An Overview of the Fiscal Policy of Pakistan 2000-2007

Abstract

Pakistan’s socio-political front has always been a cause of limelight, be it due to changing political scenarios or implementation, enactment or revival of new economic policies. This report is an overview of the fiscal policy of Pakistan from the years 2000 to 20007. It focuses fiscal policy trends in the past few years from policy changes such as introduction of new taxes, abolition of a few, change in the ratio of direct and indirect tax, the number of people falling under tax brackets, data documentation and the shift from a volatile budget deficit to an improvement in revenue collection, tax receipts, curtail expenditures and in short a movement towards a steady and more progressive economy.

Introduction

Fiscal policy primarily deals with the levels and composition of taxation, spending and borrowing by the Government. A sound fiscal policy is essential for preventing macroeconomic imbalances and realizing the full growth potential. In order to address the structural problems in the tax system and tax administration, the government has been introducing wide-ranging tax and tariff reforms, as well as reforms in tax administration. These reforms have already started yielding handsome dividends. During the last seven years, tax collection by the CBR has increased by 130.0 percent – that is, more than doubled.
Fiscal Policy For Year 2000 to 2001

FY01 witnessed the implementation of strong fiscal management along with structural reforms in almost all key sectors of the economy. The reforms were focused on documentation aimed at improving tax compliance. Other measures included a tax amnesty scheme, the extension of GST to services, fiscal transparency, measures to arrest the overrun of expenditures, and several other steps intended to promote fiscal discipline and correct macroeconomic imbalances. Despite weaker than expected economic growth on account of the drought, these measures helped the government realize a significant increase in tax revenue and contain expenditure growth. This jointly resulted in an impressive reduction of 1.1 percent in the budget deficit to 5.3 percent of GDP in FY01.
Consolidated Fiscal Developments in FY01 The primary balance has remained in surplus for the last three years in a row, showing that the fiscal deficit is primarily driven by interest payments. Another measure of the fiscal position is the revenue deficit, which also shows signs of improvement in FY01; this was the outcome of exerted efforts to control government spending, which was sharply curtailed by 1.7 percent of GDP over the last year. This was mainly on account of lower interest payments, reduction in other expenditures and a cut in the public sector development program of provincial governments. Moreover, higher tax collection also contributed to a reduction in the budget deficit. Despite lower than anticipated economic growth, consolidated tax revenues recorded healthy growth of 13.8 percent over FY00, mainly on account of higher tax collection by CBR. However, this increase was eclipsed by lower non-tax revenues (consolidated), which slowed the overall growth in revenues to 4.7 percent in FY01, from 15.6 percent last year.
On the expenditure side, a deteriorating balance between productive and current spending over the past decade has continued to exacerbate the composition of the fiscal balance. Government borrowing to finance current expenditures has not increased the productive capacity of the economy. the revenue balance remained in deficit, indicating that the government is not only borrowing to finance development but also current expenditure. This has enhanced indebtedness of the country and stilted productive capacity. An interesting feature this year, was the reduction in interest payments, realized primarily on account of lower T-bills rates, lower returns on NSS, and smaller amounts of prize money carried by Prize Bonds. Spending on social and economic services also declined, which may be the upshot of better accountability and improved governance. Despite a significant decline in overall expenditures, development spending (consolidated) recorded a healthy increase of 16.4 percent over FY00, indicating government efforts to reprioritize such spending. The compositio n of deficit financing during FY01, marked a significant shift from domestic to external sources, as external financing stood at Rs 128.8 billion against Rs 66.5 billion in FY00. This change is the result of higher inflows from international financial institutions (IFIs) as a result of the SBA, which in turn allowed the government to reduce its dependence on bank borrowings.
Fiscal Operations of Federal Government in FY01
Recap of Major Fiscal Policy Measures
The existing fiscal reforms date back to mid-December 1999, when the government announced its Economic Revival Program (ERP), which envisaged a self-reliant economy. Besides suggesting structural reforms in key sectors, the ERP announced a series of interrelated fiscal and legal reforms to correct macroeconomic imbalances in the economy. Initially, measures like accountability drive and tax survey were a source of public anxiety. However, these were precursors to the government’s commitment to institutionalize accountability and lay down the foundation of a fully documented economy. To appease public concerns related to these issues, the government announced a Tax Amnesty Scheme (TAS) in December 1999, to facilitate those who want to break away from past practices and pay their tax liabilities.
Tax Survey and Registration Scheme
The Tax Survey and Registration Scheme was launched on May 27, 2000, in an effort to document the economy, widen the tax base and add to tax revenue. The process of information collection and analysis was to be completed in three visits to businesses and households:
Despite these encouraging developments, the direct contribution from the tax survey in terms of revenue collections has been far lower than anticipated, primarily because of its medium-term nature and strong resistance by traders in the first quarter of the year. However, an enormous amount of data has been collected, which should help CBR realize higher tax collections in future.
CBR Tax Collections
One of the major challenges faced by Pakistan’s fiscal authorities is the matching of revenues with expenditures. Historically, CBR tax collections to GDP ratio, which is an indicator of tax effort, remained within a tight range of 10.5 to 12.5 over the last decade. Although, this ratio has witnessed a marginal improvement in FY01 on account of buoyant tax collections, it is still lagging behind the peak achieved in FY96. This low tax to GDP ratio can be traced to the existence of a large undocumented economy, extensive exemptions, a narrow tax base, reduction in import related taxes and the absence of a tax culture in the country. To enhance the mobilization of tax revenues, successive governments have undertaken wideranging tax and tariff reforms in the 1990s that marked a shift in the composition of tax revenue. The share of direct taxes has approximately doubled from FY90 to FY01, which is largely due to an increase in withholding taxes that account for almost two-thirds of total income tax revenue. 8
However, after peaking in FY99, the share of direct taxes has marginally declined in subsequent years.
The composition of indirect taxes witnessed a sharp swing in the late 1990s. The share of central excise duty (CED) in total indirect taxes has remained stable (except for the last two years) compared to sales tax and custom duties. As shown, the share of custom duties continued to decline over the last decade, largely due to tariff reforms and trade liberalization measures adopted Pakistan. The share of sales tax posted a steep increase in late 1990s, mainly on account of its extension to various sectors and government. efforts to replace central excise duty with sales tax..
Actual Tax Collections in FY01
As opposed to single digit growth of federal tax collections in the pervious decade, CBR revenues recorded double-digit growth for the second year in a row in FY01. In the preceding three years FY96-FY99, the actual tax collection increased by Rs 40.5 billion or cumulative growth of 15.1 percent. In the next two years FY99-FY01, tax collection rose by Rs 85.4 billion or almost 27.7 percent. A healthy growth of 13.5 percent in FY01 over actual collections in FY00, was the result of tax reforms during the year. The break up of revenues collected reveals that direct taxes increased by 12.8 percent over actual collection in FY00. The direct tax base has also been expanded through reforms of agricultural income and wealth tax; in addition, exemptions have also been curtailed. A massive increase in workers welfare tax due to the realization of arrears also contributed to this increase in direct taxes. The growth of indirect taxes also remained buoyant on account of sales tax. During the year, monthly sales tax growth ranged from 30.7 to 77.0 percent, with an average increase of 48.7 percent over actual collections in FY00. These increases were primarily due to the full year impact of GST extension to the energy sector and several other discretionary measures, which include extension of GST to pesticides and fertilizers, and to services that was previously subject to CED. In addition, higher GST collection also benefited from improving tax compliance, a wider tax base and increasing documentation due to the on-going tax survey. While sales tax revenue grew significantly, revenue from customs and CED recorded negative growth during most of this year. As mentioned earlier, the government has been substituting CED with GST, therefore the negative growth in CED is not surprising. Cus tom duties were not able to meet the budget target primarily due to lower than anticipated increase in dutiable imports.
Surcharges
Revised receipts from surcharges not only fell short of budget target, but also registered negative growth over actual receipts in FY00. Revenues from development surcharge on natural gas were in line with the budget target and recorded a healthy growth of 11.0 percent (over actual collections in FY00). This was largely on account of the full year impact of increase in gas prices with effect from August 16, 1999. The entire shortfall in FY01 is therefore attributed to lower revenue from petroleum surcharges due to the payment of accumulated arrears to oil refineries. Moreover,higher international oil prices that were not fully passed on to consumers, also dampened oil surchargerevenue. Surcharges are considered a volatile revenue source because of the fluctuations in international prices. As retail prices were administered by the government and the effect of changes in international prices was not fully passed on to consumers, the result was an unanticipated fall in surcharges. Higher surcharge revenues in FY98 and FY99 were the windfall effect of lower international prices, which has reversed itself in the last two years.
Federal Government Expenditure
Revised expenditures on debt servicing, the largest component of current expenditures, registered a sharp decline of Rs 22.5 billion during FY01 over the previous year, but was still marginally higher than anticipated in the FY01 budget. The main impetus for this decrease came from lower interest payments on permanent, floating and unfunded debt. In addition to this, less than budgeted repayment of principal, despite higher interest payments on foreign debt (by 5.6 billion over FY00), also helped reduce this expense. The fall in interest payments on permanent debt was brought about by lower interest payments on SLIC bonds and prize money on National Prize Bonds. Defense expenditures in the revised FY01 budget, recorded an impressive decline over actual spending last year and remained lower than budgeted. This was the result of tight monitoring and efficient use of defense spending. Interestingly, the massive decline in defense spending over FY00 and the steep increase in expenditure on general administration, were attributed to military pensions, which have been reclassified and transferred to the general administration head.
During FY01, revised development expenditures were not only lower than anticipated, but also fell short of actual development spending in FY00. Lower development expenditures on the capital account were due to lower disbursements to the provincial governments, AJK, financial and nonfinancial institutions, local bodies and various other agencies/institutions for carrying out their development efforts.
The Consolidated Budget FY0217
A strong increase of 27.3 percent in development expenditures is projected over the revised estimates for FY01. Since the government has already identified four sectors to boost economic growth, the bulk of development spending is likely to target areas.19 In addition, the allocation for Special Programs and the Social Action Programs are also likely to be higher compared to last year.20 Furthermore, a strong revival in the public sector development program of provincial governments is envisaged in the consolidated budget for FY02. As mentioned earlier, the government’s financing of the budget deficit has tilted toward external sources. Following the same pattern as this year, around two-third of the deficit is expected to be financed through external receipts, while the remaining component will be financed locally.
Federal Government Budget FY02
Debt servicing are expected to increase by Rs 24.2 billion, while Rs 11.4 billion are reserved for banking sector reforms and for NADRA. In addition, Rs 6.4 billion increase in expenditure on social services is projected. Four sectors include agriculture, small and medium industry, information technology, and oil, gas and mineral sector. Special programs include Khushal Pakistan, the Drought Relief Program and Devolution Plan. While, expenditures on the social action program aims at improving social services in select areas, which include primary education, nutrition, health, population welfare, water supply and sanitation.
Fiscal Policy For Year 2001 to 2002

