say, in 1977-78, are still far short of what they can be given imaginative and determined policy decisions to broaden t h e tax base effectively.

Taxation - structure

In t h e age of tailor made turnkey systems it is unfortunately, not possible t o shop for an ideal tax sjrstem t o buy and instal with the expectation that it will ever take root and grow in its new habitat as well as it did in the land that gave it birth. A tax system might appear ideally suited for one kind of people and geographical location. But it does not follow that this system when imported by an allien people,, i.e. people other than those who conceived and developed it. would be anywhere as effective. The cultural/sociologica1 factor can be very important in this context for it can define the operative parameters within which any system must operate. The compatibility of a system to its environment is thus a crucial factor. Unl12ssthe parameters of this system are attuned to the circumstances of its environment there is every likelihood that a mismatch situation will arise causing a rejection of the offending arrangement. In an evolutionary context, t h e comple~nent,arityof a tax system t o the operative circumstances of its txology can undergo change with the passage o f time. Thus a system that appeared t o be working stifactorily at one poirit of time could at another time appear t o be ridden with factors that indicate an asymmetry with its environment. Perhaps the most important aspect t o be taken note of here is that the social values of a people can undergo change over time thus altering their responses. As a result of this often subtle and sc.arcely perceptible . . L , . . . " -

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Fi?i..c~?!!wpt~mtiws in

Pakistan's Eco,vomic Developmen t

perfectly adapted with the values of a peopl~tt can become maladjusted. The tax structure in an economy encompasses all the diverse direct and indirect levies that governmc:!nt at various levels (Central, Provincial, Local/Municipal) impo:ses t o generate revenues. Infact the objective of a taxation levy can conceivably be other than mere revenue generation. Thus progressive direct taxation of income and wealth would, besides raising revenues, also aim at reducing the inequities in the distribution of income and wealth in society. Whatever be the objective, these levies in their totality constitute the taxation structure in a given time frame. A study of the taxation structure focuses on (a) shifts in the taxation structure over time relative to various levels of economic development (b) the size of the Government sector and the level of economic development (c) the limits to tax reform policy given the constrains of historical-institutionaland sociocultural factors. Taxation structure is of great significance in the context of revenue mobilization. The effective mobilization of revenues is crucial in any scheme of economic development. What patter the economic development program takes is not important, for effective revenue mobilization is basic to all schemes of economic development. As economic development progresses government r e venue shares of gross national product increase. This is what experience teaches us and the logic of the situation suggests that over time this government share of the GNP must grow progressively larger so as t o ensure that full employment equilibrium is maintained. This is so because the marginal propensities to consume, invest and export tend t o decline as income levels rise. If follows therefore that unless the taxation structure is effective in generating adequate revenue government will not be able t o d o its bit in ensuring maintenance of full employment equilibrium.

II 1

The execution of a program of economic development induces structural changes in the economy. The different phases in economic development-Industrialization, 1Jrbanization

Specialization, Democratization, Secularizatiori - productivity and income changes impact o n government shares of national income. Thus independent of the ideological underpinning, progressive development of the economy causes government share in the national income t o increase over time. However while this trend is universal, the pattern may not follow a stereotyped or uniform direction. Thus while in one case direct levies may be prominent in the flow of revenue t o government in another case indirect levies may assume significance. However it is to be noted here that in t.he early stages of the execution of a program of economic development indirect levies are of much greater significance accounting for anywhere upto 85 5% of the aggregate government revenue. As development progresses reliance o n indirect levies generally declines and direct taxation of income assumes significance. If this does not happen in the normal course o f events then it could point t o structural deficiencies in the fiscal arrangements and t h e skewed pattern could very well lead to social tensi.ons as the fiscal burden of the underprivileged rises. Besides the structural changes induced by economic development refeered t o above, ideological change over time too impacts o n resource mobilization. Ideological change will be one of t h e determinants of the size of t h e government sector. Thus a capitalist state with a socialist slant in Britain in the 50's can bring big government in its wake and bring t o the fore criteria like welfare committments that were not evident in t.he earlier phases. Ideological committment:; (welfare o r security and defence) will also determine what share government would like t o appropriate of the aggregate national income. A government committed in a big way t o pr'omotion of public welfare or to national defence would have a greater absolute need for revenue than another government -not so committed. Changes induced by the ideological imperative however are preceded by the changes that require the maintenance of a complex, democratic, industrialized State. These maintenance requirements necessitate that government function a t a certain minimum level. Changes i n the structure of taxation over time are relatable generally, t o a number of variables. Per haps the most important of these is t h e d w r e e of 'openness" o f tihe economy. This

points to the significance that can be attached to the foreign trade sector. The larger the size of the foreign trade sector the greater the prospect of the taxation structure being an induced effect of the activity of the foreign trade sector. The foreign trade sector is significant in terms o f the possibilities that exist for the generation of revenues t.hrough the levy of duties o n imports and exports. Depending on the elasticity of demand of the products of this sec1;or and the quantum involved levy of duties can yield steady revenue. However the incidence of such levies is indirect andl so far as it is the consumer that has eventually to bear the impact; of the levy, the impact of such levies is regressive. Too great a dependence on import duties can distract attention from other more important areas of fiscal activity and can cause 1ast.ing damage to the direct tax levies that in t h e final anlysis are of such crucial significance in ensuring a more equitable distribution of,income. Per capita income is another variable that will induce changes in t h e taxation structure. As an absolute figure the figure for per capita income is an indicator of the economic well being of the country. A steady increase in the per capita income augurs well in that it & a pointer that the country is developing economically in a positive manner. Per capita income will be one of the determinants o f taxable capacity of the populace at large. It ought t o be fairly obvious that the higher the per capita income over the thereshold at which bare meaningful survival is possible the greater the fiscal potential and pc.~ssibilityof yielding revenues through levy of taxation. Just as obviously, it follows that a level of per capita income that en'sures mere survival is hardly capable of yielding revenues of any significance. It should be noted however that the absolute figure of per capita income does not indicate fully the possibilities in the fiscal context. Rather, the pattern of distributior~of income would determine largely how far it is possible t o "squeeze" the populace at large so as to extract the optimum or near optimum tax revenues for the exchequer. A skewed pattern of income distribution would not be promising in this context for it would impact adversely o n the tax base. Now the narrower the base the smaller the revenues that such a limited base can

Taxation Structure

be expected to yield-and vice versa. Third world countries typically present a scenario in which we are c~onfrontedwith a significantly skewed pattern of income distribution. One of the objectives of the economic planners in such a. context is t o change the skewed patterns of income distribution and replace it with a more equitable and uniform pattern. In order to do this the instrument of progressive rates of taxation on income is a vital tool the proper and imaginative utilization of which can go a long way in countering an inequitable, skewed pattern of income distribution. Insofar as the pattern of income distribution impacts on the issue of progressive direct taxation of income, this is a cause of inducing tax structure change. Also, insofar as the existing pattern of income distribution is the result of the incidence of levies on the income of the people the pattern of income distribution will be an effect of the fiscal arrangement. Cultural style is the last important variable to impact on tax structure change. The cultural style of a people will. determine the attitude and responses of a people to assorted fiscal enactments and will be responsible in no small manner in determining the effectiveness of fiscal meilsures. As cultural conditioning is deeply ingrained in the individual psyche it is of great significance in this context and itis adequate comprehension by the economic planners is essential if their planning, especially in the context of the fiscal arrangements that are made by them, is to meet with the degree of success that is desired. Cultural conditioning can be both postitive and negative in terms of the receptivity of a people to change. A cultural melieu that emphasis passive acceptance of the status quo o r one that discourages much energetic effort due to a fatalistic outlook and worldview would hardly be congenial t o a context where significant, revolutionary change is important. Culture is an amalgam of diverse influences o n the psyche and the impact of cultural factors can be quite subtle and therefore, it may not always be easy t o identify these factors and to work o u t their significance individually. However religion is one of the important factors. It is well known how Tawney has identified protestant religion-or t o be more accurate, the protestant ethic as a prime factor in shaping the destinies of a people wedded t o

Tawney has been carried away in his analysis by the c~verrinding significance attached to religion, it certainly cannot be denied that for the great majority of people in most countries and especially in the developing world the importance of religion as a motivating factor can hardly be denied - or overemphasised. Tax structure - the Pakistan context

The narrow base enigma has been a bane in the Pakistan tax structure from the beginning. In 1987 when the population of the country is a hundred million plus, the total number of income tax payers are just over one million. Agri income is exempt by statute in its entirety. A good part of the non agri income enjoys either partial or total exemption under some incentive provision. A host of deductions, exclusions, allowances further erode the taxable base. The net result of the situation obtaining is to yield a very narrow base indeed. The revenue that this truncated base is capable of contributing t o the exchaquer is bound to be poor. Eesides the factors cited above the huge parallel economy, whose size by one estimate has been determined to be half that o f the country's GNF', is almost completely outside the ambit of the fiscal operations of the regular economy and deprives the exchequer of huge revenues while latching on parasitically as it were to, the distribution!marketing and other facilities of the regular economy. While resource mobilization remains a primary o'bjective in the levy of income tax, of increasing significance, is the provision of incentives through deliberate manipulation of the income tax law as it impacts o n selected categories of taxpayers. The scope of fiscal measures expressed through the direct taxation of income is servely limited however, by the extreme ly narrow tax base. This is apprarent from the fact that direct taxes contributed only 13 % of the aggregate revenues in 1986-87down from 25 % in 1949-50 and 17 % in 1 9 7 9 8 0 . The taxation structure of Pakistan is characterized by a pronounced lack of any dramatic changefor better or for worse. The pattern of revenues yielded are: more or less, the same since independence. Over 80% of the tax revenues flow from indirect taxes and duties on imports are the largest single

Taxation Structure

category here. Per capita income has increased from Its. 396 in 1959-60 t o Rs. 6,336 in 1987. However the tax per capita has increased nominally. Considering that government expenditures on administration and defence (the forced division of the country in 1 9 7 1 notwithstanding) have escalated astronomically the inability of the fiscal apparatus t o provide the required funding has created a crisis state that by its very logic now generates pressures for change that could prove t o be irresistable. T o be sure foreign assistance has baled out the country for quite some time now. Yet the aid climate t o o is becoming more and more difficult and this too can only exacerbate an already bad situation. Fortutious political circurnstance in the relations between nations cannot be expected forever to provide avenues that become exit points from disaster situations. That the fiscal scene is dominated by rampant Lax evasion is frigheningly apparent from t h e brazen operations of the parallel economy and the ease with which rt,.gular business avoids the taxrnan. Tax evasion in Pakistan is rampant-as would appear even t o rhe uninitiated from the statistics given above. While due payment of income tax is not made by all categories of taxpayers the evasion is chronic and widespread in the non corporate sector. And ofcourse the by now monstrous proportions of the parallel economy are outside the reach of the taxman virtually in it.s entirety. The magnitude of tax evasion can be gauged from the r e port of the NTRC that estimated the total tax evaded income in one year at Rs 50, 763 million with the total quantum of black wealth amounting to Rs. 1,70,000 million. The abject failure of fiscal agencies to deal with the problem is apprarent from the fact that the total tax collected by the deptt of .income tax in one year is just about 35% of the (potential) amount that could have been brought in as revenue. The basic system of corporate income tax in Pakistan has been fairly stable over the years with an income tax of 30% and super tax of 30% o n profits-reduced t o 55% overall in 1983. The maximum rate of personal income tax has been reduced from1 97% in 1958 t o 75% from 1961 through 1964, t o 70%

Fiscal Ittlpem t i w s it1 Pahisratr 's Ecorron~ic.Developttrorr

from 1 9 6 5 through 1975, 60% in 1 9 8 3 thru 1 9 8 5 and 45% in 1986. In relation t o tax base, income taxes in Pakistan have been estimated t o have an elasticity co-efficient of l . 5 2 over the period 1952-53 t o 1963-64 and 0.83 over 1972-7'3 t o 1979-80. This inelasticity is responsible for the fact that increasing GNP is not automatically translated into proportionalbe increases ilk revenue. Progressive erosion of the already narrow tax base has resulted from the fact that the zero bracket exemption limit has been revised upwards from Rs. 2,500 in 1948, Rs. 6 0 0 0 in 1 9 5 7 Rs. 12000 in 1974, Rs. 18,000 in 1 9 8 3 and Rs. 24,000 in 1985. Further, a variety of allowances, deductions, clredits, rebates and other concessions have been allowed over th1.1 years. These have caused a sharp diminution in the the effective rate of tax. Originally designed as incentives for investment and industry, many of these now appear t o have definitely outlived their utility. Structurally, the direct taxation system in Pakistan has not shown much resilience and has not been responsive t o changes in the GNP, t h e per capita income, the distribution pattern of income among various sections of the population, the changing composition and scale of foreign trade and similar other parameters. This has been due mainly t o an inherent rigidity in t h e tax system. T h e inadequate coverage of the tax net due t o the blanket exemption of income derived from agriculture coupled with the plethora of so called incentive exemptions, deductions, allowances and assorted exclusions have dramatically reduced the impact of the income t a x o n the aggregate of incomes generated in the economy. Thus excelat for narrow segments t h e income generated in t h e rest of t h e economy cannot b e effectively subjected t o tax as there is no built in "automatism" that would (automatically) mop up potential revenues. T h e lacuna and loopholes in the t a x law are so many and so evident that not much effort o r imagination is required t o get away with a "token" payment. T h e only discernible change of any significance is in the fiscal incentives package that has been designed in various phases of t h e development programme of the coun~try.

Taxation Strucmre

Broadly speaking, the package of fiscal incentives put t o use in a particular period reflects an endeavour to help facilitate achievement of the specific objectives that have priority in the growth strategy for that time frame. It needs t o be pointed o u t here straight away that by themselves fiscal incentives cannot be expected to bring about changes o n a meaningful scale. Such change will take place only when the fiscal incentives package is correctly integrated into the overall planning and development format structured for the economy as a whole. Unless the incentive measures "mesh" synchronously with the variety of disparate elements that make up the development program of the country an asymmetrical situation will result in reducing or even nullifying altogether the designed efficacy of the incentive measures. In Pakistan, unfortunately, integration has left much t o be desired. Successful integration pre supposes long range perspective planning. This however, is one of the most conspicuously deficient areas in our development effort with the result that adhoc measures t o implement various policy decisions-including fiscal incentive lawshave become the norm rather than the exception . The net result of this has been that many of the fiscal incentive laws are noteworthy only in their intention rather than the results that have followed in %hewake of their enactment.

4 Base Broadening: a leading issue in tax reform:

That there are just over a million income tax payers in Pakistan is a perplexing enigma with serious in~plicationsf o r resource mobilization. Considering that the total population of the country now exceeds a hundred million, t h e taxpayer population is clearly minuscule. What adds dramatically t o the narrowness of this base is t h e fact that 60% (almost) o f t h e aggregate income tax collections, emanate frolm the corporate sector. That the position here t o o is skewed is apparent from the fact that a handful of multinationals and a smattering of public'sector enterprises fund t h e entire contribut.ion of t h e corporate sector. Thus the great majority of private limited companies, as also a considerable part of publiic sector units and multinationals exercise their t a x prowess o n paper-argueing claims for exemption, allowances, credits and rebates, exploring legal loopholes in the statute, contriving continueing losses, camouflaging acquisitions - in short doing everything but paying tax o n their income. As for the vast multitude in this tax universe comprising t h e proprietory businesses, partnershi;, concerns (firms), individuals (partilers in firms, individual recipients of property income, interest income, lease money etc) & A.O.P.'s, the less said -in 1:erms o f their relative tax contribution- t h e better. T h e wage earners and the salaried class,by and large, contribute their bit t o the exchequerperforce. T h e deduction of income tax at source leaves them no option but here t o o there does exist room for manouver for the imaginative, bold and enterprizing -and there are quite a few here who have these traits.

Fiscal In~pemdwsin Palcistan 's Econ<~rniCDevcloprnent

What are the root causes of the narrow tax base in Pakistan? Are the people so improverished that only 1%of the total population has the capacity t o pay a tax o n their earnings? While Pakistan certainly falls in the category of a developing country and poverty is certainly an issue of' significance, there is little doubt that the narrow tax base has nothing t o d o with these aspects of the economy - atleast not t o the extent that the base is narrow. There are two principal reasons for the state of the t a x base; (1)The largest single economicsector in Pakistan, Agriculture, contributing about 30% by itself to the gross domestic product and employirlg 60% of the total population, is outside the ambit of income taxationhas been since 1947; 2) the burgeoning "parallel economy" whose awesome economic potential is evident from the fact that some estimates place the income generaled therein at 50% of the GNP of the "regular economy," is affected only marginally by the income tax levy thus contributing practically nothing t o the exchequer. All income from agricultural activities has enjoyed statutory exemption since the inception of Pakistan and the reasons for such preferential treatment are supposedly rooted in the economics of the situation obtaining in the iagricultural sector. The arguments advanced by those advocating a continueing exemption from the levy of income tax to the agriculturists, revolve around the thesis that the burden of taxes that the agriculturists bear is such that they just d o not have the capacity t o suffer any additional t e a t i o n . Seccondly, it is alle ged that t h e nature of the landholdings and their geographical dispersal make it administratively difficult, if not impossible, t o attempt to make assessments of agri. income to charge income tax. What is required now is an evaluation of the veracity of the arguments advanced by the agriculturists lobby. Available data on the burden of direct taxes on agri shows that direct taxes on agri have risen at a :slower pace than the growth in agri incomes. The percentage of direct taxes on agri vis-a-vis the value added in aeri indibat~nt h ~ t h o w m o

has actually declined from 1.9% in 1972-73 t o 1.3% in 1978-79. Other data indicates that while direct taxes on agri income have increased by 78% between 1972-73 and 197'8.79, direct taxes o n non-agri incomes have risen by 182%. To be fair, direct taxes do not tell the whcrle story. Almost 8570 of federal revenues are derived from indirect taxation. The agriculturists argue that as indirect taxes are paid by all, it should be assumed that the agri populatiorn (the highest for any economic sector) bears the heaviest burden. Strictly on merit it is either fair nor logical to make a distinction between agri and non-agri incomes for purposes of taxation. A distinction so made arbitrarily amounts t o creating a preference for one class of income over the other. Instead of creating such a preference for which there appears t o be no economic justification, it is suggested by the counter exemption lobby that just as incomes below a certain level are exempted from income tax, the same principle should be extended t o agri income. This would take care of the subsistence farmers who would be automatically excluded. Levy of income tax on agri income is also recommended to reduce the evasion of income tax in Pakistan which is by all accounts, considerable. The availability of statutory exemption for agri income has resulted in the systematic exploitation of this exemption by those enjoying non agri income. Through the simple expedient of attributing part of their income t o agricultural activity they are able to secure substantial tax benefits. In reality ofcourse such people are not actually significantly engaged in agriculture at all. Powever since they have purchased agri land-which may be marginal land o r even wasteland (banjar) for all they care- it is not too diffic1111tto hoodwink the federal tax authorities on the bonafides clf the jnvestments made by them and attributed t o the earnings of tiheir agri holdings. O n another and more subtle plane, the "phantorn" flow of funds from agriculturists t o non agri business contrived artificially through the creation of "ghost" liabilities, has provided legal cover t o substantial investments funded b y accumulations of untaxed "black" money. Had agri income been subjected to income tax then it would not have been so simple a

Fiscal Impemrives in PaMstan k Economic DewIopmen:

matter t o create such liabilities as the affairs of the agriculturist would have been as much subject t o scrutiny iis the person engaged in business. So far however, the income tax authorities have no direct record of the agri activities. Only sketchy information of dubious origin is relied upon to decide on the bonafides of a reported liability shown as owing t o the agriculturist. Again, since bank accounts are as a rule not reported t o the tax authorities - only those accounts are reported that "suit" the taxpayer (or agriculturist) - the cash flow of funds constitute an added impediment in this context as these cannot be monitored. Thus if income generated by agriculture were made taxable, the "facilities" presently available through the "devices" mentioned above, for securing huge unwarranted, tax benefits, would be negatived. The feasability of mobilizing revenues from, thc: agri sector through direct taxation of income generatedl there is also apparent from the fact that the agri income tax would be more income elastic than land revenue. With a greater yield per acre, higher procurement prices and mechanization, incomes in the agri sector have risen considerably, but yield, in terms of direct taxes from agri, has lagged behind appreciably. To illustrate the point, it is pointed out that between 1 9 7 2 - 7 3 and 1978-79, the yield from the direct taxation of agri (land revenue and irrigation charges) increased by 7852, while value added in agri,at current factor cost, increased by 1 5 7 9 ~ . That the taxable capacity of the larger farmers (:who constitute the rural elite) has improved over time is evident from t h e considerable increase in consumption expenditure of the rich farmers. According t o Alavi, even when there are adverse changes in the terms of trade for agri, the rural e1it.e enjoy considerably enhanced real incomes. The conspicuous consumption of the rural elite is not only an indication of t h e steadily increasing affluence of t h e rich farmer but it is also a pointer t o another evil - that of accentuating differences in income, distribution in the agrarian sector. Progressive rates of income tax, if applied t o the income of this rural elite, could,over tirne,alleviate this malady, the persistence of which can only bode ill for the social stabili-

Base Broadening

ty of agraria and for the politico economic well being of the country in general. However one looks at it, there appears t o be little justification for a blanket exemption for agri income. There is no denying that the small farmer with a limited landholding may not be able t o bear the burden of additional taxation. However barring such exceptions, levy of an income tax would appear to be fully justified - and even necessary if the revenue needs of government are t o be met and if the federal government is to put an end t o deficit financing. An obvious consequence of bringing agri income within the pale of federal taxation would be t o broaden the income tax base considerably. This is obvious from the fact that more than half the population of the country is engaged in agri pursuits, Such base broadening would therefore mean more taxpayers and that would mean increased revenue for the federal exchequer. It ought t o be noted however that while the number of taxpayers will certainly increase, the additional income tax revenue realized as a direct consc.quence of doing away with the exemption presently available for agri income, would not necessarily be proportional t o the broadening of the tax base. This is because a number of concessions would still have t o be allowed to agriculture. This would be necessary t o say, encourage modernization and compensate for deterioration in the terms of trade. As for countering the huge losses in revenue suffered as a result of the depredations of the parallel economy, the matter has been dealt with indepth separately, in chapter 13.

The Taxation of Business Profits

Realignment of tax burdens among different business entities Different Legal entities are treated variously by current tax law. Thus the proprietory, t h e partnership, the Association of Persons and the corporate forms of business organization all suffer varying tax burdens for given levels of income. In addition the partnership and corporate forms are further differentiated between registered and unregistered firms and between Private and Public limited companies. The present treatment of different legal forms appears not t o have been designed to differentiate the tax load according to any clearly discernible criteria. Prior to 198283 the registered Firm category received preferential treatment. Thereafter the preference stands reversed with the private corporate entity best placed to effectively minimise tax burdens.

A uniform system for taxing business enterprize with specific relief features for small business, irrespective of the legal form of the business would facilitate greatly the structuring of optimal marginal rates of taxation-opthnal in a manner as t o balance revenue yield with equity. The objective ought t o be t o identify a "small business" not on the basis of arbitrarily contrived legal form but on the basis of income size and ownership characteristics. 41

I i

Implications o f a high marginal Rate of Tax:

In order t o appreciate all facets of the probllt?m it should be recognized that there can be situations in which a high marginal rate of tax can serve specific fiscal objectives such as when it is the intention t o mop up supernormal earnings of business generated by tariff protection, n~onopoly, inflation etc. The high, marginal rate emerges in such situations usually through the interplay of multiple tax rates on income, principall y through an excess profits tax which is levied in addition to t h e income tax. T h e need for such a levy (:an arise due to new revenue needs such as for special purrlose development activity or even during wartime. In the economic developmsnt context, high marginal rates can be theoretically justified on the ground that they would encourage employers with abnormally high income t o lower prices for t h e i ~products or in the alternate t o raise wages. Thus where the tar takes a high proportion of each additional unit of earning,, deductible expenditures are cheap and additional net earnings have little appeal. Furthermore a high marginal rate can serve as a symbol of the governments resolve to take excessive profits out of growth. Despite the possible advantages of a high marginal tax rate in certain situations it is also a fact that in a peacetime economy dedicated t o expansion and troubled by inflationary pressures a high marginal tax rate injects evident inequities, incentives to waste cheap tax currency and disincentives t o growth and efficiency. As far as multiple tax rates are concerned these are generally considered obsolete in the context of future tax planning. The verdict of fiscal authorities generally is that they are conducive t o waste and inefficiency. Where the high marginal rate emerges out of a high tax rate graduation of a single tax on income, this can be seen as a misguided application of the progressive ability t o pay principle that encourages framentation and discourages the growth of business enterprizes. A unitary flat rate would appear to have obvious merits from the standpoint of simplicity and consequent administrative efficacy. Nevertheless, the fact remains that it would not alleviate existing inequities in income distribution and could conceivably even contribute t o exacerbate the same. There would also b e considerable problems with working out an effec-

The T a x a t l a of Buslness Profin

tive unitary rate of tax that would ensure the same generation of revenue as the present graduated rate structure and at the same time reduce the burden of taxation. A true unitary system would mean doing away with imputation of corporate income. This would then mean loss of significant revenue from this area. Infact for private limited companies this is the only .area of revenue significance as far as t h e exchequer is concerned as only nominal corporate profits are disclosed "as a rule." (Because the company has a separate juristic c!ntit.y it is recogs tax, under nized as a person apart from its directors. T h , ~ the the present system, falls on both the company and its directors. Piercing the ccrporate veil however makes it only t o o evident that in actual fact the separate identity of the company is a fiction created by statute. The identity of the directors merges into that of the company . It is the company that in the final analysis pays the tax both for itself and its directors. In this view of the matter imputation of its income subjects the company t o multiple rates of taxation. A true unitary flat rate system would therefore necessitate doing away with imputation). The corporate ability t o retain earnings and disburse salaries t o its directors, rule out, given the present format of the statute, disclosure of significant net pre tax profits for the private limited companies which are under no pressure t o declare dividends It would be difficult t o offset the revenue loss from this area. T o o high a flat rate of tax would abruptly escalate tax burdens especially for the small t o medium enterprizes . At the same time the supernormal earnings of the larger enterprizes would not be mopped.up by government which in the long run would exacerbate inequalities in income disi,ribution. The deliberate planned quest for an egalitrian stxiety would thus remain unfulfilled.

A complicating factor in the structuring of a unitary flat rate tax system is the presence of many smcill o r new business enterprizes that need preferential treatment in order t o be able t o establish their roots and grow.Subjecting them t o a relatively high flat rate would thus run counter to the stated objective of ensuring their survival and prosperity as it is these p r e sent day small enterprizes that are ultimately expected t o grow LIP into the mature medium and large size enterprizes of tomorrow.

business enterprize is a generally accepted proposit ion, yet it has been argued that there does not really exist a good economic case for the preferential treatment of small 1)usiness. It is pointed out that the truly small business is econon~ically inefficient and it does not make much sense t o tau subsidize the inefficient. It is also pointed o u t that small busitless already enjoys, directly o r indirectly, some kind of price umbralla effect from the forward shiftin:: of heavier business taxes on large enterprizes so that tax relief o n t o p of tax :>hift.ing becomes a kind of unjust enrichment. Attention is drawn t o the fact that it is the new business that really warrants favorable treatment and n o t merely the existing small business-and for new business it may actually be advisable to give relief through measures other than provident tax subsidies. The countervailing arguments for according relief t o the small business enterprize hinge on the recognition that inevitable gaps occur in t h e credit and risk capital supply svstem and since small business depends heavily on internal funds for growth some tax forbearance is essential. Furthermore, it may not be at all practical t o attempt identification or "New business" vis a vis the small business. Anexisting srr~allbusiness e a number of years c in e ~ i s t ~ e n cfor a new business through change in! is not t h e sort of "new business" thrat t h e statute would like t o support and promote.

The taxation of agricultu ral income Rationale and alterllative approaches

It should be self evident that sv.ccessfu1 implementation of a meaningful program of economic dev~:lopment entails mobilization of sizeable resources t o fund the effort. It is not only t h e size of t h e program chai necessitates significant mobilization of resources but also the fact that a rapid rate of growth is required t o offset anti growth and growth limiting factors and t o yield that crucial extra t o lift the economy t o a threshold of self sustaining economic activity, It is vital in the context referred t o above t:o first target those groups - o r sectors - that have so far becn able t o escape tax liability under current law. Especially important here is the escapement of taxation o n income. Income from agriculture is exempt in Pakistan because the law governing the taxation of income ('I'he Income Tax Ordinance 1 9 7 9 ) declares such income t o be outside the ambit of taxability. The statute as presently in fo19ce was preceded by the Income Tax Act of 1 9 2 2 (as adapted for use in Pakistan by Act XI of 1 9 4 7 ) which t o o incorporated a similar exemption. The continuation of this exemption for agriculturists not only deprives the federal exchequer of significant potential revenue but also sabotages attempts t o inculcate the ideal of voluntary compliance which is central to t h e f~lnctionalefficacy of any system of taxation.

TABLE 5 COMPARATIVE B U R D E N O F DIRECT T A X E S O N AGRICULTURAL AND N O N -

AGRICULTURAL INCOMES ( RP

Mlllio

DIRECT T A X E S O N A G R I C U L T U R A L INCOME (LAND REVENUE & l R R l G A T I O N CHARGES). DIRECT T A X E S O N NON - AGRICULT U R A L INCOMES (CORP TAX. W E A L T H TAX. W O R K E R S WELFARE T A X . G I F T TAX. ESTATE DUTY).

S O ~ C Rashld ~ : & Arnjad -

T h e Management o f Pakistan's Economy 1947-82.

T h e t a b l e s h o w s t h a t while d i r e c t t a x e s c n agricultural h ~ c o m ehave incraosed b y 7 8 70 b e t w e e n 1972-73and 1978-79.direct taxes non-agricultural incomes have risen b y 182 %.

FLrcal Imperatives In PaMstan 's Ec:onornic Developt~retlt

In terms of economic effects a progressive land tax imposes penalties on the extensive cultivation of land. Logically, the greater the degree of progressivity in its structuring, the greater would be the incentive for an intensive - rather than an extensive - investment and productive effort. Administering a progressive land tax however is not without its problems. We consider these now. The progressive land tax we envisage may be levied "In Rem" or "In Personam." However, the land tax is generally viewed as a personal tax and has not been t~ased"In Rem." This aspect is problematic in that it is an obst,acl~to effective enforcement of the levy as it can clearly hamper the collection effort in litigous situations since delinquency could not be countered easily by successful attachment of the land. Thus while an "In Rem" basis would be clearly preferable for a progressive land tax, nonetheless, in cases where the economic circumstances of the owner are identified as,Jh e pivotal element in structuring optimal progressivity, the tax ,would have to be "In Personam" (i.e. personal). The rationale for the progressive land tiax being what it is - introducing a new progressive element into the tax structure, countering land concentration and stimulating more intensive land use - it would appear* reasonable t o entrust the :federal government with its administration as all the objectives specified are objectives of national economic policy.

An important problem is that of determining the manner in which progressivity is to be built into the land tax. In this context a factor of relevance would be the objectives before us that motivated the structuring of this levy. If the objective is t o discourage the unproductive use of the land, imposing the tax on each land "Unit" would serve the purpose. If on the other hand the objective is to generate revenue and reduce the concentration of land it would be better for the tax t o fall on the owner. Deciding on an adequate rate structure is difficult. The rationale for greater progessivity is an improved redistribution of income. Though laudable, realism dernands that public perception of the matter be given due weightage. Quite often

people perceive a nominal rate as being high and ignore the fact that the "effective" rate of tax may be quite low. Generally, the relative ease of evasion and problems of control make it difficult t o administer a progressive land tax. Thus large landowners could adopt the simple expedient of dividing their land into "Optimal" units - if the size of each "Unit" is t o be the basis for taxation. It shoul0. be possible also t o set up a number of corporate entities whose holding would not be subject to the progressive rates. Besides the administrative problems there could also be political difficulties in structuring progressivity and enactment of a suitable rate structure. The centraljai~thoritymay find this aspect the most onerous considering the risk involved of alienating an important part of the electorate. Keeping this in mind, one alternative could be t o have a flat. proportional rate of tax.

A Presumptive Income Tax An alternate to the progressive land tax coilld be a presumptive income tax. This would facilitate curbing tax evasion and stimulating agricultural productivity. Thus farmers who were able t o realize returns less than the presumptive basis fixed for the tax would have t o suffer higher taxation than those dissimilarly placed. Thus the greater the productivity of the land the less would be the impact of the tax. This by itself would be a powerful incentive t o pitch produktivity at the highest level possible. A desirable spin off of !.he tax would be the reduction in speculative sales of land if the tax were capitalized. The major problem here is that of determining precisely the presumptive basis to be adopted. One way would be t o estimate a "Normzl" yield for a given unit of area. This would require fixing a percentage yield considered "Fair."' The "Forfait" system as applied in France is an interesting alternate. Thus system entails estimating average income per hectare for each kind of farm activity aarried on and using this average t o estimate individual farm income by multiplying the averasfo not i n f i n m a nay hontgrn h x r t h o nllrnhor n f hoctsrac

devoted to that farm activity. This does not ofcourse permit individual evaluation of the particular circumstances of each , of farmer. Rather farmers judged t o be similarly ~ l a c e d more less, have to accept placement in the same general category with regard to a level of income considered reasonable. They are thus placed at par with regard t o suffering taxation although there would ofcourse be differences betweeri them. The assumption however is (and it does not appear to be an unreasonable assump tion) that such differences (between farmers similarly placed) would be marginal and not substantial. I t should be recognized however that successful implementation of a forfait system requires a high degree of administrative preparation. I t requires organizing an effective data base. Notwithstanding the difficulties there is the decided advantage of approximating closely the effective income - much more so than one general rate of return. A problem of significance that arises in the case of the presumptive income tax is that of deciding whether the presumed income from agriculture should be "Integrated" with the other sources of income or should be assessed separately. The former appears t o be the desirable approach. However it would have t o be seen in this context whether losses arising from agricultural operations can be carried forward and offset against other income. If the statute does not permit such carry forward and offset then ofcourse "Integration" would not be feasible. Ofcourse the actual possibility of deducting losses from farm income from other income realized would be minimal as there should normally be no question of loss in the case of presumptive incomes. At the same time it has t o be recognized that the law must make some provision for possible losses arising due to extraordinary circumstances viz natural catastrophes. At the same time care sho~mldbe taken t o ensure that deduction of nonfarm income losses from the presumptive income o n agriculture is not permitted. The Feasibility of Strvcturing Incentives for the Agriculture Sector: There appears t o persist a continueing fascination with the efficacy of incentives in increasing agricultural productivity. Across the board availability of credit Tor agricultural activity

Fiscal lmpemn'ves in Pakisran 's Economic Lleve/oprnen~

per se, subsidies on fertilizer, allowances for investment in .agri. machinery, for investment in variegated farm improvementsl'structures etc. etc. are especially favoured. In actual practice, however, the feasibility of these so called incentive measures does not appear t o have been conclusive1y established. Not only d o these incentives create problems in administering the tax but actual practice does not appear t o support the thesis that they necessarily lead t o increased productivity on the farm. It is therefore desirable that incentives be structured with great care and only where prima facie there is reason t o hold that they would have a beneficial impact on productivity. Concluding Remarks: Agriculture will have to make a much higher contribution to the federal budget given the imperatives of accelerated economic development and meaningful structural transformation of the economy as a whole. There appears t o be sound economic justification for imposition of really strong taxation on agri. income -especially on the big landowners. A progressive land tax combined with a presumptive income tax could yield good resuits both with regard t o generation of revenue and for achiewng other economic objectives. However where political impendiments to implementation of a progressive land tax are pronounced, other alternatives can and should be explored and these include structuring a fairly heavy proportional land tax. Whatever alternate is chosen (or "Mix" of alternates) it should be recognized that effective tax policy for the agri. sector will have to be formulated in conjunction with other specific meaqures viz land reform, technological change and specific measures t o improve the lot of the small farmer. The theoretical justification for levy of taxation on agricultural incomes revolves around the thesis that there obtains a potential capability in the rural sector t o generate surpluses which can be tapped to yield revenues for the govi. However this potential capability is not automatically translated into revenues for the govt. Far from it, without deliberate policy measures the ~largelyrsubsistence farming of the majority of farmers in the rural sector in most third world c!ountries would

TABLE 7 DlSTRlBUTION OF CROPPED AREA - PAKISTAN

Year

Food Grains

Cash Crops

Pulaes

Source: Provincial Agriculture Departments.

Oil Seeds

Veeetables

Condiments

Fruit

Others

5.1

Fiscal Imperatiws in Pakistan's Gconotnic D e ~ ~ e l o ~ ~ t t r ~ . ~ ~ :

continue the traditional farming stabilized a t a low level equilibrium. Characteristic features of the developing econcrmy include a predominantly agricultural bias,a high labor-land ratio, disguised unen~ployment, a substantial non--monetized segment, traditional farm technology poor access t o the market, inadequate transportation and deficient credit facilities. Whatever small surpluses are generated d o not find there way 1:o the market. There is thus very little demand for non farm articles as the resources for funding their purchase are deficient.. This restricts the possibilities of demand generated industrialization.

The objective o f development is t o structurally transform this predominantly agricultural economy and bring about industrialization. This requires resources. As the orlly avenue for generating resources is the agri. sector, ways and means will have t o be found to extract these resources. This however is easier said than done. As pointed o u t above, in most cases the capability t o generate resources in the rural economy is 'potential' not 'actual'. Levying taxation and its energetic realization however has been found t o be a necessary first step in initiating change. As there is no way t o escape taxation the only answer is increased productivity by cultivating available land more intensively o r bringing additional land under cultivation. The marketing of surpluses leads to monetization and commercialization of the agri. In order t o ensure that pro1:luctivity continues to increase, the extra labor on the land - the disguised unemployment - has to be shed. These laborers must now make their services available to the nascent industrial sector. The surpluses reelased from increased agri. production and transferred t o the urban sector through the market, fund t h e wage bill for the labor transferred and employed there o n projects. Also funded from this surplus these newly set up projects begin t o throw up their own surpluses which are then recycled into new urban projects. While it is true that the historical experience of Japan lends strong support t o the need for effective taxation of agriculture, nevertheless it needs t o be recognized that significant differrences exist between the situation in meili J a ~ a nand Dre

The taxatiotr ofagiiculrrcml income

sent day third world countries. The most marked difference is between the exercise of procrustean authority in Japan and the inability of most third world countries t o resort to such a stance in the latter half of the 20th century when the great majority of them have opted for democratization and popular participation where strict regimentation and wholesale command measures are difficult t o enforce making it that much more difficult for the executive authority to implement measures that might not find popular acceptanceand it goes without saying that taxation - of any sort - has never been popular! The political deterrent t o the exercise of procrustean authority prevents a reenactment of the scenario of meiji Japan. This does not mean however that the rationall:! for taxation o f agriculture is not as valid today as it was in the 1880's in Japan. The modalities are now required t o be different because o f a changed political environment. Before we proceed further o n the matter it must be recognized that the argument for taxation of agri. is NOT based exclusively on the thesis that the logic of t'he developnlental model requires that such taxation be resorted t o in order t o generate theresources to fund the effort - although ofcourse this is not untrue. However this is not the fundamental reason. That reason - which may not be immediately apparent - is that there exists a slack in the agri. sector in terms of untapped capability which the right set of policies can exploit t o release resources t o fund the overall develop effort. However if it be correct that no slack obtains in the agri. sector then it must follow that resort t o taxation would d o no good - indeed would cause a lot of harm - infact would bring untold misery for those who owe their existence to the land and might even eventually dispossess them. Therefore before anything else is done it must be shown t o the satisfaction of all that the agri sector does infact have this slack. The reason why govts are unable t o make headway in promoting a program of taxation of agri is because they are not able t o marshal1 the evidence that could conclusively clinche the issue in this context. It is not that this evidence is not there but rather that govt is not aware of what evidence to present and in what manner t o the populace at large t o convince them that such taxation measures are not only desirable from the point of view of the economic theoretician but also feasible. If that analysis can be

Fiscal Irnpera fives in Pakisrarr P Economic l > c v e l o p ~ ~ : . n r

TABLE 8 AREA, PRODUCTION AND YIELD PER HECTARE O F MAJOR CASH CROPS IN THE MAIN GISOU'ING COUNTRIES 1984-85 Country

----.----------

Area 000 Hectare

Product ion 0 00 Tons

Yield Kgs per Hectare

1 - SEED COTTON (PHUT1'Y) INDIA

8000

3750

46 9

USA

4233

7760

1833

BRAZIL

3321

1872

564

PAKISTAN

2242

3026

1350

TURKEY

750

15214

2032

EGYPT

440

1100

2500

MEXICO

28 3

65 2

2302

INDIA

3167

177020

55904

CUBA

1400

7 5000

53571

PAKISTAN

904

321.40

35 568

USA

302

254.27

84238

6000

75 000

112

8500

75893

5'250

67308

ECUADOR EGYPT MAURITIUS

presented in terms comprehensible t o the man in the street or the village - things would become much mlore easy for t h e govts finance wizards who want desperately t o levy t h e tax o n agri but are unable t o d o so because their arguments are just not convincing enough. Taxable capacity o f a person is based o n the income he can earn in a given period less the subsistence requirement f o r himself and his dependant family. What remains after meeting the subsistence requirement is t h e extra out of' which taxes can be paid. In a society with skewed income distribution those at t h e upper end of the skew will have t h e most capacity t o meet taxation levies - notwithstanding the fact that their subsistence requirements would be larger as their perception of subsistence would be different from say a small farmer with a limited landholding. Thus average per capita income data is not really very useful in defining taxable capacity in a given sector of t h e economy. We mu st know how this income is actually distributed. Inequalities of distrib~.~tionmust mean differences in taxable capacity. Sectorally, t h e contribution t o the GDP, the total inflow of public expenditures vis-a-vis t h e sectoral contribution t o govt revenues are the relevant factors t o be considered in assessing t h e fiscal performance of one sector. This performance may then b e compared with that of other sectors t o see whether all sectors are contributing uniformally - consistent with their economic potential - t o t h e national developnent effort. An analysis o n these lines will resolve crucial issues of intersectoral and interclass equity. Equity between different sectors in t h e economy demands that relative t o their economic performance interms of total income generated, total benefits received - public expenditures and economic surpluses yielded, different sectors must make t h e same relative contribution t o national revenues. If one sector contributes less because official policy discriminates in its favor then intersectoral inequity results. Similarly between classes of people - upper, middle, lower-placed in different sectors considerations of equity demand that people similarly placed in society in terms of their placement in a particular class should be making t h e same relative contribution t o national revenues. If they d o not then those who are unfavourably

Fiscal Impemtlves in Pakistan k Economlc Development

placed would suffer from a situation of inequity. Taxation levies therefore have t o be structured so as t o ensure intersectoral and interclass equity so that a perception of fairplay exists among the populace which perception is vital t o the effective conduct of national development policy which requires significant sacrifices t o be made by all strata of society. Cooperation of the people is thus vital and this cooperation can best be ensured by actively promoting equity by deliberately formulating policy in a manner as t o ensure that burdens fall as equally as possible o n all classes of people. In a developing country considerations oC agri productivity may acquire primacy over considerations of pure equity. That there exists an actual slack in the agri sector in Pakistan appears t o be indicated by various indices viz inefficient cropping pattern, underutilization of fertilizer, inadequate &/or improper use of pesticides/insecticides, improper use of irrigation facilities and misutilization of private investible potential in the hands of the farmers - all these are indicative of slack in the agrarian economy. Once the fact of slack being actually present is established then additional taxation will mobilize this slack and result in increased agri production because of the enhanced motivation for making up the income lost in additional taxation. The case of levy of land tax in meiji Japan is a case in point in this context. The heavy taxation of agri brought in its wake an increase in land and labor productivity which is unparalleled in the economic history of the world. Ofcourse it was the successful harnessing of the dormant capacity that led to the increased productivity. The agri sector is being favoured over the non agri sector as far as the fiscal operations of the govt are concerned. This is evident from the fact that taxation ,of agri incomes has enjoyed statutory exemption from the charge of income tax since 1947. Furthermore, indirect taxation which generates the bulk of the national revenues does not reach effectively all segments of the agri sector because of the persistence of

The taxan'on of ag~lcultumli n c o t x

TABLE 9 AREA, PRODUCTION AND YIELD PER HECTARE O F MAJOR CEREAL CROPS IN THE MAIN G1:IOWING COUNTRIES 1984-85

Area Production Country

000

Hectares 1. WHEAT

USA

26197

INDIA

23614

CANADA

13688

TURKEY

9000

AUSTRALIA

11959

PAKISTAN

7259

FRANCE

4832

MEXICO

1242 2. RICE (PADDY)

INDIA

42800

B' DESH

10500

THAILAND

9700

BURMA

4680

PH' PINES

3330

JAPAN

2315

000

Tons

Yield Kgs per Hectare

FIscal Imperariws in Pakistan 'S Econotnic Development

U.S.A.

1126

EGYPT

420 3. MAIZE

U.S.A.

29062

MEXICO

8864

INDIA

6000

INDONESIA

2500

ITAI,Y YUGOSLAVIA

963 2360

PAKISTAN

809

TURKEY

550

CANADA

1192

S ~ I I ~ PAuririiltiiral P. Statictirc nf Pakistan lQR5

Fisml Imperatives in Pakistan 's Ecotlornic. Developnrent

There is reason t o believe that the lower classes in the agri sector have not made as much a contribution to national revenues as the lower classes in the other sectors. The lower classes must bear a marginal tax burden that is consistent with their marginal ability t o suffer taxation. It has already been pointed out above that the indirect tax burden is not as heavy in bhe agri sector as it is in the rest of the economy - contrary (.o popular perception of the matter - The overall picture, looking to both direct and indirect tax levies, clearly indicates that the tax burden on agri is on the whole marlkedly less than the other sectors. Subsistence: Subsistence has different implications in the agri and the other non farm sectors. This is because subsistence has a biological as well as a sociological basis. In strictly biological .terms it entails the requirement to keep body and soul together i.e. it is essentially a survival matter. In that narrow sense it can be argued that the subsistence allowance both in caloric and monetary terms would be roughly the same. The difference in this context is immediately apparent however when we consider the sociological dimension as well. WhLenwe do this we take into the fact that families in the rural areas, in general, do not spend as much on fuel, lighting, house rent etc as do their counterparts in the other sectors. Infact the difference in the expenditure under the Heads cited can be quite siginificant. Furthermore other "necessary" expenditure that non agri families in general and urban families in particular have t o bear is that connected with clothing, footwear, medicine, education and even entertainment. In all these areas the agri family escapes much of the high expenditure enigma that the non agri family cannot - in varying degrees ofcourse. An additional complicating factor is that non agri families have to make the bulk of their purchases from the"marketw and have thus to contend with service and marketing costs that add t o prices.

In view of what is stated above it is apparent that "subsistence" in the agri sector costs less than in the non agri sector. That being so the incidence of indirect taxes - which generate the bulk of govt revenues - is necessarily markedly less o n the

The taxaticm of agricultuml income

TABLE 10 AREA OF CROPS COVERED BY GROUND PLaANT PROTECTION MEASURES - PAKISTAN --

Crop

Area sprayed As % of cropped area

Area sprayed a.s % of cropped area

6.0

4.4

PADDY

COWN SUGARCANE

OILSEEDS FRUITrnGET TOBACCO OTHERS Total

Fiscal Itrrperariws i ~ rPakistan's Ecoruriri? Dcvc~loprrre~lf

TABLE 11 PAKISTAN POSITIONS IN VARIOUS CROPS AN INTERNATIONAL COMPARISON

Pakistan position

Vl'o r ltl Tot a1

Wheat

8 Countries

Rice

El Cclurr tries

Maize

9 Countries

Seed Cotton

9 Countries

Sugarcane

'i Countries

Source: Agricultural Statistics of Pakistan 1985.

The data tabulated in Tables 6 to l ' k indicates that there is a good deal of "slack" in Pakistans agriculture and there is room for significant improvement in productivity through extension of cultivated area, use of fertilisers and plant protection measures (use of insecticidesipesticides). In the opinion of many, levy of taxation on agricultural incomes forces the otherwise complacent and conservative : agriculturist to increase unit output (productivity) to compensate for the revenues lost t o taxation.

The mxation of agricultuml income

agri sector than elsewhere. This therefore adds t o the advantage that the agri sector has through the income tax exemption. In other words we can conclude safely that the tax burden there is markedly less than in the non agri sectors. This is contrary to what many commentators say - especially those who speak "for and o n behalf" of the agriculturists - who would have us believe that the tax burden is infact roughly the same for the agri sector vis-a-vis the other sectors since indirect taxation which everyone has to bear must have an exaggerated impact in the agri sector as the majority of the population resides there. Lower subsistence requirements in the agri sector mean a higher relative taxable capacity. That is why we say that the agri sector has the potential capability to suffer much higher taxation than it currently has to bear. The incidence of benefits of public expenditures is another important aspect t o be considered in the context of the economic argument in favour of additional taxation of the agri sector. An analysis of public expenditures on the current and the capital account would reveal that the govt expenditures incidence is much greater than the tax incidence on the agri sector. This implies a net outflow of public funds both on the current and the capital account from the no:] agri sector t o the agri sector. What it boils down t o is the inescapable fact that the agri sector is receiving much more monetary funding than it is contributing. A case of intersectoral inequity is thus established.

7 Tax legislation in developing countries

In the modern era the continued improvement in the material condition of a people has been a goal cherished by many but practically achieved by a select few. In recent times and especially since the cessation of hostilities among the warring nations in 1945 a host of newly independent countries have made their advent on the political map of the world. Most of these countries, released from colonial bondage, found themselves bogged down in the morass of pover1.y. IIowever taking a (cue: from those amongst them who through concerted, deliberate effort had succeeded in forcing change in the material well being of their peoples, the planned quest for economic betterment is now a ubiquitous phenomena. Different countries have however met with varying degrees of success in pushing back the rising tide of poverty. The common rc?alization is however, that ordered development is a multi dimensional effort based on many variables. One of the key areas in planned econonlic development is the fiscal dimension that focusses critically on ways and means concerned with the generation and disbursement of Government finances. It is generally acknowledged that tax legislation and tax administration play a key role determining both the pace and direction of economic development. Restructuring the tax system has a high priority in countries faced with inequitable distribution of wealth, inadequate domestic resource availability and deficient fiscal machinery to curb the fires of inflation and t o influence savings and investment patterns.

Fiscal I t n p e m t l w r in Pakistan 3 Eccmornic l ~ e w ! o p r n e n r

Much of the interest shown by third world governments in modernizing their fiscal opparatus stems frorn a desire to accelerate the pace of economic development. The principal areas of interest are those concerned with generation of revenues and include improved taxpayer compliance and the search for new, hitherto unknown sources of revenues. Another byproduct of the heightened interest in this; sphere is the attempt to use the fiscal mechanism t o divert the flow of wealth away from activities that hinder or obstruct economic development and towards those activities that promote orderly, effective growth. Development oriented tax legislation takes the form of tax exemptions, subsidies, special allowances under the corporation and individual income taxes for accelerated depreciation or reinvestment. The objective in mar,y cases in which these "incentive measures" are incorporated in the statute through specific legislation is the promotion of indust~:ializationwhich is seen by most developing countries as the sine quo non of economic progress. However a variety of non industrial activities are also promoted through these incentive measures cloaked in the garb of tax preferences, Such activities include promotion of private saving, construction of housing and the like. As mentioned above, industrialization i an objective of high priority in the developing countries plan of action drawn up t o break through the poverty barrier and take the economy onto a new higher threshold. For this reason tax incentive legislation usually focusses critically on this area.

The most important objective is t o provoke, through the impetus of tax incentive legislation, economic pressures for the channelization of investment flows towardls manufacturing activity identified as being specially desirable from the standpoint of the structural transformation of the economy, accelerated economic development and long term growth prospects. This is not t o say of course that all these objectives are capable of realization through the same measures but the general thrust is towards their realization and the incentive measures are consciously tailored with such objectives in mjind. While tax reform measures focus o n generation of increased revenue, eliminating arbitary or unfair differentials in

I 1

tax burden distribution and ration4izing archaic procedures in vogue in tax administration and modernizing tax administration through induction of technology and modem management ~ractices,the impact of tax incentives is t o erode tax revenues, create new differentials in tax burden distribution and burdens the administration with new pressures. The negative features cited above notwithstanding, tax legislation is perceived as contributing directly t,o an escalation in investment activity that would lead t o heightened economic activity and, over time, hopefully play a key role in the development drive. Such 'induced investment' activity would also lead t o increased generation of revenues. In this manner therefore, incentives are seen as actually laying the basis for greater long term generation of revenue i.e. once the gestation period involved in setting up an enterprize has elapsed and the unit is capable of productive output and positive profits.

