The Pakistan Business Council (PBC), an association of the country’s top and most influential corporations, recently held a meeting with the Special Investment Facilitation Council (SIFC) to impress upon it the need to cut the corporate tax rate. It said that this was one major reason preventing existing corporations from investing further in the economy and also acting as a deterrent to new investment coming into the economy, both domestically as well as from overseas.
The economic reasoning behind this is sound – when corporations are left with higher disposable income, they are likely to reinvest it further into expanding their operations. Also, when overseas companies are eyeing various destinations to invest in, one of the key metrics they look at is how much of their income they will get to keep after tax. The greater the ratio – that is, the lower the corporate income tax – the more attractive the economy will be in terms of attracting both domestic and foreign investment.
So, the PBC cannot be faulted for looking out for the interests of its members, especially when it comes to the whole structure of taxation. A report on this matter also said that Lieutenant General Sarfaraz Ahmed, who is National Coordinator of the SIFC, agreed with this assessment in a meeting where the chairman of the Federal Board of Revenue (FBR) was also present. The latter said that if the tax rates were cut, then a gap in taxes of over a trillion rupees would have to be met. The irony here is that it is very much the job of the FBR to collect taxes, and if there is a gap, then plugging that is its responsibility. Furthermore, the way to increase tax collection is not to continuously increase taxes on those who are already paying, but to widen the tax net. The FBR chief’s reported response suggests that tax policy is strictly bound by the Board’s inability to widen the tax net to include sectors of the economy that are currently outside it, or to ensure that those already in the tax net pay their fair and due share of tax.
Of course, this debate also begs the question: what about the salaried class? Who is there to speak for its interests before the SIFC and the federal government, to safeguard its right not to be taxed unfairly or disproportionately? There is no Pakistan Salaried Class Council or Pakistan Salaried Persons Union to fight its case before the FBR or the federal government. But the same principle should apply, though its impact on the economy would work not through increased investment but increased demand for goods and services, which would materialise as an increase in consumption.
Policymakers will have to weigh the pros and cons of the effectiveness of such an expansionary policy, which seeks to kick-start GDP growth but may cause inflation to rear its head again
Government ministers and senior officials, and the International Monetary Fund as well, have all said of late that Pakistan is stuck in a low GDP growth trap, and that this is also one primary reason why its poverty levels are on the rise. A cut in both corporate and income tax will boost GDP growth through the increase in investment as companies seek to expand their operations, and through an increase in consumption as people have higher disposable incomes and use that to purchase more goods and services.
Basic economics suggests, however, that a cut in taxes will likely lead to inflation in the economy as overall demand rises for goods and services, thereby putting pressure on prices to rise. That is where the State Bank will play a role, since it controls monetary policy by regulating the interest rate and, through it, the cost of borrowing and inflation. This means that if the federal government were to reduce taxes in the economy, it would have to contend with the possibility that inflation would likely be a consequence.
That said, an understanding of basic economics would suggest that the way to spur GDP growth is either by cutting taxes or increasing government expenditure. One likely consequence of that is inflation and reduced tax collection, at least in the near term. However, once the economy is on the road to robust GDP growth, the decrease in tax collection will be more than offset by incomes rising as the reduction in taxes spurs investment spending and consumption expenditure. This could take some time, though, and that is where policymakers will have to weigh the pros and cons of the effectiveness of such an expansionary policy, which seeks to kick-start GDP growth but may cause inflation to rear its head again.
That said, expansionary fiscal policy is one of the ways usually preferred by governments the world over to boost a sagging economy. Unfortunately, while Pakistan also has an economy mired in sluggish growth, it also has a relatively low tax-to-GDP ratio, and cutting taxes may further lower it – at least in the short run. Only in the medium to longer term will such a strategy pay off, because that allows the economy to grow, and when real incomes grow, tax revenue automatically grows with it.