The emphasis on fiscal reforms encompassing documentation, transparency, and improving tax compliance, initiated by the present government, continued during FY02. However, unlike FY01, which saw a notable fiscal consolidation, the efforts to reduce the budget deficit during FY02 to the targeted 4.9 percent of GDP were not successful as the overall deficit rose to 6.6 percent of GDP. The specific factors driving this outcome include the negative impact of international political developments, unanticipated defense expenditures, and some one-off adjustments. A compositional breakdown of the overall FY02 deficit is instructive; while revenue collections were admittedly lower than the target, the primary contribution to the above-target deficit was from a sharp rise in expenditures. The decline in revenues was, to a degree, explainable by a slowdown in domestic economic activity, a consequent decline in imports, as well as the negative impact of two unexpected trends that altered key tax bases, i.e. a continuing decline in domestic inflation and the appreciation of the Rupee against US Dollar, both of which contributed to a decline in ad-valorem tax receipts.
Fiscal Performance Indicators
As no single indicator can properly assess the overall fiscal performance of a country, a set of indicators has been presented to gauge the consolidated fiscal operations of the federal and provincial governments during FY02.
Deficit Indicators
The unadjusted overall budgetary deficit has clearly deteriorated during FY02; not only is it higher than the actual budgetary deficit in FY01, the rise clearly disturbs the overall downward trend visible since FY99
Revenue Indicators
FY02 has seen a surprisingly strong jump in the revenue-to-GDP ratio, which rose by 1.1 percentage points even as the tax revenue to GDP ratio remained almost unchanged. In other words, the buoyant 15.4 percent growth in revenues is primarily driven by rising non-tax collections, which is based on three main sources: (1) interest income on government loans, (2) dividends frocorporations, and (3) profits from other organizations.

Expenditure Indicators
The total expenditure to GDP ratio approximates the government’s share in the overall economy and provides information on the fiscal stance of the government. As evident from, after falling sharply in the first half of the 1990s, it depicts a gradual downtrend in succeeding years. Unfortunately, this gradual slide was almost exclusively at the cost of development expenditures. During FY02, the total expenditures to GDP ratio has jumped sharply from 21.3 to 23.7 percent, largely on account of current expenditure.
Fiscal Developments at Federal Level
The revised FY02 federal government revenue receipts stand at Rs 632.8 billion. While below budget target, this figure is still 18.3 percent higher than the collections during FY01. The improvement is almost entirely based on higher non-tax revenues.
CBR Performance
Tax Efforts
The overall performance of the taxation system depends on its revenue generation, which is generally gauged by the tax to GDP ratio. Historically, the Federal tax to GDP ratio fluctuated in a band of about 2 percentage points around a mean of 11.4 percent. Within total taxes, there is a structural shift from indirect taxes to direct taxes as reflected in the rising direct tax to GDP ratio. recent tax reforms reduced the role of these taxes, and therefore the continuing marginal up trend in direct tax collections over the past three years is quite encouraging. the variation in the indirect taxes to GDP ratio explains most of the variation in total tax collections. This co-movement also highlights the government’s heavy dependence on indirect tax revenues despite the regressive nature of such taxes. The present government has initiated wideranging taxation reforms to correct structural weaknesses, which include a Tax Survey and Registration Scheme supplemented with Tax Amnesty Schemes to ease public concerns, introduction of new Income Tax Law, a new Self-Assessment Scheme, etc. Broadening the tax base and improving efficiency in tax administration remained the main planks of taxation policy. These were implemented by reducing the number of taxes, rationalizing tax rates and penalties, and simplifying collection procedures. All these measures helped the government realize double digit growth in tax collections during FY00 and FY01, as also reflected in the rising tax to GDP ratio. However, lower growth in FY02 primarily due to slowdown in economic activity, lower imports and higher tax refunds undermined the government efforts to record buoyant growth for a third year in a row.
Trends in Monthly Tax Collections
Although overall growth in net tax collections was disappointing during FY02, trends in monthly tax collections are insightful. Despite exceptional developments during the year under review, the seasonality remained unchanged, with peaks in revenue collections coinciding with quarter. Another important point is the clear improvement in revenue collections during the last quarter of the year. Specifically, revenue collection during Q4- FY02 witnessed impressive growth of 16 percent over the same period a year ago, with both direct and indirect taxes contributing to the improvement.
Expectations Fell Short of Targets
As in the previous year, the CBR tax targets saw three revisions during FY02, but the actual collections of Rs 403.9 billion were still quite low compared to the final revised target of Rs 414.2 billion, as well as the budget target of Rs 457.7 billion. The initial budget target of Rs 457.7 billion was revised downward to Rs 444.7 billion in August 2001 to account for the shortfall realized in actual tax collections during FY01.12 However, the impact of the September 11 shocks, and realized shortfall during Q1-FY02 forced CBR to resort to another downward revision of the FY02 target to Rs 429.9 billion by October 2001, based on preliminary projections of further revenue losses. However, the mid-year collections again fell short of the revised target, as the economic assumptions proved too optimistic. Refund/Rebate and Gross Collections
During FY02, gross tax collections rose by 6.3 percent year-on-year, but net collections rose by only 3.0 percent due to a sharp increase in the payment of tax refunds/rebate. Specifically, refunds rose to Rs 79.3 billion during FY02 compared to Rs 62.1 billion a year before. Consequently, refunds/rebate as a percentage of gross collections jumped from 13.7 percent in FY01 to 16.4 percent during FY02. The massive growth in refunds/rebates was the upshot of government efforts to substantially reduce the accumulated arrears of refunds/rebates. The government also streamlined the refund/rebate claims process, in a bid to help exporters remain competitive.