Tax incentive legislation is however not universally applauded. For from it it is perceived as institutionalizing features in the economic system that ultimately distort patterns of investment t o create an undesirable bias towards capital intensity which directly contributes t o exacerbation of the labor redundancy problems that beseige most developing countries and furthermore - and more dangerously - make such enterprizes viable which without the crutches of tax incentives would clearly not be viable. Thus inefficiency becomes deeply ingrained in the economic format. The increased projection of revenue from the induced investment stimulus of incentive measures are also seriously questioned. It is felt that there realy is no, guarantee at all that there will infact be such investment atleast on the scale necessary for benefits t o outweigh the costs. There is one area however in which tax incentive legislation can unquestionably lead t o benefical results. This is when tax incentives become instrumental in actually leading to tax reform. This can conceivably happen when the incentive removes a factor in the tax system that militates against the dictates of economic development. For instance there is no doubt that generlized tariff walls that have a becomea seemingly perpetual feature on the economic landscape will create hindrances in the way of economic development by preventing, among other things, the importation of industrially necessary

machinery or equipment. Now incentive legislation that removes the tariff generally or selectively will remove this artifically created bottleneck. In its effect it would coincide there fore with tax reform measures that aim t o eliminate such bottleneck choke points in the economic system generally that inhibit; industrial development by making impossible a smooth supply of vital raw materials and ancillary equipment,. The rationale for tax incentives rests on tlhe presumption that these render otherwise unpromising investments attractive as they make possible accelerated recovery of capital and a higher rate of return. Furthermore, tax incentives release investible funds that would otherwise have been absorbed in defraying tax demand. Thus re-investment becomes possible and the significance of this in the context of capital deepening and widening can rardly be overemphasised. Besides these directly relatable reasons, there is the additional fact that such incentives contribute to improving the overall investmtmt climate and are thus crucial in attracting funds that would i:n their absence flow to alternate applications elsewhere where the investment climate is relatively more conducive. As a general statement much of what is statc.d above would appear to be plausible. However a more rigorous analysis necessitates that the relationships amongst the key parameters be explicitely stated. That however is easier said than done. The main complicating factor here is that it is not easy firstly t o isolate the parameters that , in a given socio economic set up would have a bearing on investment decisions and secondly, even if all - or most - of these factors were actually identified, even then it would not be practically possible t o establish a precise cause and effect relationship between either the totality of these factors and an invest decision or between oneor a few - of these factors and the investment decision. In other words it is really not possible t o quanify in any meaningful manner, the net value of an incentive provision in terms of its capacity for stimulating investment. The "Mix" of factors that are of consequenl-e in determining the attractiveness of an investment decision include the quality-besides the availability- of infra structure facilities. Also significant are the investors largely subjective, (due to the absence of adequate statistics) assessment of present and future

Tax leglslatlon in developing countries

market conditions, availability of labor, credit, raw material, power, transportation, distribution facilities, skilled manpower etc. Besides all these there is the added complication of the ever present possibility of political ferment and up'heaval with its atlendent highly adverse impact on economic stability. For all these reasons the role of the tax factor is to a considerable extent indeterminate and this would be true no matter whether taxes are high or low as it is not at all axiomatic that high taxes should necessarily and in all circumstances meian low profits. Infact the profitability of a venture would appear to be more directly linked to the quality and level of public services and market facilities rather than the rate of tax per se. There is ofcourse no denying that prohibit.ive rates of taxation can indeed be disastrous for profitability and therefore in the assessment of prospective investment. But then it veyy rarely, if ever at all, happens that a truly prohibitive rate tax schedule is struc t u r d deliberately. So varied is the ecology of tax administration that it is not really possible t o make a meaningful comparative study of the role of tax incentives in stimulating investrrient in different types of political, social and economic environments. Thus if it can be shown that certain types of tax incentives have been useful in one country it does not follow that these woud also be useful in another country - and this would be especially true if the comparison were being made between a relatively less under developed country and another that is rather more underdeveloped. From what is stated above it would appear to be rather mystifying then as t o why have tax incontives been as popular as they have been with most development planners. It appears that the pressures for taking decisiorls to further economic development being what they are in t,hird world countries tax incentives offer a relatively easy way out in the sense that with their enactment planners and legislators both feel that they have done their bit t o do something concrete which can be cited as an achievement before the public at, large and before important international forums as well. The latter is es~~ecially in the context of eligibility for foreign aid and it is widely perceived that taking such decisions improves the aid climate obtaining in a country thereby making it attractive for the . I , . . , "

., ;,, , ..+

The rationale for exemption from income Tax: The stimulus from an exemption from income tax manifests itself in an increase in the prospective return that an investt o r may be able t o realize from an investment opportunity. Typically this occurs by an enhancement in the internal rate of return. Thus, for example, the internal rate of return from a given business venture could b e say 5% under a 50% income tax' Now assuming that this 5% rate of return in not adequate as an inducement t o invest what possible implication can say a five year tax exemption have? Given a perpetual annual return of Rs. 1000 deriving from an initial investment of Rs. 10,000 the 5 year tax exemption would increase the annual rate of return by 305 ie t h e 5% internal rate of return would after the exemption, be pitched at 6.5%. This could then be the critical point which would be sufficient t o induce the investor t o commit funds for the prospective enterprize. The stin~ulusvalue of exemption from income tax is magnified when it is combined with exemption from other fiscal levies like import duties. In actual practice the income tax exemption is infact added t o an exemption from other such levies. While the exemption undoubtedly boosts profitability it must be recognized that its precise impact in boosting productivity and therby making an investment opportu:nity that much more attractive is but one aspect of the stimulus relationship. Another, and probably eqllally significant, if not more, aspect of the fiscal dimension here is t h e psychological impact of the incentive measure in determining an investors pe,rception of the investment climate in t h e jurisdiction where tliie incentive is operative. Thus if t h e investor is suitably impressed by the range .,f incentive measures in vogue his assessment of the potential vorth of such investment may go beyond what a simple costbenefit equation would suggest. If such infact be the case then tax relief would act as a psychological triggering device that compels and draws capital and enterprize t o rriove t o where such relief is available. An important aspect in this context is the relation o f income tax exemption t o incentives provided by special depreciation allowances.

legislnfion in dewloping coun Mes

Despreciation and t h e acceleration of depreciation, figures prominently in the outcome of an investors decision t o invest because it can dramtically alter the profitability position by signiPicantly reducing taxable income. The method of depreciation would be significant here for it would determine how rapid t h e write off is. Needless t o say the more rapid the acceleration the more t h e tax base would be eroded. Combining tax exemption and depreciation is however a different proposition. As far as an enterprize is concerned during the period of exemption the best results are (obtained with the most decelerated depreciation technique. In this way most of the depreciation allowances would still be available after the expiration of the exemption period. Otherwise the bulk of such nllowances would be consumedduring the period 1.heexemption ;s operative. While tax exemption is a stimulus both for the domestic as well as t h e foreign investor there is doubt as t o !,he magnitude of t h e incentive measure. Investor gains take the form of enhanced financial ability and increased incentive t o undertake business operations in the exempt sector. Experience would appear to indicate that the financial ability t o undertake investment is most improved by exemption from import dutiesl' Refief from income tax aids in the ability t o undertake further expansion but would not appear t o play such a large initial role although it could mean that loan capital is easier t o obtain since the chance of having the means to amortize debt will be greater. On the other hand the incentive to invest is increased by the granting of income tax relief or the estimated prol'it picture will generally look much better but there is little incentive for further expansion unless the enlarged facilities also receive tax exempt status. While enhanced financial ability effects zre very important for local investors who have difficulty in raising sufficient capital t o operate an enterprize these might be less important for the foreign investor who can more easily tap capital funds o n reasonable terms in the home country. Incentive effects that appear in the form ctf a rise in the prospective rate of return are important for all investors who emphasis profitability. They become very important for t h e

Fkcal Itnperarlws br Pakistan's Ir'co~romlcDewlopmetrt

local investor if they are strong enough t o raise the return in manufacturing t o the point where investment in that. sector appears more profitable than investment in some more traditional line. For the foreign investor however the incentive effects assume significance only if they raise the rate of' return over that which could be obtained in manufacturing in some other country.

Tax exemption: R.evenue loss VS benefits: Having acknowledged that tax exemption is infact a viable investment stimulating device it would be desirable t o ascertain the extent to which the benefits in the form of net new investment are sufficient t o cover the loss in revenue a:;sociated with grant of such exemption. In order t o make such a comparison, it is necessary t o distinguish between fiscal sacrifice, or the gross revenue loss, and true or net revenue loss associated with the extension of exemption to enterprizes that woulcl have invested without the subsidy. Viewing the exemption program in isolation, a possible criterion with which t o attain the optimum structure of the exemption system would be t o offer benefits to the point where the incremental value of true revenue loss is just; equal t o the incremental value of the investment induced by the st.imulus. In other words, the aim is to maximize the difference between net induced investment and net true revenue loss. In terms of the criterion for maximization o f the difference between net induced investment and net revenue loss the following equation would help clarify the matter. Change in total revenue loss change intotal investment

Induced investment Autonomous investment.

Thus if it is argued that for a marginal addition to total investment the increment in gross revenue loss will just equal it, so that the left hand side of theexpression above is unity, and if it is further argued that half of the additioi~alinvestment is directly induced by the exemption stimulus while half is autonomous, (would have occured without the exemption), then the exemption program will just be paying fok itself in the sense that an added rupee of true revenue loss is associated with an

Tax legislation in developing c o u r ~ ~ ' e s

added rupee of induced investment in general. On the assumption that gross fiscal sacrifice will equal gross investment, induced investment must exceed autonomous investment in order for net benefits t o arise. Even if an exemption program were judged cln the basis of the suggested criterion t o be a no gain proposition, it would not necessarily follow that it should be rejected. In i3 dynamic situation, the timing of investment under the exemption program may mean that the economy will reach the stage of self sustaining growth more rapidly with the program than without it, even though the criterion indicates that no gains are to be made. On the other hand a judgement of substantial net benefits in terms of the criterion does not necessarily mean that a tax exemption program should be accepted. ,qpplication of this criterion simply indicates whether this part~culnrprogram is worthwhile. It cannot indicate, without further information, that some other program will not have an even higher yield. Because of t h e many problems connected with income tax exemption, it would seem highly desirable t o explore other avenues of approach t o the problem of investment stimulation via the tax mechanism. Schemes that might relieve tax burdens in a more desirable fashion than the income tax exemption measure such as the allowance of tax relief c.ntil the initial investment has been recouped together with 7;arinus devices that permit delay in tax payments (deferral) ol,ight also t o be looked i n t o . It must be remembered that manipulation of the tax mechanism alone is not likely to produce astonishing results in promoting investment in less developed countries. The barriers to investment are complex and diverse and no panacea exists that, will bring them down. It may even be doubt,ed that the tax structure is important in the minds of undertakers of new business enterprizes, although it may become more significant at later stages of expansion. Insofar as this is the case, better results might be attained by concentrating tax concessions in the area of promoting desirable expansion by ex.isting firms and attempting t o attract new enterprizes through other types o f inducements.

Fiscal Iv~perativrsin Pakistan's Econotnlc Development

exemption program that the venture is not likely to be blessed with great success in the form of vast increases in investment. It should also be understood that tax exemption schemes although relatively simple t o legislate, are difficult t o administer, and that the use of this technique is fraught with the dual dangers of loss o f equity in the tax system and the possibility that the government will be unable t o finance needed expenditures without inflation. The second dimension relates t o the potential. for earning a return on money not needed for immediate use-interest. The time factor is of relevance here in that a higher earning of interest follows the deployment of funds for investment over a longer period. Profitability analysis takes this phe~iomenoninto account by discounting sums that will be received in the future and adding interest to sums that are received prior t o a reckoning date. Thus, money benefits of equal amount will not be termed equal if they accrue at different times. Amounts received prior t o a reckoning date will be worth more, and ammounts received after such date will be worth less, than the same absolute magnitudes received at t h e reckoning date. The differential depends on the time interval and thc. interest rate. In other words, it is possible t o find a rate of interest o r discount that will make sums of different absolute magnitude accrueing at different times equal in absolute amount. Fiscal incentives that d o not directly reduce initial outlay requirements may nevertheless affect financing indirectly through their influence on prospective profits. If exemption from profits tax is offered for ten years and if the tax rate is 50%, after tax profits will be 100% greater during the exemption period than they would have been without the incentive. This goes a long way in facilitating expeditious capital recovery and as such constitutes an important investment stirnulus. The same observation applies t o a variety ~:)fra.pid amortization (accelerated depreciation) schemes. In order t o simplify the analytic format i t would usually be necessary t o make assumptions about pertinent factors having a bearing o n the operational aspect of the incentive measure in general. Assumptions must be made about some o r all of the following: future costs,revenues and irlvestment plans; t h e timing of benefits; the relevant horizon (time span) for

i.r legislotfon in

developing c w n n i e s

evaluation of the benefits; the rate at which futurc:t returns are to be discounted; the exact nature of benefits etc. Assume that there exists an investment opportunity that entails an initial outlay for the acquisition of equipment of Rs.1000.To make the analysis simpler it is assume!d that these are the only costs involved. The expected life of the equipment is assumed t o be 1 0 years . Let it also be assumed that Rs. 200 of the initial outlay consists o f import duties and that the anticipated gross operating profit is Its. 200 per year and that the income tax rate is 30%. The problem before us is t o discover the potential rate of return o n the investment with and without tax incentives. The annual cash flows associated with the investment opportunity without any incentive in force would be Rs. 170. (Annual gross profits Rs. 200 less annual income tax Rs. 30). Thus over the ten year lifespan of the equipment net returns of Rs. 1700 would be generated leaving a profit of Rs. 700 over and above the cost of Rs. 1000. The rate of return implicit in these data is that interest rate (rate of discount) which will just equate the series of Rs. 1 7 0 per year to the irritial outlay of Rs. 1000. In the present case the rate of discc~untwould be 11.1 %. Given a gross profit rate of 1 7 % it is clear that it pustulates a profitability position that is in excess o f the discount rate that would equate the future stream of Rs. 170 per annum to the investment cost of Rs. 1000. Now with incentives coming into play let us assume that a waiver of import duties is ordered as is an exemption from income tax. The first measure reduces the initial acquisition outlay by Rs. 200 so that the equipment in question an now be had for Rs. 8 0 0 instead of Rs 1000. The exemption from income tax increases t h e annual return t o R s 200--from Rs. 1 7 0 previously.. The gross profit rate now jumps t o 25%. Over the ten years lifespan of the equipment the investment will now generate Rs. 2000 which will vield a profit of' Rs. 1200. Cost can now-because of the incentives-be recouped in four y e m instead of the 5.88 years without the aid of incentives. From a practical standpoint it obviously makes more sense t o choose that set - or combination- of inclentives that raise the prospective rate of profit most.

FLrca[Imperarives In Pahisran's Ecorromlc Development

Depreciation of wasting durable assets a!;sum.es significance in that it is the accumulation of such durable capital stock in the shape of industry that is at the root of much of the development effort of third world countries. It is widely beleived that in order to stimulate private investment in depreciable assets something more than a "normal" provision of depreciation is required as a deductible expense item. This stimulus measure most often mamifests itself as an accelerated depreciation incentive measure that permits a more rapid write off of an asset than its normal usage in a given activity ent.ails. Among the various types of rapid write off methods, the initial depreciation deduction which provides that a definite percentage of an approved investment may be deducted from income or profits in the first or early years of the life of assets, is the most widely employed. Tax systems in less developed countries are often not well adapted t o the requirements of a modern industrial stxeity, and this fact places limits on the usefulness of any particular incentive device that is appended to the system. In practice, many incentive devices that can be employed in more advanced countries may not fall within the range of administrative competence in less developed countries and other "incentives" may in fact serve merely to offset obvious defects in a given situation . Although no system is perfect, the (,ax systems of less developed countries are too often composed of a patchwork of provisions containing many flaws and imperfections.. In some cases the letter of the law is not enforced; in others, the law is not fully understood . On the other hand since the incentives that willsbe considered here affect primarily enterprises in the modern sector of the economy, it is likely that conditions will deviate from those in more advanced economies much less than might be supposed. In the modern business sector, much higher standards of tax enforcement generally prevail than in the traditional sector, and investors in this sector are likely t o have access t o sophisticated tax counsel and t o be motivated in much the same way as their counterparts in more advanced economies. A necessary condition for an effective tax incentive is a substantial tax from which relief may be granted. While a few countries in the less developed countries of the world may

Tax legiskztfon in developing countries

have rates that are too low t o meet this condition, the median rate on corporate income of about 35% is sufficiently high for meaningful incentives. Moreover, higher rates are not uncommon. Because accelerated depreciation means that deductions for tax purposes may be taken at an earlier date than before, even though the total amount of the deductions is in the case of a single <asset,,thesarne as in the normal depreciation case, the rate of return will generally be raised. Since funds that would otherwise be turned over t o the revenue authorities remain for a time in the hands of the taxpayer he may be thought of as the beneficiary of an interest free loan, the proceeds of which may be invested at a profit. One met.hod of measuring the effect of the loan is t o compare the expected internal rate of return from a given opportunity with normal depreciation and accelerated depreciation. For exa:mple, if the pre tax rate of return is 5% and the statutory tax rate is 50% the after tax rate of return o n an asset with a 20 year life span will be 2.65% when depreciation is taken in equal instalments over the life of the asset; and it will be increased t o 3.84% if total depreciation is taken in equal instalments over the first five years. Variation in the treatment of depreciation allowances for tax purposes may influence decisions t o invest in depreciable property because of its influence on three important variable - The rate of return, risk and financial resources. For purposes of investment profitability analysis the present value of depreciation deductions may b e considered as equivalent t o a reduction in the cost of assets From this point of view, by offering depreciation deductions the treasury is in effect helping t o finance capital outlays. When the present value of the allowance is raised from 10% t o 32%,,the treasury is actually reducing the cost of assets an additional 22% and it is posible t o convert a reduction of this kind t o in equivalent increase in the prospective rate of return from the investment. In general, accelerated depreciation of the types most frequently employed will act to increase prospective rates of return by a few percentage p o i n t s

.Fiscal Impemtlves in Pakistan r .liconomic Development

Accelerated depreciation involves changing the pattern of discrimination in the sense that the new depreciation system will almost invariably favor certain kinds of investment more and other kinds less than the old one. A change from ordinary straightt line de~reciationt o straight line with initial depreciation deductions clearly favours longer lived investments,while a switch from straight line to declining balance depreciation will yield a pattern of discrimination which depends on the discount rate, but which generally most favors assets with medium lives. Unfortunately analysis of the effects of accelerated depreciation on the rate of return cannot lead to any definite conclusions about the ultimate effect of accelerat:!on on investment decisions. Before any predictions on this score can be made it would be necessary to know the elasticity of investment demand with respect to an increase in the rate of return. A priori, however it would seem unlikely that investol. responses would be highly sensitive to small increases in return rates and an elasticity as great as unity would probably be an optimistic asumption since it implies that an increase in the rate of return from 10% to 11% (a 10% increase) will lead to a 105% increase in investment demand. To achieve a response of this magnitude there is no doubt that acceleration would haire t o operate in a favourable investment climate that tends to minirnise risk factors and provides adequate financial resources. Such conditions do not generally exist in less developed countries, but accelerated depreciation itself may help to create some of them. While evaluating the influence of accelerated depreciation on rates of return investors in the real world often rely on simplified techniques or rules of thumb rather than- more accurate and rigorous technical analysis such as the use of compound interest calculations. Perhaps the most widely employed device of this kind is the pay-of!! period approach in which the acceptability of an investment is judged on the basis of its ability to return sufficient profits (gross of depreciation) in a specified number of years, generally less than half the normal life of the investment, to repay the initial outlay. In its pure form this technique uses no explicit discounting procedures. Thus if an investment costs 100 and is expected to last 10 years, returning gross profits of 211 per year, and if a 5 year pay off period is demanded, the investment will just meet the requirement.

Tax

legisbtion in developing counnles

To illustrate further the use of the pay-off period criterion in making investment decisions in the context of fiscal incentives structured to facilitate flow of funds to a particular sector of the economy the following example maybe cited. Suppose that a four year pay-off period is r equrred and there is a 50% tax rate if an investment of 1 0 0 in a machine promises t o yield gross profits of 30 per year over the 1 0 year life of t h e asset. After tax this will be reduced to 2 0 per year when depreciation is taken in equal instalments over the 10 year span. Consequently five years will be required for t h e investment t o pay for itself and if a four year pay-off is demanded the investment will not be made. Now if full depreciation is allowed in equal instalments over five yearshowever,tti~eswill amount t o 5 per year over the first 5 years leaving gross profits of 25 per year towards paying for the investment. Thus the four year pay-off period criterion would be met indicating acceptance of the investment.

Factoring in "Risk" in making feasability assessments is important for this is a key parameter albeit somewhat vague and even indeterminate, some might say. The fact is however that most business ventures are inevitably attended with risk. Some risks1 can be insured against but not all risks are amenable t o such insurance. The willingness t o bear this kind of risk or uncertainty is at the foundation of entrepreneurial activity. Because the group willing t o bear the responsibility for the outcome of risky ventures is rather narrow in a developing country, policies that reduce the degree of risk associated with growth promoting investments are extremely imponant. Be cause accelerated depreciation improves prospective profit rates and rr~akesinvestment in depreciable assets more liquid it may be said t o diminish risk in a general way when the problem is viewed in a narrower context. However, it is not always true that acceleration provides a greater stimulus for more risky ventures than less risky ones. In a very general sense it may be said that inv~storstend to allow for risk by discounting anticipated future pr0fit.s with an interest rate that rises as a function of the degree of risk invol-

ved. Thus more risky ventures will often be asked t o bear the burden of a higher rate of discount. Risk producing factors are likely t o increase with time and the risk factor may therefore be accounteti for b y employing a discount rate that rises with time. Since the crude pay-off period approach implicitely posits a zero discount rate during the specified pay-off period and an infinite one following that period it may be thought of as a special liniting rase of the discount rate that rises with time. More sp~cifically,the riskier the opportunity, the shorter the p a y a f f period will be relative to the life of the investment. Finance: It has been slated abovr that accelerated depreciation does have the effect of raising the prospective rate of return from a single investment. Uilder t h e usual circumstance obtaining in the real world, and especially in third world co!intries, the offer of accelerated de?retldtlon often aimour1i.s to a conditional prornise of financial benefits that will arise ( j l l i ~in the future. Even with initial depreciation deductions, the benefits may not significantly influence the ability of a new firw t o finance its original outlay, although an older t5stablis1,ied enterprize may have sufficient income from other sources t o enjoy direct and immediate financial benefit in a perfectly conlpetetive capital market. T h e new firm would be able t o imrrcsv the amount represented by the present value of the expected benefits, but in imperfect markets, the existence of futu:e benefits may have little effect o n t h e firms ability t o finance the initial investment even though acceleration increases prospective profits. Where the major problem of investors is raising sufficient funds t o meet the original costs cf a new investmeni , a greater incentive may be obtained with direct subsidies, low interest loans, relief from taxes applicable t o investment out la:;^, or other similar devices. In the longer run, however accelerated depreciation can significantly enhance the ability of the successful enterprize t o undertake expansion o r replacement expenditures. Since the successful firm will have a growing stream of investment expenditures, the amount of the "loan" which it derives from rapid depreciation allowances will increase steadily. This is so

Tax legi~lationin developing counm'es

because the larger deductions taken in the early years o f life of the enlarged stock of new depreciable assets more than offset the fact that smaller than normal deductions are allowed during the later years of life of older assets. Contrariwis~?,if the firm is not successful and shows a declining stream of investment, the srnaller than normal deductions associated with older assets will predominate so that the interest frets "loan" will predominate. Finally, the firm that just maintains its stocks of depreciable assets will neither increase nor decrease the size of its "loans" once the stage is reached where depreciation funds are used entirely to finance the replacements required to maintain its capital stock intact. From the analysis made so far it would appear that simple tax rate reduction is not strictly comparable to a change in depreciation systems. This is both a merit and a drawback of accelerated depreciation. I t is a merit because a careful selection of a system can provide a desired discrimination even if statutory tax rates are the same for all. It is a drawback because the extreme complexity of the discriminatory patterns presenl.ed by various systems means that the ultimate effects are difficult to anticipate. In some important respects the differences between tax rate reduction and accelerated depreciation are of greater moment. Tax rate reduction offers an obvious advantage to firms and they may adjust to it wtihout altering any fundamental accounting procedilres. Insofar as it achie~.esthe same effects as acceleration, it is therefore the more efficient mechanism. However, a general rate reduction willcappljr t o all taxpayers, and it is not tied t o an act of investment in depreciable assets. Particularly, when the aim is to stimulate purchases of new, real capital assets, an incentive that is as general as rate reduction will appear inappropriate. One alternative h u e could be short term selective rate reduction, but with this method serious problen~sincluding criteria selection and administration, arise, so that accelerated depreciation may be a better alternative. Accelerated depreciation and investment allowances: Among alternative accelerated depreciation procedures initial d'epreciation deductions stand out not only as the most frequently encountered but also as possessing characteristics

Flscol Impemrives in Pakistan's E c o n ~ m i cOewloprnent

that recommend them from an analytic point of view. Since they are especially favourable for long term investment, provide extra funds at an early date, and are conceptual1:y simple, it is understandable that they have been chosen by so many less developed countries as an investment incentive. Since initial deductions however have the disadvantage of altering what is likely to be the long term depreciation formula o r the formula which would most probably be acceptable to the accounting profession for a proper determination of enterprize income in the books of accountscor~sequentlyit would be desirable if the general features of the initial depreciation deduction are wanted to find a device that wouid provide the same incentive and yet not alter the normal depreciation formula. Since the investment allowance which offers a special deduction proportional t o the anlcunt of investment but without prejudice to ~:~orr?!al depreciation, possessing the same basic properties as the initial depreciation deduction and yet avoids the problem of accounting for inco~rie with two formuias, it merits careful consideration as a substitute for accelerated depreciation. No single investment allowance can substitute directly for a given initial depreciation deduction. If only the general incentive features of the initial depreciation are desired it, may be reasonable t o select h o or three values for the investment allowance according to the life of the investmmt. For shorter term opportunities like machinery and equipment an invesment allowance of one third the size of the inilial depreciation deduction might serve while longer term opportunities could be accorded investment allowances of two thirds the size of the initial depreciation deduction. With such a policy about t h e same incentive effects would be attained through investment allowances as through initial depreciation. A question that arises is whether the achi~vmentof approximately equal incentives will cost more in tc?rms of revenue loss with the investment allowance. Experience with the two incentives would appear t o indicate that for both long and short lived assets and for various growth rates postulated, initial depreciation deductions that provide roughl!, the same pure incentive as investment allowances will cost albstantially more for a number of years. Conversely, were a fixed amount of revenue sacrifice stated, it would be possible for a number of years to provide a greater over all incentive with incentive

Tax leR;'slor(onin dewloping cotrnrries

alliowances than with initial depreciation. From either point of view, t h e investment allowances stands out as the better alternative for countries wishing t o purchase the greinter incentive per unit of revenue loss during the first 10 t o 20 years of an incentive program. Since these years will usually be considered the most important, the investment allowance m.ay be judged the better alternative. Revenue effects of tax incentives: A question of significance in the context of' the structuring of fiscal incentives is whether t h e invest men:!.^ k d u c e d by tax incentives will, through additional profits taxation, be able t o yield revenues that would offset the tax losses associated with giving the incentives in the first place. The revenue loss may be defined as t h e reduction in taxes paid when accelerated depreciation or other incentives are granted, assuming that none of these funds are used by firms t o increase investment outlays. The revenue gain is the addition t o profits taxes that arises because some portion of the extra funds available t o firms as a result of incentives is infact devoted t o new investment expenditures that in turn generate taxable profits. The ratio of such gains t o revenue losses is usled as an index t o indicate t h e extent of revenue recovery. Full recovery would be achieved at t h e point where gains equal losses.. or where the ratio equals unity. Full recovery of revenues is rather improbable. In most cases the degree of recovery is less in t h e short run that in the long run. It seems that tax incentives, even when they generate favorable investment responses, will mean that revenues will rise less rapidly than they would without incentives. In less developed countries revenues will generally have t o be recouped throu.gh the imposition of additional tax burdens at other points in t h e economy. Although the stimulus of tax incentives may be desirable in economically under developed countries, the costs of such incentives in terms of revenue sacrifices are of considerable significance. Government expenditures for necessary overhead projects in such countries are more likely t o be controlled by revenue restraints than in economicallv more advanced count-

Fiscal In~pemnvt-sin Pakistan 's Econornic do re lop me?^ r

ries because in most developing countries it is singularly difficult t o increase the level of taxation significantly. Tax reductions in one sector, whatever their merit, are not easily matched with offsetting tax increases in other sectors, and in view of potential inflationary effects, an evaluation of tax incentives must take the revenue losses into account. On t h e other hand t o the extent that incentive programs are successful, the new investment induced by them will raise taxable 1::apacity and will tend to offset the tax losses. It appears that in the absence of increased investment tax rate reductions will involve a revenue loss since acceleration of depreciation in an economy with a given rate of gr~wt:iof investment will provide larger deductions for profits tax. It appears also that there is a revenue reduction associated with this stimulus unless the rate of growth is increased enough t o offset this loss. What proportion of the extra funds made available through the introduction of incentives will be invested is difficult t o ascertain. It seems reasonable t o assume however t'hat marginal additions t o profits will be treated in very much the same way as profits in general. If firms customarily retain 2 5 t o 5 0 % of earnings for purposes of business expansion, it seems likely that extra earnings resulting from the inwntives will also be handled in this fashion. On the basis of available evidence it appears that revenue restoration is not likely in the long run in the case of long lived assets. A 25% recovery appears t o be quite possible while r e covery in the neighbourhood of half that arnc~untmight be expected with short lived assets For full restora.tion ofcourse the gain loss ratio must be unity. Given the favorable assumptions of a 40% tax rate and a 20% profits rate this would call for lom investment of the extra funds provided by the incentive. Accelerated depreciation will generally raise prospective rates of return by one or two percentage points and with very rapid systems such as expensing (immediate 1C)O% depreciation) the prospective rate of return may typically. rise as much as four percentage points. Apart from raising the prospective profitability of invest-

Tax Ir@slafion in dewloping ~oiirirrics

t? 7

mcnts acclearated depreciation can provide add[tio:ial financial resources for investors in depreciable assets. Given a constant compound interest rate of growth of gross investment outlays, faster write offs mean that a larger proportiori of investments can be financed through tax relief for an indefinite time. Whatever the relative intrinsic merits of investment allowances, accelerated depreciation or other similar devices attached t o investment in fixed capital assets, it: sh(:~uldbe realized that the primary decision t o adopt such measzxes involves the policy choice of favoring such investmenl:~over expenditures for research, training and education, 1::eneral working capital and other public and private goods and services, Whether this particular variety (if discrimination is warrantetl depends on che character of the obstacles to economic dew!!opment operating a t particular times in particular countrit?~and t o some ext.ent on the type of economic development that is desired. In the absence of a carefd study of all the major f:actors however, it should not be assunled that special stimulatic;n for invesr;lents in fixed capital are necessary cornponer~tsof a development program. In any case it is exceedingly doubt.fu1that they xi11 ever be sufficient in themselves t,o launc:?. a wave of development expenditures. U incentives of this ty:;e aie employed t h e y should be closely integrated with ot,her pilases of the effort to promote economic growth. Among t,l-~seare not only general tax reform, but also the entire range oi' general and firiancial control, public investments and otl-ier expenditures 1:nd generally the body of law and practice tl?iit i::f!uences the investment climate. Fiscal incentives will almost inevitably iesult in revenue losses. Unless revenues are abundant, a situatiun rarely encounte:ed in less developed countries, this will mezn rhat some inembers of the community, perhaps those that are not placed so high in the income and wealth heirarchy as the beneficiaries of incentives, will usually have t o bear a greater burden through either additional taxation o r inflation. If the result is inflation, then even t h e beneficial effects of incentives o n investment may be destroyed both because of the likelihood ol' misallocation of investment expenditures and because of the inadequate provisions for replacement that are likely t o be made with normal or even somewhat accelerated depreciation methods. T o counter these effects would require special controls over the invest-

Fiscol Irnpera tfws In Pakistan 's Econornlc Development

ment process as well as the introduction of depreciation systems based on replacement costs or at least periodic asset revaluations. These measures are ofcourse difficult t o administer and are likely t o involve substantial costs for both business and government. Moreover revaluations or 1:eplacement cost depreciation which amount t o additional tax relief are surely paradoxical measures for dealing with a sit1.1ation that arises from insufficient taxation in the first place.

A type of incentive particularly adaptable t o agri or mineral operations is the imposition of higher discriminatory rates on inefficiently or underutilized holdings. Thus higher taxes may be levied on idle land in order t o make underutilization particularly costly. In Pakistan there has been a .reluctance t o assemble and think out the basic details which make up the foundation of any worth while plan and t o be bound for long by a plan once formulated. In addition there has never been adequate central planning machinery. Numerous offices in various government ministries and agencies have been provided with varying degrees (of authority and influence over the industrial sector of the economy but integration and central direction have been lacking . Lack of planning has been costly. It i:; generally felt that the time has arrived for a comprehensive ;approach t o replace "the project t o project" handling of Pakistam economic d e velopment. The lack of over all planning and integration of the operation of the incentive provisions often has been cited as an important contributing factor t o the failure of incentives in Pakistan. There appears t o be no instance in the recent past when tax exemption was " The" decisive factor in an investment decision. Even more importantly, it appears that in most cases the tax exemption possibility is not even taken into serious consideration when considering an investment. Many firms do not consider it a t all. Those that do consider it seem t o classify it as a windfall to be used if ultimately recieved; they certainly do not consider it worthy of justifying an investment

Tax !egishsbnon in dewloping countries

decision even in part. Incentives instead of leading t o incresed reinvestment by foreign investors may result in a net reduction of funds available for reinvestment in thecountry. Unless care is taken in their design the effect of these incentives may simply be t o permit the foreign investor t o retain his previous level of reinvestment while increasing the amount of earnings that he returns t o his home country. Depreciation deductions in future years are not worth as much as the equivalent deductions offered during the current year because with the cash obtained with the curlrent years deduction it would be possible t o earn interest which would enlarge the fund before the future deduction becomes available. For this reason future deductions must t e discounted s o that their present value is just sufficient given the rate of interest t o provide the same total fund when the future deduction is actually taken as could be obtained with a smaller current deduction. The interest rate used t o disco1.1nt future deductions will depend on the investors views of the Suture and the alternatives open t o him. The range of 5% tc) 20% however is wide enough t o cover most situations. In general the larger deductions offered in earlier years by accelerated systems will raise the present values of the future deductions because of the smaller discount that must be applied t o near tern? receipts. There are other grounds for preferring tihe investment allowance. From the point of view of formulation of legislation the burying of an exemption in depreciation makes it easier to adopt and harder t o remove while handling it :;eparately from depreciation makes t h e exemption subsidy element more open, more subject t o close scrutiny and more likely to be rescinded and removed when appropriate. Tax reductions associated with incentives should not lead t o a failure of aggregate demand and thus t o unemployment of productive capacity. If there is induced unemployment the potential taxable income from new investments may not be realized or may be offset by reductions in taxable income and spending elsewhere in the economy. Governmental budgetary policies designed t o counter such tendencies on the other hand

f-fscalItnpera rives in PaMstarr 's f co~iortiicDr~,rloprnerrr

able to assume that the chief problenl in developing rountries will be excessive rather than deficient aggregate t1em;rnd. The Puerto Rican experience Income tax incentives though ubuquitous in their presence on the fiscal statutes in most third world countrits, have not really lived upt,o the hopes o i those who have de!;igned them for these incentives have been found wanting in their ability t o induce investment t o flow from the capital rich countries t o the scarcity areas of the developing world. According t o the theory given in the textbooks the carefully structured fiscal arrangements ought t o have been instrumental in provoking capital flows from the surplus regions t o the deficient areas. That this did not happen ill actual prictice could indicate flaws in the theoretical framework It appears now however, that private investment can be quite fickle in its perceptions of viability. Thus non tax consideration:; can indeed ? private entrepreneurs evaluation of play a significant part i ~ the r s political the worth of an investment opportunity. F a c t ~ ~ like stability, infra structurs facilities, size and quality of the labor force, geographical placement, availability of raw materials, proximity t o port area etc etc' can loom larqe in the e n t r e preneurs mind and will usually be crucial in any decision that he makes. This should not be taken t o mean however that fiscal incentives have c.o role t o play in invclstment decision making. The experience in atleast one countl~y, Puerto Rico, would clearly indicate that such incentives can indeed be instrumental in provoking the kind of investment flows that third world planners would like t o see much more often than it is their lot t o be witness to. Perhaps if we were to examine the Puerto Rican experience a bit closely we might be able t o isolate factorj that can help us understand the incentive mechanism better. We may then be able t o make the sort of adjustments or changes that could make a qualitative improvement in the fiscal design of incentives in o u r own countries. There is n o denying that Puerto Rico's special relationship with the United States has played an irnpolrtant part in he success of t h e fiscal arrangements that it has structured.

Tcx leg'slo tion in dewloping coun Mes

Puerto Rico as a self governing commonwealth territory of the U.S. enjoys a special relationship with a highly developed country. To start with, Puerto Rico was underdeveloped in every sense of the word. Abundant manpower, relatively low average wages combined with aggressively and irn aginatively promoted tax incentives based largely on availab~lityof exemptions linked to new industry plus the existence of' a market area in close proximity t o the U.S. in its totality created the sort of impact that successfully provoked investment flows from mainland U.S. t o the peripheral area. Over time this has led t o systematic industrialization. Gradual emigration to the U.S. has alleviated population pressures and has prevented their exacerbation. The excellence of its administrative machinery is in no small way responsible for the success of the incentive program. Insofar as laws and rules are administered by people, the administrations role is pivotal in any program of ir:iplementation. The inherent complexity of fiscalsstatutes make it all the more necessary that administrative expertise be of a high order also. Proper monitoring of the operation of fiscal laws rnakes considerable demands on the administrative apparatus. It is essential that for optimal effect the fiscal laws be integrated into the general body of laws and regulations in the stat(?.Adhoc arrangements where integration is the exception rathlt>rthan the rule create disequilibria and contradictions that nelzative much of the momentum that maybe initially generated by the fiscal prorgram put into play. The success of the Puerto Rican fiscal progym would, on the basis of the available evidence, appear to be primarily due t o assured stability, attractive incentives earnestly promoted, imaginatively designed and skilfully integrated into the legal framework of the country. All this coupled with administrative expertise of a high order and the availability of a vast market for the output of the newly set up industry have combined t o ensure success for its fiscal program.

The design of tax incentives

Structuring tax incentives is not easy. As a stimulus measure an incentive provided through deliberate interference with statutory taxation measures is expected t o enhance profitability sufficiently to increase competetiveness. On the negative side is the revenue that the exchequer loses as long as the incentive remains in force. Tax incentives have been considered important in the context of promotion of industrialization. Tht: geographical dispersal of industry is another important criteria kept in mind while designing these incentives. The lack of adequate linkages hinder the smooth flow of factors involved in production across the economic expanse. Tax incentives a:re expected t o conlpensate for such limiting factors - atleast t o an extent. In the opinion of many, while designing tax incentives the long term objectives should have primacy over short term goals. Disproportionate effort expended to redize proximate intermediate goals can be counterproductive for eventually such a (shortsighted) approach could interfere with and even prevent the achievement of the more fundamcmtal objectives of public policy. Investment Incentives The rationale for the deliberate encouragement of specific industries is that these could lead the way in the industrialization effort by giving a cue t o other related and comple-

Fisml Inipemtiros in PaMsrar~'sEcor~ornlcLleveloprnenr

mentary activity through the externalities - linkages - that thejr induce. Given an acceptance of such a scenario, t h e interest of the planners in designing the incentive measures is easily understood. In their scheme of things efforts t o attract capital t o the leading industries has high priority and tax incentives are considered a crucial component of the plan. While increased availability of capital ~ ~ o u lcertainly d go a long way towards increasing the output of :.he specific industry t o which the incentive has been targeted, in many n capital cases an unintended by-product is the s u b s t i t ~ ~ t i oof for labor in the favoured industry. Over time chis could lead t o generalized substitution of capital for labor over t h e full spectrum of the entire industry. Considering that third world countries are plagued with severe problems related t o labor redundancy d u e t o over population, such a development amounts t o a distortion in factor utilization and bodes ill for the future economic format that would take shape as a result of such incentive measures. It would be recognized however that the real reason for such selective subsidization of investment is obviously not merely t o increase the capital stock of an industry targeted t o benefit from the incentive but rather t o enl~ance the capability of the industry t o produce more of the desired output. Thus it is the capability t o throw up increased output that is the long term objective. When the incentive measure is based upon output rather then upon investment in the selected industry than it will have the effect of increasing capital formation without distorting relative factor prices,. The measure then will not have the effect of creating a, bias for adoption of techniques of production that result necessarily in capital intensity (more capital per unit of output:). General investment incentives have the serious defect of underpricing capital in general. Considering: the fact that developing countries are capital deficient the underpricing of capital would intensify demands for capital goods. Most of these would be machinery and allied items and the great majority of these would originate from already established industry abroad. A greater chunk of the already scarce foreign exchange would thus be appropriated for importing such capital goods.

The only redeeming feature of a policy of structuring general investment incentives would be the stimulus it gives to foreign investment and t o domestic industry produci~ngcapital goods. However in the majority of cases these benefils are not likely to outweigh the disadvantages as it is increaAngly becoming evident that non tax benefits might weigh significantly in the calculations of the foreign investor and in his scale of parameters having a bearing on feasability these could have primacy over the advantages confi?rred by tax benefits. PLS for domestic industry producing capiti\l goods since this is already an area that is sought to be develokted it would not be realistic to expect that in the formative phases of economic: development it would be sufficiently developed t o be able to make a siginificant contribution thru production of adequate quantities of capital goods. Among the many enigmatic problems that planners in third world countries face is that of opening up backward regions in the country by effecting a decisive change in the labor-- capital mix and thus initiate dramatic chanj:es in productivity. The objective clearly is to escalate wage l12velsfrom their exsting depressed state to levels that are socially acceptable and t o increase aggregate industrial output. As should be evident from the statement made above the problems posed by regional disparities in levels of economic development have multiple dimensions. Because of resource constraints the government is unable t o uni1ate:rally make investment in all the various undeveloped regions on a scale that would lead t o meaningful change. The alternate plan thus is to induce private investment to move into idhest.areas. This however is easier said than done. The less developed regions in a country are traditionally characterized by lack of infra structure (means of communication, energy supply, education, healthcare etc) and an adverse labor - capital mix in whatever industry obtains there. The economic deficiencies insulate and isolate the backward region from the more developed areas due to the weak linkages. Over time, therefore, left t o themselves, the problems posed by underdevelopment breed on themselves and exacerbate and accentuate the original situation. As a direct sequel while the rich in the country keep on getting richer the poor not only

Flrml Impemtiws in PaMstan s Economic Development

remain poor but slide downwards on the poverty scale. Given the above scenario the reluctance of private enterprise to move into so forbidding a situation i~squite understandable especially as improvement of the condition of a people is hardly the principal motivating factor in the calculations of the entrepreneur when he makes an assessment with regard to the feasability of an investment decision. The cost - benefit equation is the key to a positive response from private enterprise and the costs being what they are, the benefits are not likely to be a sufficient inducement for t h e enterpreneur t o take on the daunting challenge that the backward region presents. However, if costs are lowered sufficiently, then it follows logically that the benefits would appear to be more attractive. Going a stage further, if it is possible t o lower costs and at the same time increase the benefits the attractiveness of the situation improves dramatically. Insofar as the tax burden constitutes a cost factor it impacts unfavorably on profits. As in the final analysis it is the profits that can be realized that loom so liarge in the mind of the enterpreneur, a reduction in the tax birrden is expected to do the trick in luring the entrep to the backward region. Taxes are imposed through statute. They can thus be withdrawn completely (exemption) o r held in abeyance (tax holiday) or levied at a reduced rate. (preferential taxation).). Most fiscal authorities today do not favor tax exemption as a means of attracting private enterprize to the less developed regions. It is increasingly being felt that most of these incentives are in the long run counterproductive. One of the reasons that such incentives are viewed with disfavor is that these have been seen over time to lead to a substitution of capital for labor. Considering that most third world countries are labor abundant and capital poor it makes much more sense t o use labor wherever .it is feasible to do so i.e. wherever its use does not impact runfavorably. on productivity and lead t o deficiencies in output. Given the need t o increase product^ ty, induction of capita!l is essential as there are very real limitations to what labor alone (or labor with very little capital) can achieve. In any case the use of more capital is one of the aims of development policy. After all, industriali-

The design af &x incen fives

zation means putting machines t o work for man :;o in t.hat context substituting capital for labor is inevitable. However the continueing use of more and more capital per unit of output perpetuates capital intensity in industry and ,this trend once established is difficult t o reverse. The dangers inherent in such a situation include exacerbation of existing labor redundancy problems faced by the developing country. Additionally, labor is unable t o acquire the work experience that in the long run is crucial t o instil capabilities that will have the most long lasting impact in terms of enhanced pr~:)ductivity of a significant segment of the total available labor force. In addition t o the reasons given above, t a x e:remptions distort information relevant t o quantification of the real cost of economic development. Such quantification is necessary t o evaluate and monitor the efficiency of a development program. After all it must b e known what the execution of a development plan entails. Insofar as t a x exemptions represent revenue deliberately foregone, t o that extent it represents the cost of bringing development t o the less developed region. However the fact that a specific industry has come t o the target region frequently clouds the cost involved. Again - and this is important - it may not be at all clear that it was the tax incentive that was actually instrumental in bringing the industry t o the backward region. Infact the available evidence suggests strongly that the exemptions actually constitute windfall gain:; t o industries that would have located in the region in any event. One of the problems. with tax incentives is that once enacted they tend t o become institutionalized. Over time the beneficiaries get conditioned t o the incentive and find it increasingly worth their while t o come t o their defence whenever they face a challenge. This vested interest will take great pains - and even incur much expense - t o ensure that the incentives are retained irrespective of the fact that they might be poorly designed, inequitable or ineffective. Tax incentives manage 'to escape public scrutiny largely because they are not treated as items of public expenditure when infact they are really on all fours with the public expenditures in that they consume potential public funds. It is increasingly being felt that explicit subsidies achieve

Ftscal Imperatives in Pakistan 's Economic Development

more in terms of desired objectives (viz increased output, employment and domestic value added in exports) without creating undesirable distortions in resource allocation. Also the cost of the incentive is much more evident when administered through a subsidy. Thus the well-worn paths taken by tax incentives - accelerated depreciation, investment credit, initial write off etc - should be trod on not with alacrity and blind enthusiaism but rather with extreme caution and may be even reluctance so that the inevitable negative effects are minirnised.

An appraisal of the scheme of fiscal incentives incorporated in the Pakistan Income Tax Code 1 Pakistans Tax Profile The Income Tax in Pakistan is a Federal Tax.. The Law governing the charge of Income Tax and Corporation Tax is codified in the Income Tax Ordinance of 1979 which supersedes the (Indian) Income Tax Act of 1922 as adapted in Pakistan through Act XI of 1947. Resource mobilization remains a primary objective in the levy of Income Tax. Of increasing significance however, is the provision of incentives through deliberate manipulation of the Income Tax Law as it effects selected categories of taxpayers. The scope of fiscal measures expressed through the direct taxation of Income is limited however, by the extrerrlely narrow tax base. This is apparent from the fact that direct taxes contributed only 13% of aggregate govt. revenues in fiscal 1986-87 down from 25 % in 1949-50 and 1 7 % in 1979-80. The bulk of the income tax revenues emanate from the coopc~ratesector (55 - 6 0 %). Salaried individuals contribute a further 20-25%. What aggravates the "narrow base enigma" is the continueing exemption for income derived from agriculture. Thus, while the agri. , sector contributed 20 % to the GNP (at current factor cost) in 1986-87 the federal exchequer received nothing by way of income tax. That the Income Tax base is indeed narrow is further highlighted by the fact that'there were fewer that 1 million tax~avers nationwide in 1986 - when the total nonulation

100

Flscnl Imperoflves In Pohdston's Il'conomic Development

(65% of which is still in the rural-largely ag:ricultural approached 100 million.

- areas)

The basic system of corporate income tax in Pakistan has fairly stable over the years with an income tax of 30% and a super tax of 30% on profits. (Reduced to 55% overall in 1983). The maximum rate of personal inconne tax has been reduced from 97% in 1958 t o 75% from '61 thru '64, to 7056 from '65 thru '75 / 606 from '83 thrn 1985 and 45 % in 1986. The 'zero bracket' exemption limit was Rs. 2,500 in 1948, Rs. 6,000 in 1957, Rs. 12,000 in '74, Rs. 38,000 in '83 and Rs.24.000 in '85. Income tax evasion remains widespread and it has been estimated tliat the actual yearly collection is about 40% of the potential amount. In relation t o tax base, income taxes in Pakistan have been estimated to have had an 'elasticity coefficient" of 1.52 over the period 1952153 t o 1963164 and 0.83 over '72173 t o '79/80.2 This deterioration continues in the succeeding years. INTEGRATION O F FISCAL INCENTIVES WITH THE ECONOMIC DEVELOPMENT STRATEGY. AN OVERVIEW Since 1947 the economic development program of fakistan can be seen to have passed through various 'phases' with a specific 'bias' evident in each such phase. Broadly speaking, the 'package' of fiscal incentives3 put to use in a particular period reflicts an endeavour to help facilita.te achievement of the specific objectives that have priority in the growth strategy for that time frame. The first phase in Pakistan's growth strategy can be seen to extend from 1947 t o 1958. The outstanding feature of govt. policy in this period was a pre-occupation with building up industrial infrastructure. As part of the effort to promote industrialization, a variety of fiscal incentives were put into play. These included accelerated depreciation allowances, tax concessions on industrial profits and exemption for capital goods from customs duties. Gross monetary investment in the private sector increased

from Rs. 5 1 5 Million in 1949-50t o Rs. 1030 Million in 1954-55. The largest increases were recorded in Industry, Urban development and Traders stocks. As against this, public sl~ctorinvestment lagged behind remaining at about half the private sector level. Phase-2 would be over the period 1960-65. This is also the period of the second five year plan and the underlying theme of the growth effort in this phase is illustrated through adherence to the doctrine of "functional inequality" i.e. a belief that in order t o buuld up savings and create entrepreneurial dynamism, a significant inequality in incomes is a necessary evil in the initial stages of western style (capitalist) economic development. As Pakistan openely "aped' the western model class inequality was tacitly accepted as 'unavoidable'. The pro-industrial bias' in policy continued and the fiscal concessions made available in phase 1 were extended t o phase-2 with the significant addition of a 'tax hcrliday' scheme providing an across the board exemption frorn income tax for specified industries set up in the less developed areas of the country. The accent thus was not only on industrialization per se but rather on the geographical dispersal of industry consistent with the pursuit of "balanced economic growth." The Tax Holiday concession devised in 1959 continued till 1972, when it was abandoned. Although it became a controversial measure it offered nevertheless a significant fiscal concession and showed the seriousness of the government's resolve t o aid "new industry." Private Sector investmerat in this period amounted t o Rs. 3662 Million in 1963-64 and Rs. 4198 Million in 1964-654 yielding a percentage increase of 14.64. The largest increases were recorded in manufacturing, transportation, housing and agriculture - in that order.

A major change in development strategy took place in 1965 with the implementation of the third five year plan. This change was evident in the emphasis n0.w placed on the development of intermediate and capital gocads industries as against consumers goods industries and, what was much more important, a heightened awareness of the need t o bolster the agriculture sector. The latter came t o pass not in t,he natural course of events but through the compulsions of repeated disastrous crop failures.

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Hscal Imperanws in Pakistan :r Economic Developmen t

The fiscal concessions package contrived for the third plan in the context of Income Taxes showed no radical departure in content from what was already being implemented on the launching of the third plan except that the concessions were now targeted to the selective exparlsion of industries geared t o agriculture and exports. Accelerated depreciation allowances and tax holiday continued tcl be the principal features of the fiscal package. Gross fixed capital formation in this pcxiod was indicated at Rs. 3231 Million in 1964-65 and which increased to Rs. 3493 Million in 1969-702. As against this public sector investment amounted to Rs.2831 Million in 1964-65 and increased to Rs.3342 Million in 1969-70: In the private sector investment the largest increases were recorded in manufacturing, transportation and housing. The first radical change in policy since 1947 came in the early '70's when a new govt. that did not espouse a capitalist or quasi capitalist economic development philosophy, came to power. It made its intentions clear by firstly, devalueing the rupee in may 1972. This measure had the effect of cancelling the 'subsidy' the industrialists had hitherto received as a result of the overvalued exchange rate. Secondly, the abrupt increase in the procurement prices of agricultural goods was clear manifestation of the determination to change the pro-industry anti-agriculture bias of the growth strategy adopted in the past. The private investor was no longer viewed as the principal vehicle for promoting industrial development. The State now came to play a direct role in the establishment of 'basic industry'. A wide array of industrial units were nationalized and fiscal measures came t o focus more on 'resource mobilization' and less on 'tax relief'. For the first time in 1972-73 Gross Fixed Capital Formation in the Public Sector overtook the Private Sector Capital Investment setting a trend that increased sharply in magnitude in the following years. The significance of this reorientation of policy is evident from the fact that whereas in 1972-73 capital formation in the public sector amounted to Rs.3920 Million against Rs.3726 Million in the private sector, by1976-77 public sector investment stood at Rs.18642 as against Rs.9215 Million only in the private sector. Thus public sector capital

formation had recorded an unheared of increase of 47170 over the period 1971-72 to 1976-77 whereas private sector capital formation in the comparative period had increased only by 157%. Also in this new 'era' the much touted ta.x holiday scheme was withdrawn (in 1972) the experiment, begun in 1959, having clearly failed t o yield the desired results. The current phase, begun in 1977 with the dramatic exit of the Peoples Party govt. brought in its wake, once again, a reversal of policy. The private sector came back in favour and a fairly attractive package of fiscal and] non-fiscal incentives was gradually assembled in order to promote private investment in industry. The income tax corr~ponent of this 'package' will be looked into in depth in the next section.

THE SCHEME O F FISCAL. INCENTIVES IN THE INCOME TAX ORD., 19791 The Ordinance of 1979 is essentially an attempt at rationalization of the body of Income Tax Law condifiedl in the Old Act as it was widely recognized that repeated 'amendments' incorporated therein had made it cumbersome and difficult t o comprehend. The new Ordinance was however, a departure from the past in that it incorporated some of the fiscal incentives introduced by the new Govt. that had come to power in 1977, designed t o promote private industry. In this section we examine, in some depth, the variety of fiscal incentives as these find mention in the Ordinance. "Amendments" incorporated in the Ordinance through 1986 are also examined.

Depreciation:

Since 1947, a key element in the fiscal package has been the allowance for depreciation. Such an allowance has traditionally been allowed for the use in business of wasting assets. However, it is the acceleration of the ordinary depreciation allowance that makes it a significant fiscal incentive for it enables a qualifying business t o minimise tax liability or even avoid it altogether not only for the current year but for succeeding year(s) as well - depending o n the type and magni-

1 114

Flscal Imperadws in Pakistan 3 Economic Development

tude of the investment made. The legal sanction for the depreciation allowance under the Ordinance is available in Clause (V) of sub-section (1)of Section 23. Such allowance is available for buildings, machinery, plant, furniture for fittings. The amount of the allowance itself is t o be calculated in accordance with the stipulations made in The Third Schedule t o the Ordinance. Normal (Ordinary) depreciation is allowable under clause-2 of the Third Schedule. The rate of such Ordinary depreciation ranges between 5 and 30 percent for different classes of assets. A noteworthy feature here is the 100 percent depreciation allowed as Ordinary for below ground installations in mineral oil concerns. Clause-3 allows multiple shift depreciation. However, the really important part of the depreciation provisions in the context of acceleration are contained in Clause-5 that incorporates a special incentive in the form of initial depreciation allowed in addition t o the normal 'ordinary' depreciation. Such initial depreciation is admissible at the rate of 25 per cent for residential buildings for industrial labor as against 10% for other buildings. On machinery (olther than ships or motor vehicles not plying for hire) the rate of initial depreciation is also 25%. An added incentive here is that where a 'new' industrial undertaking commences c~ommercialproduction after 1st July 1981, initial depreciation is admissible at 40%. In such cases the total depreciation allowance can add up t o 60% - assuming multiple shift operation.

As a result of an amendment made t o the Ordinance through the Finance Ordinance of 1982 Clause (cc) was added t o the Third Schedule which permits scheduled banks and financial institutions t o claim initial depreciation at a rate of 40% of the written down value on machinery and plant leased out by them. This is a somewhat novel arrangement8 where by the bank or financial institution instead of loaning funds on interest leases out machinery and plant; equipment bought by it and earns lease money thereon. Ultimately the lessee will buy out the assets. Till such time the lessor only claims depreciation as the owner of the equipment. Lease money received is assessable separately in terms of section 30(2)(d). It is important t o point out here that under the law presently in vogue the sale price realized on the disposition of

Fiscal incentiws

I US

any depreciable asset is directly deductible from the last written down value o n record and any losses resulting from the sale are ignored (i.e. not recognized) till such time as the entire class of assets to which the said asset belonged have actually been sold and there is an overall loss o n the sale. On the other hand any gains made o n disposition are immediately recognized. As a result it is possible that an asset having beell rapidly depreciated as a consequence of acceleration may, before the time it is sold, end up with a written down value of zero or with a WDV that is lower than the amount realized on the sale of that asset. Such a situation is quite conceivable given inflationary conditions and the manner in which the accelerated depreciation provision operates. Thus it is possible that the incentive of accelerated depreciation be actually defeated-unless of course an organization keeps or] adding new plant and machinery. As against this, under the ~xovisionsof the repealed Income Tax Act of 1922 (Act XI of 1947) if the sale of an asset resulted in a realization that was less than the Written Down Value then an additional 'terminal allowance' was allowed t o the taxpayer in terms of section IO(2Xvii) of the repealed Act. If the disposition resulted in a realization higher than the WDV then the 'extra' depjeciafion that had caused the WDV t o fall so sharply was brought to tax-but only t o the extent of the depreciation that had been allowed originally. There was thus a 're-capture' of the 'extra' (accelerated) depreciation allowed. Where no deprecialion had been claimed o n an asset the excess amount realized oker the original cost was not subject t o tax. Under the present law therefore, the taxpayer may end up worse off both if has suffered a loss on disposition and also if he realizes a gain as in the first case the loss may not be immediately recognized (till the entire 'class' of assets to which the asset sold belongs has been disposed off) and in the second, the gain is brought t o tax immediately as Ordinary Income and not as a Capital Gain (which infact it is). Ostensibly the objective of the whole arrangement is t o block possible 'speculative' sales of depreciable assets but, as has been pointed o u t above, an anamolous situation can concievably arise for the taxpayer with consequences that would effectively negate the 'incentive' aspect of the accelerated depreciation provision.

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r ' : ' , - . ~ l 3 r y r r ? t l wfxs Pakistan's L:conomic D-evelopment

(b) Hundred percent 'expensing' of all expenditure (including capital expenditure) in the first .year of operation,. in :specifically.designated activities. This is a significant fiscal concession and the aim is t o promote business related scientific research -(clause (xii) of Section 23(1) -the setting up of any educa.tiona1 instiution or hospital in Pakitan for the benefit of the employees o r their dependants-(C1 (xiii)-and the setting up of any institute for the training of industrial workers provided the said institute is recognized by the Federal Government or any local Authority. The object here is t o promote the building up of infra structure in educatior! and medic21 facilities. Normally investment in these areas is expected from the government. 'Where a commercial establishment or industrial undertaking takes an initiative in this context the govt. , through the provisions referred t o above, would in effect be providing a subsidy by foregoing the tax on income equal to such expenses. This incentive can also be spoken of as a 'tax expenditure'. (c) Incentives t o promote savings & investmerit In order t o promote savings a whole range of incentives are provided. These are contained in sections 3 9 through 46 of the Ordinance. Collectively, they form the 'Investment Allowance.' First, there is (in secticn 39) the allowar~cefor life Insurrance premium paid. The rationale behind the allowance is not only t o encourage a middle class earner t o provide for the future of his family but more significantly t o encourage capital formation. This is made possible by the f,act that the bulk of the insurance premiums is collected by the State Life Insurance Corporation. This Corp. is a major investor in the country, investing in the share capital of various companies approved by the Controiler of Insurance. However the allowance here is subject t o certain conditions. Thus if the annual premium paid exceeds 10% of the sum assured no relief is admissible on the excess. The object here is t o defeat possible manipulation of the provision by say taking out a policy payable after 1 2 months and claiming relief on the entire sum assured. Another requirement prevents recognition of assurance where the policy is surrendered or paid up within :36 months. Also,

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107

if the premium or proceeds are payable outside Pakistan, the allowance cannot be claimed - even by a person 'ordinarily resident' in Pakistan. Section 40 of the Ord. pro.rrides for an allowance for moneys contributed t o a provident fund (whether the fund has been set up for public or privateemployees). Prescribed rules require that the funds so mobilized be invested in Government Secruities. This is obviously to thwart any speculative use of the fund. Section 41 of the Ordinance provides for an allowance on account of investment made by noncompany taxpayers in specified areas including the share capital of approved Pakistani investment Companies and (approved) Pakistani Tndustrial Public Companies provided the allotment of shares is made directly by these companies. A minimum holding period of three years is prescribed for all such investnlents except Invest. Corp. of Pakistan Mutual Fund Certificates and shares of approved companies. The allowance facilitates mobilization of capital by the Invest. Corp. of Pakistan and the approved companies referred t o above. Also the holding period requirement prevents early encashment of 'open ended' certificates. Incentives to encourage retention of the shares of public companies and certificates of Mutual Funds by the investor include exemption s f dividend income upto Rs.15,000 = from income tax. Furthermore, capital gains realized cln share transactions stand exempted under the Second Schedule t o the Ordinance. Also, the realized value of Defence Savings Certificates is exempt from income tax.

A blanket exemption from income tax t o the profit made from investment in various sa~lngsschemes introduced by the govt. encourage channeling of funds t o these schemes by the small investor. However no rebate from tax is allowed on the original investment in these schemes. Only the profit stands exempted. Section 43 provides an allowance t o non-c::ompany taxpayers investing in Pakistani Undustrial Public Companies owned atleast partially and managed and controlled, directly or indirectly by the Federal Government.

paid by an individual subject to the overall limitation laid down in Secti0n45~whois not entitled t o any pension benefits, t o secure a contract of annuity with the State Life Insurance Corp. of Pakistan or the Pakistan Post Office Life Insurance Deptt. Section 44A has been specifically provided t o enable professionals not having the benefit of a providend fund or a pension scheme t o secure an annuity. With a view t o encourage liberal donations for education and charitable institutions the govt. has made it possible for a taxpayer t o donate even his entire income and yet enjoy and exemption from tax on the entire amount. This is possible through the machinery of section 47 of the Ord. However the law requires that the recipients of such 'largesse' be approved institutions. One such approved recipient is the Quaid-e-Azam Memorial Fund. The major incentive for exports from the income tax side is the 55% rebate on income tax and super tax payzble. Almost all categories of exports qualify for the rebate except raw cotton and a few other specified items. Exports also receive generous concessions on the indirect taxes side (customs duty & sales tax) so that the aggregate fiscal incentives package plays a vital role in coiisolidating their competitive position inter,lationally. That the encouragement provided has paid ,, off dividends is evident from t h e fact that Pakistan's exports have increased from Rs. 1700 mill. in 1,700 t o Rs. 10,286 mill. in 1 9 7 4 7 5 and t o Rs. 63,268 in 1986-87 (in current prices). Thus Pakistani exporters have not only got o a r the "shock' of the loss of the East Pakistan market but have been able t o make significant inroads in larger and much more competitive markets The "export" of manpower has, since the mid seventy's, been an increasingly important source of hard currency. The remittances from PAistanis employed abroad, especially the middle east, now is in the region of 5 Billion Dollars (U.S.) annually i.e. 'both' from official and 'unofficial' channels. Remittances are now the single most important category of foreign exchange earnings for the country and have partially compensated the loss of foreign markets for traditional Pakistani exports due t o stiff competition froin South Korea, Taiwan and India. The entire remittan~eis statutorily exempt from Income Tax. However this area has not received the attention that it deserved. Much of the Rupee equivalent of

the remittances has been dissipated in conspicuous consumption and in real estate creating significant inllationary pressures. There is a pressing need for structuring of effective incentive measures t o ensure the channelization of these funds into meaningful investment. The problem assumes heightened significance from the fact that avenues for employment in the middle eastern region are becoming more limited by the day caused partly by declining oil revenues due to a fall in the price of crude and increasing military budgetary requirements resulting in much reduced outlays for the d.evelopmenta1 projects of the type on which most of the Pakistmi manpower has been engaged. (d) SPECIFIC INCENTIVES FOR THE CORPORATE SECTOR: (I)

Partial exemption for Industrial profits.

Specified industrial undertakings viz those engaged in manufacturing, processing, shipbuilding or the generation and supply of energy are allowed an exemption from tax equal t o 10% of the capital employed provided the undertaking is new and does not employ plant or machinery previously used in Pakistan for business purposes. Also, the undertaking must not have been formed by the splitting up or the reconstruction or reconstitution of business already in existence. The requirement that 'all' the machinery employed in such an undertaking be used for the first time in that unit in Pakistan is clearly unreasonable as it would disqualify an undertaking employing even nominally any machinery previously used in Pakistan. It is hardly realistic t o debar an undertaking in so drastic a manner. As for determining the amount of capital employed for purposes of calculating the allowance some discretion is available t o the assessing officer which conceival:,ly could create complications in sorne situations. The exemption from tax is avialable in the first five years of commercial production. If the profits are not adequate t o cover the exemption no deficit can be carried forward. This can defeat the intent of the legislation as after availaing the benefit of accelerated depreciation

I10

Ftsml Imperatives in Pakistan's ,4'conomic Dewlopment

allowance very few undertakings would be disclosing significant profits in the first two or three years of operation. The benefit of the legislation would th1.1~be lost for this period as against the five years contemp1ati:d by the statute. Section 48 of the Ordinance Contro:ls this exemption. (11) A TAX CREDIT FOR BALANCING, MODERNIZATION AND REPLACEMENT O F MACHINERY and also for extension of plant capa~::ity. Section 107 allows a tax credit at '1 5% of the cost of machinery and plant installed for balancing, modernization and replacement of the equipment in use in an existing industiral facility. The credit is allowable in the year of installation of the machinery and not in year in which commercial production commences. Any unabsorbed tax credit can be carried forward t o two subsequent years only. Although no separate approval of' the C.B.R. is required here, the requirements of rule-42 have to be satisfied. These require a certification from the Director of Industries as t o -the category of machinery intended to be installed. Bureaucratic red tape can create problems here especially as the said official has no direct liaison with the tax deptt. and moreover is under no legal obligation t o issue such a certificate. Valuable tirne can thus be lost simply in persuading the Director that the machinery statute. is intended fcr a use covered by the ~xerr~ption In actual fact every conceivable prartical situation is already covered by the exemption and it is difficult to visualize any other reason for use of such machinery. It may be pointed out here that no such certificate is required for preferring a depreciation claim for the machinery. (111) A Tax Credit for companies investing in the share capital of other Pakistani Companies. Under section 106 of the Ord., a tax credit is available t o companies investing in the shares of other Pakistani companies. Of course the investment has t.o be made in approved companies. The tax credit is available at 30% for the so called underdeveloped areas viz Baluchistan, the Tribal Areas, the Northern Areas, h a d Kashmir and

Fiscal incentives

111

at 15%for the rest of the country except Karachi, Lahore and Faisalabad for which areas no credit is available. The minimum holding period for such shares is five years otherwise the relief is liable to be withdrawn. In case the undertaking does not disclose positive income the credit can be carried forward for any number of years. There seems t o be no compelling reason for providing for the holding period of five years. Onctt a 'share' is purchased its subsequent sales on the stock market does not amount to 'dis-investment'. The holding period requirement thus does not appear t o be rational. Another mamolyhere is that the credit is only available from the date of commencement of commercial production. The relevant rules require that the undertaking issuing ,!he shares give a firm date in this context. If for any reasorr it is subsequently not able to adhere t o the schedule announced any credit already allowed to an investing company is liable t o be withdrawn. This appews to he ~ a t e n t ly unfair insofar as the investing company has no means of forseeing any delay in commencement of production and can only rely on the schedule and projections given in the fezsability study. Withdrawal of the cr~bditunder these circumstances w ~ u l dclearly appear to lie a n unwarranted penalty on the investor.

( W )Tax Rebates. Under the first schedule rebates in 'super tax' (also called Corporation tax) are allowed to certair. companies. Thus there is a rebate of 5% merely for getting ,; company listed on the stock exchange. This is t o encourage the liquidity of stocks and thus provide an incentive for investors to hold shares and consider them convertible into cash at short notice. Additional rebates of 5% are allowable t o such companies the paid up capital plus free reserves of which do not exceed Rs.500,000. If these exceed half a million rupees but do not exceed one million, a rebate of 5% will be admissible only if it also owns an industrial undertaking.

If the original cost of the fixed assets, exc:luding land, owned by even a private Pakistani company, does

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Fiscal Impemlives in Pakistan 'S .l:conomlc Developmen t

not exceed Rs.5,000,000 it will still be entitled t o a rebate of 5%. A rebate of 10% is allowable t o a E'akistani company on profits and and gains derived from processing, freezing, preserving and canning of food, vegetables, fruit, grain, meat, fish and poultry.

A rebate of 15% is allowable on the income, profits and gains earned abroad and remitted into Pakistan. (V) Exrnption for dividends Subclause 80 (c) of the Second Schedule exempts totally dividends of new public companies distributed out of the profits of new industrial undertakings. The exemption is available for the first five years starting from the year of commercial production.

(VI) Exemption for Foreign Technical Personnel Pakistani companies have frequently t o employ foreign technical personnel in the first few years of a new industrial undertaking equipped with sophisticated modern technology. However approval from the State Bank and the Commissioner of Income Tax has t o be obtained. The remuneration received by the foreign person so employed will then stand exempt from tax for three years. In case the period of employment exceeds three years another concession is available in that tax paid by the employer on his salary will not be treated as a perquisite. Industrialists may thus be able t o negotiate favourable salaries for the foreign personnel employed by them. This will obviously impact favourably on their cost of production. (VII) Other incentives for the corporate sector include an exemption for all capital gains arising from the disposal of movable assets. The exemption holds good for the assessment years 1975-76 through 1988-89. A tax credit of 50% is available on the amount invested by Pakistani companies in the shares and debentures of the Equity Participation Fund. The entire income of an

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113

investment company registered under the Investment Companies and Investment Advisers Rules 1 9 7 1 stands exempted from Income Tax. Also, the income of a registered company equal t o the face value of bonus shares issued by it standsexempt from 1977-78 through 1987-88. This is another concession aimed at enlarging the capital base of companies. Furthermore, dividend income declared and paid by public companies registered between 1st July 1978 and 30th June 1982 out of its; profit for any income year ending o n or before 30th June 1 9 8 2 is exempt and the dividend income received from public companies engaged in an industrial undertaking and registered between 1st July 1978 and 30th June 1983 is exempt for a period of five years beginning from the year in which commercial production commences. For t a x holiday companies falling in this category the concession has been extended for a further five years through the 1983-84 budget. Finally, inter-corporate! dividends are taxed at a reduced rate of 5% in the case of Public Companies and at 15% for foreign companies. For private companies the rate is 20%. (e) INCENTIVES TO

ATTRACT

FOREIGN CAPITAL.

(I) The Tax Holiday Scheme. The first 'experiment' in giving a tax 'holiday', begun in 1959 ended in 1972. In 1977 the 'holiday' was revived though of course in a modified from. As p,t?r the new scheme, a blanket tax holiday is allowed t o all. new industry starting commercial production uptill the 30th June 1988 for a period of 5 years, located in Baluchistan, certain areas of the frontier province and Azad Kashmir. A tax holiday has also been allowed t o certain specific industries irrespective of their geographical location. In this context priority has been given t o agro-based industry especially that engaged in the manufacture of agricultural implements, poultry farming and dairy farming. Industry with an export potential such as that engaged in garments manufacture has also been included here. Such 'holiday' is also available t o the (data processing industry.

Fiswl Imperadves in PaMstan's Econon~icDevelopment

Besides the above, a tax holiday has also been granted to an industrial undertaking located in an 'industrial estate' approved by the C.B.R. Iocated in the so called 'less developed' areas of the country. Also, the holiday applies to companies set up between 1st ,luly 1981 and 30th June 1985 and engaged in the em;ploration and extraction of specified minerals.

(11) The Export Processing Zone, Karachi. Industry set up in this zone will enjoy a blanket exemption from income tax for five years. This includes an exemption for the income of any foreign personnel employed in the industry. The exemption is further extendable by govt. depending on the initial performance. Also, any capital gains realized o n sales of assets and shares also qualify for the exemption. (111) Other incentives for foreign capital include an exemption from income tax t o interest paid (a) t o a nonresident o n a private loan used on a govt. approved project in Pakistan; (b) by an industrial undertaking in Pakistan under an approved agreement with a financial institution in a foreign country: (c) on m:>ney borrowed abroad (with the prior approval of the gov:.) for purchase abroad of plant and machinery; (b) to an agency of n f o reign govt. or an approved foreign national for loans made to the Federal Govt. or to other persons in Pakistan under an approved arrangement; and (e) by the authorized banks in Pakistan on their foreign accounts. CRITICAL EVALUATION An important objective of fiscal policy in Pakistan has been to increase the savings rate so as t o be able to channelise funds into investment o n a magnitude that would impact decisively o n the overall growth rate of the economy. It thus remains to be seen now how far the fiscal concesdons offered so iarsas discussed above, have been successful. In the context of economic development strategy, capitalist philosophy has traditionally relied o n high concentrations of income in a society characterized by marked inequality of income distribution, t o release entrepreneurial leadership and finance for investment

in the early stages. Pakistan, relying o n the wester11 'model', sought t o duplicate the western economic experience by tolerating concentration of income1' in a few hands and even encouraging it so as t o build up the level of investmt~ntin the initial period of development. From 1947 through 1969 the private sector was looked up t o as the 'engine of growth' in Pakistan. Liberal credit and a variety of fiscal incentives fueled the engine' while savings were recycled back into investment (atleast a major part thereof) and the 'arrangement' sustained the sector and even gave it a degree of dynamism. Gross domestic savings, in real term, that amounted t o 4.6% of the GNP in 1949-50 rose t o 6.8% in 1954-55, 12.2 % in 1964-65 and high of 12.5 in 1969-70. Gross fixed investment in this period amounted t o 4.6% of the GNP in 1949-50, 7.9% in 1 9 5 4 5 5 . 21.1% in 1964-65 and 15.6% in 1969-70. Of the aggregate gross fixed investment private sector investment amounted to 7=* in 1949-50, 72 % again in 1954-55, 54% in 1964-65 and 52% in 1969-70. The significant role of the private sector :IS further made evident by the data for Domestic Fixed Capital Formation which goes t o show that the private sector corltrobuted 39%, 54% and 52% in 1959-60, 1964-65 and 1969-70 respectively, of the total gross domestic fixed capital formation which rose from Rs 2014 Mill, in 1959-60 t o Rs. 6746 Mill, by 1970.

In t h e post 1970 period when a reversal of national policy took place and the private sector lost its pre-eminent position, private sector investment declined t o 5.6% of the GDP in 1972-73 and t o 5.2% in 1976-77. Of the aggregate gross fixed investment the private sectcr contributed 49% in '1972-73, 32% in 1974-75,29% in 1976-77 and 34% in 1981-82. Hrr the P.P.P. era (1972-1977) government was clearly not enamoured with fiscal incentives and appeared t o be sceptical of their efficacy in promoting the accelerated structural transformation of the economy. It was (correctly) percieved that fiscal concessions had not facilitated the geographical dispersal of industry but had led t o concentration of industria.1 ownership and had badly eroded the already narrow tax base. The 'revival' of the private sector in 1981-82 paralleled a reversal in national policy in 1 9 7 7 when the left leaning Pakistan Peoples Party government was replaced by a rightist military gavt. that seorned the socialist leanings of the govt.

it replaced. From the data given above it is apparent that the private sector did infact respond positively to the incentives it received over the period 1949-50 t o 1969-70. How much of this 'r8esponse' can be correlated statistically t o tho package of incentives bearing on income tax and Corp. tax is a question whose answer can only be inferred and that too in very general tt:rms given the constraint of data limitation. A study made in the 70's concludes that the tax 'holiday' scheme1' which was an important fiscal concession over the period 1959-1972 cost the exchequer upto Rs.1293 Mill. At the same time the 'holiday' itself resulted in a high degree of concentration of economic power and encouraged the formation of uneconomic units. The highest benefit!; accrued to those inidustries which were already earning very high profit margins and in terms of a greater regional balance the effort was minimal. The tax holiday per se was seen to have motivated investment in only 20% of the cases and most of the investment took place in the relatively more deve1opl::d regions of the country - where ofcourse the holiday was for a shorter period. The tax holiday scheme was revived in 1977. In its operation over the the period 1977-83 it has been seen that the investment actually made in tax holiday area::, coiistituted 14% c:~f the total investment in this period, 71% of the inveStment so made has been in areas that are not the most underdebeloped in the country. Further, the ' approved' investment in tax holiday units constituted 26.1% of the total approved investment. Also it has been observed that the actual realization of investment in tax holiday industries has been 22.8% as against 41.5% in non tax holdiay areas. /

It is probably too early t o comment on the effectiveness of the "revived' holiday. However tentatively, it appears that the response so far, is at best, lethargic. Probably the single most important factor in the fiscal incentive package discussed above has been the accelerated depreciation allowance. It is almost jmpo'ssible, because of data constraints, to quantify precisely t h e actual impact but the significance of this concession is evident from that fact that given multiple shift operation a new industrial under-

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taking can expect t o recoup its entire capital inkestn~entin the first 3 to 5 years. Together with the additional concession of partial exemption of income that would be available in most cases, the impact of the allowance is further enhanced. However it needs to b e pointed out here that the nature of the operation of the depreciation allowance has created an inducement t o invest in industries that ,:ire re1at'ively 'capital intensive.' This has not only aggravated the unemployment problem but has contributed significantly in turning the terms of trade against the agricultusre sector in the country thus adding t o the stagnation in that crucial area of the economy. At the same time it has t o be recognized that there is really no truly 'appropriate' technology for a developing country. The best technology that is available has got t o be imported and that happens to be capital ir-tensive. It enables efficiency in production enabling a developing country like Pakistan to maintain a competitive posture internationally and to convert the technical efficiency of the imported machinery into significant investible surpluses thus making possible a 'second round' of investment. 'The solution t o the enigma here is therefore, not easy.

In the post 1977 period two of the most, significant fiscal incentives appear to be the B.M.R. Credit (for Balancing, modernization replacement and extension of existing plant capacity) and the partial exemption of income. During 1977-78 t o 1981-82 a total investment of Rs.12.8 Mill. was approved for the areas entitled t o partial exemption of income. This constituted 33.5% of the total Invest. Out of this, investment amounting t o Rs. 3.90 Miil. constituting 28.9% of I,he approved investment actually materialized. As for the B.M.R. Tax Credit, available statistics reveal that the total number of industrial units availing the credit increased from 130 in 1979-80 to 1 6 7 in 1981-82 with credit amount indicated at Rs.103.77 (Mill) in 1979-80 and Rs.135.16 (Mill) in 1981-82.

While the B.M.R. Tax credit appears t o be an extremely important fiscal incentive it has been observed that in practice more and more units are making increasing use of the credit for the extension of existing capacity. The prolalems created by the existing high concentration of industry in many indus-

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Flscal Impemftves In Pakistan s' Ec,onon~lcDevelopment

trial towns have thus been aggravated. Taking cognizance of this trend the credit was withdrawn for existing industrial units located in the developed regions of Karalzhi, Hyderabad, Lahore and Faisalabad in 1983-84. Foreign capital has not so far shown much inclination for investing unilaterally in large scale industrial ventures. In the early years lack of necessary infrastructure inhibited such movement. Later, an adverse political climatediscouraged foreign venture capital from moving in. A more favoirable climate for the foreign investor now obtains and espe~iall!; with the negotiation of serval Double Taxation Avoidamle Treaties and various fiscal concessions an improved response can be expected. CONCLUSION

Fiscal incentives, especially accelerated depeciation allowances and, in the post 1977 phase, the B.M.11. T'ax Credit do appear t o have had an impact on both the quantum and type of investment. In general, these have encoui:aged investment in relatively large scale, short gestation, capital intensive projects. While such incentives are not the only determinants of investment, however, insofar as they impact on the overall profitability of an enterprize they d o enter into investment decision making. It is necessary though, that tihe govt. monitor on a continuous basis, the operation of these incentives so that any attempt at perverse exploitation of an incentive (as happened in the use of the tax holiday incentive in the period 1959-1972) be checked and defeated in time. It is also imperative that a concerted effort be made t o enlarge the tax base significantly. The present narrow base woulc1 appear t o deter structuring ofs effective incentive measures :ISmch incentives impact unfavourably on resource mobilization.

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119

NOTES -..

Because of deficiencies in the data base, especially for the 1950's' the statistics compiled by govt. agencies have t o be interpreted cautiously. For the 1950's the data as collated by the Central Statistical Office (tilie CSO) with regard to gross fixed investment for all sectors was based mainly on a 'commodity flow method' and that was an important reason for deficiencies creeping in. Some sector estimates even today, as for the non-monetized investment in agriculture, may still be considered as kough approximations'.

The macroeconomic identities of key variables cited in relation .to savings and investment are clarified as Under:Ciross Fixed Invest.

Gross domestic savings plus external resource balance(i)

Elxternal resource balance

Imports of goods and nonfactor services minus exports of goods & non factor services.(ii)

Gross domestic savings (as 5% of GDP)

Gross Fixed Invst. minus external resources balance (iii )

Gross national savings (as % of GNP)

Gross domestic savings plus net factor income from abroad (iv)

Gross fixed investment

Gross national savings plus external resource balance minus net factor income from abroad. (v)

The observation that the private sector responded 'positively' t o the incentives received by it does not ofcourse mean that the response was 'adequate'. Infact., the overall savings rate in Pakistan has never been consistent with the requirements for "take-off." but rather, has been

Fiscal I m p m n ' w s in PaMston 's Ecoi~omicDevelopment

deficient by atleast 1 0 % at the best of times,. 4.

The declining elasticity coefficient means that tihe income tax structure is, over time, losing its abilit,y t o 'mop up' significantly the incremental additions to revenue that ought to result from expansion of the tax base as a sequel to normal economic growth.

The fact that private industry has received preferential treatment in Pakistan should not be taken to mean that agriculture has been completely ignored. Inl'act the continueing 100% exemption from income tax on all income arisirg from agricu!ture is in itself an indication of the 'sacrifice' that the federal exchequer has b'een forced to make in terms of revenue foregone. Furthermore, direct subsidies for key agri inputs and support prices for agri produce have been an almost permanent feature in Pakistan. Also land reforms by !rationalizing the size of land holdings and improving thereby the lot of the peasantry have all resulted in improved agri productivity. At the same time, however, it is true that all that has been done has not been enough. Perhaps a crucial "li(1istake" made has been the dissociation of the agricultural sector from the industrialization experience of the rest of the country. Agro-based industries have never received the attention they deserved and thus the self re-inforcing "feedback" (from agriculture to industry and vice versa) necessary for the "symbiotic growth" of these two sectors has: been lacking leading inevitably t o the isolation and stagnation of the agri sector.

The ability of (West) Pakistan industry t o find alternate markets abroad after the secession of the (.astern half of the country in 1971 is an achievement whose significance is often ignored. That together with the 'fortuitous' (considering the time period) employment of thousands of Pakistanis in the Middle East in the mid-seventies and continueing till the present day - surely saved what remained of Pakistan from imminent economic collapse. Although the government played a significant role in facilitating developments, it goes t o the credit of the private sector that it was able t o rise t o the occasion and wize opportunity as it arose often in a highly competitive, and even at times, hostile, environment.

Fiscal inceentiws

REFERERCES/EXPLANA TIONS Coijt. o f Pakistan Taxation Structure of Pakistan 1980-81 P 20.1' I. Got-t.of Pakistan Pakistan Ecor~ondcSurvey 1986-87 2. Viqr~r& A mjad The hfana~ctnento f Pakistan economy I94 7-82 - 0 UP 1984 3.

Thr Afa~~agement of Pakistons Econotn), 1947-82 Viqar Ahmad & Roshid Anljad Oxford Crniv. Press 1984 Pp 65-1'04

In 'current prices '. In 1959-60 c o ~ ~ s tprices. a~~t In 1959-60 corlstant prices.

. 6. 7.

(Repealed) Inconle Tax Act 1922 (ACT XI of 194 7 - ar~lcndcdPakistan Inconie Tax Ordir~arice19 79 (XXXI) of 1979 Finorrce Orilblo~ice I980 t h m '86. Inconle Tax Lars. S A SALrinf 1986-87.

This has been pro~joked,in large part, b ~the . '~sla~on~izatiot~" n~eo~~rras ofrhe post 1977 period that uew Irterest' as being specifical1.y prohibiied as a receipt under Islartiic teaching

Sectior~45 limits the total brt.estrr~entallou~ance(sectio~i3';' thrcrrgh 44) t o a rriaximum of 1/3rd of the Total Incorrre or Rs. 50.000 - rc~/!;clrrl~?r is hixhcr.

10.

Rashid A~r~jad Irrdustrial Corrcerltrariot~ m ~ dFcor?omic Potc~rin Pokisrar~ L1niv.. o f the h r ~ j a bLahore 1947 L White Ind~istsrialConcentration & Econ. Porc3erin Pakista?~Pn'tlceron 19 74

1I .

B. A. Azhar - Tax Holiday for Iridus. Delielop - An emlltorior~t'ukismn Economic Jo~rmal1973-74 Fp 72-85 E'iqar & Awljad - The hfanagemenr of Pakistan Econo~nj~ 194 7-82 0 U P 19.34 Pp 2 72-3

Law and procedure controlling the taxation of self assessed income in Pakistan

INTRODUCTION OF SELF ASSESSMENT IN PAKISTAN The first fifteen Years Self assessment of income, in the context of its taxation by the government, has had a chequered history in I'akistan. After independence in 1947, Pakistan adopt? the old Income Tax Act of 1922 (Act XI of 1947). This statute controlled the federal taxation of income till June 1979 when a new Income Tax Code, the Income Tax Ordinance of 1979 (No XXXI of 1979) superseded it. Between 1947 and 1979, two attempts were made t o introduce self assessment of incolme in Pakistan: the first in 1964 and the second in 1977. The Scheme of 196485

In his Budget Speech for the fiscal year 1964-65 the Finance Minister referred to the Self Assessment Procedure as a departure from the 'dilatory and cumbersome' system of universal audit that had 'been in operation for over half a century.' Rule 46 was added t o the income tax rules, vide SRO 84 (R)/64 dated 28th August 1964 tn lay down the procedure f o r self assessment. The broad features of' the Scheme were: (a) it was applicable t o all 'persons' except 'firms' that had not yet been granted 'Registration,' partners of *The Sel Arm, procw underwent significant chnnge through Ute F~nanceAct 1988. TM stcdn, d w m i coNldn these cMngcs and ImY( appraiwl upto ouU year 1987-88 on@

I24

Ffscal .Impc.mtfves in Paktstan 's Economic Development

such firms, partners of Registered firms whose total income exceeded Rs. 25000 and cases of persons deriving income from a business, profession or vocation whose total income exceeded Ks. 25,000: (b) it was also applicable t o individuals deriving 75% of their income from salary, irrespective of the amount of total income; (c) The prerequisite for eligibility under the scheme was that the total income declared by ;I person in the Return filed was not less than the income on which he had been assessed under section 2 3 of the (repealed) Act in respect of the laliest assessment year wherefor the assessment had beer1 made. In 1965 .the scope of the scheme was enlarged t o include all persons deriving at least 75% of their income from rent, interest o r dividends. However where the only source of income was business, profession or vocation, the return would continue t o be ineligible if the income exceeded Rs. 25,000.1. Another 'concession' made was that although clause (d) of rule 46 was not deleted, nevertheless the preconditon for eligibility under the scheme that income disclosed currently not be less than the latest assessment on record, was waived retrospectively. Although by 1966 the number of taxpayeirs had increased to 3, 10,486 from 2, 19, 432 in 1964, the main objective of the schemeto create an atmosphere of trust and !confidence between the taxpayers and their assessors - could not he achieved. The 'quality' of the returns - in terms of both the quantum of income disclosed, especially for business income, and compliance with the provisions of the statute and rule 46 - failed t o register any significant improvement. Rather, it appeared that more and more taxpayers sought t o 'exploit' the scheme by filing deflated returns and taking their chances in acceptance by the assessing officer. The assessor on the other hand found himself under no obligation - no change whatsoever had been made in any of the provisions of the Act - t o 'accept' a return even when it was 'eligible'. The result was that after 1967 less and less was heard of the 'scheme.' The old system of universal audit soon pushed out whatever remained of the scheme.

Self Antr. Law & Procedure

I25

The Scheme of 1977

Ln 1977 a fresh attempt at introducing self assessment was made. The following amendments were made in the Income Tax Act and the rules made thereunder:(i.)

Sub-section (1) of Section 23 was substituted by a new sub-section which provided inter-alia:(a) Where return of income was furnished under sub-section (1) of section 22, the Income Tax Officer "may determine" the income on the basis of such return: [ Emphasis mine] (b) where discretion is exercised by the income tax officer under sub-section (1)of section 2 3 he must pass the order in writing before t.he end of the assessment year; and (c) while determining the total income, the income tax officer may make necessary adjustments including adjustments in regard to 'un-absorbed depreciation' and 'losses' t o be carried forward to the following year.

(ii) By adding the word 'or the total income and the t o t d world income and the tax payable has been determined under sub-section (1) of section-23' in sub-section (1) of section - 34, the provisions of section 34 were made specifically applicable t o the assessments made under section 23 (1): and (iii) By adding the words 'Except in case in which an order has been made under sub-section (1) of section 23, in the second proviso t o sub-section (1) of section - 34, the two prerequisites for re-opening an assessment namely 'definite information hasing come into the possession of the income tax officer' or the prior approval of the inspecting assistant Commissioner of Income Tax were both rendered superfluous. Another change brought about was the :substitution of Rule-46 by Rule30 through SRO 794 (1)/77 dated 22 August, 1977. The main feature of the new Rule-30 (prescribing the

fiscal Inlperariws tn Pakistan's Eccinorn~cDeveloptnent

136 1

I I I

! 1

i i

procedure for self assessment) was that where a person derived income from a business, profession or vocation, the requirements in regard to the filing of copies of manufacturing/ trading account, profit and loss account and bidance sheet etc. were dispensed with-except in those cases where the sales or receipts declared aggregated t o Rs. 500,000 o r more. Proviso to the new Rule30 provided' that the Rule shall not apply: (i)

in respect of the assessment of any year where no return was filed for the year irnmectiately preceding that year; or

(ii) in respect of assessment of any year for which a firm makes an application under section 26 A,,or (iii) in respect of assessment for the year for which the income declared is less. The Central Board of Revenue through Circular No. 11 o f 1977 dated the 25th September, 1977 waived the disqualification contained in IClause: (I) and modified the disability embodied in Clause (111) of the proviso t o Rule-46. Thus the only 'persons' ineligible under the new scheme were 'unregistered firms' and 'persons' declaring loss,that was not on account of the allowance for depreciation. The scheme of 1977 was certainly an improvement over the scheme of 1964 mainly in that it had a wider scope and also because of the amendments made in sub section (1) of section 2 3 the asse sing officer could now accept a return under self assessment and yet take cognizance of expenditure incorrectly claimed as a deduction by recomputing the total income of such taxpayers. However the feature of the scheme allowing wide discretion t o the assessing officer t o reopen an assessment already made under sub section (1) of section 23 through recourse t o section 34 (sub section - 1 ) was received very adversely by taxpayers. They were convinced that given the wide latitude, the assessing officer would be inclined to make recourse to section 34 on the flimsiest of pretexts because his didretion in this context was not fettered by any specific explicit statutory requirement. The IT0 was not even required t o make sure that he had

Self Asstt. Law & Procedure

127

'definite information' available with him nor was he required t o make a reference t o his supervisory officer (the IAC) o n [.he matter. There was thus a perception that the I T 0 had been invested with unlimited powers with regard t o cases falling under self assessment. This negative perception was enough to make taxpayers highly sceptical of the value of the scheme t o them. The credibility 'gap' between taxpayers and assessors remained as wide as ever. The tax lawyers in Pakistan criticised bitterly this aspect of section 34 and considering the close rapport they had with the taxpayers, their stance was respo1:isible in no small measure in eroding very badly the edifice of the latest scheme for self assessment. The Scheme of 1979 With the repeal of the Income Tax Act of 1922 (No. XI: of 1947) and the enactment of a new Income Tax 'Ordinance' (No. XXXI of 1979) the self assessment of income was :not only retained but the substantive .law relating t o such assessment was formally incorporated i n b e code itself and laid down in section 59 of the Ordinance of 1979. Within one year of the implementation of the 'Ordinance' it was made mandatory for the I T 0 t o accept a return filed under self assessment where it met the stipulated requirements. This was indeed a rad:ical departure from all previous schemes for self assessment ar; it did away with all 'discretion' on the matter thus ensuring the acceptance of all qualifying returns. Further, except for specified cases t o be formally notified by the C B R ( and whose number would not in any case exceed 5% of the total number of returns filed) self assessment would embrance all 'taxable' income, whatever its source and would also not be restricted by any specified 'ceiling' for the quantum of income. Another uirique feature of the scheme is the concept of 'immunity' 'A taxpayer now wishing t o ensure that his return of income is not selected for 'detailed scrutiny' provided that the taxpayer is not found t o be guilty of deliberate tax fraud for that would automatically oust the return from the ambit of self assessment may disclose an amount of total income for the year that is at par with a level prescribed by the C B R and arrived at a n the basis of specified criteria. By doing so, the taxpayer would in effect have 'purchased' immunity for himself for the duration of the assessment year in question. This feature

FLrcal lrnpemtives in Pakistan ". Economic Development

128

of the &heme does however have some !interesting aspects which will be dealt with later. The present scheme aims at compreltiensive self assessment and limits drastically the authority of the I T 0 t o oust a return from self asstt., - even when 'immunity' has not been 'purchased. Thus with its greatlyenlarged scope and the novelty of its features aimed at induceing voluntary taxpayer compliance with the provisions of the scheme, this latest attempt certainly appears t o make a clean break with the past. However both the substantive law as well as the prescribed procedure pertinent t o self assessment is evolving from year t o year. EVOLUTION O F SELF ASSESSMENT LAW AND PROCEDURE - 1979-80 t o 1987-88 The substantive law relating to self assessment has for the first time since 1964, been laid down in the statute controlling the taxation of income i. e. the Income Tax Ordinance. Section5 9 of the Ordinance [ sub-sections (1) ( 3 ) and (4)] forms the statutory sanction for self assessment. Subsection (1) of section-59 is crucial to the scheme for, as amended by the Finance Ordinance 1980, it directs the 'mitndatory acceptance' of a return of income filed under self asses:sment not in conflict with the stipulated requirements and not otherwise disqualified for any reason. The sub section also makes reference t o the scheme of self assessment devised by the C: B R for the year in question. Further, the sub section makes c'lear that is the return of income filed 'voluntarily' that is t o be taken up for processing under the scheme. The original sub section (1) incorporated in the Ordinance of 1979 did not mdce express reference t o either a return filed voluntarily, - 'suo moto' - or to the mandatory acceptance of 'any' return o r t o a self assessment scheme. Rather, the announced intention of the government notwithstanding, the sub section appeared t o retain the discretion of the assessing officer in disposing off a return as it provided that::

. . . . . the Income Tax Officer "imay", by an order in writing . . . . . determine the total income of the assessee. . . " [Emphasis mine] LL

Self Assrt. Law & Procedure

129

In the substituted sub section (1) the words "shall assess" found prominent mention and the C B R clarified that ". .. . a return which qualifies t o be processed under the scheme has now a right t o b e so processed "*I T h e only other change made in section 5 9 is through for the addition of an "Explanation" that clarifies that revised returns of income d o not qualify for self assessment. The other change is the insertion of a new sub-section after sub-section (1) and called sub-section (1A) through which the C B IU is formally empowered (as is any Authority designated by it, ) t o select returns of income for detailed scrutiny.

Sub section 2 was omitted by the Finance Ordinance 1980 and was simultaneously incorporated in the Ordinance as section 6 0 (Provisional Assessment t o be made on .t.he basis of the latest completed assessment under section 62, 63, 65, 59, or 59A). Sub section - 3 empowers the I T 0 t o make such adjustments as may be necessary, including those relating t o addback of inadmissable expenditure - if any - claimed by the taxpayer and also other adjustments under the law relating t o set off of losses, earry-forward of losses, credit for tax paid etc.etc. when the I T 0 accepts a return of income under self assessment and passes an order under sub section (1) of section 59. The only change made in sub section -3 has been the deletion of reference t o subsection - 2 as a con:;equence t o omission of subsection - 2 from section 5 9 through the Finance Ordinance 1980 and its simultaneous incorporait ion in the Ordinance as section 60. Sub section - 4 of section 5 9 specified the limitation of time laid down for an assessment t o be made under section 5 9 (1). Thus a an order of self assessment under section 5 9 (1) is required t o be passed by the 30th of June next following the year in which the return has been filed. Section 5 9 (A) together with sub sections (1) and (2) was inserted in the Ordinance through Finance Ordinance 1980 t o deal with the possible contingency of a return subrriitted under

assessed for any reason by the end (30th June) of a given assessment year. Also under sub section-1 of section 59 A an IT0 has been empowered t o 'accept' a return even though it may not qualify for self asstt.

SELF ASSESSMENT PROCEDURE

Each fiscal year, concurrently with the Finance Bill, the C B R announces the scheme of self assessment to b e implemented. The procedure to give effect t o the provisions of the scheme is also specified therein. Since 1 9 7 9 , the format of the scheme has remained more or less, the same. Typically, each years scheme specifies:

The scope of the years scheme with regard to existing and new t a ~ p a y e r s ;

Requirements of the Return that must be fulfilled in order t o qualify for self assessmerit;

The specific disqualifications that would oust a return from the ambit of self assessment;

Procedure for selection of cases for detailed scrutiny;

The categories of cases that are not t o be taken up for scrutiny (immune cases);

Procedure for processing of cases under self assessment:

Procedure for processing of ca.,es set apart for scrutiny;

A statement declaring that cases involving concealment of income fall outside the purview of self assessment;

An announcement by the CBR of the 'classes' of cases that it has selectedfor scrutiny; (these 'classes' pertain t o particular businesi categories or even r n m m n r ~ i n lonntnn-cl

131

SelfAssrr. Lc;'\v & Procedure

Announcement of the scheme is accompanied by issue of "circular instruct ions" clarifying specific aspec ts of tk,e sc heme and detailing further the procedure t o be followed in :particular situations. While t h e broad format of t h e scheme each year is as indicated above changes in the scheme are made each year in terms of both t h e procedure t o be followed and t h e law to h e implemented.

TAX RATES AND SELF ASSESSMENT T h e basic system of corporate income tax in Pakistan has been fairly stable over t h e years with an income tax of' 305%and a super tax of 30% on profits - reduced t o 55% overall in 1983. Further relief was allowed for public Coys in that t h e iggregate (income tax and super tax) rate was reduced from 50% to 40% with effect from the assessment year 1986-87. Sirndarly, in t h e case of personal income tax, t h e maximum rate has been reduced from a high of 97% in 1958 t o 75% from 1 9 6 1 through 1 W , t o 70% from 1965 t h r o ~ h1 9 7 5 and 60% in 3983. T h e latest change made is through the Finance Ordinance 1 9 8 5 (effective assessment year 1986-87) when the rate stands reduced Further t o 45% for t h e highest slab. Also, the lowest slab has been reduced from 10% t o 5%. Furthermore, dividend income of taxpayers (Other than companies) from specified "public" companies has been totally exempted from any charge of income tax. It does not require much insight - t o establish that prohibitive rates of income tax "eat into profits" anti' become thereby, powerful disincentives for private investment. Further, it appears that in developing countries especially, high rates of income tax have been a factor, and an important one at that, in provoking systematic t a x evasion. In the opinion o f r71uny therefore, the ultimate fate of a scheme of self assessment might depend as much on the operative rate structure as on uny other factor. Inspite of t h e apparent "truism" of t h e statement made above it is not easy t o postulate in "optimum" rate scl~edulefor t h e taxation of income. It can however be show11 through examples, that in Pakistan, atleast before t h e changes made through t h e Finance Ordinance 1985, t h e rate of tax o n income

...

. .. .

Fiscnl Imperadves in PaMstan's t ronornic Develoymerrt

132

in assessment T o illustrate the proposition made above: yt)ar 198243, taking the case of a private Limited Company declaring a net profit of Rs. 2,500,000, having ten shareholders/ Gross Tax Liability of the company and itsI~irectors/shareholders (and assuming no investment allowance for t.he Directors) would amount to Rs. 2,164,910. With an assumption of maximum allowance for investment for the ten Directors admissable under the law, their personal tax liability wil! stand reduced by Rs. 239,500 reducing the 'aggregate' tax liability (of the company and its directors) t o Rs. 1,925,4:1.0. In percentage terms this means that fully 77% of the company's profits will go towards payment f taxes.

Similarly, in the case of a Registared Firm declaring a net profit of say, Rs. 2,920,000, having ten partners each contributing equally t o the capital of the firm, the gross tax liability of the fim: and its ten partners (and assuming the maximuni allowance of investment for the partners) would come t o Rs. 1,728,875 - which is 59 7c of the net profit shown. Again, in the case of a proprietory cmcern declaring a total income of Rs. 2,920,000 the tax liability (with maximum investment allowance) would compute at Rs. 1,869,318 i.e. 64% of the net profit. It might be pointed out here that the assumption of maximum investment allowace is at best "heroic" as is obvious from the fact that making such an investment involves an outlay that takes up 1/3rdi (almost) of each Directors Total Income (in the case of the Company) and 25 5% of each partners total income (in the case of the Registered Firm). Given the illustrations given above, it is apparent that the tax rates on which the calculations have been based, are

k1.A.

Ab bast - "Burden of Income Tax".

T a r oh.server- K s r a r h l -

M a v 19PA

rather high - "eating" away a big chunk out of the profits, the business made thus leaving very little for reinvestment, modernization, replacement (of plant and machinery) expansion of capacity, research and development, building up reserves etc. etc. The "ob~ious" solution here (given the "realities7'of the 'ecology' in which the taxpayer is placed such as a weak tax administration without access t o meaningful technology that would permit effective monitoring of economic activity) might be t o simply "evade" taxes. This is d s a what infact has actually happened. Although empirical studies t o determine the extent; of tax evasion are not available at the present time, it is clear .that significant Isax evasion is infact present. Such a conc1u:;ion follows from the trends in GNP, tax base statistics and the data for tax actually collected. Total Income Tax revenues in 1 9 8 4 8 5 are indicated at Rs. 10,000 hilillion. The total taxpziyers in this year are about I million. The GNP in 1984-85 (ill constant prices of 1959-69) is shown at Rs.80045 million. As against this, in 1977-78 (our 'base year for p.urposes of comparison) total income tax revenue stood at Rs.2,833 million with total taxpayers at some 400,000 and the GNP at Rs 52074 million. Thus with a tax base in 1984-85 more than twice as lxrge as in 1977-78, tax revenues increased by 253% while the CihT in this same period registered an increase of 54 at an anrlual average percentage rate of over 6% Looking t o the expansion in the tax base and given the fact that the sectoral appropriation of the GNP is ~kewedmarkedly in favor of business and inciustry, the fruits of the growth in GNP go heavily t o private business thanks t o a distribution system biased in its favor. Given these facts it is clear that the increase in revenues aver this period is not consistent with the growth in GNP and the expansion in the tax base. My appraisal of the matter would, be that tax revenues in 1984-85 ought t o have been atleast Rs 20,000 million. Infact looking t o the tax base expansion revenues should have been even higher . It would thus apea:r to me that revenues actually collected in 198485 are less tlhan 50 % of the potential revenues that ought t o have been collec-

Fiscal Iri~perafives irl PaMstan 's Ec,,~r~orr~ic Developmcrr t

ted. While it would clearly not be proper to attribute all the tax evasion t o a high tax rate structure, it does appear that a primary motivation here is to protect the profits otherwise lost t o high taxes That being so, the changes made in 1983 and 1985, reducing the aggregate corporate t.ax and t h e personal income tax, are steps in the right direction Hut are these changes "adequate?" I t would appear to nle that they are not. I would like t o see both corporate incom,e tax and super tax not t o exceed 30 % for public and 40 ';70 for private Coys. Similarly, for proprietory businesses, the top marginal rate ought not, in my opinion, t o exceed 40%. The 'need' t o reduce taxes is actually recognized by many more than would appear at first. The difficulty however in actually implementing significant rate reduction is the apprehension that there could b e a time lapse of some significance before businessmen come out with reasonably correct declarations of income and in the intervening period the govt. might have t o contend with sharply reduced rel,enues. This analysis assumes ofcourse that the tax base remains as it is presently structured. If o n the other hand there is a significant expansion of the base - such as could happen if say income from agriculture were brought within the scope of income taxation -then ofcourse the revenue availability would be much better. But most people see little possibility of this happening atleast in the foreseeable future. It is pointed out here that the last attempt to tax income from agriculture (in 1977) was defeated before it could be implemented and that occured inspite of the fact that the 'plan' devised t o tax agricultural income allowed extraordinary concessions t o landowners, such as the deduction of capital expenditure (as that involved in the p u l ~ h a s eand use of tractors and other agricultural machinery etc) from current revenue. Thus without any base broadening of any significance, it is feared that the initial loss in revenues following a rate reduction would result in t o o large a resource 'gap' for the govt. t o b e able to bear.The apprehensions expressed above are not without substance. At the same time the fact remains that the "hard" decisions ( t o enlarge the tax base by subjecting income from agriculture t o tax o n the same terms as income from business, to revise the rate structure downwards, t o d o away with such fiscal incentives as might have outlived their utility etc. etc.)

Self A s s r t . Law B Procedure

13.5

will at some point of time 'have' to be taken if the income tax system is ever t o come t o terms with reality. What has been stated :above? does not take cognizance of the host of so-called "fiscal incentives" -- which have been discussed in detail elsewhere - which go t o depress the non~inal rate of tax so that the "effective rate of tax" is signific~intly lower. If one is to consider the full impact of these ''in~ent~ive" provisions for those classes of taxpayers that qualify,-it would be apparent that effective rates of tax for qualifying taxpayers are presently not ~rohibitivelyhigh. This should not be taken to near that there is no scope for a (further) reduction in tax rates. However the reality of the situation should not be ignored. SELECTION OF RETURNS FOR SCRUTINY The procedure adopted by the income tax department. in Pakistan for selection of taxpayers cases for audit remz.ined virtually unchanged over the period IY79-SO to 1984-85. Basically, it involved firstly, a 'matching' of advance intelligence? regarding the taxpayers activities having a bearing on the income tax assessment with the information available or1 the taxpayers return. Such information was made available largely by the Survey and Colation Organization whose role iri this context has been alluded to above. Intelligence could also have emanated from the Federal Investigation Agency, the Vigilance Wing of the Central Board of Revenue or even from professional informers. Also, the assussing officer hirfiself' might, during the course of the year, have collected pertinent details say, during the conduct of external survey or he might simply have picked up information while engaged in an examination of another case. The assessing officer was expected t o be particu.larly vigilant in the scrutiny of returns claiming immunity and these were the cases that were examined first and with the greatest care. After this examination the other returns were put t o scrutiny. All those returns where discrepancies were evident became potential audit cases. The balance returns available with the ITO were then screened for clues that pointed to tax evasion. Thus cases where there had been a significant infusion of new capita1,cases where the business fell in a category known

136

Ftsinl Impemdues tn Pakistan 's E~:onornicDevelopment

t o be yielding supernormal profits or inconsistencies in reporting etc. were the returns that were sorted out. 'These cases were then discussed by the I T 0 with his supervisor (the I A C ). In the next phase the matter was discussed by the 1:AC and the I T 0 in Committee with the Zonal Commissil:)ner of Income Tax. Those cases indicating most potential for enhancement of income were picked up in respect of each charge in the zone and the consolidated list made up in a prescribed proforma was then sent to the CBR for approval. It might be mentioned here that only a limited number of cases could be selected for audit. This was in keeping with the announced policy of the govt. t o subject not more than 5 70 of the total returns received t o audit. Upto 1983-84 the lists of cases in respect of each 'zone' (i.e. a territoriali area headed by a CIT and for Company cases a charge having specific jurisdiction over specified company cases) were sent t o the CBR for approval directly by the CIT. From 1984-85 however, the consolidated list in respect of each zone in a REGION (an administrative unit created to decentralize cont1.01and direction of field units) was initially scrutinized by the REGIONAL COMMISSIONER who then in consultation wiih the CBR approved a final list in respect of each charge in the Region that he headed. After the finally approved !list was received back by the zonal CIT, formal intimation was sent t o each taxpayer whose case had been selected for audit. Thereafter the assessment process would commence. The 'system' described above entailed individual inspzction of each return by the Income Tax Officer, the Inspecting Assistant Commissioner, the Commissioner of Income Tax and t h e Regional Commissioner. All the data tabulated on proformas in the course of the selection process was done manually by the clerical staff. Considering the workload this did not promote efficiency. IvIistakes inevitably crept in the mukitude of proformas prepared by each charge involved which was eventually reflected in faulty selection of cases creating problems when t h e assessnent cycle started. More seriously, the system gave rise t o malpractices involving departmental functionaries at various levels. The selection of cases for audit requires that complete secrecy be maintained at the time that individual returns are

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being examined. Because of manual procedures aild heavy cierical dependence this was impossible to enforr:e. The result was hat unscrupulous elements within the department would keep close liaison with taxpayers keeping them fully informed about the 'progress' of the selection. This was vary >mportant for those taxpayers whose returns were not covered by immunit y as they were fully aware that by not 'buying immunity' they had become potential audit cases. No sooner dld a taxpayer receive 'intelligence' from his 'sources' and 'contac ts' within the department that his return was being coi~sidereclfor asdit all sorts of pressures were brought t o bear on the functionaries involved in the selection process. In some cases even records of cases were tampered with to attempt interpolation of information data o r substitution of records appended with returns. Allegations were also made of functionaries approaching q d harassing taxpayers holding out promises of preferential and 'sympathetic' treatment in the course of the selection process at a "rice' ofcourse. From fiscal year 198586 the department introduced a fund.mental change in the process of selecticln of cases for audit. It was then decided to conduct a random ' ballot' of all returns held t o qualify for self assessmer~tthrough the computer availablewith the Survey and Collation Organization. TJnder the procedure the computer is programmed to make a random selection of a predetermined number of non-immune returns identified through their "National Tax Numbers (NTS's) only. The whole procedure is implemented by the Survey and Collation Organization and not by the authorities charged with assessment work. Thz change in selection procedure descrilned a h v e was expected to remove most of the adverse aspects of the procedure previously in vogue. However the new procedure created some problems of its won the foremost being that the nonimmune "lot" of N.T.N.'s fed t o the comput,er had a very high percentage of petty (marginal) cases whose revenue significance was nominal. Furthermore, many "lmmune" cases were also fed t o the computer due t o improper processinglanalysis of the returns and which had to be-"deleted" later on. The citation of 'Tetty" cases in the detailed scrutiny list randomly selected by the computer, drastically eroded the

IZS

I.'iscal Itrrpcra rives irr PaMstnt~'s E c o ~ r r o t t ~D:r~w l o p tnenr

revenue potential o f the total audit cases selection and limits the efforts of the assessing officers t o detect and bring to tax significant tax evasion as most of these "marginal" cases were of tax payers not maintaining proper accounts and conducting business o n a relatively limited scale. Such a consequence was inevitable given the " h n m u n i t ~ " facility which was "greddily" availed by all taxpayers having access to supernorntd profits. All things considered, the only practical way out here would appear to be resort to a system of parametric selection of cases for total audit rather than the purely random ballot method. A deterrrent factor here however would be tkLelimited expertise of tax administration as a result of which it may be difficult to devise the complex formulate necessary tcs make a parametric selection of cases for total audit such as is routinely done in more advanced tax administrations viz. U.S.-4. , Japan etc. However, since access to computer based technology is now a reality even in developing countries it is possible to at least explore the system of parametric selection step-by-step, - if not in its totality. THE CONCEPT O F "IMMUNITY'' The ability of a taxpayer t o 'purchase' immunity from an audit is certainly a unique feature in the scheme of self assessment in Pakistan. All that the taxpayer has t o d o is ignore the actual income that he has infact realized in a given income year and instead 'declare' an income that is in cc)nform.ity with a prescribed standard for grant of 'immunity'. The philosophy behind the measure appears to be that bypurchasing immunity for himself the taxpayer is in effect buying peace of mind which is considered sufficiently attractive in his scale of preferences to induce him t,o declare higher income than that previously declared cor~sistent with the "immunity formula". The interest of revenue is (supposedly) safeguarded in this manner as by capitalizing o n the deterrent effect of an audit the government might be ;able to ensure the generation of 'good' revenue without going through the hassle "With eJfecr urcharr ar 1988-89 ir i s no longer porrible fi~r an assessee ro i m m u n q . " a C " ~ &her t ~ ihan i h s e of Companiex) drclanog lnconie below I lac and nor orherwire dirqual~jiedunder anv other provlrion of thr. scheme - are hable to be accepred ar declared. AN other Rerunts of lnconre are ro be subje.:.rt3dro derarled scrurritv by a panel of rhrre oficers. Ir appears rhar [he glaring de-nierirr of [he immuniry fearure finall! pro~~oked irs repeal.