Surcharges
Revised estimates of surcharges stood at Rs 53.9 billion for FY02 compared to the budget target of Rs 47.0 billion. The entire increase is attributed to higher development surcharges on petroleum products. The rise is the result of a Rs 0.75 per litre increase in petroleum development surcharge on diesel and Rs 0.25 per litre on other oil products.16 This revenue generation measure was specifically designed to improve overall revenue receipts in the presence of a binding fiscal deficit target under the PRGF. Unlike tax revenues, surcharges remained a volatile source of government revenue receipts in the past. However, the volatility in surcharges is attributable entirely to the fluctuations in petroleum surcharges given the smaller share of gas surcharges. With the deregulation of petroleum prices from the FY02, it is envisaged that surcharges will emerge as a more consistent source for the exchequer.
Non-Tax Revenues
In sharp contrast to the tax revenue picture, revised non-tax receipts stood at Rs 164.7 billion, which are Rs 25.6 billion higher than the budget target and over Rs 50.0 billion higher than the actual receipts during FY01. The breakup of non-tax revenue showed that all three heads posted a healthy growth over a year ago, but the major driving force was higher receipts from civil administration. Receipts from property and enterprise were almost in line with the budget target, but Rs 13.4 billion higher as compared to the previous year. This improvement was shared by interest income from provinces and institutions.
Transfers to Provinces
The transfers to provincial governments are revised downwards to Rs 175.1 billion compared to Rs 190.0 billion in budget estimates. This downward revision is entirely on account of lower receipts in the divisible pool.
Federal Expenditures
Revised FY02 federal government expenditures on the revenue account stand at Rs 697.7 billion, which is Rs 35.1 billion higher than the FY02 budget estimates and Rs 85.0 billion higher than the actual expenditures during FY01. Both, current and development expenditures, shared in this increase, as the former surged by Rs 55.0 billion and the rest was absorbed by the latter.
Within the current expenditures, changes in debt servicing, defense, grants and subsidies are notable. Debt servicing, which accounts for approximately half of current expenditures of the federal government, was Rs 9.1 billion lower than the budget target for the year. This unexpected saving was largely driven by lower interest payments (on domestic debt and foreign debt) as well as a fall in the repayment of foreign debt.
The savings on domestic debt were facilitated by lower-than-expected T-bill rates prevailing during the year and the retirement of Market Related Treasury Bills of worth Rs 193.0 billion in July 2001.
Defense expenditures, the second major component of federal current expenditures, was revised up by Rs 20.1 billion during FY02. This exceptional increase reflected the tension on borders with India. However, the government showed remarkable discipline in terms of expenditure on the running of civil government during FY02, as the spending was in line with the budget target. Revised expenditures on the grants to provinces and other organizations witnessed a stunning increase of Rs 17.0 billion over the budget target and Rs 29.3 billion over the actual spending during FY01. Expenditures on subsidies also played a role in pushing up the current expenditures of federal government. Specifically, subsidies were around Rs 5.0 billion higher than the budget target as well as the FY01 figure. This significant increase was primarily driven by higher payments to WAPDA.
The increase in development expenditures of the federal government on the revenue account is a welcome measure. The bulk of this increase came from higher expenditures on education, health and irrigation projects. The revised current expenditures on the capital account saw a large increase of Rs 96.7 billion over the target to reach Rs 196.5 billion, representing a massive Rs 165.7 billion rise over the FY01 figure.
Financing of Federal Budget
The revised data of federal government financing recorded considerable changes on account of factors affecting the inflow of receipts from internal and external sources, and changing borrowing requirements of the government due to shortfall in revenue receipts and overrun in expenditures. On the external front, the improved track recorded with IFIs, bilateral grants from friendly countries and relief from debt rescheduling helped the government realize higher receipts from external sources.
On the domestic side, higher receipts from the public account are mainly from the national savings schemes.
Revenue Receipts
Gross revenue collections are budgeted at Rs 674.9 billion, 6.7 percent higher than the revised estimates of FY02. The bulk of this increase is anticipated from tax revenues, which are Rs 46.4 billion higher than the revised FY02 estimates and indirect taxes are expected to contribute the greater share.
Surcharges
Petroleum surcharge receipts are also expected to grow strongly due to the full year impact of a FY02 revision in surcharge rates, and normal growth in the base. The gas surcharge receipts are expected to be unchanged at FY01 levels.
Non-Tax Revenues
All three components of non-tax revenues are projected to fall below FY02 revised estimates. The high FY02 dividend income from OGCL and other corporations is expected to fall, even as the revenue from income and property declines following the elimination of the guaranteed profit for refineries. Also, civil administration receipts are expected to be lower in FY03.
Financing of the Federal Expenditures
Revenue receipts remained the prime source of financing; an increase of Rs 23.7 billion is anticipated in the budget for FY03, largely on account of higher tax revenues. In contrast, in both internal and external receipts are expected to decline in line with the lower overall budgetary requirements. Gross financing from external receipts is estimated at Rs 198.1 billion for FY03 budget as compared to FY02 revised estimates of Rs 304.0 billion. This is largely attributed to two factors: (1) overall lower financing needs of the federal government in the wake of anticipated decline in budget outlay; and (2) absence of extraordinary gains of rescheduling and re-profiling of external debt and expected lower grants.