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of an actual audit in a large number of cases. Several questions arise here that need tl:) be answered before one can comment o n the merit, if any, of ,the feature. These are: (a) Does the measure actually p r o n ~ o t e"tax consciousness" - without which there can be no true 'voluntary compliance? (b) Does not the measure actually institutionalize the 'misreporting' of income? (c) What category ~:)ftixpayer has the maximum inducement t o avail of immunity -- the one enjoying an 'average' level of profits or the one enjoying supernormal profits o r the o n e whose profits are infact less than 'normal?' (d) Is it 'reasonable' for govt. t o lay clowrl a uniform criteria for immunity for all categories of taxpayers? Actual operation of the scheme to date would appear t o indicate that the taxpayers have reacted 'enthusiastically' in 'exploiting' the immunity provision to the hilt. In any system of voluntary compliance, tax consciousness is crucial to its success. The system of voluntary compliance structured must be such as to incorporate built-in checks to deter violation of the law and actively promotecompliance of the statutory provisions. In this context it is necessary to point o u t that should the statute contain obvious lool;~-holesresulting either from defective enactment or due t o deli'berate insertion of provisions t o achieve specific objectives, the objective of pro'motion of tax consciousness suffers as a necessary consequence. The immunity provision, is in the opinion of many, an obvious loop-hole in the self assessment law. I:t offers the tax payers clear opportunity not t o declare the correct income arising in a given period and to substitute the same by an arbitrary figure of total income derived by esclating prior income in a given manner so as t o quality for immunity from detailed scrutiny. The implicit assumption made in designing the immunity provision appears t o be that a sufficient numt~erof tax payers would be under a strong inducement to puirchase immunity by erring o n the side of revenue and not against it. The experience so far would appear t o indicate that while a fair number of tax payers have in fact purchased such immunity it is noted that most of them fall in the category of the taxpayers

that have actually earned income significantly more than what follows from the escalation formula devised. In other words, it is the tax-payers earning "super-normal" profits who are most attracted t o this provision. By granting them immunity the Government thus looses an opportunity t o probe their affairs and identify the evasion that they have contriiied. The extra revenue arising as a result of the purchase of imrriunity by such tax payers does not appear t o be a substantial amount and in any case is not consistent with their actual potential. There is, therefore, good reason to believe that all that the measure has succeeded in achieving is to institutionalize the mis reporting of income. It is indeed ironic that the greater the compliance with the immunity provision the greater is the mis-reporting. This is inecitable considering that the immunity income is rarely if ever, pitched at a level higher than the actual income arising to a tax-payer. Indeed irz actual prac tzce it has been found that the i??z?rzunityirzcome hardly e v r c,lpproaches tlze ucrual irzcome. The worry-some aspect here appears to be! the negative conditioning of tax-payers. Thus the higher the actual income and the greater the gap between the base year income and the current year's total income the greater is the incentive t o avail of the immunity provision and secure an exemption from detail+ scrutiny by paying a relatively snall anlount of extra tax. Over time, tax-payers have become so condi.tioned to this facility and have hecome so used to the enormol.ls tax benefits that arise there-from, that it is now difficult, indeed painful, for them to visualize a future in which the facility is withdrawn or modified drastically. In this sense therefore, it is evident that the objective of tax administration t o bring t o tax the actual income arising (or as close t o the actual incorr~eas possible) has bee-n futile. T h e utility of the immun.ity provision as a viable fiscal measure thus appears extremely doubtful. This is especially so in the peculiar context o f a develo'ping economy where t h e mobilization of adequate resources ought to have high priority. However, there are those who advocate continued retention of the immunity clause in the self assessment scheme as it facilitates curbing the arbitrary exercise of discretionary powers by the assessing officers. Furthermore, it frees taxpayers from the whimsical exercise of delegated authority by

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various levels of subordinate tax officials. In this context the measure is seen as a step that checks the spread of corruption. Considering the obvious weaknesses of tax administration in under developed countries it is indeed a fact that universal audit of all tax returns, as was in vogue before the self' assessment scheme in its present shape took root in 1979, giive rise to the arbitrary exercise of authority by all tiers in the tax administration hierachy. It also led t o much litigat,ion arid over burdened appellate authorities. Recovery of tax payment created through such universal audit was also hindered by the fact that the bulk of such demand was placed hefore various appellate forums. So long as final adjudication was nct announced (tvhic h process could become extremely delayed due to the limitations resulting from the inablity of appellate authorities to dispose off appeals expeditiously) tax-payers were reluctant t o pay up the tax demand raised against them. Resort t o coercive action was also difficult in such circumstances. While there is little doubt that the system1 of universal audit has considerable deficiencies of its own and its replacement by a scheme of self assessment is in the opiniori of most authorities definitely a step in the right direction, yet the incorporation of a specific provision for grant of irr~munityfrom total audit in the scheme of self assessment appears t o have made available so obvious a loop-hole as t o have largely nullified the impact of legislation introduced t o deter tax evasion. Especially glaring is the facilitv of having a uniform immunity provision for most classes of tax-payers. The inimunity provision as it is presently structured does not differentiate meaningfully between different categories of taxpayer:^. Thus while it may be common knowledge that particular cilasses of taxpayers aie enjoying abnormally high profits :yet since the immunity provision is uniform for most classes, tax-payers placed in this particular class enjoying abnormal profi.ts would reap unwarranted benefits simply because the in1munit.y provision does not take cognizance of the fact that ::.hey are very advantageously placed viz-a-viz other tax-payers. This is a considerable flaw in the structuring of the provision and detracts from much of its supposed efficiency as an inducement t o taxpayers t o pitch income levels at revenue significant levels.

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there is little doubt now that there has been a systematic abuse of t h e immunity provision by all classes of tax-payers especially those that have access currently t o super normal incomes and whose base year incomes were pitched at relatively low levels. It is high time therefore, that a serious rethinking is done o n this aspect. Ideally, its repeal would appear tc:, be indicated.' However, if that is not considered feasible, the criteria for immunity for different classes of tax-payers ought t o be differently structured. This is essential if the revenue losses inevitable under the present system are t o be avoided. ASSESSMENT Y E m S 1983-84 & 1984-85 - ALTERED CRITERIA FOR "ACHIEVING" IMMUNITY - PROBLEMS RESULTING THEREFROM: From assessment year 1983-84 a new twist was given to the concept of immunity in that whereas previously in order t o find out t h e figure of total income that woulcl enable him t o claim immunity, a taxpayer had simply to take either the average of the preceding three years assessed income or the highest assessed income in this period (- depencl ing o n whether o r riot he had claimed immunity in these three years - ) and then escalate the same by a given percentage I( 1 5 % l or 2 0 % depending in which category the taxpayer was placed). However with effect from assessment year 1983-84 the scheme of self assessment for the year (and also that for 1984-85) also r e quired that in order t o qualify for i m m u n i t . ~ ,the income returned currently be at least marginally higher than t h a t shown in the latest assessment o n record. Furthermore, the ratio of net profit t o sales evolving currently, was required t o h e the same as that indicated for the latest assessment year, assessment whetoof stood finalized at the time the return was filed. T o illustrate t h e altered immunity criteria described above and t o appreciate its implications, the folliowing example may be considered. Consider the case of a taxpayer who has not declared immunity level income in any of the three years preceding 1983-84. Assuming that t h e highest assessed income of this taxpayer has been that assessed for 1 9 8 2 8 3 at Rs. 100,000. Sales for 1 9 8 2 8 3 amount t o Rs. 10,000,000. Now the net profit disclosed a s per accounts for 1983-84 is taken at Rs. 125,000 I T;;.,n..ro

d r r 10.QJ7 h n r F;nnll%: nrkimruri rknr

with sales for the year shown at Rs. 20,000,000. The situation being as given above immunity can be claimed by the taxpayer on the basis of the criteria laid down in 1 9 8 2 8 3 by escalating the income assessed for 1982-83 by 20 5%. This would amount t o an income of Rs. 120, 000. By declaring a net profit of Rs. 125,000 in 1983-84 the incon-~edisclosed would appear to be immune as it is higher by more than 2 0 % of the highest income assessed in the period 1980-81 t o 198283. However clearly immunity from 1983-84 wo~lldonly be available if the alternative requirement for immunity as laid down in the scheme for 1983-84, (referred t o in para-1 above) is satisfied. The 'alternative requirement' for immunity requires that the ratio of net profit t o sales/ receipts in 1982-83 be the same again in 1983-84 -- and that the income declared in 1983-84 be higher than that assessed for 1982-83. On this basis the immunity level of income in 1983-84 would amount to Rs. 200,000 calculated as under: Assessed Income of 1982-83 X Sales shown in 3 983-84 -

Sales shown in 1982-83 -

Rs. 100,000 X Rs. 20,000,000 =

Its. 200,000.

Rs. 10.000,000 Thus as per the alternative requirement provision ir~troclucedin 1983-84 (and retained in substantially the same form in 1 9 8 4 85) the immunity level income amounts to R.s. 200,000. Against this the taxpayer has disclosed net profit as per books, at Rs. 125000 and this cannot get him immunity. Now supposing that the taxpayer is determined t o 'buy' i r ~ m u n i t yfor himself. That being so the taxpayer decides t o make an (adhoc) addition of Rs. 75000 t o the declared income of Rs,. 125000 t o increase the same to Rs. 200,000. He has now achieved the immunity level income calculated above. But does this infact buy him the immunity that he desires? The answer is No! and that is because again as per the scheme, any a d h w additions mad^ t n r o t l ~ r n d inrnmo aro r ~ ~ l ~ t~ni hp r dr n r ~ v o r t d i n t n

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sales which are then deemed t o have been suppressed by the taxpayer. These 'suppressed sales' are then t o he added t o the sales declared by the taxpayers currentty. After doing so the net profit t o sales ratio of the preceding year is t o be applied t o sales) the aggregate value (i.e. declared plus the s~~lppressed of the current sales. In our above example the limpsurn adhoc addition of Rs. 75,000 made by the taxpayer converts to Rs. 4,687,500 in suppressed sales. Thus:

125000 X 75000 20,000,000 =

Rs. 4,687,500

In our above example the net profit to sales ratio in 1 9 8 2 8 3 is 1 %. This is the ratio that will now have to be applied t o the agregate sales of 1983-84 which are not Rs. 20,000,000 but that plus Rs. 4,687,500 calculated as above i.e. Rs. 24,687,500. 1% of these aggregate sales will come to Rs. 246,875. This is the figure of Total Income t h a t the taxpayer is required to show given an adhoc addition of Rs. 75000 to the book profits. This ofcourse places the taxpayer in a quandary. No matter how much he enhances the amount of the adhoc addition he cannot really ever achieve immunity because the amount of 'suppressed sales' requireti by law t o be derived from the adhoc addition so made would keep on increasing and that would ofcourse escalate the immunity level income given these enhanced sales when the preceding years net profit t o sales ratio is applied t o the aggregate sales. In other words the taxpayer is trapped in a vicil:)us circle (if the original book profit disclosed by him was not enough t o buy him immunity from audit. In introducing this aspect of the immunity provision the objective was clearly t o convey the message t o taxpayers that an increase in sales in a given year should be accompanied by a proportionate increase in income. This was considered necessary because it had been observed that when current sales increased vis a vis a previous period the increase in income was less than proportionate t o the increase in sales. However be that as it may, it certainly appears that the requirennent for immunity had been defectively structured in that it clnnflicts with the 'facility' otherwise allowed to taxpayers t o increase income disclosed as per return by making an adhoc addition so as t o

SelfAsstt. Law & Proceciure

pitch it at a level consistent with immunity. This aspect of the immunity provision stands deleted with effect from assessment year 1985-86:

THE CREATION OF ADEQUATE "DE'fERR,ENCE". In order to successfully implement a progrrzrn o f self assessment o f income it is essential that there be adeqrtate visible deterrence against tax evasion. I f the average taxpayer perceives that self assessment is available to him \vitholct effective arrangements having been made to create machinery to systematically monitor economic activity, collect :zrld collate data and to feed information t o the executive 'arm"o f the tax apparatus, then he might find the benefits of tax (evasion too real to be ignored. The govt. was quite aware of the necessity for adequate deterrence when it decided to introduce comprehensive self assessment in 1979. It therefore organized a separate Survey and Collation Organization within the department of income tax, its function being to collect, collate and disserninate data and intelligence to the field offices charged with actual assessment of income tax. The basis was thus laid for a data matching program i.e. comparing the information appearing. on a taxpayers return of income with data, facts and figures independently collected by the income tax department. Since its inception the Survey and Collation Organization has endeavoured to collect information from banks regarding interest payments made, from the controller of imports r e garding the quantum of imports made by individual importers, from various authorities disbursing payments to those engaged in execution of contract assignments, * from the property tax authorities regarding house and other property held by different persons and from a host of other agencies, institutions and departments.

A serious shortcoming in the working of the Sunley and Collation Organization has been the absence of modern data 9

1 1

Finance Ordinance 1985. especially construction and supply contracts.

I46

Fiscal Imperatives in Pakistan's Ecor~onricDewloprnent

processing equipment which has hampered rts effectiveness in the efficient discharge of the functions with which it has been charged. Also the liaison that this organization has been able to establish with the different outside agencies identified above leaves much to be desired and there is considerable room for improvement here. Ideally, the S & C Orgn. should be able t o monitor information of tax significance as soon as an 'event' occurs. To illustrate as soon as an importer receives a consignment and documentation is processed by Customs, the S & C Orgn. should have all information relevant to the import in its possession. This should then be passed on t o the place of assessment of the taxpayer with the minimum of delay or better 1 still should be put in storage and 'retriev~d'when the taxpayer files his return. The information (alongwith other 'bits' of information collected and collated during the year) should then be immediately 'matched' with the information appearing on the taxpayers return and the I T 0 informed of any discrepancies, omissions and anatnolies noted. What happens at the present time is however a far cry from what is envisaged above. There is usually a, significant delay in collection of the information and its transmission t o the ITO. The S & C Orgn. presently has no data base of its own and so there can be no true collation of the data collected. It is left to the 1TO.s office to d o the matching required. As an army of clerks, literally, handles the information passed on by the S &C Orgn. there is ample scope for manipulation by interpolation or even destruction of data. While matters are still far from ideal it does appear that the S & C 0%.has infact made a: healthy impact o n the taxpayers perception of the efficiency of the department. The Organization has recently undertaken an ambitious program to build up its data handling ability by installing its own mainframe computer at Karachi with mini computers at Lahore and Rawalpindi. Key personnel are being given specialized training both within the country and abroad. The basis for building up a data base has thus been laid. DETERRENCE THROUGH THE LEVY OF PENALTIES UNDER THE STATUTE Under the

the Income Tax Ordinance 1979, levy of

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penalty and even prosecution leading to imprisonment has been prescribed for various defaults. The object here is both t o punish the 'defaulter' as well as t o have a deterrent effect on other taxpayers to stop them from behaving lkewise. The penal provisions having a bearing on self assessment procedure are summarized below. Section 108 of the Ordinance prescribes a penalty of Rs. 100 per day for failure t o furnish return of total income and prescribed statements, within the statutory time allowed for the purpose. Section 111 authorizes, in all cases of 'coincealment of Income' o r the 'furnishing of inaccurate particulars thereof' the levy of a penalty amounting to a sum not exceeding two and a half times but in no case less than the amount of tax which would have been avoided if the income as returned by such person had been accepted as the correct income. Sub section-2 o f section 111 defines concealment to include: (a) the suppression of any item of receipt liable t o tax in whole or in part; (b) claiming any deduction for, or showing anu expenditure not actually incurred and The scope of section 111 was enlarged considerably by a n h amendment made through the Finance Ordinance 1984 which made 'unexplained investment'to be also liable for penalty. Prior t o this, unexplained investment, though deemed to be income did not attract levy of p n a l t y . However advelse reception of the provision by taxpayers forced its repeal through Finance Ordinance 1987

( a ) deducr and remu rar liable ro be withheld at source, ( b ) ntuke advance tax liable alongwirh the return, in rzccordance wirh law, enrarLF a mandatory chmge of "addrrional tax" bur not levy of penalty. 'Failure

p a y v n t of tax, (c) pay admitted

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Fiscal Impemtiws in Pakistan's Economic L)evelopment

Section 112 prescribes a penalty for failure t o give notice of discontinuance of business or profession, not exceeding the amount the tax payable for the income year i n which the business was discontinued. Resides the levy of penatly described above for 'concealment of income section 119 prescribes prosecution which on conviction will lead t o imprisonment for a tern1 which may extend to five years, or with fine, or with both. The governments determination t o obtain information from all quarters pointing to concealment of incclme by a taxpayer, with a view t o take deterrent penal action as well as initiate prosecution proceedings, is reflected in the willingness of the Income Tax Department t o even enter into 'negotiations' with professional informers holding out a * promise of monetary 'reward' if pertinent information leading to confirmation of a finding of concealment is made available by them. However as these informers were understandably reluctant t o furnish information that could conceivably lead .to their own indictment (as is possible in the case of a former employee of a taxpayer) the government sought for itself the authority t o grant immunity from prosecution t o those collaborating H ith the department of Income Tax in unearthing c:.ases of deliberate tax evasion. This was accomplished through the machir,ery of section 128 of the Ordinance which specifically enables the Federal Government to tender immunity to persons such as those described above. The combined effect of the vigilance exel-cised by the Survey and Collation Organization and the use of statutory provisions permitting the levy of heavy penalties and even prosecution leading t o imprisonment does appear t o have had a somewhat salutary effect in detemng tax evasioln. This is not t o say that the 'problem' of tax evasion stands resolved. HOWever the quality of the returns being filed and the revenues being actually generated through the levy of income tax d o point t o a somewhat heightened perception of the ability of the department t o detect tax evasion and also fo the seriousness of its resolve t o bring tax evaders t o book. At the same time, in order t o reassure taxpayers that action will not be initiated on whimsical grounds or flimsy evidence it has been provided for that penalty of for concealment of income will

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only be levied in cases of 'deliberate' tax fraud and not otherwise. Also, if a person knowingly furnishes false evidence t o the department o r makes a false deposition simply t o harass a taxpayers, such person himsslf shall be liable t o be proceeded against under the criminal procedure code.

"DEEMED INCOME" UNDER THE ORDINANCE -. Implications for self assessment As per the self assessment scheme of 1982-83, it has been made obligatory for a taxpayer t o include "deemed" income in the composition of receipts making up the total income for t h e year. Now what exactly is 'deemed income?' Section 11 of the Ordinance envisages deemed income to include within its ambit,income which does notUactually"arise to a taxpayer in a given income year,but which is supposed "notionally" t o so arise. In other words the 'receipt' of such income is a fiction created by statute. T h e most important 'deeming' provisions in the Ordinance relating t o income are those cited in section - 13. These may briefly be summarized a!; under: Deemed income includes, under: Clause (a) : Unexplained cash credit found in the books of a taxpayer; Clause (aa) : t h e value of an investment/iuticle/money owned by a taxpayer and not satisfactorily explained (in the context of the finance funding the acquisition); Clause (b) : t h e value of an investment mad.e by the taxpayer but not recorded in the books of accounts or the statement of wealth; Clause (c) : the value of any valuable article o r money owned by a taxpayer when t h e valuable article o r money finds no mention in the taxpayers books cbf accounts or statement of wealth; Clause (d) : that part. . of. the value . .of .an investment . .. made

Fiscal Impemtiws in PaMsran 's Ecotromlc Developmenr

Clause (e) : the amount of an expenditure actually incurred by a taxpayer but not disclosed in the books of accounts; Tlze important thing t o note kere is tkat z r z the absence o f the deeming provisions cited tfze acqriisitior~ of' assets or rrzaliing o f irzvestrnents described above cou Id not constitute 'income' as these are not revenlie receipts. Infact most of them are capital assets or expenditure. Yet legislative intent here is clearly t o empower the I T 0 t o treat them as revenue items. This provision has considerable practical significance in that it enables the I T 0 t o get a handle on assets acquired through funds that have not suffered taxation and have thus been built up illegitimately. At the same time however ir is imperative that these vast powers be exercised judiciously. A valuation whimsically made by the I T 0 can easily impose an insufferable burden of tax. In order t o prevent this from happening it has made mandatory that the additions made t o total income by invoking these provisions meet the prior written approval of the supervising officer (the IAC).

Besides the deeming provisions cited in section 1.3, section12 also contains various citations of income "dt!emed " t o have arisen. Deemed income includes here: Under sub section - (7) :!Ithe q o u n t of interest charged o n a loan advanced by a taxpayer that is less that1 the bank rate of interest plus two per cent; Under sub section - (13) : any amount paid by a tenant that is not adt o the owner of the premises obtained -rent justable against rent paid by the tenant; Under sub section - (16) . t h e amount received by a taxpayer for vacating possession if a premises reduced by the amount, if any, which was originally paid for acquiring the premises; Under sub section *

(9) : in the case of a Company, the

Deleted b y the Finance Ordinance 1985.

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amount of 'bonus' or the face value of a 'bonus share' declared, issued or paid t o shareholders out of reserves or profits or accumulated profits; In a separate category, under section 79 of the Ordinance, where a resident carries on business with a non-resident, and in the opinion of the I T 0 the business is transacted between them in a manner as to understate the true profits arising t o the resident, the I T 0 will determine the true profits of the resident and the difference between the amount so determined and the amount declared by the resident in return filed shall be deemed t o be the income arising t o the taxpayer and added to total income determined for the year; Again, in a different category, under section-25 of the Ordinance when a deduction has been allowed for any loss, bad debt or expenditure incurred and where the amount in question has been subsequently recovered the amount so recovered shall be treated as the deemed income in the income year in which the recovery was made. A similar position obtains in respect of allowance claimed for a trading liability. It is pertinent also to point out here that (under clause (c) of this section) where a trading liability disclosed by ZL taxpayer remains unadjusted after the expiry of three years of the income year in which it was allowed, the amount of such liability will be treated as the deemed income of the tarpayer in that income year. In the context of self assessment of income it is significant to note that per Finance Ordinance 1984, under clause (c)' of sub section (2) of section 111, any deemed income found to have arisen to a taxpayer under clauses (aa), (b), (c), (d) and (e) of sub section-1 of section-13 that is not disclosed in the return filed will suffer a maximum of 25 % penalty just as the concealment of other income arising under the Ordinance. Also, concealment of any amount of deemed income will automatically oust a taxpayers claim for acceptance under the self assessment scheme, including any immunity claim. However it is only the deemed income arising under section 13 described above that is liable to suffer penalty under section

Fiscol Impemrives in Pakistan 's Economic l)evelopment

111. Deemed income other than that cited in section-13 is outside the scope of section 111. Similarly, prosecution under section - 119 of the Ordinance for concealment of the deemed income indicated in section-13 is indicated, leading to possible imprisonment, or fine or both. While the deterrent effect of the provisions referred t o above are obvious, it is t o be noted that in actual practice recourse t o the provisions of section-13 is made quite frequently by 17'0's and much of the criticism is directed t o the allegedly unwarranted zeal shown in making the additions under this section. The fate of such assessment orders in appeal appear to bear out some of the criticism made. Apparently this is an area where the discretion available t o at1 assessing authority is not tempered by careful conduct of enquiry and judicious appraisal that is required keeping in mind the potentially serious conseguences that can follow for the taxpayer. Perhaps mindful of deficiencies in this area Finance Ordinance 1987deleted clause-C of subsection-:! of section 111. A QUESTION O F "FINALITY"

When does an assessment framed under section 59 become final? Per section 65 of the Ordinance as amended by Finance Ordinance 1987, the time laid down before an order of assessment can be 'reopened' ( t o remedy a 'deficiency' evident in the said order resulting from income escaping assessment or being underassessed, or assessed at too low a rate) is five years. Within this time span, an assessing officer can invoke the provisions of section 65 'Suo-m oto' if definite inforniat,ion is available on record 'or7 with the prior written approval of the IAC. The authority t o reopen a completed assessment is thus limited by time and by the per requisite of prior approval from a higher autherity where 'definite information' of escapement or under assessment of income is nor available to an ITO. It can not thus be said to be 'unbridled'. And it is certainly much more limited in scope than the powers available to an I T 0 to reopen an order of asstt made under 23(1) of the Repealed Act - when the IT0 could reopen an asstt so made o n his own if he in his discretion considered that the justification for such action was there. The ten year limitation laid down in section 65 prior co T-4

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the I T 0 could only make recourse to section 34 within six years of the completion of the assessment sought to be r e opened - when action for concealment of incorne was contemplated. Other than for remedying concealmen.t, the limitation was reduced to four years and then only two years. It was thus urged that widening dramatically the scope of section 65 would keep assessments framed under section 59 as only 'provisonally assessed' till the expiry of ten year:; when they would attain finality. In the interregnum taxpayers would have to suffer the unease of having the proverbial 'sword of Democles' hanging over their heads as they would have to contend with the possibility of sudden action under section 65. Taxpayers apprehensions here do appear tfo have been exaggerated. After all the I T 0 had been permitted to proceed under section 65 on his own only when 'definite information' was available on record. '/

The long standing demand of the taxpayers I'or reduction

in the ten year limitation period appears t o have been satisfied through the amendment made by the Finance Act 1987 in subsection (3) of section 65 by adding a proviso the result of which is t o reduce the limit time for reopening an assessment or bringing escaped income t o tax from 1 0 t o 5 years. The Finance Act 1987, has. significance in the evolution of tax law in Pakistan in-so-far as a number of enactments (potentially) of far reaching consequence were announced. Two of these deserve special mention. The first relates t o treatment accorded to certain loans. Through a new sub-section (18) introduced in section 1 2 in the Income Tax Ordinance, 1979, certain loans were declared to be treated as deemed income for tax Ilurposes. The amendment stipulated that in case an assessee claims, or shows, any amount as having been received by him as loan (s) during any income year commencing on or after the 1st July, 1987, from any person (other than a banking company, or a Finance Institution notified by the CBR for this purpose], the amount of such loan (s) shall be deemed to be income c~fthe assessee for the said income year, if (a) the total amount of loan or loans received in the income year exceeded Rs. 50,000/-; and (b) the said amount is not received through crossed bank cheque (s).

154

i,ls:.c: i.ii;)i m tives in Pakistarr 's Eow~o?rricL)ewloprner~r

This amendment in law had been introduced t o remedy a deficiency in t h e Income T a x law which enabled uncorroborated loans t o be admitted. Such a facility dlowed taxpayers t o build up capital artificially by contriliing loans from persons whose income enjoyed statutory exemption, such as agriculturists. In actual fact, of course, no loans were involved b u t by making a declaration t o this effect in collusion with a bogus creditor an infusion of funds was rnanouvered thus providing a ready conduit for "laundering" of t h e black money resources of a taxpayer. The obvious loop-hole in law is responsible for having caused enormous darr(age t o revenue and has rendered helpless the assessing a u t h o r ~ t y'3s a simple uncorroborated declaration from the (bogus) creditor usually sufficed t o authenticate the arrangement. The lenient treatment accorded by appellate authorities further exdcerabated the situation for t h e assessing authority. T h e requirement for routing such amounts through banking channels would have gone a long way in rr~akingpossible the deduction of suspect flows o f credit. However, the positive effect of the amendment in section 1 2 was quickly nullified as subsection (18) introduced in section 1 2 through the Finance Act, 1987 was withdrawn [after t h e Finance Bill had been ratified] in the wake of wide spread public agitation. Another amendment made in sub-section ( 1 ) of Section 13 b y introduction of a new proviso therein would have enabled t h e .assessing officers t o bring t o tax any unexplained asset, investment, expenditure etc. discovered by the I T 0 after t h e assessment of t h e relevant income year had been made b y treating it as deemed income under section 13 and to include t h e same in t h e total income of the income year relevant t o t h e assessnent year in which such discovery was made. Thus il' say, an investment was made in t h e income year relevant t o the assessment year 1985-86 and t h e fact of s ~ l c hinvestment was discovered b y t h e Income Tax Officer during the assessment year 1987-88, after the assessment for 1955-86 had been completed, the deemed income under section 13 in respect of the said assessment would have been included in t h e total income of the income year relevant t o t h e assessment year 1 9 8 7 8 8 and not of the income year relevant t o the assessment

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year 198586. However, if the assessment for 198586:asessment year was still pending at the time of discovery, the deemed income would be included in the income of the income year relevant to the assessment year 198586. The amendment made above under section 13 was also subsequently withdrawn again in the afterr:lath of agitation. The practical implications of the above amendment would have been far reaching as it would have in fact nullified the restrictions on the assessing authority resulting from amendment made in sub-section (3) o f swtion 65 in-so-far as "disc o v e r ~ " of unexplained investment having been made "currently" would no longer be required to be taken c~gnizanceof in the income year relevant to the assessment year t o which such investment actually pertained. Considering the frequency with which section 13 is being invoked it is now of considerable significance in the context of yielding additional revenue through levy of tax on deemed income. Much of the investment in immoveable property attracts the provisions of section 13 in-so-far as the legal instruments of purchase/ sale executed declare a value signigicantl~lower than the bona fide market va!ue of the property. The arrangements in this context are invariably of a collusive nature. Previously the levy of capital gains provided a powerful incentive to the seller to understate sale value. With the repeal of the capital gains tax, this aspect is no longer of significance for the seller. However, in order t o facilitate expeditious sale of immoveable property the seller even now does not object to understatement of value in the sale instrument - which ofcourse evables significant stamp duty. It has been noticed that a good deal of inveslment has flowed into immoveable property and the same is in many cases not funded through bona fide sources. The reduction in limitation for invoking the provisions of section 65 as a result of amendment made in sub-section (3) of section 65 by Finance Act 1987 has certainly hampered the jurisdiction of the Income Tax Officer in cases liable for action in this coritext. The amendment in section (1) of section 13, as discussed .above, if allowed t o have remained Zn force would have facilitated he task of the assessing authoritv considerably.

1 56

Fiscai Itt7::: 5:rs .(

!PI

Pakistarr 'r k'cor~ornicDevelopment

APPELLATE RECEPTION OF SELF ASS'IT LAW Taxpayers contesting assessments on factual and legal grounds are required first t o file appeal before the Appeals Commissioner and thereafter t o the Income Tax Appellate Tribunal whose decision o n matters of fact is final. The taxpayer can gain access t o the superior courts (the High Courts and the Supreme Court) only if a point of law emerges from the Tribunals decision. A taxpayer may also invoke the revisional jurisdictional of the zonal Commissioner of Income Tax but that is rarely done as by doing so the taxpayer forfeits the right t o file any further appeal in the case and the Comlnissioners decision becomes binding. The superior courts may hear an appeal in an income tax case directly only if it falls within their extraordinary writ jurisdiction --- as would be the case if say, a constitutional question arises such as when furldamental rights are affected or where a 'prima facie' case of malafide' is established. The main objection of taxpayers with regard t o the self assessment law enacted and incorporated in the Income Tax Ordinance of 1979 has been with regard t o the selection of cases (both individually and by 'classes') for 'detailed scrutiny.' Soon after the scheme was first put into effect tihe extraordinary writ jurisdiction of the superior courts was invoked in a number of cases o n the grounds that sub section (1) s f section 59 of the Ordinance "required" that where a return of income satisfied all the requirements laid down in the self assessment scheme it was "bound" t o be accepted and processed as filed irrespective of the fact whether it was covered by 'immunity' o r not. In other words such a return could not be set apart for scrutiny. It was specifically urged in this context that the procedure for selection of cases for scrutiny was arbitrary and illegal because the substantive law relevant t o self assessment as ,laid down in the Ordinance made no mention of selection of cases for scrutiny. It was further alleged that the pro.cedure of selection of cases for scrutiny was also violative of 'natural justice' as a firm objective basis was not evident in the selection procedure and gave unwarranted discretion t o the income tax functionaries involved.

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Section 65 of the Ordinance has also come under attack in appellate forums because it permits the I T 0 to reopen assessments already finalized under section 5 9 (1) of the Ordinance (in specified cases of underassessment or incorr~e escaping proper assessment) within the preceding (prior t o Finance Act 1987) ten years. It was contended here that the stipulation of a ten year period was unjustifiably protracted. With regard to the self asstt. scheme itself, the Lahore High Court (Punjab) in disposing off writ petition No. 3574 of 1984,*1 upheld the authority of the Central1 Board of Revenue in laying down a "scheme" providing fc~rthe selection of cases (both individually and by "class" i.e. 'category') for detailed scrutiny. Earlier, the Sind High Court in the case of Cannon products Ltd. Vs. ITO*' had held that the CBR did not have the authority to select cases or classes of cases for detailed scrutiny. However in the matter of the writ petition referred t o above, the Lahore High Court had pointed out that with the introduction of sub-section (1A) in section 59, the legislature had expressly authorized the CBR to e:l:ercise such power ( t o select cases for scrutiny). It was further held by the Lahore High Court, that the criteria applied for selection of cases for scrutiny ". . . . . . . . . . . . . . did not appear to be arbitrary, unreasonable or unfair. It is therefore difj;ndt to agree with the peitiouers that the 'schenles ' are beirlg operated discri~~zinately or that the power given t o the Boaru' under subsection ( I - A ) o f section 5 9 o f tlze Ordi?zance is brirlg arbitrarily exercised.'' "(Emphasis mine). . Prior to the insertion of sub-section (1-A) tihrough the Finance Ordinance 1985, it had been the opinion of the department that the scheme of self asstt. being essentially a 'policy measure' designed t o give effect t o self asstt. law laid down in the Ordinance, the C B R being the policy making ' a m ' of the income tax department was 'implicitely' invested with the authority to select cases for scrutiny. As has been pointed out *

Mohammad Asghar etc Vs Central Board of Revenue etc. [ (1986) 5 3 Tax 1 0 9 (H.C. Leh)]

[ In the Lahore Hlgh

Court. Lehore I

r (1985) 5 1 Tax 1 1 4 (H.C.Ker.)]

I In t h e Sind High Court. Karachi]

158

Fiscal Irnperatives irr Pakisrorl 's Ecorrorrlic Dt~!~cl~~ptrretrr

above, however, such a view did not find fav01.1r with the Sind Iiigh Court and although its expressed opinioc! is not binding or. federal functionaries operating outside its territorial jurisdiction the (federal) govt., considered it expendient t o stipulate expressely through sub-section (1-A) t.hat the CBR (and any authority subordinate to it to whom such authority mily be delegated by the Board) was empowered t o select cases for scrutiny. Also, by giving retroactive ap:plication to the legislation, legal cover was given simultaneously t o the previous exercise of such authority by the CBR.. This may therefore be said to be one example of judicial pronouncement provoking specific legislation. The case of Cannon Products Ltd. Vs. ITO, has added significance in the evolution of self asstt. law in Pakistan, in that it has been f$her held by the Sind High Court in its cited order, that a 'revised' return of income (i.e. a return revised after the original had been filed) did qualify fox, acceptance under a scheme of self asstt.provided it vsas not disqualified under any other provison of law. This 'finding' of the Court conflicted directly with the department's view that only returns that were filed voluntarily by the 'due date' wen:, eligible for consideration under the self asstt.scheme and all other returns were outside its ambit. Such a~viewwas considered t o be consistent with the language employed in section 59 ( I ) which made mention only of returns filed under section 55 - which is the section dealing with the voluntary filing of returils. There was no mention of returns filed under section 57 (revised returns) and therefore by implication such 'revised' returns were considered ineligible for self asstt. The Sind High Court however did not concur as, it being the vested right of a taxpayer to revise a return prior t o assessment, such rclvisecl returns in its opinion, could not be ousted from consideration under self asstt. simply because section 59(1) made no mention of them. The insertion of an EXPLANATION in section 59 (1) through the Finance Ordinance 1985 however effectively neutralized the impact of the courts decision as the amendment provided that 'revised' returns would be debarred from consideration for self asstt. T h e amendment was also given retroactive application. Here again therefore it was the action nf

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SeTf Ass!t. Law & Procedure

stantive law obtaining on the matter. Prior to Finance Act 1987 the ten year limitation period for re-opening of an assessment already finalized under section 59 (1) had been a point of controversy. The superior courts in general frowned upon, what was considered to be, an unwarranted 'extension' in the time lapse here enabling action under section 65 to be initiated anytime within ten years from the date of completion of an asstt. under section 59 (1).This " u n e w " of the superior courts is evident in the decision of the Lahore High Court (Punjab) in the case o f "Riaz bottlers Ltd. IJs ITO"*' wherein it had been observed. . .

'. . . Indeed to dlow "them" (i.e. the ITO's) t o wield '"t" (i.e. the power under section 65) for a period of long ten years is something extremely unusual. It has the effect of i.

giving them "a handle of oppression" vis a vis the assessees. . ." (Emphasis mine). This is strong language indeed but the court made no attempt t o strike down the legislation o n a constitutional ground. Perhaps it expected the government t o take immediate notice of the observations made and reduce the limitation period under section 65. But that did not happen. ~ taxpayer Rather, the specific relief provided by the court t : the in this particular case was nullified by amending sub-sectjion 3-A through the Finance Ordinance 1984 and by mak!ng the amendment applicable retroactively. The Department of income tax appearecl t o have got away with amending the law laid down in sections 59 and 65 'and' by making the amendments applicable retroactively, as only the "machinery" provisions of the substantive law had been affected. Indeed were it not possible t o give such cover to the affected assessments made under the ::.elf assessment scheme since July 1979, the scheme for the earlier years could conceivably be placed in jeopardy.

* 3

In the Lahore High Court h h o r e . Writ Petition No. 3590 of 1982

decided: 3rd Mnrch 1984.

100

Fiscal Impemtives in Paklsran 's E'conomlc Development

IMTACT C F SELF ASSESSMENT ZN'PAKISTAN The impact. that self assessment has made in Pakistan can be appraised in terms of specific criteria viz 1 ) promotion of administrative efficiency within the department of income tax, 2) promot,ion of tax consciousness among taxpayers, 3 ) expansion of the tax base, 3) quantum of revenue ge:nerated. One of the problems that plagued the department of income most before the enactment of the Income Tax Ordinance of 1979 was an alarming inefficiency in all major areas of work. Over the years the number of taxpayers (assessees) in each ITO's charge had increased appreciabl!;. With universal audit the norm before the introduction of self assessment that meant that much more paperwork and with procedures and staffing patterns remaining virtually unchanged since 1922 (when the Income Tax Act came into being in the then undivided British India) the workload was fast becoming unmanageable. As ITO's attempted t o scrutinize each and every return filed they ended up not being able t o scrutinize any significant number properly. More and more assessments came t o be made 'summarily' and many taxpayers familiar with departmental 'routine' would simply ensure that their return was taken up for scrutiny toward the close of the fiscal yeinr as that guaranteed the most summary of all assessments - and afforded the maximum scope for evasion of tax. With record keeping still organized on the old "linked file" system Inany offices appeared t o be buried in a mountain of tattercd files. The I T 0 had almost no direct access t o the records of his own office and became pathetically dependant on an army of ill paid, ill educated ill motivated clerks who nevertheless acquired considerable notoriety as petty tyrants without whose goodwill neither IT0 nor assessee could ever hope t o have much accomplished. With universal audit came virtually universal filling of appeal and that meant departmental appellate functionaries and the Income Tax Appellate Tribunal getting so bogged down that many appeals did not complete the full appeallate cycle (from the AAC t o the Tribunal) even after a lapse of three years. In the meantime, successive ITO's kept on repeaking t h e previous assessment pattern (that had given rise t o the appeal in the first place) and that in turn would ensure a a second 'round' of

Self Asstr. Law & Ifocedure

Since the introduction of comprehensive self assessment in 1979 (actually 1980 when the scope of the scheme was enlarged) an immediate result has been a dramatic reduction in the daily workload of departmental functionaries. ITO's now are required t o scrutinize only a fraction of the number of cases they previously had t o examine. This ofcourse means much more time being available for indepth examination of individual cases. An interesting development here has been the increasing number of assessments finalized by the assessing officer "in agreement" with the taxpayer with the taxpayer forfeiting his right of appeal. It appears that more and more t;ixpayers find it both more convenient as well as more econoniical t o agree t o being assessed at a ]figure! higher than that :.hewn in the return in agreement with the I T 0 rather than contest every attempt at determining a deficiency by the I T 0 during the course of an audit. This saves them the hassle of the appellate cycle and the extra tax assessed in audit would appear t o be more than offset by the savings resulting from avoiding the appeals process. Besides taxpayers feel that they get a better deal when a compromise assessment is made than if a 'regular' assessment order is framed as in the latter case the IT0 is inclined to assess at the highest figure possible and that can easily result in a harsh assessment being made. As only a few assessments are made by the ITO's even fewer assessnellts are contested in appeal as many of them are compromise assessments. This has come as a boon t o appellate authorities who now for a change-find that they have the necessary time to dispose appeals after adequate consideration of the taxpay,>rs and the departments points of view. Given the improved work environment a qualitative improvement was expected and has infact beccrme evident in the work of the functionaries charged with assessment and appellate duties. A good number of cases invoilving detection of tax fraud have been finalized during audit In the last few years. Similarly the quality of appellate orders has improved, perceptively. Thus as far as the first criterion listed above is concerned, the self assessment scheme has been a success.

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FIscol Imperatives In Pakistan 's Econoraic Development

Tax consciousness among taxpayers means simply an awareness of tax law combined with a wil1ingnes.s t o comply with the provisions of the statute - both in letter and spirit. Voluntary compliance with the law laid down controlling the taxation of income is thus the key issue here. In order t o help the ordinary taxpayer without access t o expert legal counsel of any significance, the government has sought to 'educate' the public in fundamental matters of tax law and procedure. Advertisements prominently placed on an attractive format are reqularly taken out in major newspapers and periodicals especially before the deadline for filing of returns and the stipulation of the law is made clear in simple language. Television and the Cinema have also been so used to reach out t o the public. ITO's have been encouraged (and even 'ordered') t o go out in their jurisdictions and meet with their assesees face t o face and explain tax matters and answer their queries. A society 'conditioned' as it were t o practice tax evasion (a carryover from the colonial era perhaps) will not change its ways simple because the administration was showing its seriousness in "teaching" them tax law. Perhaps mindful of this reality, the government very early decided t o show its resolve in dealing with tax evasion by creating adequate deterrence for those given t o practice tax fraud by making instituional arrangements to monitor pertinent economic activity in the country and ensuring the feedback of intelligence so gathered t o those charged with assessment work. It was thus that the Survey and Collation Organization was set up within the department of income tax. A special economic enquiry unit has been created within the Federal Investigation Agency. The CBFt has created a Vigilance Wing staffed with technical personnel especially t o detect and report on tax fraud of any kind anywhere in the country. Additionally, the department has begun t o make more frequent use of the penalty provisions in the Ordinance. The end result of all this has been that there has been a perceptible increase in voluntary compliance which is evident from the following statistics regarding returns filed voluntarily.

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The fact that non-filers (those who have not been filing returns of income although they are required to clo so) are showing a willingness t o come forth and declare their taxable income is especially encouraging. Although there has been no 'flood' of such declarants, their numbers are not insignificant given t h e tax ecology of the country. Figures available for three years in this area are

That there has been a qualitative improvemc:nt in the returns is evident from the fact that as many as 135,328 returns filed in 1980-81 voluntarily by existing taxpayers tihowed an improvement in the quantum of income declared, vis a vis 1979-80, as against 45,750 returns showing a decrease in income. Furthermore, the number of cases qualifying for immunity by declaring enhanced income consistent with the standards laid down by the CBR' increased to 60,659 in 1!381-82 as against 22,128 in 1 9 7 9 8 0 . The trends cited above are maintained in the following years. We can say therefore that as far as can be said on the basis of the existing data, tax consciousness certainly appears to be on the increase and is relatable t o the operation of the self assessment scheme as devised in 1979 and as improved thereafter. Looking to the population of the country (arn estimated 100 million in 1985) the taxpayer 'population' of 1 million is a paltry 1 5% and clearly translates intda very narrow tax base indeed. But that is attributable in no small measure t o the failure of the government to go through with legislation making agricultural income subject to income tax. Even so, it is true that the existing tax base built up on the businc::ss, service, manufacturing, and construction sectors and ofcourse on those deriving salary incomes is narrow. Considering that the zero bracket exemption limit is very low (currently Rs. 25,000 but previously Rs. 18,000 for quite some time) a very l a q e number of potential taxpayers/especially those engaged in small scale retail business, remain outside the tax net. However, since 1979. the tax base ha.. e x n a n d 4 and much of the exoansion

1 64

Fiscal Irnpemtlves in Pakistan's Ecor~omicDevelopment

is attributable to the vigorous conduct of external survey by the 17'0's *1 and also due to the efforts of the Survey and Collation Organization whose activities resultled directly in unearthing many cases of non filers.

To illustrate the improvement in this area it needs to be noted that in the first year of the operation of the self assessment scheme 200,000 non filers were detected and brought on record. In 1980-81 another 210,000 such cases were 'booked'. As a result of the yearly improvement in this area the number of taxpayers in 1985 were indicated at 1 million as against less than half that number in 1978-79. The 'improvement' here is thus self evident though it is yet a fact that many non filers remain there to be brought within the fold of the income tax laws of the country. A primary objective of enacting legislation for the taxation of income is to generate revenues for the government. This does not ofcourse mean that such legislation does not have other objectives but only that mobilization of revenue remains a very important objective, especially for the government in a developing country which is always short of cash.

Prior t o 1979 two experiments with partial self assessment (in 1964 and 1977) had shown that universal self assessment would most probably result in a precipitou:; fall in income tax revenues. This had a lot t o do with the negative tax mentality of the public with whom tax evasion appeared t o be a deeply ingrained habit so that self assessment would give them a unique opportunity t o indulge in this pastime (of tax evasion) especially because the tax administration was so weak and without access to any economic intelligence gathering apparatus that could enable it t o detect tax evasion. Thus when the government went ahead with the scheme for comprehensive self assessment in 1979 there were many who were deeply apprehensive of its impact on revenues. However in introducing the scheme the government took two major decisions which in my opinion prevented the feared fall in revenues. Firstly, the government introduced a truly 'comprehensive ' scheme of self assessment --one that embraced all 1

w b now had the time available t o conduct such m y .

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categories of taxpayers in both the corporate and non corpcrate sectors. Secondly, the government created adequate deterrence to tax evasion by making instibutional arrangements t o gather and utilize economic intelligence effectively. The first measure improved the taxpayers perception of the goveruments credibility in fairly implementing a program of genuine self ,assessment. In this context it needs to be noted that the previous attempts at introducing self assessment were conspicuous in their 'partial' nature. Only very limited categories of taxpayers were covered by it and it did not appear (atleast the governm12nt did not make it appear so) that there would be any major change here in the immediate future. This probably disenchankd the taxpayers with the scheme at its very inception. It is fcood that in 1979 this 'deficiency' was not recreated. The second measure (creation of deterrence) appeared to have convinced the taxpayers somewhat of the seriousness of the governments resolve in not allowing self assessment t o give a free hand to those practicing tax evasion. As a direct result of the two mesures referred to above/ Government revenues did not fall. Rather each year, 1979-80 to 1986-87 there has been an increase. Thus Government income tax revenues increased from Rs. 3,354 million in 1978-79 to Rs. 5,177 in 1 9 7 9 8 0 to Rs. 7,028 million in 1980-81, Rs. 9,071 in 1 9 8 4 8 5 Rs. 9,591 in 1985-86 and 13s. 10,200 in 1986-87. So even by the last criterion given above the scheme appears to be a success although it is also a fact that income tax revenues have been placed as it were on a "plateau" since 19848 5 with little hope of any significant increase in the near future so long as the basic fonnat of the Income Tax law remained what it is presently. In the furture the Government should endeavour to rationalize procedures within the department of income tax and to give the department ready access to modern computer based information storage and retrieval systems which would go a long way in further enforcing voluntary compliance and to enable a meaningful data matching program to be instituted on a continuous basis. And ofcourse, the existing narrow tax base has got to be broadened meaningfully by bringing income from agriculture within the fold of federal taxation.

11 The political dimension in taxation

The evolution of tax laws is a complex process that reflects changing political, social and economic cross currents. While tax levies basically seek to raise revenues for government, in the modem era, fiscal enactments also seek to influence the course of economic activity. Thus, by altering the relative level of tax burdens, tax laws can actually 'promote' activity in a particular area or sector of the economy. Typically, in developing countries tax laws may be designed with the specific objective of promoting industrialization - including the geographical dispersal of industry. This is an area in which struggling third world countries have a marked deficiency. On independence in 1947, Pakistan inherited the British made Income Tax Act of 1922 - adapted for application in Pakistan as Act XI of 1947. This statute conferred an exemption from the levy of income tax t o all income arising from activities in the agricultural sector of the economy. It thus retained a principal feature that the colonial government had built into the income tax law. That (colonial) authority had been influenced by a number of factors in allowing such exemption. For one thing undivided India was predominantly an agricultural colony. Its agriculture .was practiced in a highly traditional manner and a 'rural elite' of large landowners had a strangle hold in this sector. The British augmented the numbers of the rural elite by bestowing large tracts of land to those loyal to the crown - especially where the loyalty was shown in times of crisis. Thus over time, the British gradually befriended this elite and through them ensured the continued sublservience of the 167

168

Hscal Impem tiws in PaMstan 's Economic Deielopmenr

rural population. Other than this painstaking1 y cultivated 'special relationship,' it was also realized that, by and large, agriculture continued t o be a sector of fluctuating fortunes, heavily dependent on the vagaries of the weather. I t was abIe.to feed the population of India - and yield a surplus'in a good crop year. But except for the big landowner, ownership of land did not by itself ensure a significant, 'steady' income. In any kinds paycase the farmers were all subject to taxes of vario1.1~ able to the local authority. Looking at the matter in its totality, it was not considered expedient' by the then colonial government to subject the agriculturists to an additional lev,? payable to the central government. It was felt that such a step would not only burden the agriculturist but also that it would needlessly alienate the elite whose favor the government assiduously cultivated. The 'background' given above is necessary to understand the context of fiscal enactments in the subcontinent prior to independence that allowed income from agriclrlture to be statutorily exempt. After independence, the 'special relationship' referred t o above no longer obtained. There was no ostensible need for the government of the day t o 'cultivate' the rural elite any further. In actual fact, however, this elite immediately set about making manouvers t o establish a power base in the free country. The legacy of procrustean control that it had established over the rural population stood it in good stead now and the 'experimental' democracy of the newly independent country gave them ample scope to secure a 'tilt' in their favor in the countryside - where the bulk of the country's population lived. Thus the 'logic of nun] bers' guaranteed t o this elite a commanding political position. Having secured an entry t o the legislatures it was a relatively easy matter for them to make sure that their positiorl of eminence was not disturbed - atleast not in any significant manner. A continued exemption from the levy of a federal. tax on their incomes was thus not difficult t o secure considering the political clout that they wielded. The statutory preference for agricultura'l income did ofcourse provoke a response from the non-agriculturist who could not comprehend why he should be treated any differently from his compatriot in agriculture in the matter of taxation of his income by the federal govt. However, every attempt t o

T" political dirrension in mxation

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'reform' the tax system by doing away with this exemption was deftly blocked by the agriculturists who by dint s f their numbers - and their wealth - found it a simple matter to negative the efforts of the non-agriculturists in their attempts at fiscal reform. The tug-of-war between the agriculturist and he nonagriculturist culminated in the federal govt. in January 1977 levying income .tax on agricultural income - albeit in a 'mild' manner - through the finance (supplementary) Ordinance 1977. The Ordinance was later approved by the National Assembly when it passed the finance (supplementary) Act of 1977. This legislation withdrew the exemption granted t o agriculture. However, before the implementation of this law, martial law was promulgated and the new legislation was first suspended and later its implementation was cancelled. The Income Tax Ordinance of 1979 later restored the old exemption. While no plausible reason presently obtains t o warrant a continued retention of the exemption of agric~llturalincome however, the political power of the rural elite is even today a factor of significance in the politics of the country and their 'clout' in the law making forums continues to assure them a posit ion of eminence: While the agriculturists have done all that they could to retain their privileged position in the matter of taxation of income, those deriving income from business have not been behind in monouvering t o have such fiscal laws, framed as gave them an opportunity to reduce their income tax burden to the minimum. Capitalizing on the governments eagerness to promote industrialization the private sector has extracted special fiscal concessions whicn include across the board tax holidays, accelerated depreciation allowances, tax credits, rebates, deductions, allowances etc that in the aggregate hake had the effect of pitching the 'effective' rate of tax much below the nominal rate. This ofcourse has meant sharply reduced revenue for the federal exchequer. In other words the already narrow tax base has been further narrowed. The manner in which this package of benefits was got structured reveals how adept the private sector has been in

1 76

Fisccl Imperatives in Pakistan's Econotnic Development

securing fiscal benefits of its own. It cultivated a lobby for itself in the echelons of government that spared no ct?ffort t o project its viewpoint at every forum. This lobby had too its extra territorial supporters in the aid giving countries and institutional agencies that sought t o establish the private sector on a firm footing in the country. This ofcourse added considerably t o the leverage of the private sector. The net effect of' it all was t o so puncture the fabric of tax laws through ii plethora of so called fiscal "incentive' measures as. t o result in. the ridiculously narrow tax base that has now become an enigma. It follows from what is stated above that both the private business sector and the agriculturists have been responsible in their own way in making a farce of the fiscal framework of the country, exploiting it at will, almost, to limit their burdens t o minimal levels. However, while each has an axe to grind in furtherance of its self interest the private business sector has shown its discomfiture at the privileged position of the agriculturist on many an occasion. It can now b'e relied upon t o continue its efforts for withdrawal of the exemption of agri income. Apart from the discrimination inherent in the present arrangement the same prevents the lowering c:)f tax rates that the private sector keenly wants t o see. While the private business sector can be expected t o be in the forefront of any movement t o revoke the exemption of agri income, it is not alone in this endeavour. [nfact 'academia' in Pakistan has been quite articulate in pleadi.ng for reform in this area. And, very significantly, the countries and institutional agencies that 'fund' Pakistans developmental effort are exasperated at the complacency of the policy makers in the matter of mobilizing meaningful domestic resources by effectively broadening the tax base. Both, the exemptioln of agricultural income AND the plethora of -so called 'fiscal incentives' are the target of attack by these quarters. A cumulation of forces is thus gathering momentum that could ultimately bring sufficient pressure t o bear on the executive authority t o force fiscal reform on positive lines.