Fiscal Policy For Year 2002 to 2003

FY03 saw a decisive fall in the fiscal deficit to 4.4 percent of GDP. This is the first time in decades that the annual fiscal deficit target has been met (or exceeded); and also (2) the first time in over 25 years that the fiscal deficit has moved below 5 percent of GDP. Greater part of the improvement stems from a sharp jump in revenues - consolidated tax receipts in particular depicted a 16.2 percent YoY increase during FY03. While the fiscal adjustment efforts deserve credit, there are a couple of issues that merit further consideration:
Firstly, the years the decline in the fiscal deficit was at least partially due to a reduction in developmental expenditures relative to the economy.
Secondly, a significant contribution to the reduction in the fiscal deficit during FY03 is through a strong growth in defense receipts. it is important to recall that Pakistan still remains heavily burdened by the debt incurred in the past, and needs to generate sustained primary fiscal surpluses for years to come. therefore, the government should hasten to send a strong signal to investors and businessmen through the passage of the draft Fiscal Responsibility Law. At the same time it must ensure that the resulting fiscal space, in coming years, is used to increase investments in human development and infrastructure.
Fiscal Performance Indicators The broad improvement in the Pakistan fiscal profile during FY03 is mirrored in the changes in most of the key fiscal indicators during FY03.
Fiscal Balance Indicators
In aggregate, fiscal balance indicators show that the broad recovery in Pakistan 's fiscal position since FY98 continued into FY03 as well. While the overall balance remains negative in FY03 . This not only reflects the FY03 reduction in the budget deficit, in absolute terms, but also the increased capacity of the growing economy to service the debt.
The revenue balance, which measures the share of revenues captured by non-development expenditures, also improved in FY03. Here too, the deficit fell from 2.1 percent of GDP in FY02 to 1.6 percent of GDP in FY03 (its lowest level during last five years). The reduction in the revenue deficit was primarily achieved on the back of a strong increase in revenues coupled with a decline in debt servicing costs.
The primary balance saw a marginal deterioration during FY03 due to a more pronounced decline in interest payment compared to the decline in the budget deficit. Thus, the primary balance fell from 2.0 percent of GDP in FY02 to 1.6 percent of GDP in FY03.
Revenue Indicators
Pakistan 's revenue indicators for FY03 depict some modest improvement over the corresponding FY02 figures. The total-revenue-to-GDP ratio rose to a ten-year high of 17.7 percent in FY03 compared with 17.2 percent in FY02. This improvement, and the related rise in the tax-to-GDP ratio primarily reflects the success of the government 's efforts to widen the tax base and improve tax administration, due to which tax growth has outstripped the growth in the economy. However, improvement witnessed in non-tax-revenue to-GDP ratio in FY03, despite a sharp fall in SBP profits was mainly due to a rise in defense receipts.
Expenditure Indicators there has been an across the board improvement in the current expenditure profile by FY01, with a sharp reduction in interest payments, a decline in defense spending and in general administration. In fact, the only segment that saw an increase in spending was general subsidies.
Fiscal Developments at Federal Level The revised federal budget revenue receipts stood at Rs 701.6 billion, up by 13.3 percent during FY03 over FY02. This figure is also 4.0 percent higher than the budget target for the year. The improvement is contributed by, both tax and non-tax revenues. The revised federal expenditures on the revenue account were Rs 709.2 billion in FY03,2.1 percent higher than in the previous year. Thus on revenue account, the Federal Government 's own budget was almost in balance in FY03.
CBR Tax Performance
Helped by a realistic tax target, a broad improvement in the economy and rising imports, as well as various administrative measures, the CBR turned in an exceptional performance during FY03, comfortably exceeding the annual 13.6 percent target growth for the period. The growth represents a significant improvement over the insipid 3 percent increase witnessed in FY02 . This the first time in the past 10 years that the annual tax target has been achieved.
Indirect taxes accounted for approximately 67 percent of the aggregate net tax receipts, with approximately half being accounted for by sales tax alone. However, in terms of the annual target, indirect taxes fell short of the mark due to under performance by both sales tax and excise duty, but this was almost offset by the above-target performance of direct taxes and customs receipts.
Despite the strong FY03 performance, the overall CBR tax to GDP ratio has seen only a small up tick from 11.0 in FY02 to 11.3 percent in FY03. While the tax reforms have helped raise (and stabilize) direct tax receipts by about 2.0 percent of GDP, the limited revenue yield from indirect taxes continues to be a drag on the aggregate tax performance.
Refunds and Gross Collections
The disbursed refunds declined from Rs 79.3 billion in FY02 to Rs 75.6 billion in FY03, even though exports were higher in the latter year. In fact, the FY03 refunds are only Rs 3.7 billion lower than that paid in FY02. As a result, refunds as a share of tax collected reached 14.1 percent.
Direct Taxes
After under-performing on targets during much of FY03, direct taxes surged strongly during Q4-FY03 to reach Rs 151.3 billion by end-June FY03; 2.2 percent over the target and 6.2 percent over the FY02 collections. The above-target growth of the direct taxes appears to be a result of increasing economic activity as well as growth in the taxpayer base and withdrawal of exemptions in the FY02 budget.
Withholding taxes (WHT) remained the biggest source of direct tax collections, accounting for approximately 76.4 percent of the aggregate direct taxes in FY03. three of the five major sub-categories: salaries, contracts and imports (all indicating a rise in economic activity) strongly contributed to the FY03 growth in withholding tax receipts. The fall in the withholding tax receipts from the other two categories, interest income and income from securities probably reflects the steep drop in interest rates in the economy. 'Voluntary payments ' and 'collection on demand ' are the other two main components of income tax. The collection on demand posted a small growth, which depicts improvement in the audit, detection and penalty imposition system. Within voluntary payments, private, public companies, banks and foreign companies, contributed the largest share of around 77 percent, and the individuals contribute the remaining 23 percent.4 Voluntary payments registered a decline during FY03, largely on account of a sharp reduction in the payments by PTCL (from Rs 6.4 billion in FY02 to Rs 0.1 billion in FY03), and the expiry of the tax amnesty scheme.
The real test of increased tax effort by administration and compliance would he in higher share of voluntary payments and collection on demand, as the withholding taxes are captive payments made at the source of income. Sales Tax
A robust 17 percent growth in GST receipts pushed the FY03 receipts to Rs 194.8 billion, accounting for 42.3 percent of the aggregate CBR tax collections during the period. More importantly, the incremental GST receipts during FY03 accounted for a stunning 50 percent of the CBR tax increase witnessed during the year. However, despite this performance, the FY03 still fell 4.5 percent short (Rs 9.2 billion) in meeting the target. the share of GST on imports in total GST receipts declined to 54.1 percent in FY03, from the 55.7 percent recorded in FY02. This phenomenon is explained by: (1) tariff rationalization and (2) the exceptionally strong domestic sales tax collections; while 13.6 percent growth was registered in GST on imports, a far more robust 21.1 percent growth was achieved for domestic GST.
The strong growth in net domestic GST collections was despite the fact that 99.5 percent of the total Rs 43.9 billion FY03 GST refunds were on gross domestic receipts. Interestingly, while export growth has remained strong throughout FY03, the high GST refunds (relative to FY02) is visible mostly in the latter half of FY03. Customs Duties
The exceptionally strong 44.5 percent increase in customs duty receipts during FY03, resulted in incremental receipts of Rs 10.1 billion over the FY03 target, to Rs 69.1 billion. This outcome eased the significant shortfall in sales tax receipts and contributed to the achievement of the overall FY03 tax revenue target.
The higher customs duty collections were driven primarily by a 12.4 percent rise in dutiable imports during FY03, which coincided with a jump in the effective rate from an average of 18.5 percent in FY02 to an average of almost 19 percent during FY03. The rise in the effective duty rate, in turn, was driven by a fall in refunds paid on customs duty receipts, which dropped more than 35 percent, from Rs 26.8 billion in FY02 to Rs 17.2 billion in FY03. This fall in the refunds clearly indicates that a significant portion of the increased imports during the year pertained to goods for domestic consumptions (automobiles), or for investment (machinery imports), as much as intermediate inputs for exports.
Central Excise Duty
The FY03 CED receipts totaled Rs 45.0 billion, 4.6 percent lower than in FY02, and 5.3 percent lower than the FY03 target.