Controlling tax evasion

No programme of fiscal reform can be effective unless adequate arrangements are made t o check tax evasion the magnitude of which is most disturbing in Pakistan - t o put it mildly. The extent of deliberate evasion is apparent from the oft cited statistic that no more than 35 5% of the potential tax revenue is actually collected by the Department of Income Tax. The balance 65 % goes waste. Much of it (perhaps 75 76) represents the loss due t o evasion. Another 2!5 % or so is lost due t o inefficiency of tax administration andl represents bad detailed scrutiny assessments in which obvious avenues for raising revenue are overlooked, poor collect.ion of revenue demand, both current and arrear, especially the latter, inadequate enforcement of laws relating t o at-source deduction of tax etc. While it would be idealistic t o think of putting an end t o tax evasion, there is no doubt that a lot can be done t o control it. As far as the statute goes, aleast some of the evasion is relatable to the relatively high rates of tax (particularly for the higher income brackets) that have been prevalent, especially in the years prior t o 1983. Although there has been a significant reduction in the rate of personal taxation and even the corporate tax has been reduced, the rate structure still offers an impetus for evasion as the benefits of such evasion are too real t o be ignored. The administration is aware of the problem but finds itself unable to order further reduction in view of the

1 72

Ftso~lImperatiws[n Paldstnn's Econonric D w l o p m e n r

extremely narrow tax base. Too much revenue would thus have t o be sacrificed, given the existing tax base, if t.ax rates were reduced meaningfully as the reduction of rates would not automatically lead to improved quality of returns of income-atleast ,not in the short run. Considering the governments chronic-and often desperate--need for revenue the possibility of- significant revenue loss in the interregnum(after reduction in tax rates and the time when taxpayers file qualitatively better returns) is too daunting for any government t o face up to. A major part of tax evasion in the country takes place due t,o weaknesses in tax administration. Archaic and cumbersome procedures (that have not changed much in substance since 1922 when the Income Tax Act came in the field) coupled with wholly inadequate policing, data collection, storage and collation arrangements and a lack of political will t o take tax evaders t o task has made systematic tax evasion too 'profitable' not to be indulged in. A deficiency of visible deterrence to evasion is thus a major factor to be reckoned with. Fiscal reform must include energetic measures t o counter the administrative weaknesses indicated above. R.ationalization of procedures would thus appear to be a mandatory requirement. The creation of an adequate data base together with the capacity t o analyse data and institutional arrangements t o collect data continously from all relevant areas are a l l vital steps without which tax laws cannot really ever be properly enforced. The precise chaiges required to be made in this context are outside the scope of this paper. Suffice it would to point out that modern computer based data processing systems constitute the essential technology in this area and armed with which the taxman can confidently tackle many an ingenious evader. The fact of the matter is that public perception of the capabilities of tax administration is heightened immensely if it is seen that the administration has facilities at its disposal with which it can actually monitor the activities of taxpayers that are relevant to a proper assessment of their income. While the technology is not cheap it is readily available and it can be tailored to suit the specific requirements of a particular tax administration. And it more than pays for itself (many times over infact) in the additional revenue it will h r i n ~in and through the vastlv imnroved efficiencv of the

Co11nollb1gtax ewsion

administrator. To be fair some steps have been taken in this direction in Pakistan but these are mostly tentative and 'adhoc" in nature. The lack of a political will t o take tax evaders t o task is another glaring deficiency in our system. It is astonishing that in a country in which tax evasion is (admittedly) rampant not a single tax evader has actually been sent to prison for concealment of income since 1947. It is not that t h e law does not provide for such penalty. It does. But thedepartment just does not have the nerve t o g o ahead with prosecution and force a showdown o n the issue. The 'AL Capone's" of Pa.kistan (and there are many!) thus have a field day and need !not * worry of being incarcerated in a penitentiary. Effective executive support is the only way that the will t o act decisively can be built into the fiscal system of the country. The policy regimen relevant t o countering tax evasion-with special reference to the parallel economy -is dealt with indepth in chapter 13.

The parallel economy An Overview

Broadly speaking, economic activity embraces four different areas involving the production, consumption, exchange and distribution of the output that is the end result of the cooperative application of factors of production. When such activity occurs within the f o r q d parameters pertinent t o the economic system in vogue in a particular time and place we may speak of activity within t h e "regular economy". However it is a fact that economic activity also takes place outside the formal parameters. When this happens we refer t o the "inform,al" economy mode. Generally speaking, the informal economy encompasses trading without documention (making a ;sale without issueing a sale receipt) and includes financial transactions outside t h e banking system (remittances from abroad through the "Havala" system rather than through normal banking channels). Besides this informal economy, there is the "black economy" based o n activities that are outside the pale of the law and include snuggling, dealings in narcotics, profiteering through hoarding etc. The "informal" and the "black economy together constitute the "parallel economy".

A feature of significance common t o both the "informal economy" and the "black' economy" is that the transactions and the income generated as a result of these transactions are not reported formally i.e. t o the Income Tax,Customs, Excise, State Bank and other authorities t o which, normally, reporting is statutorily due.

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Informal Mode Thus the manner in which things get done im an economy is not always consistent with the formal format of the system.

Rather,functional modes are frequently devised t o circumvent the formal format by substituting in its stead a.n informal or irregular mode. The circumstances that provoke such improvisation can have complex sociologial ramifications or, in the alternate, may be simply a reaction .reflex t o the sheer 'ctnerousness' of officialdom. There is also a more sinister facet (and in many cases a dominant one) -thzt of deliberate crirniniality that seeks lpurposefully t o thwart the formal procedure and laws so as t o force abnormal monetary gains of a magnitude impossible in the normal (formal) format. Colonial Hbritage In developing countries with a colonial heritage antipathy to Government is often rooted in haunting memories of the exercise of procrustean authority by the colonial authority. Such memories are refreshed by harking back to the old fimes through literary expression and a penchant for attributing responsibility for present day ills t o (real and iimagined) past misdeeds of the colonists. This persisting alienation of the ordinary citizen from government is at the back of much of the opposition to contributing to the exchequer, While third 'world sociology is undeniably a factor of significance, it is certainly not the only reason for the overt behavour that has led to the emergence of the parallel economy. Rather, an increasing obsession with the accumulation of riches not possible through the conduct of "normal" business activity, motivates the great majority of tho'se who are the keenest participants in the rat race. This has spawned a whole range of activities outside the pale of the law. The formal and informal facets, though clearly distinguishable, often operate side by side (in parallel) but more commonly, merge in a manner as t o render separate identification difficult. Infact one of the problems of dealing with the parallel situation is its thorough permeation of the regular --formal-

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economy. So enmeshed is it with operative facets of the regular economy that targeting the parallel economy strains the ingenuity of the best of policy makers. Government and the informal economy. Of considerable interest here is the governrn.ents participation in the informal economy. Prices fixed by Government for public utilities are usually on the basis of criteria other than purely economic. The result is that these prices do not a d e quately reflect relative scarcities and d o not evolve out of supplyidemand equilib. It is for this reason that prices so fixed have been dubbed as "pseudo prices". Revenue knowingly foregone is equivalent in its economic effect t o revenues evaded or avoided. As a result, the public at large is invested with extra purchasing power. The exchequer loses that much revenue. Reventies have thus been evaded. However, here it is the government that has, wittingly facilitated the evasion. While the object here is clearly t o benefit the public at large, the fact remains that the government by ignoring relative scarcities as reflected through 'market prices' is guilty of arbitrary fixation of prices for public utilities. The distortive effects of such arbitrary economics destabilize tihe economy and lead to a revenue loss and also to possible faulty ecnonomic planning. Why worry about the parallel economy? After all, as a phenomena it is undeniably ubiquitous-seen even in the communist bloc countries. The answer is that the operations in the parallel economy induce distortions that destabilize the regular formal - economy in a manner detrimer~talto orderly econ'omic growth.

Distortiors induced by the parallel economy.

Huge surpluses generated in the black economy fund conspicuous c o n s h p t i o n W o n a grand scale. In third world countries much of these supernorrnal profits are sunk in real estate. The palatial mansions and commercial plazas that dot the landscape are pointers t o the quantum of black resources generated ~land~estinely.

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Fbml Impemtfws In Paktstan S Economic Dewlopmenl

The intense demand in these areas of conspicuous consumption bids up prices in a manner wholly disproportionate to the aggregate demand in the regular economy. The powerful minority of the black economy thus succeeds in pinning a price perforce on an area of interest t o it. A direct consequence of this is that the people of the regular economy find it increasingly cliffioult t o participate :meaningfully in areas of economic activity where the black economy has made inroads. Economic usurpation by sheer imposition of will is thus a phenomena with which increasing numbers of the regular economy have been affected adversely.

1;;

Existing inequities in income distributilon are exacerbated as the profiteers of the black economy build up their surpluses unchecked, paying no taxes on their spiralling Iincomes.

When institutional arrangements are not utilized optimallyor are utilized perversely - decay of such institutions is inevitable. The circumvention of foma! institutional arrangements through bypasses arbitrarily structured puts such institutions into a state of disuse atrophy making them inefficient and even in some cases redundant. Thus where the basic economic framework is that of a mixed economy in which the market plays a cruciirl role, the less than efficient functioning of the market hinders economic development.

Businesses engaged in systematic tru: evasion build up their capital base and in the absence of an effective tax administration, come to acquire enough clout t o elbow out those who are not so engaged.

The often frenetic activity in the parallel economy has the potential to fuel dangerously the fires of inflation. The amount of currency in circulation is determined with reference t o the level of transaction demand in the entire economy. If the parallel economy is a largely unknown factor, it may not figure correctly in the official calculations made in this context. The voracious appetite of the parallel economy for cash can bid up significantly

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The Pnmllel economy an Owndew

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the velocity of circulation of currency, adding therby t o inflationary pressure. f.

The flow of investible funds is influenced by projections. of profitability. Since areas of investment in the parallel economy offer such a high rate of return these areas fascinate the potential investor and induce the commitment of funds although, in the context of the requirements of the proper structural transformation of the economy, these are not the most desirable areas.

The most obvious effect of the operation of the parallel economy is the way in which it deprives the exchequer of its share of tax revenues. Placed out of the jurisdiction of the taxman, the extra legal activity of the iparallel economy decisively robs the exchequer of funds vital for the countrys program of economic development.

The progressively increasing role of the parallel economy undermines, through its unhindered extra--legal activity, the "rule of law" . This subversion of statiltory authority has far reaching implications in developing the "world view" of the common man, t o whom, the law looks more and more "like an ass". This bodes ill for the orderly conduct of policy.

The emergence of an underworld elite in the irregular economy parallels the affluent class of the regular economy. Over time these rich people keep on getting richer. Such growth in family fortunes is an eyesore for the public at large. Of greater importance however is the fact that the existing skewed distribution of income in the economy as a whole remains skewed with weakened governmental authority helpless at altering the skew. Sectoral composition of GDP as consolidated in the national income accounts is based on reported data. Segments of the unobserved economy not reporting back on activity transacted therein systematic:ally understate the GDP and also distort its sectoral compcrsition.

A capability t o project present trends correctly into the future is essential t o effective planning. However the correct extra~olation of existine trends Dresumes avail-

FLrcal Impemtlves in Pakistan 3 Economt.- Developmenr

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ability of authentic data. If the data is corrupted the projections will be misleading. The greater the corruption the more misleading will be the projections. The operations of the parallel economy corrupt data and therby contribute t o defective projections thus interfering with the planning process. 1.

The ability of government to implement mexcures aiming at restructuring of the taxation system so as l o be able t o realize revenue optimally and at the same time bring desirable changes in the structure of the economy can be seriously limited by the operations of the pa~ralleleconomy. The unobserved economy being outside the pale of the law is unresponsive to measures enforced through statute. MORE ABOUT THE "BLACK ECONOI,IY9'

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In most third world countries, the black ecozomy is a buoyant sector - it is not merely doing well but is actually thriving. This aspect is of significance in that while the black economy is a ubiquitous phenomena, its increasingly aggressive posture in terms of rapid growth and assertiveness vis a vis the regular economy, is largely a third world phenomena. Much of this is due t o the fact that the institutitsnal monitoring of economic activity is weak here, making i t relatively (easy for the participants to get away with syste1:natic non reporting of income. Spiralling Cycle

That black money (usually) breeds more black money follows from the fact that the cycle of black money operation iescalates progressively, corripounding the orit~ina! act that started the cycle. To illustrate the proposition consider a person who makes an investment in real estate utilizing black money funds. Naturally he does not report the transaction: Now sometime later he disposes off the asset and makes a tidy profit on the investment. He will now also not report the ,profit so made-because he did not report the original investIment. The original omission is therefore instrumental in leading to the subseauent non reporting. Black activity is thus self reihforeing and not only ensures that there will be a second

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round of black activity but also that such activity will with time snowball - adding more and more t o its magnitude as it rolls across the economic landscape. Susceptibility of the mixed economy. We know that the black economy is p r t e n t in almost

all countries whatever the doctrinaire basis of the institutional arrangements t o regulate their economic activity. It is however a fact that the black economy thrives particularly well in the so -called free economy format economic system. While the controled, regimented, command economies of the socialist bloc of countries are certainly not free of the scourge, its depredations there are much less damaging and limited t o forays much restricted in scope compared t o the free wheeling runs possible in the freer environment of the mwket (or mixed) economy. Third world countries make especially fertile ground for black economy operations mainly because of deficient institutional development. So many black transactions go unreported simply for the fact that the arrangements irn force t o monitor economic activity are either technically deficient in themselves as a result of which the degree, of comprehensiveness in their coverage-which is a sine-quo-non for their effectiveness-is lacking, or else the technical support and back-up which is necessary t o ensure their optimum application is not available. Take the example of the (federal) revenue n~obilizationapparatus in Pakistan. Normally, "effective" tax laws are a powerful deterrent t o Mack economy operations. Since the income tax statute requires that taxable income be reported and since all income, legal and illegal, is covered by the requirement,the income tax authorities are expected t o be aware of the areas where income is being generated. They are also expected t o have the capability not only to keep such xeas under active surveillance but also to be in a position t o take measures if necessary t o enforce compliance of the tax statute. Statutory Limitation in Pakistan Income tax law in Pakistan has a major deficiency in that the entire income generated in a major sector of the economy, agriculture, is outside the ambit of taxability having been dec-

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Flsml Impemiiws In Pakistan's Econ,!~mlc Development

lared exempt statutorily - since the very inception of Pakistan. The consequences of this are much more momentous than would at first seem apparent. The exemption has become a conduit t o funnel in black money into the regular economy with ,impunity by simply giving it the guise of an agricultuial.source. This has not been difficult t o manage. Thus it is that "loans" from agriculturists, contrived artificially of course, have come to fund a good part of the accretion in wealth and capital that is actually the result of black money operations. Similarly, returns from the cultivation of agricultural land have been arbitrarily pitched at levels that conveniently make available the required "extra" funds t o launder the available black money. These two devices have been brazenly deployed to launder a major part of the black money injected into regular business especially in the non-corporate area where the incidence of t.ax evasion has been the highest. The exemption granted to income emanating from agricultural activity has enabled such income t o escape detailed scrutiny simply because the requirement of detailed record keeping has been largely dispensed with in actual practice. Thus a business declaring a liability to an agriculturist is not required t o show infusion of funds.through the media of a banking channel and a fairly bald statement from the creditor suffices in the great majority of cases to establish the bonafides of the creditor-debtor arrangement. This would be understandable if say it were a fact that agriculturists, especially the relatively well t o do (who are shown t o be advancing the loans) did not have ready access t o banking facilities or were not usually inclined t o keep there money in safe custody there. While it is a fact that the demand for liquid funds may in general be higher among the rural populace the fact remains that contrary t o what may be propagated, large sums of money are not commonly hoarded at home and banks are the main avenue of deposit.That being so, there should not be any real problem for a genuine debtor t o show receipt of funds through the banking channel. That in practice much clamor is made whenever an attempt is made t o impose such a requirement is evidence of the suspect nature of such arrangements. The fact that legislation in this context duly approved by parliament has been defeated due t o an inspired public outcry, is clear proof of the lengths to which the vested interests will go t o ensure that their privileged position is not disturbed.

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t h e Pamlkl economyan Overview

The bulk of the black money generated from business ncome manifests itself in the simple non-reporting-of business receipts and the inflation of business expenditure. Thus turnIver is systematically understated and expenditure is padded. The net result of the exercise is t o drastically curtail net profits with consequential huge tax savings. Such gains when reemptoyed in the conduct of business fuel a second round of black earnings and so the cycle goes on unabated.

To be sure the opportunity for realization of extra legal supernormal profits by non reporting of income varies from one area of economic activity t o another. The intensity of market demand is responsible for abnormal mark ups which so long as the demand lasts ensures abnormal profits. Looking t o the relatively high tax rate structure-notwithstanding the fact thr: as a result of th2 many exemptions, allowa~~ces, credits etc. the effective tax rate is undoubtedly less than the nominal rate of tax - the tax savings by withholding disclosure from the income tax authorities are too real to be ignored and this factor is responsible t o some extent in provoking the understatement of profits. However the crucial factor here is not the tax rate structure 'per-se' but rather the ease with which it is possible to circumvent the statute and evade the scrutiny of the income tax authorities. The weakness of tax admirlistration is attributable partly to lack of procedural rationalization due to retention of archaic procedures wholly inadequate t o deal effectively with the vastly increased workload and the increasing sophistication of taxpayers and their counsel in finding loopholes in the statute. An additional factor of significance here is the deficiencies in technical back-up~facilities to assist the assessing authority. Given the limitations in the manpower employed in the income tax deptt. and the fact that the quality of this manpower in terms of training and technical expertise and motivation leaves much t o be desired, the deficiency can be offset considerably if access to modern data storage, collation and retrieval facilities-computer basecl ofcourse but also including micro film-were readily available. Although beginnings have been made in these areas, these are only tentative and cover only a very small part of the work spectrum. The most prominent shortcoming here is the absence of any data base which renders scrutiny, analysis, data matching and survoillrrn~nt h g t rniinh

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Fisml Impemtfves in Pakistan ':: Ecorromic D w l o p m e n t

which permits persons with little or no aptitude for tax work t o man key positions of authority. Add to this the paradoxical position of vast power invested in a poorly paid officer class conditioned in a lore of elitism of days gome by, encourages corruption making it even easier for scheming taxpayers t o avoid the tax net.

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Supernormal profits, which are a principal ingredient of the black economy, are generated with relative ease in a market that is largely imperfect with hoarding, pricc! manipulation and the ensueing profiteering, inevitable. Besides the abnormal profits, there are the bribes, 'commission's and kickbacks that make up the black money available t o the vast official bureaucracy. Where Black Money Goes

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The principal destination of black money in Pakistan has been real estate. A good deal of it has also found its way abroad t o be stashed away in secret bank accounts. Also, some of this black money exfiltrated abroad has found its way back t o the country - attributed t o a person different from the sender and one who is resident abroad - t o provide the wherewithal t o finance assorted business ventures without having to face potentially 'risky' interrogation by the inca'me tax authorities risky because if an explanation in the context of investment made is found t o be suspect in that the so~nrcel'sof investment .are not considered 'bona fide', then the amount so found is not only liable t o be added t o total income but also stiff penalties, over and above the regular tax demand, become payable. Remittances from abroad enjoy a considierable advantage in that these are usually accepted as bonafide -without any interrogation - so long ofcourse as the funds arise to a taxpayer from someone resident abroad engaged in some kind of activity there t o lend a facade of credence to his ability to make the necessary finance available. As stated above, the principal beneficiary of the generation of black money has been real estate. As a direct consequence, the value of property, especially commercial property, h e witnessed a sharp escalation in recent years. The original black money invested here has been multiplied manifold as a result of speculative sale and purchase. The huge profits arising from

The Parullel economy an Overview

1 85

such speculation have generally escaped taxation as these have rarely - if ever - been reported correctly to the taxman. Despite some measures taken, the sale price of real estate - as well as built up property - is invariably understated a.nd grossly so. The mechanics of the distortion is quite simple. A.11 that the two parties t o a transaction have t o do is t o agree t o a mutually acceptable - sharply deflated - figure of the sale price. A deed of sale at this arbitrarily reduced price is then drawn up and formally executed before the concerned authority. Since the two parties t o the transaction affirm the same, the authority accepts the document drawn up as valid. To be sure the income tax authorities are not bound t o accept the value indicated in a deed of sale especially where the variation vis a vis market price is marked. However there is precious little that can be done by way of ]remedial action. Attempts are frequently made t o refer to the market value and bring to tax the difference between the declared value and the bona fide market value but the the app~:?ilateauthorities have, in the vast majority of cases, frowned o n such attempts usually because it is so difficult t o get hold of hard evidence t o back up and substantiate the finding of the income tax authorities that value has been understated. It has not therefore been possible t o build up useful 'case law' o n the subject. The abolition of capital gains taxation o n sales of immoveable property (since this is a provincial subject it is outside the purvew of the income tax law) has removed a "hindrance" that, if effectively structured, might have succeeded in countering atleast the more blatant cases of understatement. We know now that the black economy is today virtually a ubiquitous phenomena. No economy, no matter what its doctrinaire basis, is entirely free from the scourge. Also, the black economy is invariably a thriving sector - again almost everywhere. But the fact remains that third world countries based o n the mixed economy format in the structuring of their economic system, are particularly fertile lground, for the black economy which is increasing in magnitude at an alarming pace and, in some countries atleast, appears to be posing a threat t o the viability of the formal "regular" economy.

Fh... :.i:.~,+*~. :, xs i.7 Pakistan 's Econon!icDeveL~pment

18,

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countries is relatable t o a host of factors, many of them with a complex sociological basis, it does appear that .weak monitoring of economic activity prevents government from collecting and collating economic intelligence comprehensively and from initiating effective intervention t c ihwart the circumvention of the formal, regular economy. Third world countries are especially poor in keeping tabs on the conduct of economic activity in different sectors. Thus opportunities for quick profit making arc easily and skilfully exploited by elements specializing in this area and 5y the time government decides to move in by enacting legislation and alerting fiscal authorities, especially the income tax people, . a good deal of damage has already been done and the black marketeer has established himself on a firm basis 1'1,: which it becomes increasingly difficulty to dislodge him. What is pertinent to note here is that it is not the transaction of business activity per se tnat is objectionable (unless ofcourse outrightly criminal like drug dealing). The really undesirable part is that the black market operator succeeds in easily concealing the manner in which business is actually transacted by him and which enables him firstly t o enjoy supernormal profits and secondly facilitates the non reporting of all or most of these profits. Windfall for the O.E.P.

An illustration of how black activity takes root is the functioning of Overseas Employment Promotela in Pakistm. The opportunity for overseas employment first appeared in a big way in Pakistan in the early t o mid '7Q's when burgeoning revenues of mid-east oil produce:rs were instyumental in launching development activity based both on infra structure development and industrial projects with a view to structural diversification of the economic base looking t o the day:-still quite some time in the relatively distant future to be sure, but nevertheless inevitable ultimately .. when the oil revenues would no longer be there - or if there, would no longer be economically significant. Political ties forged with the Arab world, especially those

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manpower placement orders t o Pakistan. At first the emigration of manpower was largely unregulated. Recruiting teams came to the country and selected the required personnel on a case by case basis. A significant increase of "agencies" specializing in job placement for the horde of blue collar workers became inevitable as they were largely unable t o resolve on their own the complications inherent in the situation. For the foreign employer too it was much more convenient t o look for labor through an intermediary well familiar with local conditions and able to scout for manpower and t o deal with the procedural routine independently. It was'nt long before this area was recognized as particularly lucrative in its potential for supernormal profits for the employment promoter - or recruiting agent as the promoter was commonly known to the public at large. Intensification of the competetion amongst intending emigrants was a godsent opportunity for the recruiting agent t o begin a sustained compaign for the extortion of "on money" earnings from the eager emigrants. Depending on the area of placement, wages/ salaries and fringe benefits negotiated by the agent, '"on money" was extracted brazenly and with virtual impunity )from the law especially because no specific law existed then to regulate the affairs of these enterprizing but rapacious agents. By the time the need for providing statutory cover to the operation of manpower employment promoters was recognized, receipt of "on money" had become firmly rooted and is prevalent even today despite efforts made to bring it to the fore by the income tax authorities belatedly recognizing the losses in potential revenue to the federal exchequer through non-reporting. ~

It was only in mid 1979 that statutory control of the operation of recruiting agencies became possible when the emigration ordinance came into force. A fairly elaborate licensing system for O.E.P.'s was announced and a "watchdog" administrative arrangement structured t o (supposedly) safeguard the interest of the emigrant and t o ensure that he was not "exploited" in any way - both by the agency as well as the foreign employer. The terms of employment were required to be put t o close scrutiny by the "protector of emigrants" and i t was only after formal clearance had been granted by the

FLc-A:

-if*,-

- 7.e.:in Pakistan's Econorni'c Development

protector that the emigratit was permitted t o proceed abroad t o take up his new assignment. The State Bank of Pakistan monitored closely the receipt of foreign commissior~income by the Q.E.P. wit.h each recruiting agency required by. law t o file an annual declaration with the State Bank detailing the inflow of commission income from the foreign employer on whose behalf the agency had recruited and sent abroad the required manpower. Defaulting agencies were interrogated by the Federal Investigation Agency which, incidently, also investigated complaints (if any) of extortion of extra legal payments ("on money") levelled against specific agents. The Government guaranteed t o the recruiting agent a service charge of Rs. 2,000 per worker recruited payable by the intending emigrant. Of this an amount of Rs. 550 per worker was deducted and credited to the Workers We!fa.re Fund so that the a,gent received a net payment of Rs. 1,450 per worker recruited. This was besides the commission received by the agent from the foreign emp'loyer. The commission component varied and was generally higher for the higher qualified skilled manpower than for the blue collar labor. Against such remuneration the agent was expected t o maintain a cclerical' staff t o process the paperwork, interview the applicants, arrange their examination in specific skills where such formal evaluation was stipulated by the foreign employer, to maintain liaison with the foreign principal and t o finalize arrangements for passage t o the country of destination. The foreign passage was required by law ( the emigration ordinance) to be borne by the foreign employer who did so generally by malcing payment abroad through "miscellaneous cash orders" and sending the same t o the agent in Pakistan for being exchanged for regular tickets. Tn theory the entire arrangement was apparently' a model of orderliness and effectiveness and it was difficult t o visualize any significant wrongdoing within this format by the O.E.P. In practice, however, things were not so clean and orderly as the Gtatute contemplated. As stated above, the practice of receiving extra legal "on money'"ayrnent by the recruiting agent from the emigrant had become deeply ingrained in the system as it had evolved prior t o the promulgation of the emigration ordinance of 1979. In most cases, however, no coercion was involved as the intending emigrant was more than willing t o

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pay an amount over and abcve the service charge and provided that the "on money" demanded was "reas0~nable1', there were usually, no complaints. "On hrIoney9'Bonanza For the income tax authorities the non reporting of "on money" become an enigma that defied resolutdon. A good deal of effort was however expended t o establish that extra legal payments were infact being received by the :lgenl: and the focus was on analysing the over all activity of the agent. The department was able in quite a few cases t o establish deliberate "padding" of the expenditure statements fur!~ishedby the agents. It became known slso that in actual practice very little expenditure was actcdly incurred by the aqent. The usual practice was t o direct the emigrant t o beig the miscellaneow exp ensesespecially chose connected with securing visas and forms - and even the airport tax . Mt.ciic;i examination charges and special testing fees were aiso thrust on the emigrant. As the agent did not maintain a very e!aborate administrative set-up1 t o process the paperwork, the "office" expenses were minimal. The agent was thus able to "save" most of the expenditure that he was required bv law to bear. Besides such "savings" the agent through his ingenuity usually contrived t o "appropriate" the foreign passage payment made by the foreign principal abroad. T nis he tiid by "directing" the emigrant - who usually viewed the agelit as his ticket t o i'eldorado"- to buy hk own passage too!! The agent then 'kncad~ed" the M.C.O.abroad (refund could ]lot be claimed locally) by claiming a refund-on the ground lhat the MCO had not been utilized. Such encashment abroacl was made by the agent himself during the course of his frequent "jaunts" (business trips) abroad and there is reason to believe that collusion exists between the agent and the foreign principals staff abroad. All told therefore the O.E.P. ended up making hefty additions t o the legally stipulated service charge and commission that was his due and since the income tax people could only pin down a very small part of such additions, the largesse was (largely) tax free.

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What did the recruiting agent d o with his ill gotton wealth? Well he sunk quite a bit of it in real estate and property acquisition. There was even some investment in smalll t o medium sized industry and some money was funneled abroad for safekeeping in secure secret accounts. But because there was no clear cut uniform pattern followed by all - or most - recruiting agents and because the official apparatus t o mclnitor economic activity and gather economic intelligence has been weak and because the socio cultural ethos encouraged collusion and connivance - and corruption - violations of law are extremely difficult to establish. The example of recruiting agents has been cited to illustrate the emergence of black money earnings in an area of economic activity of relatively high market demand with the "seller" placed uniquely to "fix" quite arbitrarily and in collusion with others in the same line of business, a ','price7' that varies sharply from that "determined" - just as arbitrarily by the official regulatory authority. The economist would point out here that the 1:tlack market has come t o be established here because arbitrary rczulation ignored the play of free market forces. An obvious solution here could have been for the government t o take cognizance of the fact that intending emigrants were willingly parting with the huge sums involved in the extra legal payments made t o the agents. The government could thus have simply directed that henceforth each emigrant w ~ u l dpay an amount at par with the "on money" figure for particular destinations and specific jobs. This would have ensured that the hitherto tax free takings of the agent became subject t o regular income tax and the losses in revenue that the exchequer has been forced t o bear would then have been minimized. Ofcourse the "solution" given above while feasible technically could not have been applied in practice - for political reasons. No government in a third world country could ever have mustered enough courage t o announce such is "punishing official price" for labor intending t o go abroad.

7'he Pmallel economy an Overview

The magnitude of the extra legal "on money" payments realized by the recruiting agents can well be gauged b , r the fact that for each emigrant going abroad anything from %b.10 to 1 5 thousand to Rs. 20 to 30 (or even 35) tilousand is extracted depending as stated earlier, on the destination and the tspe of job secured. Jobs in Saudia had the highest potential here. Thus an agent sending abroad say 500 to 1000 persc~nsa year - not at all unheard of in the days before the s1u.m~in oil prices - could be making anything between Rs. 5 rnillion to Rs. 1 0 million (for 500 persons sent abroad) or even Rs. 1 5 million I! For 1000 persons the figures would ofcourse double. These are indeed staggering figures especially when one is to consider the fact that these extra legal payments supplement the regular earnings made up of not only the service charges and commission payments but also the passage money "appropriated" by the agent as described above and the expenditure "saved" by making the emigrant bear most of the business expenditure that normally the agent ought t o have borne. All told it added t o an awesome total. Just as impressive ofcourse were the losses in potential revenue that the exchequer had t o suffer as no part of the extra iegal earnings were ever reported - quite naturally - and also because the government did not have the fiscal agencies and apparatus that could monitor .r he flow o f funds effectively - including the conspicuous consumption expenditure that many of t!?ese "nouveau rich" indulged in blatantly. How Business Generates Black Money The emergence of black money in the business sector is widespread and businessmen in Pakistan are adept practitioners of the dubious art of concealing earnings from forrnal aut.hority. The case of recruiting agents has been cited only t o dramatise the extent of suppression of earnings and the ease with which interrogation is avoided. In actual fact any area of business activity that is in a position of yielding ~~upernormal earnings is fair ground for black money t o emerge. Most businesses invo'lving sales of finished goods suppress turnover as a matter of routine. This is achieved simply by ,not recording sales - which are usuallv unvouched. For this

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reason suppression is not much of a problerr~when it comes t o writing the account books: only those sales obviously .are entered in the books that are vouched. That there is -todate - no statutory requirement that would enforce maintenance of documentation to substantiate positilon of sales made, is an added advantage and certainly encourages the understatement of turnover. Once turnover is arbitrarily understated the next step in the presentation of fabricated accounts is adjusting direct expenses so as t o evolve a "reasonable" rate of gross profit. The G.P. rate is the standard initial check that the Income Tax Authorities make to appraise the results of a business. Since a deficiency in the G.P. percentage can provoke the ire of the taxman and lead t o many unplcbasant queries,the exercise of "massaging figures" t o achieve the e t ~ dof coming up with a ,"suitable G.P. rate" is taken up ir! all seriousness and while it is felt that the stress laid by the income tax deptt. on the gross profit as an index of overall p::ofitability is responsible for the "adjustment" of the trading account by business, the fact is that Pakistan is not the only country that relies on the G.P. rate for quick appraisal by the taxman. In France "normal" G.P. rates for different businesses are determined 'periodically and results disclosed by businesses falling in these categories are checked against the "srandard" rate applicable. Any significant deviation is seen as warranting investigation. However this practice has not been seen there as having led directly t o any systematic attempt at artificial presentatioil of accounts. Tax evasion certairJy exists in France but the "forfait" systen, as it is known there, is not seen as being a factor of any significance in the '.doctoring" of accounts that could ultimately lead t o tax evasion. Not only is the G.P. rate artifically determined in many businesses in the manner described above Sut the net profit rate is also - in quite a few cases - artifically contrived by debiting such expenditure as can be shown t o be incidental to the conduct of that business. The thrust is on artifical "padding" of indirect expenses and since conclusive documentation is not always insisted upon, the clever businessman - and there are many who can be so described - usually gets away with little or no documentation produced before the taxman.

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A great deal of black profit is being generated in speculative transactions especially in commodity trading. Deliberate hoarding of goods leads inevitably to profiteering with "staying capacity" being a principal determinant of the t.ime frame of holding goods by the speculator. By the very nature of business transacted in the speculative markets, documentation to substantiate purchase and sale is almost totally lacking and this by itself facilitates considerably non-reporting of income formally to the taxman - or to any other authority for that matter. Speculative trading has picked up in recent years and is often the preferred activity vis a vis say manufacturing. It is felt that not only are profits higher here and more easily generated but the hassle that is associated with manufacturing activity, especially that connected with managing labor and procuring raw materials and securing needed financing at reasonable terms, is avoided. For the businessman, therefore, speculative activity appears to be much more attractive and this is responsible for much of the spurt in this area in recent years.

As a class, professionals, viz doctors, lawyers, architects, chartered accountants and the like are responsible 'for generating black money on a truly '"epic" scale. Take doctors for instance. Most doctors in private practice-and especially top flight specialists with foreign qualifications and having consultants status - have a vast clientele. This is but to be expected looking t o the adverse doctor-patient ratio - a feature common to all developing countries. The consultation fees are often fixed arbitrarily and the patient has little option in the matter of choosing his doctor as suitable alternates may just not be available. This clears the way for virtual extortion. And ofcourse there is no receipt. The doctor reports only that part of his earnings that he chooses to intimate. The rest is simply pocketed. The same is true of lawyers,, professional accountants etc. As a class therefore, .the professionals are a step ahead of their brethren in business when it comes to generating black prof its. Bribes, kickbacks & "commissions" (to use an euphemism) are another major source of black money. The vast official bureaucracy can be tyrannical when it comes to the exercise

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Fiscal Impem dws in Pakistan s' L'conomlc Dewlopment

of authority. The maze of rules and regulations, complicated and confusing, cumbersome procedures, m o ~ ~ n t a i nofs paperwork, competing jurisdictions, slow difficult legal redress and very limited formal accountability, all cor:stitute a fertile ground for the arbitrary exercise of authority. [n a scenario such as this, corruption becomes almost inevitable especially when one considers that the buraucrat though Invested with significant authority relatively early in his career - when he (or she) is still rather immature, is also underpaid and has hardly any official facilities (residence, conveyance t?tc). T h e fact that Ire often has pressing family obligations t o meet, most involving a significant outlay of finances, comp1ic:atet; the situation immensely.

Policy Regimen t o Counter the Black Econom!y The black economy is a fact of life in our times. We live with it and yet we are all too painfully aware that it is indeed a scourge that causes a lot of harm t o the orderly development of the economy and to the people at largc. So the question arises whether it is at all possible t o do anything about it. Can we counter the forces that give an impetus t o the growth of the black economy? Can we take measures clirectly that would stop and even reverse the encroachment of the black economy o n the domain of the regular economy?

Fortunately, the answer t o all the qur:?stions listed above is in the affirmative. -4 policy regimen 'can' he devised that would achieve, t o a considerable extent, t'i~eobjectives stipulated above. Let us now consider such a regimen. Structuring a Credible Deterrence -4 citizens perception of the ability of fiscal authorities to take effective action against those who fail to report their earnings will go a long way as a deterrent measure t o counter the non reporting of income. In countrits where there is a direct tax on incomes -the great majority in the free world fall in this category -deterrence is usually 1:)uilt into the statute controlling the taxation of income through the enactment of specific provisions that provide for levy of penalties, both mandatory and discretionary, for tax evasion through con-

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cealment (non reporting) of income both directly and indirectly. The latter takes care of "devices" that a taxpayer may employ t o arbitrarily understate the true income that arises t o him such as is done by deliberate inflation of expenditure wrongly shown t o be incidental t o the conduct of a business. Most jurisdictions are not content t o raise a financial charge only against those who fail t o report their earnings correctly. The assessing authority thus also has the op1:ion t o initiate proceedings t o launch criminal prosecution of a defbulter. A conviction would thus entail a jail sentence. Fear of incarceration in a penitentiary is a powerful deterrent t o the non reporting of income. However it is not the statute itself that will instil such fear in the defaulter. %'hat is pertinent here is how the law is implemented. The defaulter will see how many of those who violate the law are taken t o task by the income t a x authorities. The number of criminal prosecutions launched and their fate in the courts will go a long way in shaping the defaulters perception o f the efficacy of the tax people in discharging their responsibilities. The oft cited example of the ignoble fate that befell gangster boss A1 capone only because o f the perserverance, committmerit and vigilance of the internal revenue service of the United States - and ofcourse the fact that the statute contained the necessary provisions that made criminal prosec~ltionpossible has served as effective deterrence t o many a tax evader - ie non reporter-since t h e 1930's when A1 capone was I'inally humbled by the law. It is effective even today because the IRS has continued t o launch successful prosecutions regularly of those in default of the law-and it has'nt spared persons holding high office-or those with political clout. T h e high rate of successful prosecutions has served t o enhance its repuration for high professional excellence. Deterrence through the Levy of Penalties under the Income Tax Statute Under the t h e Income Tax Ordinance, 1979, levy of penalty and even prosecution leading t o imprisonment has been prescribed for various defaults. The object here is both t o punish t h e 'defaulter' as we1.l as t o have a deterrent effect on other taxpayers t o stop them from behaving liktwist..

Fiscal I~rzperatiwsin Paldsran 's L-cot~otnIcDc3velopment

The Governments determination t o obtain information from all quarters pointing t o concealment of income by a taxpayer, with a view t o take deterrent penal action as. well as initiate prosecution proceedings, is reflected iin the willingness of the Income Tax Depit t o even enter into 'negotiations' with professional informers holding out the promise of moneta.ry 'reward' if pertinent information 1ead.ing t o confirmation of a finding of concealment is made available by them. However as these informers were understandabky reluctant to furnish information that could conceivably lead t o their own indictment (as is possible in the case of a former employee of a taxpayer) the Government sought for itself the authority t o grant immunity from prosecution to those collaborating with the deptt of Income Tax in unearthing 1::ases of deliberate tax evasion. This was acr_.omplishedthrough the machinery of section 128 of the Ordinance which specifically enables the Federal Government t o tender immunity t o persons such as those described above. Thus the law t o punish non-reporters exis':s. But as stated above, the actual impleme~itationof the statutlz has not borne out the oft stated resolve of Government t o punish tax evaders. Comprehensive Statutory Format Income Tax law in some countries requires the reporting of certain categories of income only. Thus in Pakistan income from agriculture is not required t o be reported - where it is the "only" source of income-irrespective of the quantum-since it enjoys statutory exemption. It does not matter that a person may be deriving, say, a million rupees from i~griculture- as a good many d o especially those having orchards and cultivating cash crops like rice and cotton. Also, the many categories of "exempt" income such as that derived from poultry farming, manufacture of agricultural implements, manufacture of garments etc. enjoy the privilege of non scrutiny of returns filed and thus get away with the deliberate "overreporting of income". These exaggerated accumulations of "white" money can then be used t o explain away investment that has been

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actually contrived through black money funding. It is obvious that unless the income tax law makes it mandatory for all income to be reported, statutory coverage will only be partial and persons enjoying the privillege of not reporting their income will be able t o fictitiously "make availsble" their (real or inflated) exempt money hoardings t o finance projects in the regular economy when inl'act black money has been invested. Efforts of the income tax authorities t o make a meaningful probe of investment are thus easily thwerted and taxation cf black money avoided. The laundering of black money with such ease not only encourages indulgence in operations that give rise t o black money but also nprov..de a convenient way cst for the black marketeer. De-Monetization of Currency All money, both black and white, is required to be kept as currency o r embodied in some asset. Where blaclt money is not embodied in an %set (viz real estate) and when such black money does not lie in deposit in a Bank-as it would not be f o r fear of detection unless ofcsurse it is kept in s fictitious account/ then it is obvious it would b e available in currency form and kept "in hand" stashed away in a safe deposit locker or any other place that the holder feels is secure enougn. Such money may be put to use in a variety of ways but the aim usually worrld be t o maintain its liquidity. Now if the Government wen? t o order de-monetization of currency (without any warning ofcourse) the hojders of such black money accumulations would be forced t o come up and get their hoardings converted Into the new currency. As the Government wou.ld - hopefullyhave taken "effective" measures to prevent obtainkg of "false cover", in theory the black money holder would inevitably "get caught". The "solution" t o countering black money accumulation and circulation thus simply involves changing the currency periodically. In practice however, this is easier said than done. In the first place, changing the entire currency of a country is a mind boggling operation. The massive printing of notes of various denominations is not only costly but practically, an extremely difficult operation - especially as no compro-

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mises can be made as far as the "quality" of the new paper money is concerned. Needless t o say, it is not at all feasible t o even consider using coins as principal currency on any meaningful scale. Furthermore, it has t o be recognized that most third world countries are short of the type of administrative resources that would be required t o oversee a de-monetization operation effectively. It may thus bme quite possible for determined - and moneyed - black money holders t o find avenues t o enable the conversion of old currency for new. The experience in Pakistan certainly indicates this t o be so for demonetization has not succeeded in making any meaningful dent in the black money hoard in the country. Amnesty The offer of a reprieve from formal interrogation does appeal t o many flush with black money funds. For this reason offers of amnesty have usually elicited a fair response. However t h e black money holders perception of the ability of government t o identify them and their black money hoardings goes a long way in affecting the outcome of ars amnesty. Most third world governments fiscal agencies are quite hampered in this respect lacking as they d o the administrative expertise and technical back-up faeilities t o collect and collate economic intelligence which together give government the clout that black money ho!ders fear. In its absence, the offer of an amnesty may not be taken very seriously as kt may be felt that it would be cheaper t o "launder" black money without the hassle of filling " declarations " etc. Nso, most amnesty's involve the payment of tax - albeit at a much reduced rate. Conditioned as he is t o avoid the payment of 'any' tax on income, the black money holder would like very much t o avoid payment of even this reduced rate if it is felt that an alternate "escape" conduit exists. Raising Money's through Sale of Redee~nableBearer Bonds by Government - at an attractive rate of return ofcourse!! The huge hoard of black money existing in most third world economies is a potential reservoir of finance - waiting t o be tapped.Gover,nmentsin third would countries are finding it possible t o gain access t o this pool by floating loan issues

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based on redeemable bearer bonds offering good rates of return vis a vis other investment opportunities. The success ,of such schemes seems assured given the security of full government surety coupled with the fact that no questions are asked both at the t h e of purchase as well as encashment. Easy convejibility is an additional attraction. It must be recognized here however that such schemes do after all increase govt. indebtedness. Burdened as most third world govt's are with hexvy debt, such schemes add t o this burden creating potentially serious problems in the near future when the time of redemption of the debt issue arrives. If by then government h:as been able t o effect the structural transformation of the economy that it aims at, and if such transformation has started yielding a positive return then ofcourse there would be no p1:oblem. But these "IF'S" are not to be ttiken lightly. Projecting current trends into the future, the pictu:e that emerges is not rosy. Many"futurologists"actual1y envisage a rather grim scenario with political instability, staggering debt burden, unbearable population pressures, the daunting challenge of urbanization etc. etc. all adding up t o an immensely complex 'mix' of problems defying any easy solution.

The Taatbon of Expenditure

,...4he

econon~ics of the taxation of expendituxe turns around the thesis - which is well founded - that despite low per capita incomes, most third world countries are plagued by conspicuous consumptior! bythe 'nouveau riche' largely spawned b y black money operations in the parallel economy. Not only does sucll consumption affect adversely the savings rate but it is slso responsible for eroding scarce foreign exchange by encotlraglng the import of consumer goods - both through formal and informal channels. It is also responsible for distorting the structural development of the economy by erlcouraging investment in consumer goods industries and develc!pm~ctof the service sector - at the expense of the development of producers goods. Development of a iital segment of t h economy ~ thus suffers the ignominy of neglect which if al1oww:l t o persist over any significant length of time can stunt t h e economy's structural development.

The taxation of expenditure is thought t o not only put a brake o n the more brazen conspicuous consumption but is

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also expected t o help identify black money centers thus facilitating the design of policy measures t o deal with the parallel economy. It would also bring in extra revenue for the exchequer and thus improve domestic resource seneration. It would also aid in the alleviation of the inequitable distribution of wealth and thus have a salutary impact in easing social tensions thereby furthering social stability. While in theory there is much t o commend the taxation of expenditure, in actual practice the exercise is not at all anywhere as simple as it appears at first sight. The data deficiencies that plague income tax administration hamper effective expenditure taxation as well. Administratively, it is much more demanding than income taxation for keepir~gtrack of individual expenditures will more than likely prove to be a herculean exercise. The yield from expenditure taxation is also not likely t o be sigificant considering the difficulties in recordkeeping which is a sine -.quo - non for effective administration of the tax. Absence of a meaningful data base and a data matching program is thus likely t o inject a pronounced element of futility in the exercise. Vigilance t o Prevent Capital Flight A good deal of black money leaves the country for a safer haven abroad. Overinvoicing of imports and the underinvoicing of exports is one way of ensuring a steady outflow and this is a ritual in which quite a bit of expertise is displayed by third world operators. Smuggling of currency is also indulged in. Currency ''swapsW are also made with local people resident abroad. All these avenues are resiponsihle for the transfer of significant sums of currency abroad each year. If the government were able to take steps to plug most if not all of the avenues used to facilitate the flight of capital abroad, then the frustration of the black money operators can be seen t o be a blow - albeit not a body blow-against the well being of the parallel economy. However, here too, there is a yawning gap between the theoretical conception of the academician and real world practical imperatives. A lot can undoubtedly be done to plug the sensitive areas that are systematically and regularly utilized for capital

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flight abroad. Stringent check on the valuation of goods imported and exported is one such measure that if succcmfully implemented could go a long way in curbing capital flight. However this is easier said than done. Deficiencies in the administrative resource base and lack of adequate technical back-up) together with widespread corruption make it well nigh impossible to put into play measures that could ef'fectively plug the 1,eakpoints in this context. Rationalizing the Tax Rate Structure It is generally believed that a prohibitive rate of income tax is at the root of much of the non reporting of income. Well if the rate structure be indeed prohibitive then ofcourse it could be an important reason for the non reporting - or underreporting - of income. We ought t o recognize here that what we are referring to is not "A" particular rate of tax but a rate structure as it applies to gradations - or "slabs" - of income. Again, it is usually a high "marginal" rate of tax i.e. the incremental increase that results from increasing "levels" of income - that is pertinent. Thus within the progressive rate structure it is the high marginal rate for the relatively higher slabs that is normally perceived as a powerful deterrent to the correct reporting of income. Popular feeling notwithstanding, the fact of the matter is that in Pakistan we do not have a prohibitive rate structure. The highest marginal rate of tax currently is 45% - for personal taxation. On the face of it this may appear to be prohibitively high but when we take into account the eroding effect of the host of deductions, allowances, tax credits, rebates, exemptions - bath partial and total - , the real rate of tax is whittled down significantly - and in quite a few cases, drastically. Thus the real problem in Pakistan is not the prohibitive tax rate :structure but the extreme narrowness of the tax base that places the bulk of the country's population orltside the ambit of taxability coupled with the fact that a weak tax administration is unable to implement existing law effectively making it relatively easy for any determined - and not so determined-tax evader t o get away with systematic and sustained evasion. Given the poor ability of the fiscal authorities t o take t n u ovndora tn tscL

t h o honnfitc

nf t n v nrmcinn hwnmn a11 tnn

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Fiscal Imperatives in PaMstun 's Economic Deue>I~pnlent

real and a temptation not easy to resist.

An important factor why the common man is antagonistic to "any" taxation of income is the apparent absence of any 'nexus' between the payment of tax and the receipt of a benefit from the state. While various facilities - free public education, good public transportation, medical care, social security, unemployment benefits, etc. etc. are common in the developed countries, these are either entirely lacking or elso available nominally and that too for a minuscule segment of: the total population. This has led many to accept as true that tlse government provides no - or few - public facilities and thus forfeits the right t o exact a tax levy on income. What is stated above is ofcourse not wholly correct. While it is indeed true that most third world governments are unable to provide the same sort of public facilities that their counterparts in the developed world are accustomed t o providing for their people, the fact remains that third world govts are saddled with onerous responsibilities which the poor domestic resource position does not permit them to discharge effect.ively. Administration, justice (law and order) and nationid defence eat up the bulk of the revenues generated domestically. Infact one head of expenditure alone, defence, can consume ahnost 40% of the budget - in "real" terms - and may be even more! Under these circumstances it is apparent that not much will be left for providing the other facilities that are taken for granted in the developed countries where ofcourse !;he resources at khe disposal of govt. are much higher. Still the fact remains that providing a reaso~able defence establishment, an administrative framework for the day-to-day running of the country and police forces for law and order - which given current trends is assuming serious dimensions-is no small achievement. The fact that the common man is not iadeguately aware of all that government does for him is actually indicative of another problem altogether - a lack of "rapport" between government and the people. This is probably a hangover from colonial times when it was considered quite inconc~eivablefor the govt. of the day to have the geneuine interest of the public at heart.

'Ihus it is not fair to blame the tax rate structure for widespread non-reporting of income. Infact even if the tax

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rate structure be relatively high, it does not necessaily follow that non-reporting of income is inevitable. The experience in the scandinavian countries clearly proves this observation. There quite high rates of taxation have not led to widespread tax evasisn. But then this is because tax administration there is so effective and statutory cover is so comprehensi.we. There is every reason to expect much reduced evasion in .third world countries too if the necessary steps are taken t o remedy the deficiencies in their administration and statutes. Breaking the Power of Vested Interests In Pakistan one reason why the parallel economy continues to grow is that effective legislation t o comprehensively broaden the scope of the taxation of income is not forthcoming thereby thwarting efforts t o enforce the reporting; of income. As pointed out earlier, the reporting of all income is necessary not only t o levy taxation correctly but also to rnonitor the income stream flow in the economy. Such monitcring is vital in the context of the formulation of meaningful po1ir:y measures and macro projections and analysis of trends and the behaviour of key economic indicators. It would not be easy t o deal with the vested groups in any head-on clash as they are bound t o score over their antagonists given their present clout through the accumulation of considerable wealth and political power. The foremost vested interest is the landed elite that continues t o exercise a powerful influence on policy formulation due largely t o its political power which is a necessary sequel t o the logic of their situation whereby they are strategically placed in the various political forums in the country including ofcourse the parliament. It is not in the interest of this elite t o permit the enactment of laws that viould erode their pre eminent position. However it is not in the larger national interest that any elite be invested with disproportionate power as self interest then comes t o dominate and public interest suffers as a necessary consequence. The initiative t o break the power of vested interests cannot reasonably be expected t o emanate from government - for govt. is usually heavily infested by those who support the vested interest. 'I'his follows naturallv from the wlitical framework of democr;acv in deve-

204

Fiscal Impem rives In Pakistan's Economk' Dewlo[~?nenr

loping countries wherby power and influence gravitates towards the privileged in society. This creates something of a dilemma because if govt. is helpless then an assault on the power of the privileged becomes that much more difficult. However govt. always has the wherewithal and the duty t o create conditions that would encourage enquiry and enlightened debate. The spread of education and a policy of involving academia in a consultative capacity t o policy making forums can create the awareness that could ultimately lead t o the general awareness that is a condition precedent to the initiation of measlrrea that would ensure the true democratization of societ3 and break up of the power of vested interests without which the design of legislation is bound t o suffer from serious inherent deficiencies. Preemption Law As already pointed out, a good part of the available black money- is being sunk in red estate. Likewise, this area is also generating black money. The principal device used t o camouflage the actual quantum of investment in real eszate transactions is collusive under reporting of sale value. The deed of sale executed is invariably for a fraction of the actlaal price for which the sale has been made. Since both the buyer and the seller are willing parties to the collusion, it becomes extremely difficult to establish subsequently, the f , x t of collusive under reporting. The Deptt. of Income Tax is alive t o this problem and there are specific provisions in the Income Tax 'Law that are designed t o take care of such a situation. However, since the deed of sale when registered is a legal document, any attempt to rebut the sale value reported therein has got ':o be backed by hard evidence. Such evidence is extremely dxficult t o come by. There are a few odd instances when the correct sale price is reported in the deed of sale but since tkis is a rarity the few isolated instances cannot become reference points in the appraisal of collusive sale documents. The sale price realized in open public auction also gives a good idea of the actual market worth of land but since such auction sale is restricted t o particular areas and particular agencies it is not usually possible to make generalizations by

The Praal!er'economy on Overview

205

taking the auction sale rate as a basis. However notice is being taken of such sales and attempts are being made t o establish benchmarks on their basis.