Surcharges
The revenue from surcharges rose 21.9 percent to Rs 66.9 billion during FY03. most of this increase was due to a considerable growth in petroleum development surcharge collections, which rose 28.1 percent during the period, despite small reductions in the fixed per litre levy.
The FY03 gas development surcharge receipts grew at a more moderate 11.6 percent, on the back of a small rise in the gas prices (as newer, more expensive, gas fields were brought on-line) and higher gas sales volumes.
Non-Tax Revenues
The non-tax revenue receipts in the consolidated government accounts stood at Rs 164.9 billion or 4.1 percent of GDP, these have posted a 13.0 percent growth in FY03 over FY02. Although, there were some setbacks on account of some heads like SBP profits (which were Rs 20 billion below budgetary target), WAPDA and NHA receipts, but this was largely compensated by income receipts from civil administration, and dividend income (Rs 9.9 billion from OGDC and Rs 12.3 billion from PTCL). The higher share of civil administration reflects higher receipts under the sub-head of defense, due to logistic supports provided to the international forces.
Federal Expenditures
The federal expenditures recorded an increase of Rs 11.7 billion over the previous year. While, current expenditures recorded a 10.7 percent rise as compared to FY03 budget estimates, developmental expenditures fell by 8.9 percent. The shortfall in revenue developmental expenditures is a matter of concern; it is an indicator of less spending on maintenance and provision of various social services. In contrast, capital developmental expenditures recorded a marginal increase of 1.7 percent in FY03 over budget estimates of FY03, and 9.5 percent over actual of FY02, even this increase is apparently due to abase effect as FY02 itself had shown a decline of 1.8 percent.

Fiscal Policy For Year 2003 to 2004

Overview
The robust growth in revenue and moderate rise in expenditures contributed significantly towards the fiscal consolidation of the government during FY04. The budgetary deficit declined for a successive second year in absolute terms from Rs.184.6 b in FY03 to Rs. 173.9 b in FY04. Due to strong growth in economy, the budgetary deficit dropped as a percentage of the Gross domestic Product (GDP). It fell from 4.5 % in 2003 to 3.9% in 2004. It was even lower than the target. There was a strong increase in revenue receipts of 11.4%. This was mainly a result of a surge in both Tax Collection and Non Tax Receipts. The bulk of it was from CBR taxes, led by a strong growth in trade related taxes. There was also a rise in Net Tax Receipts which was due to higher logistic support receipts and larger dividend from PTCL and OGDCL.
The rise in expenditure moderated to 7.9% in FY04 from 9.2% in F 03. This was due to a decrease in current expenditure (2.6%) on the back of sharp drops in unallocable expenditures, grants, social services and subsidies. This offset the increase in expenditure on defense, law and order and debt servicing. There was a 3.8% decline in federal expenditure whereas provincial expenditure rose. Developmental Expenditure in FY04 was Rs. 154 b which was against the budgeted of Rs. 160 b. There was under-utilization of Rs. 5.6 b but it was still higher from those of FY03.
There was a notable decline in net external financing due to the end of Saudi Oil facility and repayments of costly external debts. Borrowing from non-bank sources also fell because there was a drop in financing from domestic non-bank sources which represents the negative net receipts from National Saving Schemes.
Fiscal Performance Indicators
The underlying improvement in the fiscal discipline during FY04 can be seen by the movements in the key fiscal indicators.
Balance Indicators: the overall performance of the balance indicator showed a very satisfactory result. It followed a declining trend, falling to a historical low at 3.9% of GDP. The revenue balance showed great improvement. It moved into surplus for the first time in 20 years. The primary balance rose to 0.8% of GDP due to better revenue receipts.
Revenue Indicators: there was 11.4% increase in revenue growth in FY04. It pushed up the Revenue to GDP ratio. It was an outcome of the tax reforms of the last decade.
Expenditure Indicators: it also shows a distinct improvement. Total Expenditure to GDP ratio fell to the lowest since the 1990’s. It was caused by a decrease in current expenditure than development expenditure.
The YoY decrease in current spending was caused by the absence of the FY03 equity injections into KESC. Development expenditure stood at 3.5% of the GDP. The revised Federal Receipts for FY04 were Rs. 761 b and were targeted to be at Rs. 728.4 b. There was a rise of 4.5%. Receipts from CBR surpassed the target by 8.8 b and reached Rs. 518 b in Fy04. Growth in Direct Taxes accelerated to 8.8% in FY04 from 6.6% in Fy03. Revenue Collection from GST constituted 42.6% of the total CBR revenues. There was a growth of 12.3% mainly from imports collections. Custom duties also rose by 3o.6%. This was a result of a reduction in tariff rates and an increase in imports. Surcharges also rose in FY04. They were above target. The Central Excise Duty, however, was short of target.
The Federal Expenditure on Revenue Account stood at Rs. 773.2 b. Debt servicing was increased by Rs. 61.8 b. Other increase took place in defense expenditure this was basically a result of troops operation in the Western Borders. These were offset by the decline in subsidies of 11.3%.
Financing of Federal Budget
Although the reduction in the budgetary deficit significantly reduced the government’s funding requirement during FY04, government borrowing from the banking system increased due to lower availability of external financing as well as reduced availability of non-bank financing.

Fiscal Policy For Year 2004 to 2005

The CBR achieved its revenue target for the third successive year in FY05, helping raise the aggregate revenues well above the Rs 851.3 billion revised target. However, expenditure exceeded the target substantially, pushing the overall budgetary deficit to 3.3 percent of GDP, slightly above the target of 3.2 percent of GDP, and higher than the 3.0 percent of GDP in FY04. To put this in perspective, the rise in the budgetary deficit in FY05 ended a 6 year downtrend. While the overall budgetary deficit is still low, the increase in the deficit is disquieting, given the weak buoyancy in tax receipts, and the seeming inability to widen the tax base substantially. The cause of concern is the complacent tax effort and overall revenue mobilization despite the collection of Rs 900 billion. Admittedly, the weak FY05 growth in tax receipts is, in part, understandable, as it stems from the loss of the PDL revenues, following the government’s decision to buffer the economy from at least a part of the rise in international oil prices. However, it is instructive to note that the FY05 tax-to-GDP figure declines even when adding back the full budgeted PDL revenue for the year. Had the revenue-to-GDP ratio attained in FY04 been repeated in FY05 the revenue collection would have been higher by Rs 75 billion and all the fiscal indicators would have looked quite solid. Another point of weakness is the structure of government revenues. More than half of the increase in government revenues during FY05 over the preceding year is from a sharp jump in non-tax revenues, as a result of which the share of tax receipts in total revenues declined from approximately 77 percent in FY04 to 73.3 percent in FY05. Also, within non-tax revenues, a significant contribution is from non-recurring items, such as unexpectedly large contributions from defense receipts, payments from the UN, SBP profits, PTA receipts, etc. Given that these flows cannot be relied upon and are unlikely to repeat themselves in the future to the same extent, the concerns over the trend of the overall budgetary deficit in the years ahead are quite legitimate. A related weakness in the revenue structure is an almost total dependence of all tiers of government on Federal taxes. Although the National Finance Commission would examine the nature of inter-governmental fiscal relationships, the revenue mobilization efforts by the Provincial and local governments, particularly in the relatively well-off provinces such as Punjab and Sindh, have to be stepped up.
In short, the FY05 fiscal developments have exposed weaknesses in the tax systems that need to be addressed if the improvement in fiscal indicators in the current decade is to be sustained. In particular, the importance of raising revenues from sectors that have traditionally remained undertaxed cannot be overstressed. Moreover, the responsibility for this cannot lie solely with the CBR or, indeed the Federal government. Provinces enjoy constitutional authority in respect of agriculture income tax and sales tax on services – these two sectors contribute over 75 percent of GDP, but their share in total revenues remains negligible. The taxation of agricultural income has already received considerable attention at the policy level, but the tax yields remain low. More surprisingly however, there has been little debate on the poor growth in the services sector taxes. As highlighted in the subsequent sections, sustainable growth will depend heavily on tapping resources from all economic activities equitably, and the efficient usage of these resources. The provinces will have to significantly enhance their tax collecting capacity to meet their financing requirements. Such efforts will greatly improve the tax-to-GDP ratios, and will also meet the objective of fiscal decentralization.
Finally, while it is encouraging to note that a strong contribution to the FY05 expenditure growth is through a large rise in development spending, the apparent sharp (21.7 percent YoY) increase in FY05 current expenditure is clearly less desirable. However, it must be acknowledged that this rise may be over stated. The provisional consolidated expenditure for FY05 includes a massive negative Rs 78.5 billion (i.e. 1.2 percent of GDP) statistical discrepancy. If the total expenditure is adjusted for this, i.e. this expenditure did not take place, the expenditure growth drops to only 1.4 percent – which would suggest an exceptionally good performance. On the other hand, if the statistical discrepancy only represents the lack of expenditure allocation to the appropriate categories and thus lack of reconciliation without affecting the level of aggregate spending then this rise in current expenditure is indeed highly worrisome .
Fiscal Performance Indicators
Fiscal performance can be gauged through the following quantitative indicators.

Balance Indicators
All three major balance indicators (fiscal balance, revenue balance and primary balance) that had depicted an improvement in recent years, witnessed a visible deterioration in FY05, highlighting the weaknesses in revenue mobilization efforts.
• Fiscal balance is the key balance indictor for monitoring fiscal strength. An improvement in the fiscal discipline and expansion in the tax net have both been instrumental in reducing the fiscal deficits in the current decade from the high levels during the 1990s. In FY05, above-target expenditure, and the decline in the tax-to-GDP ratio, both contributed to a reversal in the trend decline in the fiscal balance ratio. This is troubling, even though not yet a source of serious concern (as the ratio is still quite low).
• Revenue balance, an indicator to judge the saving capacity of the economy, once again turned negative in FY05, after a positive drift of 0.3 percent of GDP in FY04.
While the reversion of the FY04 revenue surplus was not expected to be sustained in FY05 (as per budgetary estimates), the actual negative balance is larger than anticipated, and again points to a weakness in fiscal discipline.
• Primary balance, the third balance indicator, measures the effects of current discretionary budgetary policy by excluding interest payments. It shows how recent fiscal policy affects the government’s net debt and helps in assessing sustainability of the fiscal deficit. During the 1990s, the primary balance was around -0.5 percent of GDP, but with a gradual improvement in other fiscal performance, it remained in surplus each year during the FY01- FY04 period. Unfortunately, this too turned negative in FY05.
According to “The Fiscal Responsibility and Debt Limitation Act, 2005” (FRDLL), the government has targeted to reduce the revenue deficit to zero by FY08 and to maintain public debt-to-GDP ratio at 60 percent by FY13. The fiscal picture suggests that while the government is still on the right track to meet these targets,1 this owes more to the sustained growth of the economy rather than an improvement in the fiscal performance. Any drop in GDP growth due to unexpected exogenous shocks can adversely affect these targets.

Revenue Indicators
Overall revenue grew by 13.8 percent YoY during FY05 to Rs 900 billion. Although this growth was a little higher than the 9.8 percent YoY rise seen in FY04 as well as the average for recent year, it was nonetheless substantially lower than the growth in nominal GDP, and therefore the revenue to GDP ratio fell to 13.72 percent in FY05 from the 14.3 percent recorded in FY04. The low buoyancy in revenues stemmed entirely from tax revenues, which rose only 8.4 percent YoY during FY05, slower than the 9.5 percent YoY growth in FY04. Specifically, not only did the growth of CBR taxes fail to keep pace with the growth in the economy, the collection of surcharges witnessed a decline (reflecting the government’s decision not to raise the domestic prices of many oil products in proportion to the rise in their international prices). As a result, the tax to GDP ratio dropped to 10.1 percent.
One silver lining in the FY05 revenue profile was the strong rise in non-tax receipts. These rose by 31.7 percent YoY during the period, in contrast to the 10.7 percent YoY increase in the preceding year. As a result, the share of non-tax revenues in total revenues increased to 27 percent in FY05. The major contributions to this increase were from: (1) defence service receipts that contributed Rs 52.5 billion, (2) above-budget profits of the SBP, which contributed Rs 10 billion; and, (3) 17.7 billion of revenue from PTA.3 However, dividend income declined from Rs 74.3 billion in FY04 to Rs 56.8 billion in FY05.
In summary, revenue indicators demonstrate a very stagnant condition. Tax buoyancy estimates show a persistent decline over the last three years, falling to 0.5 in FY05, from 1.7 percent in FY03. All these factors suggest stagnancy in the tax base and weaknesses in resource mobilization efforts.
Expenditure Indicators
Total expenditure rose by 25.1 percent YoY to reach Rs 1,195.5 billion in FY05 compared to a growth of 6.4 percent in FY04. As result, the expenditure to GDP ratio rose to 18.3 percent in FY05, as compared to 17.3 percent in FY04, but remained below the historical levels. Encouragingly, this strong rise in expenditure growth is primarily on account of development spending rather than current expenditure. Current expenditure, which rose to 21.7 percent YoY to Rs 943.1 billion, exceeded the budgeted target of Rs 856.5 billion. However, when seen as a percentage of GDP, the rise is small – from 14 percent in FY04 to 14.4 percent in FY05. A substantial contribution to this relatively positive expenditure profile is the subdued growth in both defence spending and interest payment. Interest payments as a percentage of GDP actually continued to decline in FY05, while defence spending remained static as a percentage of GDP. In fact, defence expenditure has remained stagnant throughout the last six years, i.e. FY00-FY05. Net lending to PSEs increased by 21.4 percent; this rise in lending was mainly due to huge losses in the energy sector.
Fiscal Developments at the Federal Level
The federal government surpassed the revenue collection target of Rs 796.3 billion for FY05, with the actual receipts of Rs 867.6 billion, representing a YoY increase of 14 percent. Out of the FY05 collection, Rs 624.8 billion were from taxes, while Rs 242.8 billion comprised of non-tax revenues.
Thus, the main causative factors behind the weaknesses in revenue collection are the lower Federal revenue collection, and that too in the tax and non-tax components. In the Federal tax component, the surcharges/GDP dropped by 0.6 percentage points due to a deliberate policy of reducing the Petroleum Development Levy to offset the cushion of higher international oil prices. The reduced CBR revenue-to-GDP ratio has arisen due to lower collection on account of direct taxes (3.0 to 2.8 percent of GDP) and sales tax (4.0 to 3.7 percent of GDP).
The sales tax has been a major contributor in revenue mobilization in recent years, but unexpectedly weak growth receipts meant that its share in total collections dropped in FY05; while the GST receipts of Rs 240 billion were slightly higher than the revised target of Rs 239.5 billion, these were significantly below the original FY05 target of Rs 249.2 billion. Of the FY05 receipts, Rs 94.6 billion were collected from domestic resources and the remaining were collected on imports. The net collection from domestic sales tax grew by only 1.5 percent at the time when large scale manufacturing growth was 15.6 percent. Had it not been for 15.3 percent increase in sales tax on imports the overall outcome would have been even more dismal. Various policy measures, like deregistration of retailers/manufacturers having annual turnover of less than Rs 5 million, zero-rating
& exemption of duty on various products, contributed to the weak GST collections in FY05. However, the amendment in taxpayers slab drastically reduced the number of taxpayers on one hand, and decreased the sales tax to GDP ratio from 4 percent during FY04 to 3.7 percent in FY05 on the other, lowering the buoyancy of tax collection. FY05, duty relief over various commodities5 has led to a drastic increase in the import value of certain commodities like vehicles (up 70.5 percent), machinery and mechanical appliances (up 70 percent), electric machinery and equipment (up 117.5 percent), iron & Steel (up 102 percent), contributing not only to an acceleration in economic activity, but also higher customs duty collections.
Central Excise Duty
Although this tax is being replaced with sales tax, and very few heads are left within the network of Central Excise Duty, the revenue collection showed an upward trend and surpassed its target of Rs 52.8 billion slightly with a collection of Rs 52.9 billion . A commodity wise breakup shows that the biggest contribution to this FY05 increase was from cigarettes & tobacco (that comprised 41 percent of the gross annual receipts), followed by that from cement (21percent of the gross annual receipts). While the increase in receipts from the first was driven by growth in output (along with price and duty adjustments), the 17.7 percent rise in CED collections on cement reflect the corresponding rise in production following a strong recovery by the construction sector in FY05 and rising exports .
Surcharges
Surcharges are one of the most important sources of revenue for the government. In FY05, as against the target of Rs 65.3 billion, the collection could hardly reach Rs 26.8 billion, out of which Rs 16.2 billion were collected from gas, whereas Rs 10.6 billion were from the Petroleum Development Levy (PDL). The shortfall in surcharge from PDL is because of a hike in international oil prices that put the government with the difficult choice of passing on in full the higher prices to domestic consumers (and risking a sharp rise in inflation and slower growth) or reducing its fuel taxes (and worsening its fiscal position). The government chose the latter, and consequently, its PDL receipts of Rs 10.6 billion were well short of the Rs 47.4 billion budget target.