The only practical solution however appears t o be enactment of pre-ernption law which would permit govt.. t o acquire property when the sale value is reported at a price in sharp variance t o its true market worth. Such a law would go a long way in making possible a practical solution in a very difficult area. Enhanced Survey and Inspection Powers for Iricome Tax Authorities. C:;rrent income tax law in Pakistan does not permit income tax functionaries t o enter and inspect personal residential premises of tax defaulters and suspected tax evaders and their authority is restricted only t o the inspection of business premises and seizure of accounts and related documentation. Such obvious limitation of their authority hampers considtrably any attempt at a meaningful investigation into the affairs of those who indulge in activities that .result in the generation of black money. It needs to be pointed out here that a great deal of ostentatious display of riches, is made in the personal residential premises of those who have access to black money. Such luxuriously appointed residental premises are no longer a rarity in the country. However the "tax performance"of such nouveau riche is nothing short ol' a mockery of the law. They either pay no tax at all or get awLy b y paying a paltry sum. The system of universal self assessment is exploited t o the hilt in this context. Strengthening of existing law with provisions that permit entry and inspection should -go a long way in reducing the difficulties that tax functionaries currently face in dealing adequately with tax evaders. Ofcourse safeguards will have to be incorporated t o ensure that the provisions are not misused. However the risk of misuse notwithstanding, the benefits of the enhanced capabilities that would be bestowed on income tax functionaries so outweigh the negative aspects that there can be no doubt of the necessity o f their enactment. Not only would such laws go a long way in discouraging the brazen rlicnlav nf

r i ~ h t~hca t

hac

h n o n m o a l m n c t a n n m l in

thic

cw-

ment of the population but it would facilitate to a considerable extent the positive identification of those who have access to black money o n a significant scale. The enactment of legislation such has been described above is hardly a novelty. Countries like India (among the less developed) and the U.S.A. (among the developed) have had such pteovisions in their Income Tax Law for a considerable period now and the experience has certainly been encouraging. lncome tax functionaries there have been known t o go through residential premises item by item and even go so far as to inspect, very closely, the personal wordrobe and other personal effects of the subject of their enquiries. While it cannot be said that the availability of such provisons on the statute have completely controlled tax evasion it is certainly correct that such provisions have had a salutary effect in encouraging the reporting of a much greater part of their incomes than their counterparts in say Pakistan are accustomed to. This k especially true ofcourse among celebrity people like filmstars who everone knows enjoy fabulous incomes and yet who report only a small part of their actual earnings;. Looking t o the sociology of tax evasion,the deterrrent effect of exposure would appear to be a threat that is taken quite seriously by those who seek t o misreport earnings from whatever activity they are engaged in. However it is only when such exposure becomes a real possibility borne out by the practical experience of those engaging in tax evasion, will the efficacy of such laws becomes established. A persons perception of the efficacy af a law is formed by the actual effect that the law has on those whose activities it has been designed t o control. Thus the theoretical or potential efficacy is of little consequence. What matters is the 'actual efficacy' of the law in practice.

Meaningful Economic Surveillance Absence of any institutional arrangement to collect and analyse economic data is a serious shortcoming in most third world countries - and that includes Pakistan. Understandably, data analysis is not a fashionable area of activity in developing

7hePomllel economy on Owndew

20 7

countries. It is also considered quite esoteric. The manpower required in this specialized field is not readily available and where available would prefer much more t o work for the private sector where the rewards are considerably higher than what the government, can offer. These deficiencies notwithStanding, it is not beyond the capabilities of the available manpower to undertake meaningful data analysis-provided there is a planned effort. The necessity for economic surveillance arise!: from the need t o exercise effective control over, and t o design appropriate policies for, activities that are considered prejudicial to the larger national interest. Activities that emanate from the black economy and further the expansion of the black economy are the sort of activities that need t o be checked . and t o be checked in time. However effective action is only possible if the necessary information is available - and available in time. F'resent,ly, the absence of a systematized arrangement t o gather infornnation in this context is a serious stumbling 1:rlock. 'Thus individuals with imagination - ar,d some connection:; - take full advantage of the weaknesses inherent in the present anangements. This is amply borne out by the brazen iictivities of unauthorized finance companies that have successfully looted thousands of people of vast sums by posing as 1:)onafide investors capable of paying them huge returns on their invest ment - returns as high as 10% per month!! The astonishing thing is that their activities took .place in full public view. Infact even public functionaries o n occasion participated in the opening ceremonies of their "branches" thu:; bestowing on them the credibility t!ley wanted. When the bi.lbb?e finally burst in 1979 the "brains" behind this charade vanished leaving the investigators with precious little t o pursue their investigations. In 1988 again a "corneback'. so t o speak, was staged, by floating finance companies anew in the full glaze of publicity. This time however, there appeared to be f:vidence that they would not be able t o get away with everythijrlg as, though again somewhat belatedly, countermeasures have been taken. The activities of the finance companies referred to above are black economy activities because the funds appropriated are put t o use in enterprises whose finances are almost invari-

208

Fiscal Impemtl'ves in Pakistan's Economk: Development

cies like the Deptt. of Income Tax. If the necessary irlformation about their activities had been gathered and analysed in time, effective counteraction could have been put into p1a:y well before real damage was caused. Thus a number of different measures can be taken to control the activities of the black economy and to prevent its encroachment of the domain of the regular economy. The authorities are not at all as helpless as would appea,r to be at first sight. Given the will, action against black activities is not only possible but also necessary if the cause of economic developrr~entis not to receive setbacks by the revenue that the exchequer is robbed of and by the necessary structu:ral change that cannot take place due t o the diversion of funds and the alternate non developmental use to which they are put.. Of all the measures listed above, the most important would appear to be those linked to the taxation of income. Specifically, there should be a comprehensive statutclry definition of income that would include all income, from whatever source derived, - and with no except ionslexemp tions. Simultaneously, the reporting of such income must be matie nmandatory and a data base must then be structured, computer based preferably. A data matching program will then have to be developed to continuously match economic data - regarding contract income, imports made, interest received, etc etc - with the data reported on the returns of income filed before the income tax authorities. This ofcourse is no small undertaking but the technology is available and the cost, though high, is certainly not prohibitive and the returns from any investmenl made in this context are bound t o be even higher. Also, it is imperative that the cost of tax evasion be made perceptibly high. Penalties must be made mandatory and must include imprisonment where concealment is proved and shown t o be deliberate. Similarly, tax defaulters must be dealt with strictly and coercive methods used to enforce recovery of outstanding dues. The general strengthening of the income tax base must be complemented with measures to prevent capital flight through the underinvoicing of exports and overinvsicing of imports. Areas of economic activity like real estate that absorb

The Pamllel economy cn Overview

209

huge funds and where the declared version varies niarkedly from the actual version must receive special attention and the enactment of pre emption laws seriously considered. There is no doubt that once a concerted effort is made the activities of the black economy can be effectively checked and kept within permissible limits. Appraising the size of the Parallel Economy How big is the parallel economy? This is a question that has perplexed economists a good deal. Both in Pakistan and India the dimensions of this hidden sector are now considered t o be considerable enough t o be a cause for serious wony. Some estimates indicate that it is already 50%of the G.N.P. The total quantum of black wealth is postulated at Rs. 180 Billion in the N.T.R.C. Report 1987. These are staggering statistics indeed and highlight the tremendous growth in this area in recent years. Looking to the constraints imposed by an acute lack of itemized data it should be quite obvious that any attempt to pre~iselyquantify the size of the parallel economy is I~oundto be futile. However generalizations can certainly be n a d e and depending on the methodology adopted, such generalizations can be more or less accurate enough t o be of practical use. One approach in this context is linked t o s quantification of the total 'volume' of financial transactions in the It!conomy in a given period and then relating the same t o the official income. Such comparison made over different time frames can then indicate a 'changing relationship' between the volurne of financial transactions and the official income which would, hopefully, give clues as t o the size of the parallel economy. The total value of financial transactions is calculated by taking the total amount of cash in circulation as well as the amount of "bank liquidities" (payments by cheques, money transfers from one bank t o another and balances on dernand deposits) and then multiplying each by its respective "velocity" (the number of times it changes hands each year). Coniparing the same over two different time spans will indicate the growth in the volume of financial transactions vis a vis the official income. The volume of financial transactions vis a vis

210

Fbml Jmpemrlves in Pakistan 's Economic Dtwloy~rnent

the official income will indicate the size of the parallel economy because studies show that a rather stable relationship exists between the volume of financial transactions and official income - given the velocity of money. Thus an increase in the ratio (between the money involved in financial traxksa~t~ions and the national income) over time, in the absence of any other plausible causitive factor, would indicate the existence of the irregular - parallel - economy whose operatiorls would involve the use of money just as the operations in the regular economy would. Edgar L. Feige has used this technique t o appraise the size of the irregular economy in the USA ("How big is the irregular economy?" Challenge, NovDec. 1979). His studies indicate that in 1939 the ratio between the volume of financial transactions and the national inconie stood at 10:30.As his studies also indicate that a rather stable relationship exists between the volume of financial transactions in the economy and, the official incon~e(i.e. the G.N.P.) then on the basis of such a11 assumption such a ratio (more or less) should also hold good in subsequent years unless ofcourse some other factor is operative in the subsequent period that was not present in the base year. This 'other' factor,% the 'irregular' parallel economy. The comparisons made by Feige using the met,hodology described above indicate that 19% and 27% of the entire U.S. economy was accounted for by the unofficial economy in 1976 and 1978 respectively. The economic transactions in the unofficial economy amounted to nearly 22% and 33% respectively, of the calculated gross national product in 1976 and 1978. Furthermore, the data indicated that the unofficial economy increased from 1976 to 1978 by as much as 91% while the official national income increased by 23% in the same period. Economics of the Black Market The basis for a black market is laid when the price obtaining in the market place is significantly lower than the equilibrium priceie.the price dictated by the forces of demand and supply. Such a price is always arbitrarily determined and enforced by government. The available supply is tBius quickly cleared at the artifically low price and a shortage situation

The Pamlkl economy an Overview

21 1

results. The "black market" crops up t o meet this shortage and the price demanded in this black market is the equilbrium price which the government ignored when setting arbitrarily the original price. Thus there is nothing inherently wrong with a black market. It is a market which is the outcome of the play of economic forces. That black marketeers are always seen as criminals is because the people who operate this market are acting in violation of the law which requires that the e at a product in which the black marketeers are dealing l ~ sold given low price. Thus PI.(Fig-1) is the maximum legal price that is set by order of government. At this price the quantity demanded far outstrips the quantity supplied. A shortage thus results indicated by QB - Q e on the o x axis of the graph. With such shortage obtaining at price P1 a black market can be created to cater to the unsatisfied demand that results from the fact that the legal price has perforce cleared the market of available supplies leaving a large number of buyers stranded. On the graph the demand remaining unsatisfied in the official (legal) market can be plotted by subtracting distance Q1 from the original demand curve Do-Do at each price (fig-2) D l D l is then the demand for the producer on tlie black market. Likewise, the black market supply curve may be plotted by subtracting from SO-SO at each price, the quantity Q 1 which has already been supplied in the legal market. (fig.3). Silnplifying assumptions that underlie the construction of the demand and supply schedules above are that no potential buyer refuses to make use of the black market for any reason (say fear of legal action). Similarly, no supplier is m u m e d to be deterred from supplying the needed quantities om the black market inspite of the fact that the legal price is given. Given the above assumptions both the black market demand and supply curves will lie t o the left of the original demand and supply curves by the distance Q1. Their intersection will take place at a price equal t o the pre-ceiling equilibruim Pe and at a quantity QB, equal to the pre ceiling equilibrium quantity minus Q1. Thus under the assumptions given above, QB units of the product will be sold in the black market at price Pe - i e . the original equilibrium price. (Fig-l).

FLPcal Im~erallwsin Paklston 'r E c o n o ~ ~ rDevelopment fc

Fig. 1

Price I

Fig. 3

Fig. 2

14 The economics of inflation

The phenomena of rising prices in unique for iits ubiquitousness on the economic landscape. Economies placed at all segments of the spectrum of economic development are subject t o its visitation. And it affects the entire population-in varying degrees ofcourse. It would not however be correct t o portray it as the scourge that it is made out t o be. To be true it is not a circumstance that can make the general public happy. At the same time, given the realities of economic life, it is inevitable. And it is controllable-within limits. Any rise in prices is inflation. Since in the market economy with which we are familiar in the free world-a term used for purposes of distinction from the regimented command ecano-

mies of the communist bloc of countries-price is determined at the equilibrium point where demand for goods (and services) equals supply. It follows that price will change whenever the parameters that influence demand and/or supply change. When demand rises and supply remains constant-or increases less than the increase in demand-then price will increase. It is only when the increase in demand is matched by a proportionate increase in supply with no significant time lag will price remain constant. In the real world demand for goods and services is expres sed through the monetary outlay that people are wiling t o make for them. The money supply in circulation now becomes an important determinant of the level of prices. The equilibrium level is'not a static phenomena. Because it is dynamic therefore it is not the static money supply that is of Interest,

214

Fiscal Irnpemthes in Pakistan :r Eronornlc Development

but rather the way in which money chases available goods and services that is of interest i.e. the velocity of circulation of money. The equilib level of price at a given point in time is consistent with a given velocity of circu1at;ion of the money supply in the economy in that time frame. Besides the notes and coins issued by the Central Bank money is also created through conscious decision when the central government decides to print more money for its use and when the commercial banks issue money after granting credit facilities to their clients. While all money is backed by some assets (gold, securities, hard currency reserves etc.) the requirement of adequate collateral may not be as rigorous when the commercial banks "create" money. Even the central bank may not actually ensure at all times 100%back-up for the money it issues. However it should be noted that there is no hard and fast rule for the back-up requirement. It is there simply t o ensure that there obtains a rational reference point in the context of money in circulation be enough to match, roughly, the demand money in circulation be enough t o match roughly the demand for goods and services which this money is used t o satisfy, given a velocity of circulation i.e. the rate at which money changes hands. Should this velocity change the same amount of money that sustained a given price level may not in the altered velocity state be able to ensure that prices keep their existing level and prices could rise or fall depending on whether the velocity had increased or decreased. On the basis of all that has been saicl above it would be apparent that a stable equilibrium level for prices is very rare and would not be established for any significant length of time. This is so because it is well nigh impossible for any authority be it a government agency or an independent authority t o ensure a precise balance between money supply and the transactions demand in the economy So diverse is the requirement t o fund transactions in the economy and so many different types of consumers are there for various goods and services that it is just not humanly possible t o establish an exact balance. And if somehow it were possible t o establish such a balance it would not last for very long. Human nature being fickle as it is there can be no constancy in demandAstate of flux is thus inevitable.

Given the scenario outlined above, the challenge for the

The economics of !nflatim

215

concerned authorities is t o keep money supply at a level consistent with a stabilized equilibrium level of prices. As has been made clear however, this is by no means an easy task. Even taking into account aggregate parameters it is no simple matter t o postulate what the equilibrium level requirement is and there are many complicating factors. The existence of a large parallel economy is one such factor as data regrading the operation of this sector is scanty-or may not be available at all-it adds immeasurably t o the problems of authorities to guess with any degree of exactitude what the requirements of this sector are. Also, the Government itself, especially in third world countries with little or no access t o high denland natural resources, is almost always hard pressed for cash and the temptation to resort t o inflationary financing and deficit financingthe two are not synonymous- is strong. This by itself is apowerful source of infationery pressure as vast quantities of cash printed by decree creates the well known enigma of too much cash chasing too few goods setting the stage for the classic situation of inflation. It is not always easy t o identify precisely which factor, or set of factors, is responsible for inflation. The so cdlled monetary factors, ie those related to factors that flow from the official conduct of monetary policy, are the most obvious and most easily emphasised. The transaction demand for liquidity sectorally emanates from each of the various sectors in the economy ie agriculture, industry, commerce, service, construction etc. constraints of data availability make it practically impossible t o make any accurate assessment of the ieed for cash in each of these sectors. Only educated guesses can be made and that too in very broad ranges on an aggregate basis and ofcourse there is the requirement of the parallel economy which may not figure correctly in the statistics re!evant to the regular economy. The degree of control exercised by the central bank should not however be overestimated. The level at which the bank rate is pitched is ofcourse an important and very real influence. However apart from that the issue of credit by the commercial banks cannot be possibly fully controlled and it is mainly through moral suasion- besides the margin requirements- that the central bank can expect t o achieve results.

Fisml Impemtives in Pakistan s' Economlc Dewlopnlent

It should not be forgotten that the commercial banks are motivated by a desire to make profits just as any other business would be. This they do by investing the deposits of customers i.e. savings accounts and fixed deposit accounts and by earning interest on 'mounts advanced. Advances are ofcourse required to be secured by adequate collateral but only too often this requirement is not fully observed and banks have tfo face the prospect of declaring a loan to be bad. The important point here ofcourse is that every time a loan is advanced the bank is in effect pumping that much liquidity in the money stream circulating in the economy since it is only fair to assume that the newly acquired liquidity will be put to use by the debtor without an appreciable time lag and will not be kept sterileas would be the case if the money received were hoarded. But then it is hardly reasonable to assume that such money available will be hoarded and not put to actual use since a charge (interest) arises for the time the loan remains with the debtor and which charge is extinguished only when the loan is paid back in full. Now that we know that inflation is inevitable given the existing format of the economy we would alm acknowledge that when it is within acceptable limits, it is also normal. It would be idealistic and not realistic t o expect that there be no inflation at all. Clearly however the important aspect here is the reasonableness of the price rise. This again is a tricky area and it is not easy to specify what the reasonable limit is and what appears to be reasonable in one set of circumstances might not be considered so in another. We will come to that later.

If we ponder over what has been said in the preceding sections, it should also become evident that inflation is a necessary companion to economic development. Excecution of development programs entails significant expenditure of funds. This again means that liquidity is ineffect being pumped into the economy. Ofcourse the pumping in of liquidity is expected t o result ultimately in increased physical output in the economy, directly or indirectly-so long as the funds expended are for development activity. Non development expenditure is not matched with the expectation that there will be a-reverse flow of output. While inflationary pressure is present both when expendi-

The economics of infhtlon

21 7

ture is developmental and when it is not so, the mitigating factor in the case of develop expenditure is that the pressure is expected t o be offset when additional output becomes available because the money stream will then be directed against an increased quantity of goods. Of course there is a waiting period involved and it is the length of this period that will determine t o a large extent the course of the inflation. The longer this gestation period the more problematic it will be in terms of worsening existing inflation. While the potential is much greater when expenditure is non developmental it would be overly simple t o assume that all non development expenditure is neccessarily inflationary t o the full extent of the expenditure incurred. It must not be forgotten that the total output in a sector cannot possibly be taken up--purchased-in its entirety by the manpower employed therein. Thus it is the people placed in the rest of the economy that must have the purchasing power to absorb the remaining part. The adequacy of this purchasing power is crucial if effective demand in the economy is to ensure that full employment of resources. Thus while non development expenditure so called may not result in physical output of goods it does not follow that it has got to be purely inflationary. Infact it will not be inflationary at all if the production in the econc)my is present in adequate quantity so that the money stream is just sufficient t o lift this output. The problems associated with inflation arise when the money stream is more than adequate to lift the entire output and a sizable surplus is evident. It is this surplus that exerts the most harmful form of inflationary pressure and is responsible for the worst interference with the adjustment mechanisms of the market economy with which we are most familiar.

On a purely monetary plane therefore inflation in the sense o f a sustained rise in the price level results not from the injection of liquidity per se in the econoniy but from such injection of liquidity that is in excess of the requirements that would lead to full employment of resources,, The monetarists emphasise this aspect as being of prime signif'icance in explaining the course of inflation in the economy.

In the world view of the monetarist therefore, the quantity of .money per se is of overiding significance in explaining the

21 8

Flsal Impemllres In Pakistun 'S Economic Development

development of an inflationary situation - and its subsequent course in the conomy. To be sure the velocity of circulation and the availability of credit are also releavant factors the inclusion of which changes quite drastically the complexior, of the classical pure quantity theory of money but the fact remains that for the monetarists it is the quantity of money as such that is identified as the villain of the piece in inflation and it would not be considered advisable to look t o other factors that could have a bearing in explaining the nature and course of inflation. If the monetarists are correct then control of the quantity of money in circulation (cash and the availability of credit) should suffice in putting an end to the bogey of inflation and whenever there exists inflationary pressure in the economy as manifested through a sustained rise in prices then this is; an indication that the quantity of money has exceeded by a wide margin the safe limit visavis the total availability of goods and services in the economy and the trasactions demand for them. The obvious solution would be to take steps t o mop up the excess supply of money through central bank intervention and t o put a brake to any inflationary financing by Government that might have already taken place or was being actively contemplated. We all know now that exclusive emphasis on the supply of money is too simplistic an explanation of the nature of inflaItion. It would have been all for the better if it were indeed true that this was infact the case for then the solution to the problem though not exactly easy would at the same time also not be s o problematic and difficult as it is in real life situationsespecially in third world countries. Almost as a reaction t o the glib explanation of the monetarists an alternate school - if one could describle it so-emphasis with just as much certainty, the significance of so called structural factors in provoking and maintaining inflationary pressure. Rather than emphasise money supply the structuralists emphasis, as the name would appear to indicate, the very nature of the structure of an economy as having paramount significance in initiating inflation and in ensuring its continuity. Now the structure of an economy ;includes its sectoral composition and the linkages within a sector and between sectors: Aberrations in

The econinnlcr of lnfbtlon

219

the structural arrangement are cited as being primarily responsible for instigating inflation.

As far as technical sophistication goes, the axgument of the structuralists appears t o be an improvement - -to some even a considerable improvement, over the monetarists point of view. The common view is that inflation is a generalized phenomena and the entire economy is so afflicted when inflation strikes However if we focus on the structural aspect, inflation can be seen as taking root in one sector or segment of the economy, or even in a number of different trouble spots, and then spreading like a virulent contagion across the full expanse of the economy. When so localized , as it were, factors peculiar to a particular area of the economy can be relevant. Thus cost push factors in a broad range of the manufactoring sector by forcing price markups can instigate inflation - ignite the fires of inflation. If the play of forces takes on the garb of a circular constellation, self sustaining and repititive, (such as can happen if say a wage rise provokes a price rise and if wages are indexed to the general price level then this could cause a second round of wage hikes which in turn can provoke a further price escalation which in time would cause wages to rise and so the cycle would repeat itself till a sustained price rise became inevitable given the unique logic of the situation) then we have the basis for self reinforcing inflation. Now the reason that inflation instigated in one area of the economy will spread out t o the other areas is because of the synchronousness of the intra and inter sectoral linkages. There is a continous give and take between various ,segments of the economy and this passes o n the seeds of inflation which then take root whence they are transplanted. Abnormal demand pull is just as capable of instigating inflation as cost push factors. Because supply is unable t o respond immediately t o escalating demand a price rise becomes inevitable . An effort t o meet the rising demand provokes investment in production capability. The increased wages disbursed add t o purchasing power and so further fuel inflation. While inflation usually occurs concomitanbly with

220

Fiscal Impero Hvcs in Pakistan 's Economic D m l o p m e t ~r

economic development, it is also a fact noticed in the post1960's that inflation need not always accompany grc~wthinfact, and especially in the more developed economies, inflation and long run stagnation (rather than growth) have been found t o be the enigmatic duality. This has debunked the pop1.1larly accepted notion that inflation accompanies growth-whic h thesis had made it somewhat fashionable almost t o not only tolerate but t o actually approve of some inflation as a ponter that growth is infact taking place. Ofcourse this was never t.aken t o be an approval of obviously serious economic maladies like galloping and hyperinflation such as afflicted many economies in the post world war 1period. What we were talking about here was single digit and initial double digit inflation only. The phenomena of 'secular stagnation' baffled economists for a while as it was something new on the economic scent?, However the presence of inflation with stagnation is symptomatic of the fact that new investment -physical investmc?nt in plant and machinery - is deficient. One indication as t o the nature of the problem would be the fact that the interest rate having been pitched a t discouraging levels deters much of the new investment necessary t o keep t h e growth process going. At the same time the fires of inflation are fueled by a growing Government deficit that forces deficit financing and which is unable t o coax increased output because of stagnation leading inevitably t o an upward pressure on prices.

In a developing economy structural peculiarities complicate the problems that inflation poses. For one thing, most third world countries have a fairly large non monetized sector. The ability of t h e central bank t o take regulatory i~ctioln through intervention in the market is limited by this anc,maly, Furthermore, increasing Government deficits coupled with rigidities in resource mobilization frequently necessitate deficit and even inflationary financing. As output is not respcsnsive the upward pressure on prices grows and over time feeds on itself. The emergence of a government deficit is symptomatic of the fact that government revenues fall short of its expenditures. Now an individual placed in a similar position would endeavour to meet the situation b y borrowing. That would resolve the matter for the present. In the long run however, a better solu-

TABLE 1 2 . MONEY AND INTEREST RATE IN SELECTED T H I R D WORLD COUNTRIES AND T H E NIC'S

MONETARY HOLDINGS BROADLY D E F I N L D

-- - -A H I ~ C8nnU.l n o n d n d g m v l h rate 'h

country

AVFRAGE ANNUAL INFLATION -

(iUP inflator

INTEREST RATE

- ---

Nomllul intercat rste ol mnka average annual 9. -- I m d h r a t e

PAKISTAN NIGERIA BANGLADESH INDONESIA INDIA PHlLLlPlNES THAII.AN0 TURKEY EGYPT

s. K O R E A * SINGAPORE'

b u l r ~ 1

H n r k i Rank. World Urvelopnlrnt R r p l r t 1987.

2 : G o w r n m e n t of P&b%nn.Emnonde S-y.

188667

- In a mixer1 ,.r ~ n o r n vo f the quad rapltllirt format. the h t e r c s t rnte Is s key " r ~ p u l s t o r " o f r c o n o n d e sctlvlty. Whne t h e (central) B m * R.1. sets the t r m r for the b l r r q s t rate rtyuctrup tn t h e "format" econotny, depomt m d l e n d l w rnter tmudlv w r y . T h e ~ c ~ . t e a ~ U s b l U t y o f ,'lornahlr fctnrls ' i n the e r n n o m y and t h c d r m s n d f o r tc same. determines. b r o s d l y , w h e t~h e I n ? ~ r a rate ( nmnurr wUI rrtsblish Itself. G o w r n .:!?.it .:iii.~i..: :?IF r..;h !nan:L!; k n d s 'r ~r.cr?ec* t h e e . t! b dyniflrlm arvf rldw o v n t l m r . It would mean Ln r t l r r t t b t the g o w r n m r n t will ti? . ' c t > m ~ , ~ u't aql t h t h e other are.$ In t h e rronorny b o m such rlcmand emanatel. This "enmprtctlon* msu h r rpaolvra In t h e governmen1 favnor !I thr rrta. r r I Inter?* offered b y t b c # o v r r n m n t an t h e loan bsues floated b b h m o w h . Thru w h r r r g o w r n m m t d e m a n d f n r loanablc s.. .,.-a -.i :'r :r~ul.7ri? r!?c!!ed 11 :--$ thst a r e ahnormallp *h. t h e r a t e o f !nr.erel b bo.3-d t o hr hid up. Because of s "svnchrotmnrss" Ln the c o m m n c i l l I!ncrr.s( rste R n l c t l a e . the general c a m m m d d h t c r r s t rste rormst b Ukelv t o be d f c c t e d . I l h l m t r l v . rlsirg brtmest rat- w U damper, r.curll,rrnlr a c t i d t ~b, ~ n a k i n pcredit " c r p m s l w . " The ?rroR !mpn*an! arn t o mffrr would b e u h l a t~a t i o n " "heavy flnmclng" prolema much m U P t y p i r d l y Lnvulved in r c o m m i e d e w h p m e n t v i r " l n l n rtructurr" components. h a e l n d u t r i a l m t r r p r l z m pLy) become u n s t t r a n l \ r ~ n w * m c n b ~ C C I U P o f t h e hl#h "cost" o f m a h k m r h m w s t m n l --Inter& c h m s n b e l n l .n ImportmTI p u t o f such cort. O p r r a t l o w o f th* ltll,,rrnol "Parlnel eronorny" a h h a w t h e patentlrl t o .'d.stabM?e" the l n t ~ r w nt t c *uehlrc.e.

222

Fiscal Impemhes in Pakistan's Economic Development

tion would be t o increase revenues and/or t o decrease expenditures. Failure t o do so would entail repititive borrowing and that would ofcourse mean that the burden of debt would keep on rising. The position of government is analogous t o that of an individual whose expenditure exceeds his earnings. The government can however do something which the individual 'cannotthe government can print currency for its use. Ofcourse its powers in law in this area are strictly speaking, not unlimited but Government's especially in third world countries, often find, a way of getting around the legal impediments. When government's do so then we have an inflationary financing of the deficit. The effect of such additional currency printed and injected into the economy is t o bid up prices as a higher absounchanged output. Oblute amount of cash is chasing the viously therefore, this is an undesirable form of financing the deficit. When we talk of deficit financing we do not ne~cessarily mean inflationary financing of the budget through printing o f currency. However in the public mind that is the image that is evoked most often when mention is made of deficit financing. And that has conditioned the public at large t o view the very idea of deficit financ'ing with extreme disfavor. In actual fact, deficit financing means a range of policy options most o~fwhich are valid means of facing up t o a problem that will not vanish by ignoring it. This is not t o say that a deficit is a desirable thing o r that once there, it can be ignored. So long as. government restricts itself t o obtaining loans from the public by floating debentures, the government is actually mopping up savings of the public. The government is thus tapping the existing resource stream in the economy. However such mopping up has a cost - t h e interest that government must guarantee before the public would be willing t o part with its savings. This has got to be a high enough return otherwise people would not find the prospect of giving their money attractive. From this it is apparent that the government has t o compete with other areas in the economy that are willing t o pay for use of the publics money. This competetion necessarily exerts an upward pressure on interest rates and if government. indulges in this exercise often the upward pressure

The economics of !nf7adm

223

will provoke a significant escalation in interest rates as it would become more and more difficult for government to persuade the public t o part with its savings and it is only by making it attractive would such parting be possible - that ofcourse would mean a high enough rate of return. This bidding up of interest rates is without doubt an ominous development. Not only does it increase the cost of financing the Government deficit, it adds t o the cost of obtaining finance for any kind of activity as it will eventually bid up inevitably the bank rate of interest and therby set the tone for interest rates in general in the economy. This means that projects requiring significant funding, typically public utility investments and infra structure development, w o ~ ~ lbecome d that much costlier now especially where the gestation period is extended. This would thus become an argument against undertaking such ventures Considering their pressing need, the cause of economic development would thus go by default and give a boost t o anti growth factors thus hindering and slowing down ing economy can ill afford if it is to be ever able to counter the anti growth factors and come up with meaningful, effective growth. It follows from what is stated above that defivit financing and inflation do not necessarily and inevitably follow in that order. Inflation is much more likely when large scale inflationary financing is resorted to. That however is not typical. More typical is government borrowing from the public. However when such borrowing assumes a repititive pattern an upward pressure on interest rates is the really worrisome develop: ment as this can ultimately dampen investment in infra structure and public utilities. The art of effective monetary management rs to balance measures taken t o curb inflation with concomitant action t o ensure that interest rate escalation does not take place. .This is not always easy. A reduced money supply will serve t o quench inflationery pressure but it can also bid up interest rates. The liquidity preference of the public at the escalated interest rate would be less and it would be willing t o make its savings available for deployment in the economy. At the same time the high interest rate would curb investment in long gestation heavy financing projects such as are most needed in economi&

224

Fisarl Impemtiws in Pakistan 's Econoniic Developmet~r

development. Increasing money suply would reduce the interest rate but this would also increase liquidity preference. It would then become that much more difficult t o secure finance for implementation of development projects. The trick therefore is to find that optimum point where both interest rate and money supply are ideal for economic development. Serious Inflation is undesirable for a number of reasons: The most obvious is that the erosion in the value of money creates an additional burden for all especially for the fixed income groups who are unable t o raise extra funds t o match the price increase. The underprivileged in society are the hardest hit in such inflation and this has implications that bode ill for social stability. In the market economy system, prices influence resource allocation. Resources flow towards those areas where the r e turns are maximized. In inflationary situations, long gestation, high finance investment areas lose out t o shorter duration consumer goods investment where the requirements olf finance are much less. This means that investment in areas connected with infra structure development and public utilities will lag behind in the matter of attracting funds. The economic landscape will instead be dotted with a plethora of consumer g ~ o d sprojects of dubious value in furthering the future development of the economy. Failure of reproductive capability t o talie root in the econoiny is a serious deficiency and inhibits the institutionalization of the growth process. Serious inflation can wipe out household savings especially for the fixed income groups. The diminution of the savings pool in the economy hampers investment as more and more cash is used up t o fund purchases of essential item supplies. Inflation exacerbates problems posed by the government deficit. In an inflationary stuation it becomes increasingly difficult for government t o reduce expenditures. Sirnultaneously, government outlays increase as defence establishment outlays and other non development expenditures register sharp jumps. The indebtedness of Government is thus bound t o increase and the need t o secure additional funding in an inflationary situation will create pressures for escalation of the

The economics of infition

225

rate of interest so as to ensure that a sufficient incentive obtains for people t o part with funds that could be needed elsewhere in their day t o day requirement. Pitching the interest rate at too high a level will create a whole set of different problems that have been dealt with in the above sections. Inflation gives a boost t o t h e operations in t,he parallel economy especially in the black, illegal segment. Prcomotion of such operations militates against the imperatives of genuine development of the economy in a long term perspel-tive especcially with regard t o development of infra structure and the acquisition of reproductive capability. Inflation thus accelerates the encroachment of the parallel economy over the sphere of the regular economy. Over time therefore there develops a possibility that the fiscal jurisdiction of Government will actually diminish which has sel-ious repurcussions for resource mobilization and for regulatory control by government agencies. Inflation reduces the competetiveness of a country's goods in the international market for the simple reason that they now cost more. Reduced export earnings can dramatically affect the resources of hand currency. Inflation erodes social values and corrodes the fabric of soceiety. Inflation influences adversely the security perception of the populace. . It can thus provoke responses that are exaggerated and whimsical and even aberrant. These can, destabilize financial markets by causing a run on stocks necessitating large scale intervention by the central bank through support operations involving funneling large scale funds into credit markets t o maintain their credibility and for preventing a run of banks. In the market economy psychological factors are crucial and it is imperative that no development be permitted t o talie root that can heighten tension and stress. Inflation is a symption that the economy is not faring well and this affects the aid climate adversely.

226

Fiscal Impemttves In PaMstan S Economic dew lop men^

capital. The private investor is bound to be discouraged by the prospect of continueing inflation which will eat into his profit margins by escalating costs. Inflation, by provoking structural disturbances in the economy is potentially capable of sowing the seeds of unemployment.

Part I1 THE ECONOMICS OF GROWTH

Some important lessons drawn from the historical experiences of nations.

t h e agony of the Past.

Patterns of economic development followed by the developed countries of today need not be valid for all tinies and all countries.

Todate all the developed countries of the so called "free world" have relied heavily on international trade to promote the development of their industry by ensuring markets for their large scale standardized production. Good prices for finished manufactures made possible the generation of large "st~rpluses" which by boosting savings have provoked investrr~ent and thereby made possible the structural diversification of the economy with growth eventually becoming institutionalized without the use of extraneous "props" (like foreign asistance). As a developed country moved higher up in the development scale it began t o focus more on such manufactures that entailed the employment of more and more "roundabout niethods" leaving the relatively rudimentary manufactures t o the newer entrants. One of the reasons that the system outlined above yielded good results was because of the multilateral tradinl; system that enabled all who displayed a capacity t o participate meaningfully t o become trading partners o n more or less ~tqual terms. Such resilience in the system made meaningful participation a distinct possibility. Since the end of world war two the multilateral trading system has been gradually eroded and a crisis of international liquidity has been instrumental in directing trade more and more into bilateral channels. For the developing countries this

li ' ,I

230

Fiscal Impemtives in Pakistan 's Economic Dewlopmen t

opted for the (so called) free economy fonnat in structuring their economy have felt frustrated in being unable t o duplicate the performance of those among the developed country c a t e gory that they have sought t o emulate. They have thus been forced to rely on the export of primary commodities to generate foreign exchange and where this has not been possible - as when the developing country is not gifted with high value mineral wealth (such as oil, copper, bauxite etc)--the only alternate has been t o attempt t o secure loans from both institutional and non institutional sources-within and without the country, expecially the latter. This has not always been easy and even where the attempt has met with success has created serious problems of its own. Another factor of significance for the heavily populated underdeveloped country is that initial levels of literacy are extremely low. This aspect has ramifications that may not be immediately obvious. Not only is it difficult to instil basic technical skills in an illiterate populace but it is also problematic t o motivate therr and t o make them aware of "the national interest." As most developing countries have had a turbulent colcnial past it is not at all a simple matter for the largely illiterate people t o relate t o government and the administration. This makes their participation in a broadbased developmental effort very questionable. Problems like rampant tax evasion, unbridled growth of the parallel economy, corruption. etc. all ensue from what may be called a perverse sxiological base. Remedial measures can-and are being taken-but complications arise as most developing countries of the free world have opted for 'testminister style democracy" and the mixed capitalist economy based on a free market. However, illiteracy, severe resource constraints and gross defnciencies and imperfections in the economic infrastructure and the format of the market make inefficiency inevitable. The huge impoverished, illiterate population forms a poor market and its members make poor entrepreneurs. Gross inequities in the distribution of wealth create cleavages and schisms that have ominous social and economic implications. In short the antigrowth factors in the given situation are so awesome that they simply d o not compare with the problems that confronted the present day developed countries as they evolved t o their current developed state. The latest crop of developed countries in asia, south korea, singapore and taiwan-also did not have t o face problems

The 'world bank'. d d f l e a t b n o f c o u n t d r b y t n d e o r l e n t a t b n h u l o b w a : P a d o d : 1063-7 S1. !jTRONGLY OUTWARD ORIENTED

2. MODERATELY OUTWARD ORIENTED Brazil. ~ m e m CRo I w b h . Costa Rlca. C o t c d ' I w h c . Gutemel.. Indon-

btrael

. MplSyl4 T b i L D d

3. MODERATELY INWARD ORIENTED BOLIVIA, E l S . h d o r . H o n d u n k Kanya. M . d . p a o n ,

M e d m . Nl-uu..

Nlgd.,

Phnlpplncs. S n e g d . TunMa. Yw0.L. da.

4. STRONGLY INWARD O'RIENTED

-ARGENTINA. BANGLADESH. 0URUNDI.ClULE. DOMINICAN REPUBLIC. ETHIOPIA. GHANA. INDIA. PAKISTAN. PERU. S R I LANKA. SUDAN. TANZANIA. TURKEY. URUGUAY. ZAMBIA.

IN T H E PERIOD 1973-86 T H E FOLLOWING CHANGES ARE CITED CAMEROON. COLUMBIA. COSTA RICA. COTE D'IVOIRE. GUATEMALA h INDONESIA A R E PI.ACED I N T H E MODERATELY INWARD ORIENTED CATEGORY.

PAKISTAN.URUGUAYMOVEr0 T H E MODERATELY INWARD ORIENTED CATEGORY. MADAGASCAR AND NIGERIA A R E NEW ENTRANTS IN THE STRONGLY INWARD ORIENTED CATEGORY. C o u d r k s t h d move .way t m m ul " l n w u d o r c h t b l o n " t 0 a morc outward o r * n t a t b n haw bccn able t o mmctrue poltdea th.t c r m t e . blu towmrd p o d u c t b n f o r t h e e x p o d m l d r e t m t h e r th.n t h e d a m s t l c mmket.

' E x p o d I d ' w w t h b u bccn t y p l u l lor t h e r r a r n t &Y d H o w m r t b c a n d w l .=roalonol t h e m u l t l l a t d t r d i q m t e m h p o v d t o b e b o o n l o r t h e strwallr\l m m t d m of t h e " S U l h " . ha.. mnlrfnutul_ to =ow!= dl.-c!??"l?l!?? ~ ! t h'mdh - %st!!

m n d c o u n t r l n o f t h e h c c wodd- lncludlry t h e newly !ndlYPlalJ.Ud~c o u n t d o ( t b N.I.CI.). u dkecied m o r e m d morc t n d c Into b h t c r d cbannch. F i a t h e r m o m . '&Lbrth' Sourh'u.de bu not Dcterloratbn o f t h d r t e r m o f t r . d c u l d t h e ' p r o ( e c i b n U ' poUcb.of the c o u n t d o 01 t h e 'North' frsde.

The economics of g o w t h S o m e impormnt lessons

233

that compare anywhere in sheer magnitude t o what countries like say India, Pakistan, Bangladesh, Indonesia, Nigeria etc have had t o cope with. As the free market mixed economies 01the developing countries get bogged down, classical - and . n q classical - recipes for economic development based on such an economic system, fail t o be effective. It is imperative, therefore, that a determined and concerted effort be made t o deviate from traditional patterns of development in this essentialljr capitalist context and to attempt t o evolve approaches t o economic development that enable developing countries t o break the "poverty barrier" in a reasonably short time frame based as far as possible o n their own resources - material and mental.

Developing countries so far have focussed a good deal of effort on establishing "North-South" economic and political ties. The flow of foreign assistance has in part been instrumental . .. in forgoing such a relationship. East-West ideological confrontation has resulted in the structuring of alliances based o n political expediency. Countries have thus come t o be placed in a political "bloc" o n the strength of political affiliation that may have little o r no relationship t o their economic circumstances. The political dimension has, over time, come t o d o r n i ~ a t eand developing countries have not been able to s t r u c t ~ u epolicies based predominantly on their peculiar economics. By looking t o a "North-South" connection, developing countries have come t o ignore the "South-South" dim ension. By their failure'to forge meaningful economic and political links among themselves they have not able to bargain effectively with the developed countries with the result that their exports of primary commodities have had to suffer deteriorating prices therby impacting adversely o n their aggregate resc.)urce availability. Prices of finished manufactures from the developed countries have, o n the other hand, steadily increased. As developing countries continue t o look t o the developed countries for much of their demand for finished manufactures, especially those based on relatively advanced technology, the drain on their resources has been twofold resulting from lower prices for their exports and higher prices for finished manufactures. Nnt nnlv hsc

nnt h-n

~ccihln f-

Anwnlnninu r n i ~ n t i

234

F i s a l Imperatives in Pahistan's Econonric D e w l o p m e t ~ r

to negotiate fair prices for their exports of largely primary commodities t o the developed countries, they have A 1SO encountered strong resistance whenever they have made attempts to gain access t o the affluent domestic markets of the rleveloped countries in the post world war two era. This has been especially true in the area of finished textiles in which many third world countries have made heavy investment. Protective tariff waUs and quotas have effectively checked the inflow of third world exports in this area robbing them of huge revenues. The advantage that developing countries have in this area due t o lower relative wages for labour enabling them t o charge a competetive price is thus lost. Although textiles is not the only area where such a situation obtains, it symbolizes i3 trend that bodes ill for the future reception that developing countries might expect for their products that are in direct competetion with those manufactured by the domestic producers of the developed countries.

Third world manufacturers have been hindertd considerably in their efforts to duplicate the products of their counterparts h the developed countries because they have heen unable to set up enterprizes large enough to employ the technology that would enable them to take full advantage of the possibilities resulting from large scale production. Furthermore, research and development is absolutely essential if economic viability is ever t o be achieved. Both large scale production and research and development require huge funding. The existing economic format in most third world countries limits such mobilization of funds in the private sector. As a result, private sector enterprizes are typically small affairs limited t o the production of a small range of output and unablt? t o employ advanced technology o r t o conduct any meaningful research. What is stated above should not be taken t o mean that the many m a l l enterprices in the private sector are of no consequence. In fact they play an extremely important part in the economic well being of the country through the employment they make possible and the income that they generate. However it is a fact that if a way could be found to enable some of the smaller entrepreneurs t o pool their resources and come together their collective position would be considerably improved. Admittedly, this is easier said than done. :Entrepreneurs are wary of "partnerships" and there is a perception that; "partners"

TABLE 1 4 CHANGE IN EXPORT PRICESAND IN THE TERMS O F TRADE OF THE COL'NTRIES O F THE THIRD WORLD ----

- -

- --

CHANGE IN EXPORT PRICES (AVERAGE ANNUAL PERCENTAGE CHANGE/ TERMS O F TRADE) Country Group 1966-73

197340

198 1

1982

193 3

1984

198 5

DEVELOPING COUNTRIES EXPORTS (OVERALL) HlGHLY DEVELOPED COUNTRIES (OVERALL) MANUFACTURED GOODS EXPORTS O F DEVELOPING COUNTRIES' NON MANUFACTURED GOODS EXPORTS O F DEVELOPING COUNTRIES (EXCLUDING FUELS) Source:

Data derived f m m "World Bank' World development report 1987. (Presentation format mine). Data in perenthesb shows movement In terms of trade. 1986 Figures are "estimutea"

The real dgnificance of t h e trend In t h e terms of trade for dewloping countries is much greater than what the data suggestÂś. For o n e goods is M t e d as is their " r q e " of manufactured items. Moreowr, protectionist policies pursued by the dewloped countries discourage expansion o f t h e pmduction b w . Hlgh external indebtedness adds t o their problems. The "advenity"in t h e terms of trade of t h e primary goods exported by t h e develophg countries is especially mcvked and since these constitute a significant component of the total exports made, the real impact of t h e term8 of trade deterioration is qulte high.

thins: thler relative dependence o n thelr exports t o generate hard currency is very high. Quantitatively. their o u t p u t of manufactured

-336

Fisml Impem t i w s in Pakistan's Economic Dewloptlrenr

are not to be trusted in the conduct of business. The corporate form of business organization affords a way out of the impasse here. However, here too, private corporations are largely family affairs and the corporate format is used to facilitate t;ax evasion more than for any other reason. The public corporation does offer a solution but here the government will have t o take initial initiatives and "deregulate" as the economic viability of the project is established. Besides this, the government can advance the prospects of partnerships by introducing legislation to oversee the fair and proper management of enterpriies. Cumpulsory audit and strict punitive action for violation of fair practice laws is essential in this context. New statutes would require t o be enacted in many areas and machinery created t o oversee their implementation. Thus a fairly radical change in the institutional format of conducting business in the private sector would be required to ensure that "large businesses" are successfully established. It must not be forgotten that an important reason for Japans position of preeminence in many areas of business activity is because of the sheer economic power of major japanese corporations as a result of which they are able t o deploy huge resources for production, for modernization and updating of plant and equipment, for expansion, for advertising, for research and development and for setting up independent sales and even production outlets aborad. Of course this did not happen suddenly and the present position is the result of an evolution spread out over the last four decades or so. Infact some o f the corporations have an history even prior to that but a major restructuring has taken place since the end of world war two and this is therefore the period of interest t o US now. In order to oversee economic development effectively and t o be able to implement, monitor and evaluate development programs, it is essential for developing countries to be able to exercise good control over the major areas of activity. The position as it exists at present does not permit of such control. A direct consequence of this is enormous wastage of resources as a result of inefficiency and corruption. The political format of most developing countries modeled as it is after that of the advanced countries of the west, where, needless to say, the political, social and economic circumstances are totally different, has reslllted in the creation of almost chaotic conditions in the field of policy implementation. Politics in developing

countries entails a huge social cost by way of work time lost, destructive politicking, hugely expensive lobbying, corruptiun on a collosal scale (buying votes "enbloc", buying key personalities, politically motivated handouts of huge sums of money, "recouping" expenditure incurred on election after attaining office by virtually ransacking the treasury etc. etc). The best plans drawn ap by some of the sharpest minds in the countrymany of whom have made their mark in prestigious institutions abroad - fail to achieve the desired results. Much of this can be remedied if bold decisions are taken t o ensure that an "apeing" of the democratic style of the west does not become a blind obsession. It is significant t o note that asia's newest entrants t o the developed country category, south Korea, Taiwan and Singapore, although definitely a part of the free world under a mixed economy format, have evolved an institutional framework in which state control of key activities is fairly pronounced. The pretext for such control may be the emphasised need t o combat communism effectively for which discipline and orderliness is percieved as being essential, but the disorder and tumult of unadulterated western style democracy in the peculiar environment of an asiatic people conditioned t o strong central authority is ,correcl;ly recognized as being detrimental t o politicid stability which is a sine-quo-non for long term irnplementa.tion of development plans. As it becomes increasingly problematic for the countries of the South t o manouver t o positions of equality in their dealings with the developed countries of the North, one-way out could be a much greater South-South co-operatipn,.A number of countries of the South have a fair industrial capacity especially in certain areas-viz Turkey, India, Pakistan - and the same can be put t o mutually advantageous use in the tievelopment of many third world countries. The industrial output of third world industry can be absorbed in the markets of the relatively less developed in the third world and these very countries that are able t o export their finished industrial goods can also aid in setting up industrial capability in the importing third world country thus facilitating the deepening and widening of capital there. Over time this accelerated cooperation among the countries of the south is bound t o prove t o be - n ~ t a n s l l x ~ h n n n f i o i r a l s n r l w a l i n x r a d A # th--..-L...-A-- ...c em-:--

---

TABLE 15 ORIGIN AND DESTINATION OF MANUFACTURED EXPORTS OF SELECTED THIRD WORLD COUNTRIES MANUFACTURED EXPORTS

DESTINATION OF MANUFACTURED EXPORTS (% O F TOTAL) NORTH

Cc%r~try

( M%=

LNmtm market economles

SOUTH High Lnccme Oil

Exporters

Developlag Ewnomlw

PAKISTAN NIGERIA BANGLADESH INDONESIA INDIA PHILIPPINES THAILAND TURKEY EGYPT Source: World Bimk. "World Dewlopmeld Report" 1987

The yearly pementmer for destination of mmrdactcued exports will not add up t o 100 as the data tabulated above doea not lnclude exports t o Ilon report"non member" countries of the World Bank. The "ipdustrW market economies" caregory lncludea the (structuraUy) U h l y developed economieb of the "North". The d a t . s b w s that for t h e rmnufactvred expoof t h e 6 L S ~ u t hthe " prhclpal madrets are in the "North". SOUTH-SOUTH W e in thia context ir not Incredng atbiactorlly. T h b h not an encolaoging development m (see other data appended) the "South" bas had t o Butfez B progreaive deterioration in the terms of trade and protectionist policies of the 'north" imposes c e w s o n output therby rentrictiag production and prewnting full utilization of capadty thus impactha d v e m l y o n their development momentum. A posslhle way o u t of t h e impIs greater "southsouth" exchange. Part of the effort made t o win concessions from the "north"(much of It futile) may b e more profitably expended in promoting "south-south" trade.

The ecu:omics of growth-Some impormnt lessons

239

up to the ennervating competetion of the highly sophisticated industrial edifice of the advanced countries of the North, the transition to industrialization would be decidedly smoother and less traumatic in the South. The boldest decisions however will have to be taken in the area of population control. The sustained high i;towth of population is certainly the single most imporant "anti growth" factor that threatens to hold back the development of the South. So far, none of the densely populated countries of the South have been able to devise successful policies t o curb the very high addition t o their numbers each year (3%plus). To be sure some steps have been taken, some quite radical such as the forced sterilization measures in India, but nothing concrete has been achieved and proliferation in numbers cont,inues unabated. It is now being increasingly realized that effective population control is a complex sociological problem in which education, religion, meaningful leisure, living conditions. opportunities for socioeconomic advancement-all are inextricably intertwined and mesh with each other. Education may be the most important of these with religion a close second. This may be because the "world view" of the individual is probably shaped in the most important ways by these two "factors". However imparting meaningful education to such vast multitudes, given the severe resource constraints, is not the easiest of tasks Churning out low grade graduates in quantity year after year has certainly done nothing t o alleviate the situationinfact the phenomena of the educated unemployed is an ominous development that has dangerous implications of its own. Thus a great deal of dedicated planning and lots of inspired imagination is required if education is to be effectively used in combating the scourge of a threatening rate of growth of populat ion. The developed countries of the west were never confronted with the sort of population redundancy situation that faces the third world. Infact in its development phase the west had a different problem - that of a paucity in the numbers of its people. However it was one of their kind whlo first prophesied the doomsday scenario that must follow in the wake of But in the unchecked population growth-Robert Malthus. heyday of capitalism, the gloomy prediction of Rlialthus was I

I .

. ..

240

FIsml Imperadves in PaMsran 's Economic Dewlopment

result it was soon forgotten. It is a tribute t o his pres1::ience and insight that his discourse is now often resurrected and treated with far more respect than what it ever received o n its conception. For the third world however, Malthus is still very much a stranger, their own prophets and sages being so much more compelling. Communist China with one billion plus people is today the most populous country in the world. It is also one ol' most the densely populated and, very creditably, has been able t o successfully control the rate of growth of its populatiora. While it is correct that the very low growth rates of the highly developed countries of the west have not even been approached - in some of these, negative growth rates have been recorded -- the fact remains that the ominous scenario of an escalating proliferation in numbers does not obtain and given the resource position and the development activity in motion, the populatioin remains under control for the present. This has been made possible by the energetic steps taken t o educate the populace and by being able t o devise such policies as definitely encourage a smaller family. A range of incentive measures from eligibility for housing facilities to priorities for schooling, childcare facilities and levy of taxation, have been linked t o the size o f the family. The "one child family" is considered as the ideal and most beneficial t o the parents in terms of financial burden and availability of state provided benefits. Besides this, medical facilities for the people include free abortion as well as supplly of contraceptives and counselling. Over time, the "package deal" devised by the state appears t o have succeeded in provoking a change in the attitudes of the people - and there can be no better test of the efficacy of the policy measures devised. Planned effort has thus been shown t o be able t o open up a highly traditional society with mores deeply entrenched in the psyche of the people. And this has been achieved without traumatising the populace. The use of procrustean methods undoubtedly accounts for much of the success of radical policies put into play by the state but in the area of population control there is no credible evidence that any serious attempt has ever been made in china t o control the growth in numbers by the use of such methods A rather crude attempt in this context was however made in India when the government attempted t o force "sterilization" of the (under-

TABLE 1 6 PAKISTAN IN THE THIRD WORLD - COMPARATIVE DATA FOR SELECTED COUNTRIES - 1 9 8 0 8 5 population (Millions) MID 1 9 8 5

Country

Area ( T h o m n d s o f Square Kilometre3

Population density n o of P a m M perm k m

Per capita Average annual Avemge annual Income S Growth Rate 4%- of inflation rate % 1085 (1965/1985) (1980-86

PAKISTAN NIGERIA BANGLADESH INDONESIA INDIA PHILIPPINES THAILAND TURKEY EGYPT VIETNAM CHINA

Source: "World h n k " Data While Pakistan har been mercifully spared the mvngm o f sustained "double diglt"inflatlon, t h e high population growth rate 1.c a w f o r serious concern It preaem trends continue n aeri"u.5 ef& woii?d be he.it&le .*.ithL". D d e c d e h e t h \u*h regs!! to the vbbllltv of urban centers and the ablllty of the country's agriculture t o feed the people-

Communist China's dtatlon ference point.

a third world country b n o longer valid. It's phcement above & of academic interest only

a re-

242

Hscal Impemffvesin Pakistan's Economic Dewlopment

privileged) male population. The step taken was not part of an integrated policy package and the isolated "dictat" of the state evoked a negative backlash and forced its being abandoned. The 'By-Pass' AlternateThe import of much of the development economics emanating from the west is t o create a bias in favor of a broadbased "balanced growth" of the economy. Large scale deployment of resources is inherent in such a scheme of development for only then can the momentum required - the "critical minimum effort - for take off - be generated. A fascination with the dynamics of flight appears to be more in evidence here than an insight into the mechanics - and metaphysics (if one considers the cultural and psycho-social aspects of the behaviour of peoples)/of ~ i growth.c Myrdal has zeroed in on these aspects in his epochal study of the dilemma of asian peoples in their quest for ai-ceterated economic development. Ideally of course, there can be no better way to promote economic development than launch a broadbased assault across the full spectrum of the economy. Developing countries however cannot do so simply because they are unable to muster the resources to make such an effort. However the"effort9'has been made by many looking to the west for (esoteric) advice and the same has invariably fizzled out for lack of any meaningful progress made in any important area-because adequate resources could not be committed to the effort. The only viable alternate therefore seems t o be to encourage a deliberate - but planned - "imbalance" through attempting t o develop such segments of the economy only as is necessary to get the growth process started and to avoid such areas as are likely t o offer resistance so strong, or where a development effort is likely t o require deployment of such massive resources as t o threaten the very initiation of the growth cycle without which its institutiopalization is not possible. Undoubtedly, this would be a rather tricky enterprize. Political imperatives alone - given the existing political format in vogue - might make it difficult to launch such an attempt. But the limitation might be avoided if it were possible t o effect a change in the political format first.