Non- Tax Revenues
Non-tax revenues surpassed the target of Rs 141.5 billion in FY05 with an outstanding collection of Rs 240.7 billion, representing a 70 percent rise over the budget estimates. Therefore, the non-tax to GDP ratio rose to 3.7 during FY05 from the 3.3 percent in FY04. This helped out in offsetting the high expenditure during the year.
Federal Expenditure
The Federal government spending rose to Rs 1001 billion in FY05, representing an increase of Rs 11.4 percent YoY. Revenue expenditure for FY05 amounted to Rs 866.8 billion with an increase ofRs 12.1 billion; while capital disbursements declined to Rs 119.7 billion. The increase in revenue expenditure from 12.8 percent of GDP to 13.2 percent in revised estimates was mainly because of current expenditure that rose to Rs 784.7 billion against the BE of Rs 700.8 billion during FY05. This rise is principally because of public order and safety affairs (up 16.4 percent YoY) defence affairs (up 11.5 percent YoY) and general public services (up 10.6 percent YoY) that grew due to higher debt servicing.7 Developmental expenditure on Revenue Account (RE) was though 39 percent higher than FY04 but it remained below the budgetary estimate for FY05. This decline is attributable to (a) expenditure on public health services, which fell from Rs 5.2 billion to Rs 4.7 billion, (b) a fall in education affairs and services expenditure, from Rs 3.8 billion to Rs 2.4 billion (c) a decline in expenditure on economic affairs, especially agro food, irrigation, forestry & fishing, from Rs 23.7 billion to Rs 21.5 billion.
Financing of Federal Budget
Despite a larger deficit, the financing from domestic sources declined sharply in FY05, principally due to a 36.5 percent YoY jump in external finance during the year
The external resources included (1) commodity aid (Rs 78.6 billion); (2) project aid (Rs 40.8 billion); (3) Issue of sukuk (Rs 35.8 billion); and (4) IDB loans (Rs 17.9 billion). Grants provided an additional Rs 18.6 billion, of which commodity aid comprised Rs 12.9 billion. These were supplemented by Privatization proceeds of Rs 10 billion in FY05. The domestic borrowings of Rs 80.8 billion were entirely from the banking system, borrowings from the public account declined (reflecting the net outflow from the NSS instruments).
Analysis of Tax Reform in Pakistan
At present, the government is implementing reforms in the tax administration that were approved in November 2001 in consultation with (and with the financial assistance of) the World Bank. The reform strategy aims at increasing effectiveness of CBR, reducing corruption opportunities and raising the buoyancy of the tax system through organizational re-structuring, self-assessment, reduction of personal contact between taxpayers and tax collectors, simplified processes, revised terms and conditions for employment of CBR officials and improved IT management.
There are certain missing links in the reform process. Tax avoidance and evasion still appears to be widespread.13 To quote an example, out of 12,526 returns filed by corporate sector14 in FY04, only 3,888 or 31 percent have paid some income tax and the rest 69 percent taxpayers have either declared business losses or there is nil income to declare, yet there seems to be little effort to increase the tax compliance and reduce the tax gap in the country. Indeed, quite to the contrary, it appears that the suspension of sales tax and income tax audit in FY05 and 100 percent reliance on taxpayers’ version of their income, may have weakened the capacity of the tax administration to collect due taxes, as reflected in the declining tax buoyancy in recent years. Penal provisions in the income tax ordinance, 2001 have also become ineffective. Therefore, in order to meet the declared objectives of the reforms, it is necessary to highlight the tax performance of CBR in an objective manner using key economic indicators, and to monitor progress over time. The following analysis aims to make an objective assessment of the tax reform process, and to make evidence-based policy recommendations to accelerate resource mobilization and tax compliance in the country.
Resource Mobilization
(a) Tax-to-GDP ratio
The tax-to-GDP ratio, which reflects the efficiency of a tax system, had remained stagnant over the years reflecting the inelasticity of the tax system. Ironically, in the wake of the tax reforms, this ratio has deteriorated, falling from 9.6 percent in FY03 to 9.0 percent in FY05. To put this in perspective, it is worth pointing out that according to the Government Finance Statistics of the IMF, this tax ratio is around 40 percent for high income countries, 25 percent for middle income countries and about 18 percent in low income countries. The low tax-to-GDP ratio for Pakistan not only reflects inefficiency, but also indicates the inequities of our tax system, as many sectors of the economy do not bear the proportionate burden in revenue generation. Prominent examples of these are agriculture and the service sectors.
(b) Tax buoyancy
The efficiency of a tax system depends on its built-in flexibility, that is, it should be elastic with respect to tax base, so that increase in the GDP can automatically lead to proportionate increase in tax revenues. But in case of Pakistan, the volatility in tax buoyancy estimates suggests that revenue growth over the years has been the result of ad hoc taxation measures, and inconsistent policies.
While the volatility in the tax buoyancies appears to have decreased in recent years, the reforms appear to have reduced the buoyancies, which appear to be trending downwards. In other words, the trends suggest that while tax policies may be more consistent, the growth in receipts is less and less proportionate to the growth in income.
Enforcement and Compliance
(a) Number of tax payers in Pakistan.
In the income tax regime, the gap between the NTN holders and those actually filing returns has substantially widened in the last four years. It must be remembered that the number of registered taxpayers is already low in Pakistan, amounting to approximately 1.5 percent of the population. This problem is exacerbated by the rising trend of non-filing of returns, throughout the period of tax administration reforms.15 Clearly, the increasing reliance on voluntary compliance, in the absence of effective enforcement, appears to be having perverse consequences for the stability of the tax receipts and documentation of the economy. Appropriate enforcement of compliance is required to check this negative trend in the wake of USAS. The sales tax has relatively performed better on this count as the percentage of non-filers has considerably decreased. However, as the data shows, the number of sales tax net-registrants has also declined, and the total registered sales tax payers have dropped to a five-year low. This is principally due to the increase in the threshold limit for registration of retailers & turnover manufacturers, from Rs 1 million and 0.5 million respectively, to Rs 5 million in FY04.
Tax culture that promotes voluntary compliance and inculcates taxpayer friendly environment is always assumed as a key to success; however, it also needs to be complemented by effective audit, and a system of penalties and prosecution for tax evaders and dodgers, otherwise, it is likely that the tax delinquents will betray the trust and confidence reposed on them by taking advantage of the selfassessment scheme and automated refund systems. Therefore, the tax policy in Pakistan needs to strike a balance between these two important aspects. The view taken that “broad-based policy and tax reforms have substantially improved the revenue collection and opened new avenues of revenue generation”19 has yet to be substantiated in actual practice. It is quite conceivable that in the initial stage of reforms there may be a temporary dip but as long as the structural changes raise the threshold level of collection, the dip may be tolerable. But if the buoyancy, elasticity estimates do not improve and enforcement is not strengthened the dip may persist. The increase in tax revenues in recent years cannot be attributed to the tax reform. On the contrary the data shows that the system of voluntary compliance has not been instrumental in yielding more resources at least in the initial years of tax reform due to absence of effective audit, enforcement and penal actions.

Fiscal Policy For Year 2005 to 2006

Pakistan’s economy witnessed a small reversal during fiscal year 2006, as fiscal deficit rose to 4.2 percent of GDP compared with 3.3 percent of GDP in preceding year. The major reason for this deterioration was due to unanticipated expenditure incurred on account of relief and rehabilitation efforts following the October 2005 earthquake. But the fiscal deficit for the year 2006, even adjusted for earthquake-related expenses, was higher than in 2005.
Moreover, this deterioration is further explained by the weakness in fiscal balance indicators such as primary, fiscal and revenue balances. Fiscal balance that is the broadest measure of fiscal performance, fiscal deficit rose due to sharp rise in development spending, which would help increase the productive capacity and tax potential of the economy in the years ahead. Revenue balances indicate saving capacity of the economy, they remained negative at 0.6 percent of GDP in FY06, higher than the target of zero for the year. Adjusting for earthquake related expenses, the revenue balance reverts to a surplus of 0.3 percent of GDP during FY06. Primary balances turned into a deficit in FY06, declining to -1.1 percent of the GDP.
Total revenue increased by 19.6 percent, it lagged behind their modified target but the growth in revenues was higher than the growth in nominal GDP. This improvement does not seem to be sustainable because this increase was from non-tax revenue and surcharges. Tax revenues rose by 19.1 percent to Rs.753 billion which was mainly due to CBR taxes, which contributed Rs. 712.5 billion. Revenue indicators demonstrate relatively better position but the continued heavy reliance on import taxes is an issue of concern. It is imperative that government increases its resource mobilization efforts by expanding the tax base and curtailing tax evasion.
Now coming onto the expenditures, the total expenditure rose to Rs 1401.8 billion, showing an increase of 25.5 percent compared with the growth of 18.8 percent in FY2005. Despite the fact that the earthquake rehabilitation expenditure, amounting to Rs 65.8 billion, put pressure on current expenditure, the rise in the latter is relatively quite moderate. The ratio of interest payments to GDP has declined sharply to 3.1 percent. Defense expenditure has declined to 3.1 percent of GDP and seems to have stabilized in recent years. The share of current subsidies has increased.
The federal government exceeded the target of Rs 927.4 billion by 10.3 percent during FY06, collecting Rs 1022.7 billion. This represents an increase of 16.8 percent. Revenue target of Rs 690 billion was surpassed with actual receipts of Rs 712.5 billion, demonstrating an excellent growth of 20.7 percent. New administrative measures are required to improve the tax to GDP ratio. Also, the ratio of return filers in very low in upper slabs as the majority of the corporate and non-corporate declared their income below Rs 150000. Only 2 percent taxpayers declared their income above Rs 1 million annually. The lack of active and transparent audit and complete dependence on voluntary compliance in environment where the issues of corruption, fake claims for refunds, declining tax to GDP ratio are accepted realities, calls for effective measures to check the tax evasion in the country. Also, the domestic tax to GDP ratio needs to be improved as it is as low as 4.9 percent. Moreover, given that the effective tariff rate is declining, the increase in volume of trade has been a key factor driving the increase in revenues from trade taxes. This suggests that any slowdown in the trade could also adversely hit the growth in tax revenues.
Direct taxes easily surpassed the target of Rs 215 billion with an actual collection of 224.6 billion. The major chunk of income tax collection which stood at Rs 209.5 billion came from the withholding taxes, which rose by 25.4 percent, while voluntary payments witnessed relatively moderate growth of 18.3 percent. The absence of full fledged income tax audit resulted in lower collection of income tax on demand as the demand fell to 10.6 billion. This suggests that reforms have yet not significantly contributed to increasing direct taxes.
The sales tax collection has surpassed its revised target of Rs 282.5 billion with an actual collection of Rs 294.6 billion. Revenue from custom duty stood at Rs 138.3 billion, up by 19.8 percent. The revenue from federal excise duty fell a little short of the target of Rs 57.5 billion with an actual collection of Rs 55 billion. The major revenue came from cigarettes and tobacco (Rs 23 billion), cement (Rs 12.2 billion) and natural gases (Rs 6.5 billion).
Surcharges have always been a major source of revenue for the government. The total collection from surcharges stood at Rs 50.8 billion with an increase of 87 percent.
Non-tax revenues witnessed a rise of 13.4 percent, with collection falling Rs 58.8 billion short of the Rs 306.9 billion revised annual target. The major reasons for this disappointing performance were lower profits from PTA, lower defense receipts and the inability of WAPDA to service its debt liabilities.
The total federal government expenditure stood at Rs 1196.4 against the revised target of 1093.6 billion, recording to a growth of 19.5 percent. Revenue expenditure increased by 11.6 percent over the budget estimates, while the capital disbursements fell short of target by 6.3 percent.
The financing from external resources shows a big jump in FY06, as the external receipts increased to 233.9 billion, while financing from external resources witnessed a 25 percent decline. Main sources of external financing remained commodity aid (Rs 98.7 billion), project aid (Rs 63.3 billion) and sovereign bonds (Rs 47.9 billion). The overall financing from internal resources declined to Rs 57.3 billion. This is mainly because of a sharp decline in capital receipts that fell to Rs 31.7 billion, while public account financed Rs 25.5 billion. Privatization proceeds of Rs 90 billion also played a key role in financing the budget deficit during the year.
The total revenue receipts of all provinces stood at Rs 449.8 billion, of which tax contributed Rs 343 billion. All provinces recorded revenue surpluses accompanied with a huge rise in development expenditure. It may be noted that provinces have a low tax base, the aggregate contribution of the provinces to tax revenue is not more than 0.8 percent of GDP. Provinces have tremendous scope for tapping the revenue potential given that the taxation of the major sectors of the economy rests with them. Also the tax collecting capacity of the provinces needs to be strengthened to improve the overall tax-to0GDP ratio of Pakistan.
Province wise analysis shows that overall improvement is visible in every province, especially in Sindh, whose revenue deficit turned into surpluses.

Conclusion

We can reduce the fiscal deficit of Pakistan through following steps:
1) Self-assessment is a step in the right direction that must be accompanied by stronger tax enforcement, including through measures to identify non-filers. The CBR should further mine various data bases for this purpose, and work out an effective exchange of information between the income tax, VAT, and customs services. There also needs to be a clearly defined risk-based audit policy based on transparent criteria. The increase in the number of income tax returns from 1 million to 1.3 million since 2003 as a result of CBR’ s recent efforts is encouraging in this regard, but this is still a very small number in a country of this size.
2) Tax bases must be broaden. On the income tax side, sectors not meaningfully covered (agriculture, real estate and financial services and transactions) must be brought into the tax net once and for all. Capital gains taxation alone, be it on real property or financial.

Appendix

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Bibliography

• http://www.sbp.org.pk/reports/annual/arFY01/report2001.htm • www.google.com • www.getpakistan.com • www.state.gov/documents/organization/8181.pdf • www.ier.hit-u.ac.jp/~kitamura/PDF/A108.pdf

Bibliography: • http://www.sbp.org.pk/reports/annual/arFY01/report2001.htm • www.google.com • www.getpakistan.com • www.state.gov/documents/organization/8181.pdf • www.ier.hit-u.ac.jp/~kitamura/PDF/A108.pdf