The econornla of growttrSome frnportnntlesrons

243

An obvious criticism of the "by-pass" recommendation would be that it would lead t o a "duality" in the economy and the creation of "islands of prosperity" - where development does take place - in a vast "sea of poverty", is only likely t o provoke socially destabilizing resentment thus introducing schisms and cleavages that by aggravating existing social tensions would exacerbate rather than improve the given situation whose improvement is sought by the planners

It goes without saying that the mere creation of a duality for the sake of having a duality is bound t o be counter productive and could never advance the cause of economic development. But that is obviously not the aim here. Rather, the objective is t o deal with obstinate areas in the economy "after" acquiring the capability to make a meaningful effort - and not before. For this it is essential that the strategic areas be identified and1effort be focussed on them initially and as results follow - in terms of improved economic power - such power be directed in a phased manner t o the segments permitted t o lag behind in the initial thrust. In the short run the by pass decision is b u n d t o be painful and even apppear t o be proof of a callous disregard of the welfare of the underprivileged. But in the life of a nation, the short run is not the significant time frame. However callous it might sound, society will have t o pay for making accelerated development possible. The peoples of Russia and China have paid such a price and the results today are there for all t o see. On the other hand, nations that have shown themselves t o be unable to take the hard decisions necessary to make accelerated development possible continue to languish, mired,as it were,in a morass. Accelerated 4onomic development is thus not something that the rsqueamish and faint of heart can hope t o accomplish. More than anything it requires bold, decisive action - even if that means disturbing the status quo and being conFronted with short term troubles.

. An important

re-condition for sustained economic deve opment especially where planned growth IS contemplated is the presence of a sternly committed executive I will.

While the adaptability of the average japanese is t o be credited with facilitating the changeover from a feudal to an industrial society the fact is that without a determined executive will the metamorphoses wrought would have remained an elusive dream. Not only were specific policies designed t o ensure the achievement of designated objectives, but authority was aggressively exercised by the apparatus of the state to ensure compliance. Even when this meant doing some violence t o the personal freedom of the citizen, the executive leadership remained sternly committed to streering the course that it had charted for the nation. The meteoric rise of Soviet Russia as a modern industrial dynamo state parallels the emergence of Japan as an economic colossus. Here again, the systematic destruction of a heavily entrenched feudal arrangement preceded the implementation of the new economic order ushered in by the communists based on totalitarian regimentation of the economy, the cold, procrustean exercise of authority, replacement of the market as an allocativeldistributive media and its substitution by quantitative assessment of production capacity and fixation of production 'quotas' based on such assessments for the manufacturing establishments The collectivisation of the agricultural sector was another unique feature.

The change indicated above was probably the most thomughgoiqg ever contemplated in modem history. At one stroke both the political as well as the economic arrangements were m l + m - d

--AL-ll.y

a*--

h-a-n

tn-hfi-v

n# - n m t i m a m t s l

Akna-

246

Fhml Impem tives In PaMstan I Economlc Doreloprnent

sions. The number of persons affected by the radically altered arrangements was also highly significant. These two aspects dramatically enhanced the impact of the change as an ideology diarnetricallyr opposed t o that espoused by the grea.\ western democracies was now championed by a large number of people inhabiting a vast state that had the potential of great power. Indeed it was the avowed objective of t h e new socialist state t o spread its ideology t o supplant that of those to which it stood opposed. The blistering pace at which the transformation of the economy took place can well be gaugedl from the fact that within a bare two and a half decades of the revolution, the new soviet statewasable t o take o n an acknowledged economic and military giant - nazi germany and inflict o n it ' a crushing defeat therby hastening its ultimate collapse. This was made possible by mobilizing economic potential on a stupendous scale, by acquiring technological wherewithal and instilling skills in frianpower t o .attain parity with the advanced western states. Starting from a war ravaged and impoverished economic base &d with an-archaic administrative framework, the achievements of the new soviet state were nothing short of miraculous. The strong "executive will" referred t o before in the case of Japan was a prime factor in the implementation of the new economic order in societ Russia. The Soviet experience was duplicated by Red China when the revolution "exported" from soviet Russia in the 1930's finally defeated Chiang Kaishek's nationalist forces in 1948 and in doing so changed the exjsting order radically. In China too, an obsessively singleminded leadership forced changes vigorously and t o ensure that extraneous influencesdid not distract the people - o r corrupt the revolution - an insulating "curtain" as it were, was thrown up. Ensconced behind this shield,, a virtually manic leadership directed a concentrated effort in promoting industrialization on a heroic scale. The success of the effort in china is evident from the fact that ' a nation of opium eaters' - the chinese were then derisively described - stood completely transformed - all in the limited timeframe of a couple of decades. Especially impressive was the drastic, structural transformation of the economy. China became self sufficient in steel, manufacturing its own machinery including heavy industrial plant and defence

The economics of gowth-Some important lessons

24 7

equipment of all kinds much of which it has started to export. The atom was split early in the 60's and atomic pqwer put t o use. Mass literacy was achieved and technical skills instilled in a big way. Autarky in agricultural production has btten a tremendous achievement. Power generation has increased dramatically with large hydel projects completed. To be sure, strong executive leadership, especially where it is concentrated in the person of one man, has not aways succeeded in bringing about accelerated economic development. Franco in Spain, Salazar in Portugal, Peron in Argentine, Sukarno in Indonesia, Marcos in the Philippines-all failed to provoke meaningful structural transformation of the economy. Instead, debilitating economic stagnation became the lot of these countries which ultimately was instrumental in causing much social anguish and unrest and even upheaval. In all these countries leadership was largely concentrated in the person of one man. Such inordinate concentration of power combined with little or no accountability turned out t o be a volatile mix. It guaranteed inaccessibility of the executive chief and ensured his aloofness from and non receptivity t o expert opinion. The great advantage for the, centrally planned socialist economies is that the system in vogue ensures a forced pooling of technical expertise which is a safeguard against whimsical decision making. However this should not be taken t o mean that the socialist model is an ideal t o be emulated by all d e veloping countries. For one thing the extreme regimentation o f the economy makes a mockery of personal choices and in so doing induces distortions that can inflict much social pain. An unhealthy - some would say even perverse - bias towards investment in capital goods has resulted in a gross neglect of basic consumer necessities that are taken for granted in most of the economies of the - so called - free world: even those categorized as underdeveloped. In even the most advanced of the socialist bloc countries -the Soviet Union - the "poverty" of the average consumer, in terms of the quantity and variety of consumer goods available, is even today - liberalism notwithstanding - quite astonishing. When one considers that an economic system is expected t o benefit the people, then one test of economic efficiency. would be the magnitude of such benefits available in a resonable t h e frame. A system that even after fortv vears of the end of world war two still does not Pive

the people the things that are considered commonplace in the ÂŁree worldsome of which in desperate demand by the average consumer - must definitely be hlnding significant deficiencies within a facade of superefficiency.

To have accelerated economic development, a nation must be able to save meaningfully.

The planned approach to economic development is a relatively recent phenomena. It is based on the premise that, through deliberate design, it is possible t o accelerate the-growth process sufficiently t o compress the growth time frame enough to facilitate the rapid transformation of a backward economy to one that is 'relatively developed.' in a period that is much shorter than that involved "normal evolutionary growth" - such as is accomplished through the play of market forces in a competetive environment. No matter what growth "model" is followed, the engine of growth will not move sufficiently should there be a deficiency of "fii.lance" Without it, the growth process c,mnot get started. Without "adequate" finances, 'growth will be unduly sluggish and may even be,aborted prematurely. Therefore, effective resource mobilization has to be the highest priority item in any scheme of economic development.

Given a purely market economy model, the savings committed t o investment (in their entirety) by households, by government and from the surplus of exports over investment, fund the growth process. Thus the savings generated in one cycle of the development phase fuel a sixond round of economic activity and so the process continues. Each phase will be as vigorous, in terms of the intensity, variety and sheer expanse of economic activity as the previous cycle if savings are pitched

250

Fisail1;t~:jecSvesin Pakistan 's Economic Dew10,otnent

only be expected, if the level of savings register an appreciable increase. In other words, if the Phase2 performace is to be superior to the phase1 performance, it is imperative that the savings performace improve. As a logical corollary. it is equally true then that a fall in the savings rate in phase2 will provoke a diminution in the growth momentum - other things remaining t h e same. I

It should be kept in mind that "savings" and *'hoardingv are not synonymous terms. While classical capitali~stdoctrine assumed that all savings were "invested" , this we know now t o be a fallacy. In actual fact a part of the amount saved may be hoarded-kept in sterile, non productive use. This is a "leakage" in the income generation cycle and can cause equilihrium to be established at less than full employment of resources. The of 'savings' that are of interest to the economist are (.hat the disposable income stream that flows t o "productive" use by providing funds for income generating activity. Since national savings emerge from the economic"surp1us" that arises at the end of an economic cycle, the size of the surplus can be critical in determining the level of savings. Thus if this surplus is minimal and ensures for its recipient economic power that is adequate only to sustain a subsisterlce level of existence, then of course savings cannot realisticall v be expected t o be significant. A reasonably high 'surplus' o n the other hand can be expected t o yield (though not necessarily so) relatively high savings. At leash that is the potential-given favorable circumstances-that ought t o emanate from such a situation. Just as individuals save, so are governments expected t o save. Infact if individuals do not save enough, as so often happens in real life in third world countries, then it is the government that is expected to mobilize the deficient amount-i.e. the amount considered necessary by the planners tc3 sustain a required growth rate. Governments save by restricting expenditures and maximizing revenueejust as individuals do. Governments have the authority t o 'force' individuals t o save. This they accomplish through the taxation of income. However one looks at it, a successful savings effort means postponement of current consumption. Basic t o the success of a growth effort therefore, is a sustained high savings rate. In

TABLE 17 SAVINGS. INVESTMENT 61 THE C U R R E N T ACCOUNT BALANCE

- SELECTED COUNTRIES(Percent)

GROSS NATIONAL SAVINGS/GNP

GROSS DOMISTIC INVESTMENT/GNP

CURRENT ACCOUNT BALANCEfGNP

Country

PAKISTAN

16.0

16.5

16.2

10.9

12.5

INDIA

18.4

22.6

24.4

17.9

22.3

22.6

SRI LANKA

15.8

20.6

28.9

14.6

13.5

INDONESIA

15.8

24.5

29.4

13.7

MALAYSIA

22.3

28.7

35.1

PHILIPPINES

20.6

29.1

THAILAND

2 3.8

EGYPT

-5.6

-3.7

4.5

4.3

-1.8

17.1

-1.2

-7.2

24.6

26.6

-2.2

0.1

-2.8

21.6

29.3

27.5

-0.7

0.6

-7.6

25.8

20.6

24.3

20.0

26.6

24.4

22.6

21.5

18.5

14.0

2b.8

31.4

10.9

19.6

20.0

TURKEY

18.5

29.9

20.9

19.1

18.1

17.2

S . KOREA

25.1

31.8

30.7

21.5

26.4

26.9

Source:'World Bank' World Development report. 1987.

-11.8

-4.8

-6.9

-1.1

-5.1

-6.9

-3.1

-10.3

-11.4

0.0.

0.6

-3.6

-2:i

-3.7

-5 3

-3.8

252

Fiscal Irnpentfves In Pakistan's Economlc Development

the era of unadulterated pure capitalism-ie the era following the onset of the industrial revolution - economic surpluses were contrived largely through an exploit ive arrangement wherein labour was not allowed t o receive a fair wage consistent with its competetive position. Trade unions and fair wage legislation gradually brought an end to the rampant exploitation that had become the norm. Without exception, all countries that we find placed in the developed countrv categpry today, managed sustained high savings either\voluntorily~orcontrived through the levy of taxation that forced peopleto save - in order to be able to pay the taxes which then became the investment fund in the hands of government. The western democracies, wedded as they were to capitalist dogma, thrived in an environment in which international trade became for them a dramatic "engine of growth." Uniquely placed, because of colonial authority, t o procure raw materials at especially favorable rates, the generation of significant economic surpluses was almost inevitable in the given situation. Burgeoning demand, both domestic and foreign, for the finished products of the many industrial enterprizes sprouting up on their economic landscape, sustained the investment made in them - and ensured the re-investment that was vital to their expansion. Present day developing countries are not so favorably placed. On being freed from colonial bondage they inherited an infrastructure that lacked both depth and range. In the great majority of cases, third world earnings emanated principally,from raw material exports. Grinding poverty was evident everywhere. Obsessed with moving onto a new higher threshold of life, the seemingly 'leisurely' momentum of the marketplace was found t o be grossly wanting. Committed to "accelerated economic development", planned effort therefore. appeared to be the only way out of the impasse. The most important constraint, that third world countries have come up against in their quest for accelerated economic development is that of marshalling sufficient resources t o launch a sustained program of economic development. It is of course not the domestic finance only that is in short supply. There .is an acute shortage of "industrial capital" and in the initial stages this has got to be imported from sources that have

The ecmornles o f gowthSome impormnr lessons

253

enough of such resource. If the developing country does not have the export capability t o muster sufficient foreign exchange t o ensure the acquisition of the required industrial inputs, then the only alternate is t o secure "assistance" (aid) from international financial institutions o r the countries from which such imports are sought t o b e made. Considering the pressing nature of the need for "industrial capital", develop ing countries often have t o go t o great lengths t o secure the wherewithal that would enable them to acquire such capital. However in making the effort, they are often required t o accept terms that are not favorable. These so-called 'conditionality clauses' not only place restrictions on the utilization of the foreign funds secured but also requile the formulation of specific policies t o qualify for the funds in the first place. Such conditions are seen by many as actually limiting the sovereignty of the recipient country. However the real cause for immediate worry for the recipient of such finance is the cost of acquiring the funds i.e. the interest charges. Over time, these can 'snowball" and amount t o a huge burden especially as the structural changes that the utilization of such funds seek t o induce often entail an extended t ime-frame. The debt burden eats into the foreign exchange earnings and when these are relatively sparse vis a vis the actual requirements for imports, can create serious problems and hold up the development effort as the required imports cannot be madethe foreign earnings having been diverted t o debt repayment. Such diversion of resources can force the government to float new loan issues thus adding to its indebtedness. As the government would in effect be competing for;available loanable funds with others who seek t o obtain finance, the cost of such finance is bound t o increase which would mean bidding u:p interest rates. This will impact adversely o n the cost side of projects thus discouraging investment in long gestation, high cost projectssuch as are typically involved in infra structure development. In contemporary times, Japan is often cited as a classic exampie of accelerated economic growth. The Meiji Restoration of 1867-i-plunged Japan, as it were, into the modern era. By 1917 Japan had already shaken off the deadweight of' its feudal to past- and. had---launched a determined, 'broadbased' effort . -

TABLE 18 EXTERNAL PUBLIC BEBT AND DEBT SERVICE RATIO O F SELECTED T H I R D WORLD COUNTRIES & T H E NIC's

DEBT SERVICING AS % O F :-

EXTERNAL PUBLIC DEBT DUTSTANDING A N D DISBURSED: Countn

(Millions o f U.S. Dollars)

A s % o f GNP %

1970

1985

Change

1970

1985

Interest-Payments onexternalpublic Debt Millions o f U.S. Doll-

1970

1985

GNP

1970

Exports of Goods and Senrlces

1985

1970

1985

PAKISTAN NIGERIA BANGLADESH INDONESIA INDIA PHILLIPINES THAILAND TURKEY EGYPT S. KOREA SINGAPORE * Source:- World Bank World Development Report 1987. I n the decade and a half b e t w e e n 1970 and 1985. third world external indebtedness has increased dramatically. Thls is worrisome because t h e increase in indebtedcess is not matched b y a concomitant improvement in t h e s t ~ c t u r a transformation l of t h e economy which would confer o n it t h e potential t o increase exports a n d t h u s b e c o m e able t o generate the1.hdcurrency"earnings which form thewherewithal f o r t h e liquidation of the d e b t liability.

7he economics ofgrowfh-Some impormn t lessons

255

cation were the keynote and theme of this truly heroic effort by a people steeped in an insular, inbred, factional, warring, highly ritualized lifestyle. The willingness to postpone present consumption was an important, indeed crucial, component of the development effort. Heavy taxation of agriculture, the predominant economic sector, with all economic activity conducted there privately, released a good part of the funds required t o get the development effort going . To be sure, a legacy of the procrustean exercise of authority was also a very important part of this effort. Willingness to accept the official "dictat" thus may not have been spontaneous at all times and in all matters. By nature, the japanese have shown themselves to be a thrifty people. Inflationary pressures notwithstanding, the japanese have usually saved a good part of their c u m n t income. Thus "conspicuous consumption", which is the bane of all third world countrieq-hasnever posed a dilemma for Japan. The dissipation of scarce resources has therefore been avoided and this aspect is of much greater import than it might appear at first. Infact, in the context of Japan, this has crucial significance for the country is particularly disadvantaged in its deficiency of natural resources.

h the Pakistan context, savings have been poor at the best of times-like in the early '50s when the boom provoked by the korean war yielded a bonanza of hard currency earnings for the country through its golden fibre (jute) exports. wbich were dissipated with such despatch on the import of automobiles and assorted consumer goods as to be a 'flash in the pan' as far as resouces go. An extremely narrow direct tax base has forced dependence on a variety of indirect taxes, many of them regessive, for making available the bulk of the revenue required by government for meeting its current expenditure needs .As no worthwhile surplus remains to meet the capital expenditure require ments, these have t o be met perforce by raising moneys through loan issues, borrowing locally from the banks and also borrowing abroad. A chronic lack of self sufficiency in domestic resource availability is thus very much in evidence.

256

Fiscal fmpemrlws In Pakistan's Economic Development

The inability t o mobilize adequate finance domestically has been at the root of many of the problems Pakistan has faced from the beginning. However the failure is also due to a lack of national will, of improper priorities and an ill keeping the agriculture sector out of the fold of direct taxation. The "easy way out" has always had a fatal fasci.nation for many species of the humankind. For the pakistani nation this appears to be a complusive obsession. A serious program of economic development usually means a lot of belt tightening Paradoxically, in Pakistan no regimen has ever been devised that would require any belt tightening at all. Part of the reason for this is the availability of aid from abroad. Pakistan having decided very early to be in the western sphere of influence 'became linked to the western neo capitalist scheme of things. Over time the aid largesse has assumed addictive propertions and has impacted adversely on domestic resource mobilization. zation.

IV Both capitalism and socialism and variants thereof have their good points. The "success"of an economic system however, would appear to be related not merely to its intrinsic technical merit but also the "ethos","ecology" and "worldview"of the people "adopting" or adapting it. The closest that the system is to the socio cultural setting, the greater the chances of its success. Alternatively, the people must adapt to the alien system. They must consciously change their outlook and their "worlduiew."

In our times the emergence of a host of cc~untrieso n the world scene following decolonization has witnessed a struggle between the champions of capitalism and socialism t o force their political and economic systems o n t h e e developing countries. Their logic is that since their politico-economic format has yielded such good results in terms of economic achievement and in improving the quality of life of their peoples, therefore the same results should follow if a developing country were t o adopt the system that has taken root and thrived in the "home" country. However as many developing countries have learned t o their chagrin, the adopted system has often failed miserably when "planted" in the virgin soil of a "backward" third world country. Such failure of "a tested system" is often attributed by a developed country t o a lack of commitment o n the part of the host country. It is usually pointed out that the host peoples have not bothered t o create the set of conditions that are necessary t o ensure the success of the system. Much is made of the "institutional deficiencies* present and a failure t o remedy such deficiencies is cited as a key factor in the apparent failure of the system. There is no denying that every economic system requires that the institutional framework peculiar t o the system be faithfully structured if it is t o be optimally effective. However it is also true that most developing countries 'have socio - cultural "roots" that may harbour elements and ingredients that are inimical and antagonistic t o the "foreign" system and work t o reject the alien implant.

I I

258

Fiscal Impemtlves in Pakistan 's Economic Dewlopmenr

The advent of the ideological state on the world political scene has added a new dimension to the problem of adaptation t o a foreign politico - economic system. The problem appears t o be ~articularlyacute for the Islamic state for the values htrinsic to the Islamic faith d o not allow for compromises that could jeopardise the very basis of the faith. Howevt?r in actual practice compromises have been made primarily because alternatives t o the western capitalistic economic syste:m and the political democratic framework originating in Britain, are not readily available. The reasons for this lie in a paucity of meaningful research into various facets of the Islamic faith.. The Islamic state is the first true welfare state in history. It is intolerant of elites and it makes the well being of its peoples a primary responsibility of the political and spiritual executive. The faith enjoins its adherents to strive to attain the ideal state both in spiritual and worldly matters. The weak, disadvantaged and underprivileged are the special responsibility of those who are better off. Islamic society does not glorify t h e )'survival of the fittest." "Cutthroat" competetion is anathema to Islam. It does not require much insight to see that the values and motivation inherent in the western democratic state and its attendant capitalistic economic system are diametrically opposed to the Islamic norms. It would not be fair therefore to expect the two to ever have a "symbiotic" relationship. Infact the inherent contradiction between the two is so marked as to make ceexistence impossible. Thus the failure of the western politicoeconomic system in an Islamic society is not a fault of the system as such, but signifies an incompatibility between the two. The situation outlined summarily above holds true for many third world countries in africa, latin america and asia In many different ways the societies in these countries have unique features the roots of which go back to antiquity and which distinguish them sharply from their more modern counterparts. Because of these fundamental differences, it becomes difficult if not impossible for their peoples to identify themselves with and relate to the values and norms peculiar to western society whose politico economic system they now seek to emulate.

The economics of growth-Some important lessons

259

There is no denying that t h e human capacity for adapta tion is considerable and as society has evolved from the primitive to the modern form its inherent capability t o adjust t o changing circumstance has increased significantly. That would appear t o be the reason why even s o called highly traditional societies like that of the japanese and the chinese - and the korean - have been able t o cope exceedingly well with the western form of politico economic system. However this ability t o "cope" is not a matter of simple evolutionary change. The "direction" that evolutionary change takes is important. Thus we see that the real reason for the success of the japanese is relatable to a peculiarly "pragmatic" direction given in its transition from the traditional t o the modem form. Such pragmatism included a sharp .l, distinction drawn between church -and state so that t h e political format of the state is divested of any religious tinge. More'importantly, it also includes an ability t o identify those elements from amongst its own traditions that need t o be retained, developed and refined t o enable the people t o have a sense of identity. Thus japan discarded its traditional ways and opted for the .western politic* economic system but it retained its peculiar language. This does appear odd as the ornate and complicated ideographic form of the alphabet - and 'its peculiar grammer is indeed cumbersome and has nothing a t all in common wi,th the western form. But it was percieved as central t o the japanese "ethos" and necessary for japanese individuality and uniqueness. That the perception has been correct is evident from the huge success japan has had in developing a system of education based on it own cultural resources that has absorbed thle knowledge of the west and made its own unique contribution t o it. It should be noted however that the Japanese have not hestitated to "tamper" with their language t o make it easier t o comprehend. Thus the very large number of "characters" required to be learned in classical japanese stand drastically curtailed - but the basic ideographic form remains intact. What is stated above would also appear t o be true of the chinese. Indeed chinese civilization is the older of the twoand one of the oldest in the world. However chinese society was "thrust" into the modern age much more rudely than the japanese. Despite this "trauma" it has been able to cope with the pressures of change and has a d a ~ t e dwell t o a politico-

26 0

Fisml Impemrlws in Pakisran 's tconotnic Development

capitalist west but nurtured and developed in neighbouring Russia. It might be significant in this context t o note that the political format based on strict regimentation andl control and the necessity for the,procrustean exercise of authority which is central to a socialist system (as distinguished from a truly eommunist system which appears to be a theoretical ideal at present) is quite compatible with the political traditions of both Russia and China. This could be one reason why the people have not had much problem in coping with the'xigors' of the system. One should be careful t o note however thlat not every secular state has done we!l in adapting t o a foreign ideology. Turkey is one example of a traditional Islamic society attempting t o discard the Islamic politico economic format (Islam one must not forget lays down a comprehensive prescription for all aspects of life - the social, cultural, political and economic-) and adopting the western system. The experience has, so far, not been encouraging - despite the fact that Turkey went far to put on the western garb-literally. Turkey lztinized its alphabet, adopted western dress and western political and economic institutions. That the change, which was thorughgoing by any standard has not had salutary results is borne out by the protracted political ferment in recent times - that is whenever the procrustean exercise of authority has been relaxed - and an economic development that has not brought the country in the ranks of the developed despite the significant time frame in which the new system has been put into play. The example of India too is a pointer in this regard. Here again we have an ostensibly secular state adopting the politico economic format of its erstwhile colonial masters and after more than four decades of independence still grappling with serious economic problems. By third world standards the economic edifice built up in India is impressive but if one considers the example of modern China one can see how great a gap there is between the two in terms of sheer economic achievement. China has done wonders in the eradication of mass poverty, malnutrition and illiteracy providing employment and shelter for a huge - the worlds largest -- population, controlling the growth of its population and building an impressive industrial infrastructure without the massive infusions of foreign assistance t o which third world countries - including

:he economics of growthSome Imporhmt l e s a s

26 1

India - have become conditioned, as it were. India on the other hand, is still plagued by grinding mass poverty, illiteracy, unemployment, indebtedness (including external indebtedness) a population growth rate that is threatening and an industrial edifice that is chaotically structured. It is apparent therefore that whereas China has adopted well to doctrinaire socialisn and its regimented and controlled economic system with no market t o aid economic decision making and distribute the national product, indias tryst with westminister style democracy and mixed capitalism tinged with elements of non marxian socialism have kept the country underdeveloped and within the ranks of the third world - four decades of "development" notwithstanding. This is not to belittle the achievement India has made in certain areas, especially the development of its agriculture and specific segments of industry - including fairly advanced areas like metallurgy, heavy chemicals and the like. But the fact remains that in a world setting the.Indian achievement pales before that of China - and even south korea One is forced t o conclude therefore that there must be elements within the Indian ethos that do not mesh with the alien format of its politico-economic system. It is also evident that not every society can make a smooth transition to the sort of pragmatism that would enable it t o adapt effectively to a foreign system. This would appear to be espscially true for a traditional soceity that has not been "opened up'bnd fully exposed in a manner as to make it compatible with the foreign system sought t o be implanted. The "mistake" that many third world countries appear to be making therefore - as evidenced by their continued third world status - k a failure to have an integrated and comprehensive approach t o economic development. It is not enough to "import" a politico economic system. One must also create the essential conditions that would make the implant fully workable. Decisions ( to modernize) taken in kolation, create imbalances that stifle and thwart the growth process

v Inequities in the distribution of income and wealth lead to the creation of urban and rural elites that compartmentalize the economy and create powerful vested interests whose foremost objective appears to be a preservation of their privileged position. Because of the political and economic power of these elite classes the fruits of economic development gravitate towards them. This state of affairs, if allowed to continue, has the potential of becoming the single most important threat to orderly development. The Iran experience is a pointer to what the compartmentalization of society and the economy resuliting from perpetuation of inequities in the distribution of wealth and income can lead to. In the Shah's Iran there appeared t o be a situation tailor-made for rapid economic development. There were no forbidding pressures of population. The oil wealth of the country guaranteed a bonanza of petro dollars. A leading superpower, the U.S., was eager and willing to extend help and cooperation in every field. Political stability seemed assured, thanks to "savak" and a huge military establishment - its arsenals bristling with top of the line, state of the art equipment - devoted t o the monarchy and the existing order. Literacy was increasing yearly and the administration rightly boasted of its "white revolution". Industrial development seemed to be making good progress with brand new plant dotting the landscape. Agriculture too was vibrant. lnfact everything seemed perfect. And then in a traumatic, rapid, sequence of events, cataclysmic destablization occured which the iipparently well entrenched forces of the existing order could do little to control

There can be no simple explanation for the sudden downall of the Shah's regime and the "system" that, had been painitakingly structured over the years. There is little doubt now 'lowever that a build up of forces diametrically opposed to ?ach other based on an affluent "praetorian" dite obsessively leuoted to the person of the shah, the monarchy and the ark-

264

Fisml Impemtiws In Pakistan 'J ~FconomicDevelopment

class conservatively linked to deep seated fundamentalist forces and a vast body of students aware of the powttr of ideas and the masses, on the other hand, eventually so polarized iranian 'so ciety as to create an unbridgeable schism. Over time, privileges continued to gravitate towards the elite and the rich kept o n getting richer. The middle class however found that its bargaining power vis a vis the elite steadily deteriorated and the fruits of economic development did not percolate clown the ladder as evenly as they ought to. Infact the middle class had t o be content with only a trickle. All elites are minority forces that maintain their authority by virtue of their economic and political clout. When the power of the military is added a decisive tilt in the balance of power occurs. It still however remains a minority force juxtaposed to the rest of the population. The logic of numbers ensures that an aroused majority must prevail over a powerful but decadent minority. It had happened in France in 1789, in Russia in 1917 and in China in 1948. In each case, to be sure, change did not take place in an orderly, evolutionary manner. Rather, a tumultous upheaval turned the existing order upside down-and inside out. And change was not sparked off spontaneously but required a catalyst-usually a well articulated and propagated idea that is able to catch the imagination of the majority of the people. When economic development is perce~rled as benefiting a select few, the groundwork is laid for an exploitive scenario which the "victims" continously embellish with facts and figures to prove that a perverse motivation exists on the part of the privileged to not only deprive the underprivileged of what is rightfully theirs but also to deliberately exploit them by putting into play schemes that exact from the underprivileged a price that is unfair. It is not necessary that actual, deliberate exploitation be a fact. It is enough that it be percieved as such. Vague generalizations based on isolated cases can thus be manipulated in a manner as to substantiate an exploitive scenario. The psychological aspect is critical and looking t o the limitation of illiterate - or at best semi literate - minds little able to collate information and draw valid inferences, it is apparent that this is fertile ground for the propagation of false'loods or half truths that can inflame the uninitiated but do not

The economics of growth-Some impormnr lessons

TABLE 19 THE DISTRIBUTION OF INCOME IN PAKISTAN 1980

1987

7.0

6.1

2. % Share of GNP going to richest 20%

45.4

49.8

3. % Shareof GNP going to poorest 40%

19.1

16.1

1. 70 Share of GNP going to poorest 20%

4. % Share of GNP received by top 5%

31.7

35.7

5. % Share of GNP of Rural Rich

40.8

42.2

6. % Share of GNP of Urban rich

48.1

45.3

7. % Share of GNP of rural poor

8.5

7.8

8. % Share of GNP of Urban poor

6.8

7.8

ii !i 1I !I Ii

Source: Economic growth in the 1980'sProfesjor Sajjad Haider "The Nation" 26th May 1988.

The pronounced "skew" in the distribution of income is readily apparent from the above data. Not only does this

bode ill for ameliorating the lot of the common man but in a developmental context is inmical to economic growth because of its destabilizing potential. Concentration of income provokes conspicuous consumption and gives a boost to the operations of the "parallel economy". M i l e the rich get richer, the poor remain mired in poverty with grave social portents. Absence of a "middle class. of any depth, does not permit aggregate national saving to be pitched at levels necessary for self sustained economics development. The super rich habitually inin moving "ca~ital"t o "safe havens" abroad.

I :

II I '

266

Fiscal I?-pcmtlves in Poldston's Economic .Development

inform or educate anyone. The bengali revolt in former East Pakistan is typical of this trend. The alienation of the peoples of East Palcistan was certainly not deliberately provoked by the west Pakistanis and no diabolical scheme of exploitation was put into play in this context. This is amply proved by the fact that even after independence no credible "evidence" has been unearthed by those who then read much "deliberate" exploitation in the "system". While it is correct that the foreign exchange earned from the sele of east Pakistans golden fibre, jute, provided the bulk of the nations foreign exchange resources after independence and also that project implementation was much more vigorous in west Pakistan especially after the mas.ive indus basin replacement works that had a "snowball effect" across the full spectrum of the economy in the west, the fact remains that east Pakistan disparity visavis the west was relatable more to the yawning gap between the two wings on independence due t o years of deliberate colonial neglect than t o any callousness of the west Pakistanis. Even the pattern of recruitment t o the armed forces that became the focus of much vitroilic debate - and had besides an economic dimension t o it in the lopsided flow of income -- was attributable t o the british policy of keeping the bengali people away from the armed forces allegedly due t o their "non-martial" characteristics but probably more due t o an anarchic streak that has been much in evidence even after independece from the west. Whatever be the reasons - and there were many - east Pakistans plight was not directly the result of perverse west Pakistani design. But the perception of the common man was otherwise. This was actively encouraged by the pro india lobby and the economics of the situation was lost in the tumult of the unrelenting psychological warfare waged by those who stood t o benefit from secession. There is no denying however that with an alternate politico-economic format, things could have been different and the lot of the east Pakistanis, qualitatively better. The "system" inherited on independence was that designed by the british. It was adopted by Pakistan with marginal adjustments only. Such a system was ill suited t o the exigencies of a free country committed to the promotion of accelerated economic development. The logic of the political set up created a pronounced bias towards elitism and the urban and rural elites spawned by the system divided the economy into spheres of interest effectively compartmenta'

The economics ofgmwth-Some fmpmtant lessons

26 7

lizing and insulating these spheres from the rest of the economy The fluid flow of wealth and income was thus checked and set the stage for the subsequent distributional inequities that were to create the plethora of problems that defied resolution and culminated in an explosive ventilation of grievance that turned into a revolt of the bengali population of the country. The exploitation scenario is complicated further if ethnic diversity be a factor of significance. The perception of unfair treatment and economic exploitation is heightened significantly if sharp ethnic divisions be present. This aspect was an important factor in the East Pakistan case and was also dominant in the 'Ibo' revolt in Nigeria in the late '60's Ofcourse the " r e bellion" was crushed there and secession thwarted but at the cost of much human suffering. The economic cost of the war was also considerable. That political and economic dimensions intertwine, with the political aspect often dominating, (good econonlics usually losing out to bad politics) the significance of the political format adopted by a country can hardly to overemphasised. Thus if a political arrangement fails, then the economic infrastructure can often go into shambles and that too quite rapidly. This has occured often enough in third world countries t o warrant serious concern and should therefore be accorded a high priority when "adoption" of a "system" is under consideration. A skewed pattern of wealth and income distribution is also objectionable in that it does little to facilitate the sort of capital widening that is necessary to build up the economic edifice of a country. As wealth remains largely localized and concentrated in a few hands the gene@ population is prevented from participating meaningfully in the economic development of the country. The advent of the large corporate form of business organization which is n&essary under mixed capitalism both for significant capital mobilization and in order to ensure large scale production and the use of roundabout methods in produc tion--and also to make possible research and development is unnecessarily delayed. The experience of Japan in this context is significant as is also the experience of south korea and taiwan.

Just as the successful prosecution of a war necessitates the formulation of a "winning strategy", so it is that the planned structural transformation of the economy require that a "design for accelerated development"be drawn up and implemented.

The deliberate acceleration of the development process was first attempted by Japan when with the meiji restoration in 1867 policies were devised t o lead t o industrialization. Japan sought to make up the backlog in industrial achievement vis a vis the west in the shortest possible timeframe. It is pertinent t o note that Japan did not simply seek to import industrial plant and machinery but rather launched a broadbased effort in which a change in the personal attitudes of the japanese people was sought to be made just as eagerly as a change in technological capability. Japan may thus be said t o he the first country to realize that sociology was just as important as technology in the development process. This required a good deal of soul searching as at that point in time there was no development economics to refer to-nor was sociology an acknowledged separate discipline. With remarkable insight the japanese focussed on three key variables: education, sociology and technology. As for the political dimension, here too Japan sought to emulate western democracy and aggressively brought about the unification of the country structuring a strong central authority which demolished the centuries old bastions of power presided over by local warlords. But here old Japan proved too strong and the democratic set up proved to be a facade behind which procrustean authority was ruthlessly exercised by the power elite headed by the military. The mythical and mystical person of the emperor buttressed the new order and was skilfully exploited by the power elite to ensure obedience to official dirtat whirh hnd theurn1

mval

snnrnvrrl

2 70

F l s a l Impem tives In PaMstan 's Econon~fcDewlopmen t

Japan planned for its accelerated economic development in a carefully calculated effort that sought t o inculcate in its people the "knowledge" of western man which quite correctly was seen as the motive force behind the extraordinary achievements of the west. Education was therefore assigned very high priority and "batches" of the brightest students were sent abroadrLy the government t o study in the best institutions in America, France, Britain and Germany. The accent was o n science but the humanities were not ignored. Nor did the japanese ignore their own cultural heritage. Rather they consciously sought to enrich it by a constant reaffirmation of their unique individuality. Mass literacy was acliively promoted and a vast pool of skilled labor created. The transplantation of western technology in the virgin soil of Japan was another bold experiment. Japan was content in many cases with the importation of second hand "used" plant. Even obsolete plant was eagerly sought. The advantages in this were twofold: the equipment was relatively inexpensive and "copying" such equipment was very instructive and was actually an aid in learning. As labor was cheap in Japan, the output manufactured o n such equipment could be priced low thereby making it highly competetive in the international market which the japanese began t o make inroads into with a vengeance. True, quality initially was poor and the label " ~ a d e in ~ a ~ a n ' l w athe s object of much derision but the Japanese managed t o make good sales nevertheless finding the colonial territories of the western democracieg good markets for their low priced copies of expensive, high quality r~roductsof the se improved western industrial giants. And the ~ a ~ h n e gradually product quality making their own innovations in the design of technology. In the crucial formative phase of Japans economic development the state took the initiative in the acquisition of industrial plant from abroad. It was only after the technology so acquired had been set up and made operational that it was put up for sale to japanese entrepreneurs. Thus while the western capitalist economic system was adopted the state became the first capitalist in Japan. This was a momentous step indeed because otherwise the fledgeling . entrepreneurs might have found it extremely difficult to muster o n their own the large amount of capital required t o finance the purchases of western indus-

The economics of growthSome imporrant lessons

2 71

trial units. Furthermore, an individual, especially in an underdeveloped country - such as Japan was then - is much more disadvantageously placed than a government in negotiating purchases from a developed country. However the policy of selling t o private enterprize industrial units already in profitable operation by the state paid off hand.some dividends in the rapid s1;ructural transformation of the Japanese economy. The Japanese were quick also t o discern tlie potential o f the corporate form of business enterprize in a capitalist environment. Policies were deliberately designed t o encourage the formation of large public c o r p o r a t i ~ n swhose access t o large amounts of finance was invaluable in large scale prc~ductionand has been of considerable significance in making possible research and development. Infact it is this research and development that has been at the back of Japans emergence as a world leader in several important areas including electronics, optics, automotive engineering, textiles and shipbuilding. Needless t o say it is extremely difficult for the smaller entrepreneur operating individually or in partnership t o lay aside signiricant capital t o fund a research and development programme that is truly meaningful. Corporate power therefore has played a pivotal role in fueling Japans engine of growth. The "behind the scenes" role of Japans government in promoting economic development without resorting t o regimentation and control that deliberate planning often entails is a phenomena of the utmost significance. After the large scale devastation of the Japanese economy when many western "experts" were firmly o f the opinion that Japans days as an industrial power were over and henceforth Japans salvation lay in the development of its agriculture and primary manufactures at best, t h e . Japanese government began a "covert guidance" programme for the private sector that skilfully made available vital economic intelligence t o private entreprise and by establishing a close rapport with it continously devised policies that strongly promoted the efforts of private industry. Government and private enterprise thus merged, so to say, and became two facets of one face. Over time this became a truly~'symbiotic relationship. "M.I.T.1"' thus stands o u t as the kingpin in t h e elaborate indirect planning scheme ingeniously put into practice ' - ~ i n i c + rnvF T - C l n n l n n x r

P7 TN'T'T

Trda

2 72

Fiscal lrnpmrtiws in Pakistan's Econornfc Dewlor~rnent

since the end of world war two. It was M.I.T.I. that was instrumental in "provoking" the hugely successful japanese drive in automobile manufacture, shipbuilding, home video equipment, steel etc. Currently M.I.T.I. is behind a sustained Japanese effort in computers as in its assessment successful computer development and application will be the key to success in diverse areas in the 21st century. Obviously the Japanese economic miracle ~ r o u l dnever have been possible had not specialized intelligence been available. Although Japan has eschewed formal planning there is no denying that a good deal of behind the scenes planning has been present on a continuous basis ever since the Meiji restoration when the momentous decisions were taken to come at par with the western democracies. A pool of highly trained manpower has been created over time that although employed deliberately in a low profile has been behind the design and implementation of policies that ensured the structural transformation of the Japanese economy. Strategy and tactics have been developed and refined over time by a trained manpower skilfully deployed t o enable Japanese industry t o w e s t markets from entrenched weste!n competetitors. In many ways thus the problems posed by economic development have been tackled and resolved - o n a war footing. While Japans economic development is a study in the capitalist context in which free enterprize leads the way in a highly competetive environment dominated by a free market, at the other end of the spectrum is the planning that takes place in a highly regimented command economy. Obviously, the planned effort here is highly visible and is infact the dominant feature of the economy. While the mechanics of the growth process are ofcourse quite different vis a vis the capitalist economy, it might also be said that actually the difference is not really that significant for here the state becomes "the" only entrepreneur and at the same time strives t o perform all those functions that the free market performs in a capitalist system. In a way the same objective - of promoting economic development - is being promoted in a different manner. However an important difference lies in the ability of the state to virtually "commandeer" resources. Every thing in the state,--its land, its population, its mineral and water rewurces - is at its disposal t o d o as it will. This immense power confers on the

The economics ofgrowth-Some Important lessons

2 73

state a leverage that makes it an extremely potent force in every area of human endeavour. Properly applied, such power is bound to lead t o highly significant results. So far we have before us the examples of Russia and China - and their satellite states - only as examples of unbridled state power. And the results have been, todate, highly encouraging. Both Russia and China have wrought a revolution in the structural transformation of their economies. h o k i n g t o the limited timeframe within which this has been achieved the significance of the effort is enhanced manifold. It would b e no exaggeration t o say that never before in human history has so much been achieved in so short a time. Here again, as in the case of Japan, the deliberateness of the effort stands o u t prominently. Conscious human endeavour has been responsible for this metamorphoses. Here again, the sustained effort of trained manpower has been behind the astonishing speed with which structural transformation has taken place. Very little has been left t o chance. Everything has been planned. Many mistakes have been made but much has been learnt from these mistakes and in t h e end remedial measures have been designed imd put into play. Specialized expertise having been allowed a relatively free hand - within limits ofcourse, political constraints being significant in an ideological state - and the results are there for all t o see. If planning is t o be truly successful, continuity is absolutely essential. It is only a sustained effort that rr~aintains growth momentum. It follows from this logic that a break in the continuity of t h e planning effort will reduce, stop and even reverse the forward growth momentum dread y achieved. What happened in China in the tumult of the "cultural revolution" of t h e sixties is especially instructive in this context. \When the revolution was launched, a drastic soul searching replaced the normal evolution of policy in all areas of activity. In c.conomic planning t h e prevalent schemes were dubbed as deficient having been allegedly inspired by 'bourgeois' thinking. Many ongoing projects were scrapped and radical new measures taken instead. One such measure was the decision t o set up literally thousands of small "backyard" steel furnances which were expected t o yield an output qualitatively and quantitatively superior to the traditional large steel mill. As the revolution rlnucanor=td intn a n a r ~ h vi t c fa111tvInoio Wac cnnn o u n n u d

and

2 74

Fiscnl Imperatives in Pakistan's Economic Dewlopnienr

But the time lost as a result of the disruption of the cultural revolution actually put china back almost ten years and it was no easy task t o put t h e economy back on the road t o progress. T h e cultural revolution in china is of'course an extreme example. In developing countries so many things happen that cause- breaks in the sustained implementati.on of development plans. As a result "adhocism" has becomc a regular feature. Most plans devised are short term. There i~stalk of long term perspective planning but that is usually rhetoric. The lack o f continuity is o n e of the important reasons t,hat growth momentum is not maintained and cannot be accelerated enough t o provoke a "take - off" of the economy.

Throughout history it is the country's manpower that has distinguished or disgraced it in the comity of nations. Whether it be warfare or cultural or economic achievement, the "worth" of a people stand out in stark relief.

It is indeed ironic that abstract ions like "st ates","empires" "nations", "ltingdoms", "republics", receive credit for achievements that are essentially achievements of the people. Li!:ewise, when such entities demean themselves (as the "Third Reich" did in world was two) the individuals that collectively symbolize the entity often retreat into the background.

1 p

Throughout history, - both ancient and modern - it is the intellectual and physical vigour of the people that has left lasting impressions t o be recorded for posterity. P;eedless t o say, therefore, the most valuable asset of a "state" is its population - provided it has qualities that can be put t o use: o n the battlefield, in the factory, in its agriculture, in leadinsit t o new frontiers of achievement. Bereft of such qualities, !.he population can just as easily become a liability, consuming the national product but contributing little. Looking at the developed countries of today, we find that there was a time in their history when there was little in terms of tangible physical achievement that they could claim credit to. In many cases we d o not really have to g o far back in time. The U.S.A - which is the leading economic power in the world today -- was "virgin territory" in the 17th century with a few intrepid adventurers perilously placed in safe havens on the coast. However it was not long before the immigrant population of this new world overtook many an ancient superpower. Before the close of the 19th century, America was already fast nn t h e

WRV

t n h ~ ~ n r n i nauwnrlrl nnwor T . i l r ~ w i c n .Tanan

2 76

FLrml Imperatiws in Pakistan 's Econon~icDoelopment

economic colossus of today - was a war ravaged feudal society noted for its pathalogical hatred of all things foreign. This was so as late as the mid 19th century. However these very people overcome their distrust and hatred of things foreign and within just over half a century hungrily devoured what the developed democracies of the west could teach them with an application that put them o n the way t o becoming asia's leading military and economic power. History teaches us that the mind of man harl+urs ~ o t e n tial enough to work wonders in this world - but,;in order to harness its tremendous potential it has got t o be educated. It must be taught t o draw on the experience and lessons of the past in order t o be able to build for the future. Witllout such an effort the mind must remain a blank slate. Since economic development is an effort at improving the qu,ality of life through concrete economic achievement, the mind must play a pivotal role. It is this mental resource that in the final analysis will determine whether the effort is going to succeed or n o t Unfortunately this is an area that has not received attention enough in most of the third world countries struggling to attain developed country status. They have succeeded in acquiring the physical "hardware" of development but since their people remain largely illiterate - o r because the literacy given their people is not consistent with the requirements of the situationsuch (countries;are unable t o sustain economic development for any significant length of time and thus fail to imititu tionalize the growth process. Also, because their collective mental capabilities lack the necessary range and depth, such countries are devoid of the "residual capability" that could enable them to recover from serious "traumaw- a devastating war, a natural calamity etc. The overriding significance of "residual capability" is borne out vividly by the experience of Japan and Germany after world war two. Both countries had been thoroughly devastated in the conflict and had emerged as losers deprived of almost all their industrial base. The little that remained was not enough to lead t o economic recovery. Even with foreign assistance neither country could hope to regain its former position in the foreseeable position. Yet in just over a decade both were placed on the road to economic recovery and in another decade were overtaking some of the victors of the great war --Britain

278 EDVCATION IN T l t E T H I R D W O R m -

TABLE 21 SELECTED COUNTRIES-COMPARISON

WlTH T H E N.I.C'Sg

NUMBER ENROLLED IN SCHOOL AS PERCENTAGE O F AGE GROUP

PAKISTAN

NlGERIA

103

BANGLADESH

UiDONESIA

118

121

116

INDIA PHILIPPINES THAILAND TURKEY EGYPT

2 3

106

113

101

116

106

111

101

29 25

101

113

118

116

109

11s

S. KOREA*

101

10s

SINGAPORE.

106

11b

110

118

VlPTNAM

2 -

Tbe newly Lndutdalhed counlrles (N .l.C1s).

106

100

113

S o w e : World EU&.

World D e v ~ b p m m Repon. l 1987.

I h c prcusd .bysndly p m r lttsncy n t r In P.Uusn L, the re.ult both of n d r n a n d r u o u r c e m P r t h & Soodobfied Lmvaatlrrr blnder Irmak s e h m U a d rtbnlc d l v c d t y ob.huets r e d y acerpuner of .'I" ~ t l o lanauase. d Tbc m r u b o o d r u of ektc " e W b modlum" aducatlolul I n d l t u t l o n caterins to the wbmn and md rleh h s lntroduecd a potentdaUy d v l g c m u " d d t y " ln tbc e d u c a t l o d V k m . All h a w coldrtbukd to the e m r n t e h o . In a l u u t l o n whlcb buomlnouspodints for the future. DxsAlc actIan h c a l l e d f u r 15 INS ale. ~ W C ~ u the aeeeloatlon of e c o n o d e dcveiopment I. now recogdrrd u b c h g d k c U y LLnlred to in\+strnent In education.

The economics of gowth-Some important lessons

2 79

and France. This was indeed a metamorphoses but behind it lay the residual mental capability acquired by the patient efforts made in the past that could not be destroyed even in military defeat and became the basis for a magnificent recovery. Ofcourse even such capability wpuld not have been enough had the current education of the( japanese peoples been neglected by the government of the day. But the fact remains that such residual capability was crucial to full recovery. The advent of the technological society has injected a new urgency for the acquisition of specific skills. Needless to say such skills can only be acquired if a basis for such acquisition obtains. Without a good basic education it is not really possible t o acquire fully comprehensive technical proficiency to derive optimal benefit from the complex artifacts of the technological society. Besides, research and development, which is a crucial ingredient of this society, cannot be undertaken in any meaningful manner if the necessary skills are not available in the people. The relevance of education to survival in our intensely competetive age is relatable not merely t o technologid needs but has another, not readily discernible dimension. This is the sociological aspect and it has t o do with the way people think with their attitudes, their responses; indeed their "worldview:' In the opinion of many, without proper education it is not really possible to give the worldview a positive stance People deprived of meaningful education thus remain mired ina morass bred by ancient superstitions and negative attitudes and d o not have the wherewithal t c grasp what is significant :In a given situation. To expect ~ocjpleso disadvantaged t o perticipate meaningfully in a developmental process is asking t,oo much. What one must expect here however is for such people t o hold up the development process. One of the most serious problems facing third world countries is a very high rate of growth of popula1;ion. Such unchecked proliferation nullifies much of the concrete achievements made in economic development. What is exasperating however, is that despite the obvious problems that rapid population growth poses in an environment of severe resource constraints people seem to be oblivious t o the dangers that are is store for them. Even official "propaganda" goes unheeded.

280

Fiscal Impemtiws in PaMstan 's Economic Development

Why so? Are people so stupid as t o wilfully ignore the dangers inherent in the situation? the answer appears t o be that the people lack the "knowledge" that could make then aware of the real significance of the situation. It is their "ignorance" that is at fault. This need not necessarily mean that they are illiterate. Infact when the literacy imparted is deficient, a "distorted worldview" can easily result.

If third world countries are t o be able t o overcome the plethora of "anti grbwth" factors that dot the road t o economic development, the crucial significance of education as 'The' leading factor will have40 be grasped. The exa~nplesof China, south Korea, Taiwan and Singapore are vivid testimony t o what miracles proper education can wrought. Likewise, the disturbing experience of India, Pakistan, Banglandesh, Nigeria and many others highlights in no uncertain manner, what serious prolems beset those who dare to neglect education.

VIII

Many once rich & powerful nations missed the ~ndustrial revolution and entered the 20th centu as relatively backward hile the reasons for their countries. predicament are varied and complex perverse attitudes appear to be highly significant.

Economic growth is the end result of a complex play of diverse forces that create an environment in which initiatives are launched that are instrumental in the structural transformation of an economy. Modern technology has played a vital role in facilitating such a change. Historically, the impetus t o the setting up of "new industry" has followed in the wake of developments that are not easily and certainly not rigorously marshalled. In "virgin territory" the machine syinbolizes mans challenge t o nature. The Tdea" that ushers technical change will emanate and take root only if the right set of conditions obtain. Many of these requirements are "mental". Attitudes therefore &e highly significant. The ability of a people t o carve out a chos,en destiny for themselves is relatable t o their "world view." Their perception of the control that can reasonably be exercised by man vis a vis his environment will mould their attitudes andl fashion their responses. This in turn will eventually be responsible for giving such responses a "positive" or "negative" stance. As the "response" we speak of is essentially a mental phenomena, the human mind has a lot t o d o here. And since the mind is an amalgam of a baffling diversjty of mental inputs, the dominant mental input will determine the attitude of a people at a given time. In a backward society where the people are largely illiterate, the predominant mental input is usually that of religion. The 'content' of their religion o r what is per-

282

ceived t o be the content will be the key factor then, in determining their worldview.

k; F

Fiscal ini~pe~~r;';c.s in Pakistan 5 Economic Development

It is generally accepted that "nonwest.ern man" has by and large, a fatalistic outlook. Many of the woes of "eastern man" are also attributed to this negative attitude in which 'destiny' is seen as wholly pre-ordined. Since it is unfortunate ly the lot of our eastern man t o be placed among the poorest on our planet, a relationship is often perceived between his worldview and his poverty. Much of the negativity in (he third world worldview follows from obscurantist obfuscation of the real nature of their religions. There are many instances in history when the forward march of a powerful nation is seen t o lose momentum, eventually to 'stop dead its tracks', as it were. In some cases a reversal is even evident when instead of any progress there is regressio n.

In economic development the phenomena described above is of interest because it serves t o identify factors and relationships that are of relevance in the growth process. Spain is an important case in this context. Here we have a leading "old world" superpower that with the 1479 union of Aragon and Castile became united under a central authority and prepared-the way for her to become the richest and most powerful state in europe - and the world. Spain had established a vast empire in the South Americas - the New World - and her intrepid, plundering, adventurers - the conquistadores looted the fabled riches of the New World with abandon. Spains fleet of 'galleons' transported the treasure across the atlantic back to the motherland. Eventually, Spain was t o amass a vast hoard of gold, silver and assorted precious gems. Spains europ a n teritories included the netherlands and in the east, the Philippines. Looking to the rich heritage, one would expect Spain t o continue its onward march and be a m o k the front ranking nations when the momentous trauma of the industrial revolu-

The economics of growrhSome importanK lessons

283

tion hit europe. However t h t w q not to be so. The rot had already set in and Spain became a second rate power. did not It would be misleading t o oversimplify and cite "a" particular cause for spains decline. Nations d o not collapse "overnight", as it were -- least of -all "great nations." However there are always causes that have overriding significance in this context. The renaissance was instrumental in "provoking change" in europe by eroding the basis o f the feudal, monastic, agrarian culture of the middle ages and replacing it - gratlually - with a secular culture rooted in a rebirth of classical forms and ideas in the arts and the rise of urban, mercantile civilization and a new ruling class. Wherever the renaissance ideas took root, a er by change in mental at tit udes followed. Spain h o w e ~ ~ became circumstance and design, an insulated, isolated bastion of medievalism, far removed from the ferment and zross currents of the renaissance. While the light of the renaissance lit up europe, Spain remained engulfed in darkness. A cruel inquisition tormented and crushed all dissent, stopped debate and ushered in "a new dark age"-as far as ideas go. With religion degenerating into obscurantism complemented by an essentially despotic, narrow power base, creativity of expression became impossible. The implicications of this ominous development for the future of Spain were disastrous. With the mental faculties of an entire nation put to disuse, atrophy was inevitable. The industrial revolution made its momentous advent on the island of Great Britain. The choice was n : ~ tmerely fortuitous. The island people had revolutionized their outlook by broadening the powerbase and &vesting paliament with real authority in matters of governing the state. The unbilical cord that linked Britain t o the papacy had been severc?d. The trauma of this separation itself provoked and promoted independent mental expression. A new "protestant ethic" revealed itself and aided capitalism in establishing itself firmly as an economic system. The ferment in the life of the peolples of Britain brought about by the many changes that took place over two centuries, changed mental attitudes perceptibly and culminated in the series of achievements that put the b r i t i h people more and more in control of their environment enabling them t o

284

Fiscal I r n p e m t k s in Pakistan's Economic Development

Bereft of any impetus for meaningful change, saddled with a medieval political arrangement and insulated by its isolation from the ferment on the continent, Spain stagnated. What is stated above is undoubtedly an oversirrlplification. It is just'' not possibly t o dissect history so neatly. But the point made - that attitudes shape mental responses -. would certainly appear to be valid, for it is not only what happened in Spain that proves this point but the demise of many a great power in history is relatable t o perverse attitudes resulting from a deficient and impoverished mentality. Infact, throughout history, the dynamic development of a people is relatable t o the motivation induced by ideas shaping their worldview.

For a developin country the quest for an "appropriate tec nology" is likely to prove elusive. Simply because a country is over opulated does not mean that it "must" labor intensity in all areas application.

Technology as a factor in economic development has crucial significance and from t h e experience of a1 the present day developed countries of the world it is easily cited as a pivotal factor. The use of technology has made posslble standardized 1-e scale production. Ipcreased output has brought in its w&e a fall in unit prices. Countries able t o deploy modern technology effectively have been able t o capture large markets for their products and looked at in this context, international trade, at least till recent times, has rightly become an "engine of growth" for them. The use of highly capital intensive "round-about" methods of production has added a new dimension t o the role of technology in the economic development of a country. Much of the accelerated increase in productivity in the present day l of developed countries is relatable t o the s u c c ~ ~ f u use 'round-about' production techniques. However, for t h e developing countries of the world there appear' t o be no easy answers t o the problem of technological choice. U'hile use of technology is admittedly essential t o accelerate economic development, the use o f particular types of technologies has proved t o be a much more complicated problem t o resolve than it appeared early on. The problem has been particularly difficult for developing countries plagued with problems of populatioi~redundancy. In such countries the use of "generalized" capital intensive techniques has apparently, appeared t o exacerbate the population redundancy problem. At the same time, given their

286

Fisca! Impemtives In PaMstan 'S Economlc Development

under-developed state, such countries have been alnnost totally dependent, at least in the initial stages of their economic development, on the developed countries for making available to them the infusion of modern technology necessary t o form a basis for the industrial Mra-structure that is required to get the development process under-way. Two approaches have been generally adopted in the matter of selecting technology for use in developing, countries. The first approach was based on the deliberate induction of "used" technology from the developed countries. This w& the approach adopted by Japan in the initial stages of its drive towards industrialization. Japan imported used plant, from Britain and other european countries especially in the area of textile manufacture and also in steel making. After farniliarisation with the old, and in many cases, obsolete technology, Japan endeavoured to improve it on its own and thus laid the basis for the indigenous manufacture of plant and machinery which in the initial stages amounted t o little more than "copying" the technology of the West. Over time however, as it gained experience and built up its level of technical expertise, Japan was able to significantly enhance its ability to manufacture plant and equipment on its own. By the time Japan bad got involved in the Second World War it had acquired the technical wherewithal t o design and fabricate modern technology independent of out-side assistance. It was the acquisition of this capability that gave Japari the "residual" potential to recover from the trauma and massive dislocation of the huge material losses suffered in the ;second world war. especially the saturation bombardment of its industrial centers. In the post war, period Japan displayed a remarkable recovery and mured for itself a place of eminance in the comity of developed nations.

h contradistinction to the approach adopted by Japan, the newly industrialising countries (N.I.C'S), South Korea and Singapore, both resorted to the use of highly capital intensive round-about techniques based on ultra modern, state of the art, technology. They imported the latest, most mwiern technology and started their industrialisatior~ effort .Prom there. Their success is evident from the fact that in merely two and a half decades of sustained effort, they ha,+? clearly broken away from the shackless of backwardness and are today placed among the front runners. These countries have been able to

TABLE 22 ECCINOMIC STRUCTURE O F SELECTED THIRD W O R L D COUNTRIES COMPARED WITH THE N.1.c.'~

GROSS DOMESTIC PRODUCT

DISTRIBUTION O F GROSS DOMESTIC PRODUCT (PERCENT)

( w o n 5)

.4griculture

1965

1985

Industry

1965

Manufacturing

1986

1965

1985

Services

1965

1985

PAKISTAN NIGERIA BANGLADESH INDONESIA , MDIA PHILIPPINE THAILAND TURKEY EGYPT S. KOREA* SINGAPORE*

Soume: World Bank, Wor!d Development Report :1987 The changing complexion of t h e 'developing' economy over t w o decades of development is e n d e n t f ~ o m t h e data tabulated above. The "drift" away from Agriculture and towards industry h clearly dlscerntble.

288

Fiscal I m p e r a r t ~ sIn PoMstan's Economlc Development

institutionalize the growth process and have been able t o sustain the same on a recurring basis on their ow1.1. As against the approach favoured by South Korea and Singapore, India,, after attaining independence, opted- t o "mimic" the approach favoured by Japan arnd thus sought build up on used plant and equipment imported from the developed countries. Its effort in this context was motivated primarily by a desire t o make use of the labour intensive techniques relevant to such technology, the use of which was thought to be necessary in order to alleviate its population redundancy problem. In actual practice however, it was found that such technology proved to be inefficient inso-far as it was not able to yield the increases in productivity that the more modem and capital intensive technology was able to do. The net result of the use of obsolete technology was t o make the end product non-competetive in the market both because of its relatively high price and deficient quality. Furthermore, the "investible surplus" that emerged as a result of the use of such obsolete technology in the initial stages was also found to have been adversely affected. This investible surplus, on a national scale, is a crucial determinant of the resources that can be deployed in successive rounds of ecoi~omic activity. Should the investable surplus be eroded the resource position suffers as a necessary consequence thus limiting further the already limited ability of the developing economy t o invest in developmental activity. In the opinion of many, the quantum of the investable fund available t o a developing economy is-of crucial significance. The -french economist, Charles Bettelhei~m,("Choice of Technology and Economic Development") has elaborated on this aspect and has illustrated its dramatic impact in ensuring the success of a development drive. Since modern technology assures not only standardized large scale produ~ctionbut also lower cost per unit, the investible fund that emerges from its deployment is bound to be significantly higher than what would result from the use of obsolete technology. The "catch" here of course is the impact of capital intensive technology on population redundancy. Apparently, .widespread use of highly capital intensive technology is bound to create serious problems in the matter of absorbing the huge :;upplies of unemployed labour ubiquitous to most developing countries.

The economics of growthSome imporant lessons

289

For such countries continued inability t o provide employment to this large pool of labour amounts not only t o a wastwe of human resources available in plenty but also has omlnous political implications. There is no denying that labour available in plenty constitutes an important economic resource. No developing country can afford t o ignore the availability of this resource for long. The example of communist China in successfully putting to use this resource illustrates the positive results that follow if the right approach is followed. The popular view in this context, that large supplies of labour can only be successfully absorbed if labour intensive technology. is used, i a fallacy. That this line of reasoning is not consistent with the objective parameters in a developmental context is evident from that fact that there can be no single, "standard" choice of technology for the entire range of activities that are t o take place in an economy. The modem economy is a highly comp1,ex structure and embraces features that necessitate varying capital --labour combinations in different areas. There may thus be spheres of economic activity in which the use of labour intensive technology may be fully warranted. At the same time in certain other areas, the use of capital intensive technology may be indicated. In still other areas, a middle position may be warranted. The point to note here is that technology must be "matched" t o the activity. Thus activities inherently complex in nature may be best served with complex capital intensive technology employing highly "round-about" methods necessary to ensure sustained high productivity and to maintain "competetiveness" in the market while at the same time an investible surplus is adequately generated. The whole question of technological choice thus boils down t o one of "appropriateness" of the technology sought t o be employed. The experience of different countries todate would appear t o clearly indicate that there are no ready-made solutions in this regard. The technology developed in an advanced country may or may not be appropriate t o the peculiar needs of a developing country. However, it does not always follow that the technology of a developed country is consistent with the needs and resource position of a developing countrv. As mentioned a h n v ~it si the "a~t,ivitv"to which the

TABLE 23 STRUCTURE O F MANUCACTURING IN SELECTED THIRD WORLD COUNTRlES A N D THE N I C S

DISTRIBUTION O F MANUFACTURING V A L U E ADDED- 'i-1900 PRICES-

Coualry

VALUE ADDED IN I A A N V ~ ~ A ~ U R I N G (MILLIONS O F ID80 U.S. Donus) Food and ~aricunrne

Textikm .nd dot-

hbchhuv m r d 'Ihmpori Qulpment

Cbcml&m

0th.~

PAKLSTAN NIGERIA BANGLADESH INDONESIA INDIA PHILUPINES THAILAND TURKEY EGYPT

SINGAPORE

1114

228

Souma: World Burt. World Development Repor(. 1981. An iadlmtlon o f the masnnude o f the M l r t r W b e I l n In the datm lor n l u e d d e d h r n m u i m d ~ (ml2) 11 U M N c U r to note that =hn d d d to Mid* the bdlan m.(nltudes indlcntlq d r m a t i d y the npbi p1970 raa almost iom t h n n higher than 1h.t tn r Lor- BY 1904 1. L o r u h.d mmc n r y d l In the stnutun1 hamterrnatbn o i the emnomy.

n e economics of growrhSome Important lessons

291

context. The examples of Communist China and India both show that the assumption that the only way to alleviate problems forced by population redundancy is deploy labour intensive technology on a large scale is fraught with grave risk. Communist China during the course of its tragically misguided "cultural revolution" great leap forward' 'embarked on a programme of building "backyardsteel furnaces" o n a very large sclae throughout the countryso as t o both meaningfully employ its large population and t o ensure the large output of a vital prod u c t s t e e l . The attempt, we all know how, was an economic disasaster and caused such dislocation as t o not only stop the forward momentum of the economy but also to reverse it dramatically. In the opinion of many experts, the mistakes (including the one cited above)made China loose more than a decade in terms of development time. Similarly, in India, the Amber Charkha programme, t o produce cotton cloth by the use of thousands of small spinning and weaving units set up In homes and small establishments all over the country was a complete failure as not only was the end product substandard, but also it was limited in quantity and uncompetetive in price when compared with the production possible through the use of modern technology. It is thus imperative that "simplistic" solutions t o complex problems - such as that of technological choice 'be religiously avoided for decisions based on "Naivete" rather than experitse and imagination are bound t o be counter produc tive. Structuring an industrial base. For most Third World countries extrapolation of present day trends does not take us t o a future that is radically different from the world we live in today. The reason is that anti growth factors led by the scourge of population growth are more than adequate to ensure that on balance the threshold of economic achievement in 2000 A.D. remains roughly where it is in 1987. Does this mean that there is really no hope? ofcourse not. However we have got t o realize that in the find analysis people eventually get what they deserve. A people who fail to red the writinn n n

+hn .wall

rnrrc+

+ha

C I I ~ ~ P V

PAIIPP~~~IC??W!S

W e rn~~st

292

Mrcnl Impemtlves In Paklstan 's Economic Development

Aq the advanced countries of the world more into high tech areas of economic activity residual areas are now available for countries willing and able to make forays into previously forbidden teritory. We have examples before us' already. South korea is ofcourse a scintillating, and very relevant instance.

In S. Korea we have an example of a country that has moved into areas of economic activity that were not long ago the exclusive preserve of asias economic collosus - Japan. Consumer electronics, textiles, automobiles etl::. were successfully usurped. This new territory was not easy to secure for Japan was not inclined t o surrender meekly. However in the face of decisive advantages on the cost side due 00 lower relative wage rates and technological capability based on patient structuring of an effective industrial base, the challenge could not be countered. It would appear that the crucial factor here is the structuring of the industrial base. What is required is the development of interocking segments in the technological infrastructure that lend support t o each other and together ensure that there exists a broad based capability t o participate collectively in a developmental effort.

An industrial base is not a mere conglomeration of industries. Its vitalcomponents include a pool of skilled manpower, a plan to link the development of this pool with the requirements of a growing base, an effective logistical system, a fiscal system that provides the wherewithal t o fund the building of the base and a planned industrial layout that provides for the setting up of variegated units that each focus on different areas viz steel, machine tools, heavy chemicals, mechanical fabrication etc. In Pakistan we have not been able t o structure an "effective base". T o sure we now have a steel mill, a heavy mechanical complex and machine tool capability. These however have not helped the country make any significant inroads into international markets through the e x ~ o r tof 'manufactured goods. Nor has the base been put t o use effectively irr opening up the

The economics of growth-Some important lessons

293

backward and underdeveloped areas of the domestic economy. In order to ensure the vialbility of the economic base in the initital stages when the developmental effort is taking root the functional capability of the base needs t o be estabilished. The examples of both Japan and S. Korea show that such capability is best established by focussing the application of the economic base to opening up the backward domestic economy by aggressive and sustained effort directed towards modernization. It is only when the economic base has achieved criticality in its structuring that the first experiments can be made for making inroads into international markets. An important question. here is when does the economic base achieve criticiality? Based on the examples of Japan and S. Korea it would appear that in the so called free world group of countries the break away point of criticality is when the new aspirant to membership of the club of developed countries starts to take on one - or more - of the developed countries it seeks t o emulate in a given area of economic activity and in direct 'competetion seeks to replace it. Japan did this in textiles and then .in assorted, uncomplicated consumer goods--, including (but not restricted to) toys!!

S. Korea has followed suit in like manner taking on its giant neighbour that ironically supplied much of the technological components of its economic base. The potential capability of the economic base was then patiently translated into actual achievement as one area of economic activity after another was taken over and successfully retained through consolidation of the break in effort. This consolidation, it appears is the second crucial determinant of the test of criticality. This is so because the initial break - in may well be a fluke - a chance happening not justified by objective parameters. The newcomer must prove that he has staying power and that he can retain the (ground that he has captured.

2 9

Fiscal Impera dves in Pakistan 's Economic Development

ket for its increasing output of textiles produced on machines, not handlooms, provided the opprtunity for take over and consolidation. T o be sure the market was s o large that it was 'nt necessary for Japan t o attempt t o take it over in its entirety. However in the segment of mass demand for simple cotton textiles the Japanese were able t o outprice the competetion. The first dent in the stronghold of the established industrial powers of -the west .-Britain, the USA-was thus made. Subsequent consolidation was not easy. The derisic~n and sheer contempt that greeted the first consignments of nianufactured output from Japan was hardly any encouragement. But patience coupled with continueing effort resulted in a gradual but perceptible improvement in quality and eventually not only consumers but the countries that Japan sought t o emulate accorded acceptance- albeit grudgingly. After the trauma of the 2nd world war Japan had t o start all over again. However because of its residual capability the reconomic base was restructured in a relatively short time. By the 50's the recovery drive was in full swing. However this time Japan felt capable enough t o attempt forays in areas other than textiles. The world demand for motorcars appeared t o be an ideal test area. Motorbikes were there too and cameras. And then there was the great opportunity ushered by the explosive revolution in electronics. Japan in classic predatory manner made cunning and aggressive forays in all these areas and was able t o win thanks to its residual capability based on the concrete achievements of the post meiji modernization drive. For S. Korea the task was more difficult. The western democracies realizing that in a truly free market world they would lose out t o Japan in a number of important areas of economic activity thus placing in jeopardy'large segments of their economic edifice, had decided t o arbitrarily restrict imports from the new competitors. Thus low price alone could not now secure entry in the markets of the west where the really large profits lay. The flock of newly independent third world countries however was a fortuitous event. An alternate market was now available. No doubt a smaller market and a cheaper market but a market nonetheless. The profits ofcourse were lower but they were enough t o justify the ddspening and widening of the economic base at home.

The econornicssof growth-Some important lessons

Machines make possible mass production and mass production means lower prices. Modern machines mean not only mass production capability but also the capability t o improve on quality and t o optimise reduction in cost per unit therby ensuring maximum mark up i.e. profits folr the given price that gives a control of the market. This is precisely why it is not possible in the present post world .war 2 era t o structure an effective economic base the technological component of which is obsolete and outdated. S. Korea percieved this important insight early on in its development drive and sought t o structure a modern tekhnological edifice by installing the latest -which is not necessarily the biggest - in steel making capability, in machine tools, plastics etc In vivid contrast t o this and as pointed out above-India in the early stages sought t o acquire steel making capability by buying antiquated plant from Britain. Similarly in textiles it sought through the much touted arnbar charkha program, t o m a s produce textiles o n handlooms. Both the attempts backfired. In another context, Red China in the traumatic years of the cultural revolution attempted-in all seriousness ofcourse-to mass produce steel through a plethora of backyard fumances. Again the attempt was a hugely expensive failure. That its modem economic base has paid off handsome dividends is amply borne out from the successful inroads S. Korea has made in a host of different areas of economic activity. Its success can be judged from the fact it has actually replaced Japan in all the areas in which it challenged it. This is no small achievement for a country that did not have a residual capability like Japans, that was ravaged by war in the early years of its independence, that had t o bear a heavy defence burden and that was placed in an international economic environment which if not actually hostile to aspiring new entrants did not otter much encouragement either. However, as pointed out elsewhere also, the recipe for sustained economic growth that worked in the 60's and 70's for S. Korea and taiwan need not work for 3rd world countries in the 80's. After all Japan did buy second hand plant for its textiles.

296

Fisml Imperatlws In Paklstan 's Econc7mlc Development

and taiwan did not do thisjIndia tried t o ape the Japanese but the attempt did not meet with the kind of success Japan had. The S. Koreans on the other hand bought the best that money could buy and built from there using regimented stability t o ensure relatively low internal prices- and that included wages for labour. In the 80's increasing protectionism has reduced growth in world trade and this means that third world countries will have that much more difficulty in making inroads into international markets. An export led development drive therefore. does not seem to assure the guaranteed generation of hard currency o n a scale adequate to fund the acquisition of economic material to deepen and widen the economic base and usher in the elusive stage of self sustained growth leading to high mass consumption. It is clear therefore that there is no universal formula applicable t o all countries for all times. However there is no denying that with a deficient economic base there cannot be a n y self sustained growth.

they help resolve.

Governments and bureaucracies go together. Governments must have "legal cover" for their actions. Everything that they do must be backed by an "authorization"- a law or a rule that can be quoted. This necessitates a veritable maze of statutory enactments in diverse areas of activity.bThus we have civil, criminal, municipal, revenue laws - t o mentSiqnbut a few. To implement the legislation requires a virtual army of "civil servants". In theory this "army" should greatly facilitate achievement of the objectives for which the statute h a s been designed. But that is in theory only. In practice bureaucracies have provoked great resentment against their members by the public. The third world scenario in this context presents a chaotic picture of public functionaries constantly at loggerheads with the people they are expected t o serve. 'Fhe end result of this strife is to lead t o great inefficiency in administration. Things therefore do not happen the way they are supposed to. The implications in the context of a developing country are especially serious since economic development suffers. Considering that a huge bureaucracy is specifically earmarked for the execution of development plans, this is indeed a great waste. Most third world countries today have a colon.ia1 past. On gaining independence they have usually copied the politico economic format of their erstwhile colonial masters. This has ofcourse included the selection and training procedl.lres and heirarchical organization of civil servants. Considering that t h n v a w r a t i n n a l e nf a d r n i n i c t v ~ l t i n nn f a r n l n n i a l n i i t l i n r i t v

Fiscal lmpavrtiws in Paldstan :F Economtc Dewlopment

298

first and foremost, the exercise of authorrty --- usually procrustean - to ensure continuation of the occupying power, it is evident that for a free country t o continue with the same set of laws and regulations - in general -that were conceived in a colonial mould, is t o antagonise the public which in the changed circumstances resulting from independence jilstifiably expects a more compassionate, receptive, considerate and responsive administration. The "accountability" of public functionaries t o the people is also a matter of considerable significance and public representafiives feel (wherever there are bona-fide representatives) that it is their ri&t to haul up errant public functionaries before a proper forum and interrogate - and if necessary chastise - them. This change in perspective thus alters radically the complexion of administration. However we see that in actual practice, public functionaries continue to behave in much the same manner that they used to before the departure of the colonial authority. The body of laws, rules and regulations enacted during colonial rule continue t o be followed. What is highly significant is that administrators are relkctant to reorient theif behaviour vis a vis the public and revel in the exercise of procrustean authority which they feel makes them command great respect in the public. The capability to induce fear in the public is perceived as a mark of distinction. 1

This persistence of "elitism" is at the root of many of the problems that third world public functionaries face. Modern day bureaucracies are saddled with an enormous worlkload made inevitable in an environment of threatening population pressures and the increasing complexity of life in all spheres Most statutes, thanks t o continueing "amendments" made with a monotonous regularity, have assumed a highly distorted and complicated form quite different from that contemplated in the original "parent" legislation,. This by itself has been instrumental in increasing the size of the bureaucracy. However mere increase in size has not had salutary results as the bureaucracy continues t o be beseiged with a workload that threatens t o overwhelm it. Thus the size though large in absolute terms is still not large enough. As the existing size-perceived as highly bloated -eats up a large part of the available revenues governments are unwilling t o approve any further increase. Inefficiency thus soon becomes ingrained and institutionalized.

The ecmomia of growthSom important lessons

299

Technology available today, properly deployed, does have the capability t o facilitate greatly the task of bureaucra.ts aspecially those dealing with routineptandardized, repititive tasks involving data. Unfortunately, bureaucracies traditionally tend to be highly conservative - more so in third world environments - and the induction of modem technology is thus delayed - or even thwarted. However it is being realized that technology assisted rationalization of procedures - mostly computer based systems - appears the only way out of the impasse in many areas of bureaucratic activity viz revenue tax - assessment, collection, collation, storage and retrieval of statistical data having a bearing on fiscal policy formulation and implementation, economic planning and the like. Third world buneaucrats are usually invested with too much authority at a relatively early stage in their careers. However due to revenue constraints and higher priorities assigned t o other sectors, the bureaucracy is generally ill paid especially the lower and middle level functionaries. This is responsi.ble in no small manner for opening the floodgates of corruption by the deliberate misuse and akbitary exercise of power. Widespread corruption however has implications far more serious than what the generation of ill gotten gains would suggest. It has spawned a huge class of functionaries so conditioned to receive extra legal earnings that situations are deliberately created to provoke the generation of such moneys. In other words nothing - or very little - gets done unless the "price" is paid. For the ordinary man in the street the sheer burden of this price and the manouvering that is involved in its payment can be literally crushing. Furthermore, the huge scale on which extra - legal earnings are generated has contributed significantly to a vast "parallel economy" that is outside the ambit of official control and which distorts and subverts the functioning of the regular economy. Also, the "exploitive" menta1it.y that the situation breeds in public functionaries is inimical t o the public interest.. As an end result, the public and the administrator ,are being increasingly isolated and insulated from each other. This compartmentalization and polarization has grave sociological implications of its own and bodes ill for social stability and cohesiveness so essential t o ensure unity of purpose and action in a nation.

ganization is vital if optimal performance - or near optimal psrfnrmance is t o he euyectd :!T thic pro3

The present day "convergence"of economic systems indicates that the limitations on both sides of the spectru'm are being recognized as are the strong points.

Pure capitalism advocates and extols the accumulation of "private capital" t o fund the acquisition and'operation of the costly equipment necessary t o ensure large scale systematized production. The key t o the successful operation 01the capitalist economic system is the 'marketplace' wherein all exchange takes place and which allocates economic resources to diverse activities by fixing factor prices in accordance with the pertinent supply - demand equation obtaining. The "market" also distributes the national product to the participants in the production process, again in. accordance with their relative supply-- demand position. The "market" will perform its role "optimally" if cornpetetive conditions prevail throughout the marketplace -- which en?ompasses the entire economy. Any obstructions o r hindrances to the free play of market forces will "corrupt" the system and thus make it that much inefficient. Thus a "free market" becomes the linchpin of the capitalist system, automatkally, and always 'correctly,' making the adjustments necessary t o fine tune the economy t o remain on an even keel with resources flowing freely across the expanse of the economy t o be utilized in areas where their utilization is likely t o be most beneficial and self interest of the entrepreneur and consumer becoming "enlightened self interest" by force of the logic of the system. In the free market economy the consumer is "sovereign"

heed t o his decisions and enters into the production of such goods as are in demand. In order t o minimise costs and ensure large scale production so as t o be able to cater t o the demand effectively) specialization and division of labour becomes necessary and is another important feature of the capitalist system. Full employment of resources is made possible as all savings are invested and there is no hoarding. To be sure there maybe transient 'frictional unemployment' but no long term redundancy.. At the opposite end of the spectrum is the highly regimented, fully controlled economy of the socialist (mamian) system. The means of production are controlled by the state and all production operations are centrally planned by an agency of the state (the central planning board or commission). Priorities and physical production targets for all commodities are set by the central planning board which also determines the physical quantities of all resources, including labour t o be used as inputs in the production of each commodity. Consumers have no direct voice in prodiuction decisions. They may have a choice in what they consume, however, subject t o the limits imposed by the central planners decisions regarding the production of consumers goods. If consumption goods are not distributed by command, then consumers are free t o buy consumption goods in markets at government set prices. Laborers may be assigned to their jobs or the central planners may set w3ge rates in such a way as t o try t o achieve the allocation of labor among industries called for by their plan. When economic resources are allocated according t o the commands of a central planning authority, we can also speak of a command economy. All means of production are owned and operated by the state and directed by the central planners who determine how much final output of each good is to be produced, how much of each input, including labor, is t o be allocated t o the production of each commodity, and the quantity and composition of ouput t o be received by a1.I workers, including managers in charge of state enterprizes. In the command economy, the marketplace does not exist. Consumer sovereignty is absent o r at best only nominal. All

The economics of growthSome Importon? lessons

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production and distribution is the sole prerogative of a state apparatus whose preferences become the criteria for the allocation of economic factors for utilization in production and for determining what compensation (price) is to be paid for the use of these factors. Relative scarcities emerging from supplydemand relationships thus become redundant in the context described. Capitalism in its pure form has probably never existed for any significant length-of time - not even in its birthplace: post industrial revolution Great Britain. The perfect competetion based on perfect mobility and perfect awareness of market conditions and absolute consumer sovereignty have never been presentl ie their totality; Likewise, the absolute command economy has never been present in its pure from-not even in the Soviet Union. Under a (less than pure) capitalist system Britain emerged as a major industrial power. However early on in its evolution it was apparent that the sort of capitalism that had taken root was prone t o deficiencies and gave rise to ills that could cause great social anguish by its skewed distribution of wealth and blatant exploitation of labor by the owners of capital who because of their superior bargaining position were able to inflict a wage rate that made a. mockery of the market price of labor arising from its relative scarcity position. Furthermore, the so called consumer sovereignty turned out t o be very limited in its scope with the consumer often duped into accepting something which he was "told" was best for him - at a price that was higher than that warranted by its relative scarcity position in the market. More ominous was the tendency of the system t o be subject to highly destabilizing gyrations symptomized by marked fluctuations in prices and levelsof economic activity. The emergence of the command economy was largely a reaction t o the deficiencies of the so-called free capitalist economy. However the theoretical basis of the command economy rooted as it was in marxian dogma prophesied the ultimate collapse of the capitalist system and its replacement by thoroughgoing communism. Economic forces were decreed as being within the control of man. Lndeed it was considered necessarv

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FLrarl I m p m t l w s In Pakistan

'J Ei:onoml~Developmenr

aberrations of perverse market forces corrupted by the machinations of grasping, self seeking capitalists. The evolution of the capitalistic system in Britain -as in other countries of europe and the USA - witmm-xl a marked increase in the structural complexity of t h e economy and the increasing use of roundabout methods of ~roduction.With the development of standardized machine tools, technical change became rapid and the advent of heavy industr~isaw the emergence of a technolclgy that necessitated massive infusion of capital and futhennore required a "waiting period" (gestation period)which at times was significant. In certain =ear, especially public utilities, it became increasingly risky for private enterprize t o operate, as returns were not quick e n o ~ hand the requirements of capital investment were much too high. Another feature of significance was the emergence of "trade unions". At first resisted by the capitalist ownt?rs of industry, the unions finally prevailed and became a recognized - and powerful - arrangement t o bargain for rights and privileges including the right to a fair wage. It was n o longer possible for the owners of capital t o exploit labour at will -- though some exploitation is inherent in the capitalist system considering the heavy bias in favor of capital. However it is true that the sort of blatant exploitation of labour that characterized the formative phase of capitalism is just not ~ o s s i b l today. e Thus even before the advent of the command economy in soviet Russia in 1917, changes had already taken place in the capitalist system in vogue in the western democrac:ies of Britain, America and France. State ownership and control of key areas of economic activity was already becomir-g a regular feature and organized labor was becoming increasingly and aggressively assertive. However the free market continued t o be the key and distriinstitutional arrangement for resource bution of the national product with supply demand equilibrium determining relative scarcities and pitching prices at given levels. As yet academia in the west found nothing fundamentally wrong with the existing economic order and indeed considered it resilient enough to "self adjust" rapidly t o normal full employment equilibrium should any destabilizing variation from the norm occur. Infact such variation was yiewed as an h e m tion resulting from an unlikely set of circumstances.

The economla of growth-Some Important lessons

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The myth of "self adjustment" fostered by the advocates of capitalism received a devastating rebuff from the apocalyptic events1that followed the stock market crash of 1929. -4s economic activity in the United States ground to a halt, bringing in its wake massive unemployment, the shock waves of America's deep depression were felt worldwide. A radical doctrinal change in capitalism took place with the revelation by John Maynard Keynes that "unaided" it was perfectly possible for the capitalist economy t o remain in less than full employment equilibrium for a protracted period and arbitrary government intervention was, necessary in such situations to st,abilize the economy by the sustained infusion of purchasing power. Employment thus had to be "given" t o the people even if this meant putting them t o work in areas where there was no current need for the work they were being asked t o do. The resulting accretion to "effective demand" would result in a higher level equilibrium escalating the national product by bolstering economic activity. The need t o monitor economic activity paralelled the Keynesian revelation that a complex capitalist economy - or a mixed economy-did not possess any magical property of continuallself adjustment and needed to be "tampered" with quite frequently if it was to be kept on an even keel. A sequel to such monitoring was the advent of economic planning - in limited degrees of course but present nonetheless. T o be sure no formal five year plans have ever been drawn up in the western democracies but an army of "analysts" maintain a watchful vigil over t h e torrent of data that computer aided statistics spew forth with monotonous regularity covering all facets of the economy. A number of important formal planning techniques like InputOutput analysis have also been developed though their use is not pervasive. Capitalism today thus presents a much modified scenario from what its creators visualized. The "drift" in its evolution has clearly been towards greater state ownership of the means o f production especially public utilities, increasing governmental intervention t o remedy destabilizing aberrations, close monitoring of economic activity and even a degree of economic planning. Also, fair wage legislation is ubiquitous8 and inequities in this context d o not remain unnoticed for long. No ,.vndnwn

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306

Fiscal ImpemHws In PaMstan 'r Economlc Development

siding blatantly with the owners of indust~y.The prodigous industrial potential and the high standard of living of the western democracies is living proof of the highly successful coexistence of democracy and "mixed" capitalkm. The highly regimented command economy such as obtains in the Soviet Union is of much recent origin m,~kingits advent with the creation of the worlds first socialist st,\te in Russia. The free market of the capitalist system was done away with and replaced by centralized planning directing resource allocation on the basis of specific criteria. Returns to economic factors came t o be determined not by supply-demand equilibrium but were assigned on the basis of "need" and on the value assigned to the individuals contribution in a productive activity. The rationalized regimentation was expected to bestow a significant degree of predictability to economic phenomena and to remove the whimsical aberrations of the free market thus protecting citizens from the destabilizing gyrations of the capitalist economy. The great advantage of the command economy, besides facilitating removal of inequities through exploitation of labor by capital, was to ensure accelerated econonnic development enabling the socialist economy to 'catch up' with the developed western economy in the span of a few decades rather than go time frame through the agony of development over a pr~tr~acted and subject to the cycles of depression that characterize the swings in the capitalist system taking their heavy toll in terms of social and economic cost. While the command economy succeeded splendidly in structuring, in a relatively short time - frame, an ecommic edifice that gave huge productive potential and more significantly, reproductive potential, it soon became evident after the end of the cold war period following the cessation of hostilities in 1945, that in terms of economi,~efficiency and consumer satisfaction the economic system born in the Soviet Union and transplanted in communist europe, China, N. Korea and Vietnam, left much t o be desred. Its fidings in agriculture were especially galling as collectivisation failed miserably in bringing the autarky desperately sought by the planners forcing these countries t o import huge quahtities of foodgrains from the highly productive private capitalist farmers of the

The econornlcs of growth-Some lmportan t lessons

30 7

west whose surpluses fed not only the communists but also the teeming millions of the third world when they experienced crop failures and deficiencies in production. Fundamental changes in the command economy format did not come about easily. The doctrinaire basis did not permit of ready compromise. But the deficiencies in the system could not be ignored for long especially when it came t o be recognized that in areas of research in key areas like computer development and applications, computer software Jevelopment, superconductivity research and applications, genetic engineering, cybernetics, robotics etc etc. and especially in its ability to innovate and t o harness the creative potential of its manpower, the soviets had begun t o lag behind significantly vis a vis not only the americans but even the japanese. Rigidity was characteristic of the soviet command econom; in both the leninist and stalinist eras. A heavy bias towards capital goods investment was evident in these phases and the evolution of soviet economic doctrine placed heavy emphasis o n the development of planning models over given time frames (the five year plans) that strove t o encompass all facets of economic activity within the plan framework. There was no "market" in the "free, capitalist - or mixed - econonly" sense. This immediately imposed a severe burden in termsof irformation -data-collection and collation. A daunting number of 'sub-plans ' had t o be conceived and developed for each factory, each - collective - farm, each state institution whatever its complexion and scope - and there were only "state institutions" now: the private sphere had completely vanished. Considering the hugely ambitious targets fixed by the planners t o achieve "parity" with their western antagonists in the shortest possible time, the enormity of the planning assigrunent can scarcely be overemphasised. The consolidation of the many sub-plans into a "national plan" and the mobilization and matching of resources with priorities assigned t o different areas of economic activity was a truly herculean task. The vast expanse of the Soviet Union and the imperatives of national defence further complicated an already complex scenario.

As political and economic dimensions were so closely intertwined it was just not possible for economic thought t o - . . .

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Flsccll Imperadues in Pakistan's Ecr--,c

figured prominently in the planning activity. As the defence of the new socialist state was the number one priority, the f!c:;. cf resources t o defence relaced projects was obvious. Consumer goods had low priority and the people were told t o make the sacriices necessary and to forego consumer items even at the risk of some - or even much - inconvenience, The straight forward bias simplified matters a great deal and made the planning task easier. With the end of the secortd world war, the soviet people were not to get much respite as the country had been devastated and the sheer cost of the war both in terms of men and material was staggering. No sooner had the great war ended that the 'cold war' begun in right earnest. The nucleur imperative injected an ominous - and hugely costly as well as mentally demanding - dimension and ensured that the state of crisis continue . The use of procrustean methods was inevitable and even necessary in such a difficult situation and it was only the ruthless and even at times brutal execution of directives that maintained the forward momentum of the economy. In the soviet system, relative scarcities reflected in prices derived from supply - demand equilibriurr~ are not of any significance as the command system fixes prices deliberately on the basis of given criteria. As prices d o not provoke resource flows between and within economic sectors in the command ecommy. their derivation is not of any importance in this particular context. This is however not t o fay that prices are n o t of any significance at all in the soviet type economic system. Prices define value in the sovi& system just as they define value in the capitalist system. And by defining value they facilitate exchange just as they d o so in a free market economy. However in the soviet economic system a deliberate attempt is made t o ensure that the price fixed relates to the set of factors identified as relevant. Thus production cost may be -and often ~s- one such factor. The aggregate production cost, i. the sum total of the cost arising at different phases of the production process. Enterprises sell products to intermediate distribution outlets at "wholesale prices'' derived from an already calculated "average production cast" for the various firms engaged in the production of the given article. T o this average production cost is added a very modest profit mark-up. This is the standard practice. However it is to be noted that the profit mark up is practically a formality and in actual practice if a state enterprise has, for any reason, a production cost

7he economics of growthSome important leaons

309

that varies sharply from the "norm" derived from the production performance of other enterprizes producing the same item, then the production cost cannot be covered by sales revenues and such a state enterprise would be forced t o incur a loss to be made good by a state subsidy. Hence the normal and widespread phenomena of planned lossej. Soviet pricing policy accords differential treatment to intermediate industrial goods and to consumer goods sold t o the public. As long as tlie former are traded between enterprises and govt. organs, price levels are kept disproportionately low as taxation is not a component of the formal price structure. In the case of consumer goods however, a hefty !'turnover tax" enters into the price format. Because of such differential treatment accorded, the soviet price structure is sometimes spoken of as a two tier price system. If we are to focus o n the mechanics of agricultural pricing in the soviet system, we would be entering a different realm, so t o speak. Now a "third tier" of prices wouId be evident. Just as consumer prices in the soviet system have been high, so have prices of agricultural commodities been traditionally lowrelative t o the wholesale price level of intermediate inputs of industry. Agricultural prices have also been low relative to production costs for agricultural .commodities. It is significant t o note in this context that wage rates for farm labor are not what they ought t o be and it has been possible to keep them low because direct taxes on agriculture have been 1igh.t and the incidence of the turnover tax passes the rural population by as the clientele in retail stores normally does not ir~volveany significant number of 'rurals.' It has thus been possible to artifically contrive a relatively low production cost for i~gricultural produce. The arbitrariness inherent in soviet pricing policy is all too evident even from the summary account given above. Such arbitrariness has been at the root of many of the problems that have plagued the soviet economic system. For one thing, the SG called "planned losses" have usually been a camouflage for mismanagement and inefficiency with prices varying widely from the optimal. For another, the overall soviet pr:icing structure has lacked rationality in that relative pricrq are :not usually

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310

Fiscal Imperatives in Pakistan 'r' Economic Dewropment

been possible t o structure coherent prices for finished products and intermediate inputs - derived from a coherent scaffolding. The "peaceful" ouster o f Kruschev from the political scene appears t o be a turning point in soviet policy formulation and the blind rigidity that had become characteristic of the soviet system now began to show signs of relenting. However the first important signs of a change in this context appeared in the mid sixties. The thrust of the "reforms" was t o yield a coherent set of industrial prices. This ofcour:;e necessitated that the objective basis on'which these prices were structured be first established o n a firm footing. In a sense this reglization by itself was a crucial development for it signified an awareness that the system in vogue was deficient and w&.in need of reform - something which would have constituted anathema a short time ago. The basic aim of the reform measures of the pricing structure was t o rationalize relative prices by bringing them closer in line with relative costs of produc:tion. This did not mean then - just as it cannot mean now even in the wake of "perestroika" and "glasnost" - that prices would be permitted to vary in line with changing supply and demand, conditions. This would be asking too much from the soviet system for it would amount t o a negation of the basic premise o n which it has been established - that the very essence of the capitalist system is inimical t o fair and orderly economic relations between and within economic sectors. Since the free play of market forces is t he very essence of the capitalist system and crucial to supply - demand equilibrium and thus price determination, therefore it cannot ever be realistically expected that any r e :arm measures would actually envisage "in toto" adoption of such a basis for the pricing structure in the soviet system. Notwithstanding what is stated above, it is a fact that a small sub set of prices has been taken out of the category of "fixed" o r "ceiling" prices and put into the free price category by actually permitting supply and demand t o yield something like an equilibrium price. This has been true usually - though not always - for over fulfilled production quotas of consumer goods and agricul t u r d produce. These hare been essentially "incentive" measures that aimed at injecthg some stimulus in

the soviet sq stem for int rebed production - a stimulus other than that bdsed on the procrustean exercise of authority: if that can be called a "stimulus." This cannot therefore he really seen as a fundamental reform measure for it is clearly not that. There are indications that soviet planners may have been using "reference prices" approximating in some measure t o "presumed" scarcity prices to see how credible the plan format is in a supply - demand context. This should not be taken t o mean that where there is a marked variation from the presumed supply - demand context there has been any attempt to modify or alter in any way the basic parameters of the plan. However if true (precise information about the exact objective basis of economic planning remains largely classified and only lately have broad generalizations in the context of plan formulation begun t o be made public) then this could atleast indicate that an attempt is underway t o rationalize prices with reference t o a given parameter - scarcity prices - as it obtains in a relatively free market context. Insofar as even an "exercise" is being made in the context described above, -this can be spoken of as a move towards reform because it could ultimately lead to the development of "market type institutions". One has t o say this with "tongue in cheek" because the inherent rigidity of the soviet system must not be underestimated. The soviet system has done a good job of bodily lifting the economic edifice to a new markedly higher threshold. Its present deficiencies are not such as t o render it redundant. However in a highly competetive world environment, especially in the context of "North - North" competetion, it is imperative that "improvements'" be made to ensure that the challenge from the competetion in the 21st century can be reasonably met. It is in this context that " r e form" acquires significance. Every small step taken toward a greater degree of c o herence in the structure of prices can be considered "progress" As such "coherence" must inevitably lead t o a lessening of the extreme regimentation that has been characteristic of the soviet economy for many years therefore in the context of the phenomena of "convergence of economic systems" this would mean a move towards a freer, more "plastic", more "responsive" (responsive t o genuine constructive criticism, both domestic and foreign) and more "rational" system.

Fisml Impemtives In Pakistan's Economic oewlopment

312

The fundamental "flaw" in the doctrinaire soviet system would appear t o be the belief that it is at all possible t o plan comprehensively and effectively every facet of activity in a highly industrialized structurally very complex, economy. Looking t o the intricate interrelationships between economic segments and considering the sheer magnitude of such functional segments no system in which human interference "at every stage" is necessary can possibly cope with the prodigous workload involved. Not even with the aid of super computers has it been possible t o develop programmes that would encompass the full spectrum of economic activity within its ambit. In other words the work done by the "marketplace" as a "clearing house" of information has not been possible t o duplicate in a workable manner for an advanced, structurally intricate economy. For this reason it has become imperative if the soviet system is to remain viable in the future - that adjustments be made to make the soviet system more "pragmatic" This would necessitate certainly, a loosening of the rigid framework characteristic of the "classical" soviet system.

The basic format of the cor~mandeconomy devised in the soviet union has been emulated in other communist countries t o which the revolution has been "exported". However, attempts have been made t o "tamper" with the system to improve its operational performance whichhas generally been found wanting in several important respects. This has been especially evidant in comunist china. The "drift" towards "pragmatic rationalization" noted in the soviet system and about which we have spoken above, is much more marked in China and there are indications that china might be getting ready t o break away from the soviet format in a fairly radical reposturing of ideology in which the deliberate structuring of "market type" institutions might be much in evidence. If this does come about then the'schism between the two communist giants could take the shape of a permanent perhaps unbridgable cleavage. To conclude we may say with confidence that the logic o f the current world situation makes inevitable great economic

control to limit aberrations, to accelerate the pace of economic development, t o reduce distributive inequities and to stabilize cyclic variations in the so called, free economies. Concomitantly, for the regimented command economies a loosening of the oppressively harsh control characteristic of the system has be-

T k econornlcs of gruwth-Some irnportunt lessons

313

come necessary so as to breathe new dynamism into the system and to ensure. that chronic stagnation is aviod.ed. In short, survival of the two systems requires that they "converge" and "borrow" from the other what they lack themselves.

Sources

315

Sources: Chapters 1 t o 8. The protracted tax reform debate in the United States an integral part of "REAGANOMICS" - provides an especially useful backdrop to isues involved in ths highly specialized area of fiscal policy. The author had an intensive one year academic exposure to important aspects of this debate at the Harvard University School of Law (1985-86 Session) when he participated in the H.L.S. International Tax Program as a nominee of the Goverment of Pakistan. The sheer weight of erudite - even esoteric -- comment flooding the media in the U.S. in the course of this debate, was enough t o tease anyones imagination, but for those with a professional, academic interest, it was also highly instructive. While the Pakistan income taxation system is hardly "on all fours" with its U.Scounterpart, much of the technical framework of the two systems has common features, For this reason, the author was able to bring' to bear lessons learnt at the H.L.S. in this context in his technical evaluation of the Pakistan tax system. The following materials deserve special mention here:

- The Presidents Tax Proposals to Congress - IJ. S. Government Printing Office, WASH. ,D.C.

- Bartlett and Roth - " The supply side solution" Chatham House publishing Inc N.J. 1983. The Wall Stareet Journal. May 31, 1985 "Winners and Losers in the tax revolution".

- The Wall Street Journal, May 28,1985 " Reagans new tax overhaul plan."

Fisml ImpmafIws In Pakistan's Economlc Development

316

formalized through the Income Tax Act of 1922 was adopted Pakistan in 1947 virtually unchanged. Although subjected to repeated yearly "amendments" mainly to provide so called fiscal incentives, its basic format was the same as that devised by the British. The statutory exemption for income from agriculture has continued and the narrow tax base ktxps revenues a an abysmally how level. The 1979 Income Tax Ordinance replaced the Act of 1922 but the change was "cos~netic"and not substantive and represented more a desire t o rationalize the arrangement of the statutory provisions that successive "amendments" had rendered quite chaotic than t o alter dramtically the legal format. The following additional sources are cited. - HINRICHS A General Theory of Tax Structure Change During Economic Development. (HARVARD LAW S'CHOOL International Tax Program-). - SULLIVAN The Search for tax principles in the European economic community. (HARVARD LAW SCHOOL -- International Tax Program-) - LEON YUDKIN A legal structure for effective income tax administration. (HARVARD LAW SCHOOL - International Tax Program

- 1. - STEPHEN R. 3,WWIS Jr. Taxation for development

- principles and applications.

- DAVID N. HYMAN - PUBLIC FINANCEA contemporary application of theory to policy.

Sources - RICHARD GOODE

Government finance in developing countries. - C.P. KWDLEBERGER & B. HERRICK

Economic development. 1

- GUNNAR MYRDAL

Asain Drama. - HEILEBRONER

The economic problem. - VIQAR AHMAD & RASHID AMJAD

The management of Pakistan's economy 1947.82

-PAKISTAN ECONOMIC SURVEY- (Various issues). - INCOME TAX ACT 1922 (ACT XY O F 1947)PEALED -

RE-

-INCOME TAX ORDINANCE 1979 (Amended). - RAZA NAQVI

THE LAW & PRACTICE O F INCOME TAX IN PAKISTAN. - KANGA & PALKIVALLA

THE LAW & PRACTICE O F INCOME TAX (India). - "TAXATIONw- RAZA NAQVI Ed. various issues-

-NATIONAL TAXATION R E F 0 RM COMMISSION (PAKISTAN)-

THE FINAL REPORT .- 1987.

-TAXATION ENQUIRY COMMISSION REPORT. - 1971.

1 1I

Fisml Impemffwsin Pakistan's Economic Development

- M.A. ABBASI i

BURDEN OF INCOME TAX KARACHI MAY 1984.

TAX OBSERVER"

- M.A. MAJEED ! i

I i : r

COMPUTERIZATION OF THE PROCESS OF SELECTION OF CASES FOR DETAILED SECURITINY - TAX OBSERVER' KARACHI JULY 1984. - S.A. SALAM

i1 f .

INCOME TAX LAW.

'i I.

4 ,

-L. WHITE INDUSTRIAL CONCENTRATION & ECONOMIC POWER IN PAKISTAN. -B.A. AZHAR TAX HOLIDAY FOR INDUSTRIAL DEVEILOPMENTAn Evaluation -- PAKISTAN ECONOMIC: JOURNAL 1973-74pp. 7285.

- N. KALDOR STRATEGIC FACTORS IN ECONOMIC DEVEWPMENT.

- J. P. COLE THE DEVELOPMENT GAP

- BARLOW & WENDER FOREIGN INVEWMENT & TAXATION - DERNBERG & MCDOUGAU

MACROECONOMICS.

Sources

319

-RICHARD GOODE "Reconstruction of foreign tax systems'" (RICHARD M. BIRD AND OLIVER OLDMAN (eds) READINGS ON TAXATION IN DEVELOPING COUNTRIES-RICHARD A. MUSGRAVE "The Theory of public Finance - A study in public Economy. (Mcgraw Hill, 1959).

Ffscol ImpemD'ves In Pahistan's Economic Development

320

Sources: Chapter 9

-The Income Tax Act (Repealed) 1922 PJo. 11 of 1947(as amended ) -The Income Tax Ordinance 1979 (as amended).

XXXI of 1979.

-ANTH@INE r. (ed) "TAX INCENTIVES FOR PRIVATE INVESTMENT IN DEVELOPING COIJNTRIES". DEVENTER: KLUWER, 1979. -DOMINIC, M. "Income Taxation and foreign. investment in Developing countries. AMSTERDAM: lN"IERN.4TIONAL BUREAU OF FISCAL DOCUMENTATION. 1980.

-S.A. Salarn Complete Income Tax Law.

321

Sources

-A.G,

Merchant- "Income Tax Law"

- Tax observer

1982-M.A. Abbasi- "Burden of Income tax" Karachi - May 1984.

- Tax Observer

-MA. Majeed - "Computerization of the process of selection of cases for detailed scrutiny. "-Tax Observer, Karachi - July 1984. -[ (1986)53 Tax 109

(HC Lah)] Mohd Asghar vs. CBR-

Lahore Hlgh Court. -[ (1985)51 Tax 114 (HC Kar)] -Cannon Products Ltd.

vs. ITO-Sind HIgh Court, Karachi. -Ria2 Bottlers Ltd. vs FO-Lahore HIgh Court-Writ Petition No. 3590 of 1982. -Messrs Escorts Ltd. vs IT0 Lahore, 1975 PTD--50-N.T.R.C. REPORT, 1987.

Flrcal Imoem tlves in Pakfstan 3 Economtc Dew lovment

322

Sources : Chapter 10 -Income Tax Act (Replealed) 1922- No. XI of 1947-Income Tax Ordinance 1979- No. XXXI of 1979-Finance Ordinance (1980 through 1986j -Self Assessment Scheme-Central Board of Revenue 197980 to 1986-87.

- SRO 8 4 (R)/64 dated 28th August 1964. -SRO 794(1)/77 dated 22nd Aug. 1977. -Circular instructions CBR Islamabad.

- Taxation-Journal (1964) Vol - 1 0 Page 4). -Taxation Journal (1966) Vol-14, page 1 4 .

- Taxation Journal (1979) Vol39, page 9. - Taxation Journal (1 969) Vo119, page

35.

-Taxation Comrnision Questionaire 19 71

- Taxation Journal (19 74) V o l 3 0 , page

45.

-Taxation Journal (1979) Val- 39, page 69.

-Central Board of Revenue, Brochure 976lCBR dated 24th June 1981.

- Taxation Journal (1981) VoI43. -Burget Speeches 1964 thru 1987.

Sources

323

Sources: Chapter 14 -GERAID M. MEIER " LEADING ISSUES IN DEVELOPMENT ECONOMICSSELECTED MATERIALS AND COMMENTARY " C H A F I V N. Y., OXFORD UNIVERSITY PRESS' 1964.

" Public Finance in Under developed countries", WILEY, N.Y. 1972.

-RICHARD M. BIRD AND OLIVER OLDMAN (eds).

" READINGS ON TAXATION IN DEVELOE'ING COUNTRIES", JOHN HOPKINS, BALTIMORE, 1975. -MCKINNON, ROUND, I.

" MONEY AND CAPITAL IN ECONOMIC DEVEWPMENT" BROOKINGS, WASH, 1973.

" GOVERNMENT FINANCE IN DEVELOPING COUNTRIES."

Fiscal Impemtiws In Pakistan's Economic Dewlopmenr

324

Sources : Chapter' 1 5

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About the Author. Mr. Muhammad Munir Qureshi, Director General, Directorate General of Income Tax (Training & Research), Lahore, is the senior most officer of the Income Tax Group in Grade-21. He was appointed as Director General, DOT, in April 2006 after competing in a selection process under the Internal Job Posting [IJP] policy of the CBR. He has completed 37 years in Government Service in Nov 2006.; has served for 6 years at the Income Tax Appellate Tribunal, Lahore, [2000 – 2006] as Member; was promoted to Grade-21 in Oct 1998 and appointed Member [HRD] in the CBR and he served in that post till March 2000; has worked as Commissioner, Income Tax from Oct 1990 to Oct 1998; as Addl Commissioner from 1979 to 1998 and as Income Tax Officer from 1969 to 1979. Before joining Govt Service in 1969 he worked as a Research Associate at the Harvard Advisory Group to Pakistan [1968 – 1969]. Mr Munir Qureshi holds a Masters Degree in Economics [HONOURS SCHOOL] from the Government College, Lahore [1967] and was placed in the Academic Roll of Honour of the Institution for his outstanding merit. He has previously studied at Aitchison College, Lahore. In 1985 he went to the Harvard School of Law, Harvard University, USA, and successfully participated in the International Tax Program [Aug 1985 to june 1986], a specialized course in Tax Administration that attracts tax specialists from all over the world. Earlier, in 1977 he went to Japan to participate in a seminar on Fiscal Management under the auspices of JICA [the Japan Int’l Cooperation Agency], in Tokyo. He has also attended Training courses at the National Institute of Public Administration, Lahore [1987 – 52nd Advanced Course in Administration & Development] and in 1995, at the Pakistan Administrative Staff College, Lahore, [-the 62nd National Management Course]. He is widely traveled and has been to the UK, France, Italy, Switzerland, USA, Canada, Spain, Portugal, Holland, Indonesia, Australia, Singapore and Saudi Arabia. He is the author of a book on Fiscal Management, “Fiscal Imperatives in Pakistan’s Economic Development,” published in 1989 and has also written numerous papers / articles published in various newspapers / magazines. He is married and has two sons, Omar, age 25 [BA., LLB, Punjab University(2005)] and Hassan, age 24 [MBA., IT (2006)]. His wife, Leena, is a graduate of the Home Economics College, Lahore (1980). Their only daughter, Kiran, [‘A’ Levels, Grammar School, Lahore, [2003]& an Hon’s student at the Punjab University, [Management Science] died in 2004, at age 19.