Tax structure, Public Expenditures & Poverty Alleviation

In modern days, tax-expenditures policies are used as an important vehicle for resource transfer from the rich to the poor. In Pakistan, however, the incidence of taxation and benefit of public expenditures have not been helpful in alleviating poverty. A large and relatively rich segment of the population escapes from the payment of direct taxes. Agricultural income is exempted from income taxation. Concessions, exemptions and tax holidays provide to industrialists loopholes for tax evasion. Limited coverage, lack of documentation, poor tax administration and low tax morality allow traders, shopkeepers, professionals and service sector in general to get away with nominal direct tax payments. With a narrow tax base and high tax rate, incentive for tax evasion is high. In the circumstances, direct taxes fall mainly on the salaried class, large corporations and holders of saving instruments. Indirect taxes are notorious for their regressivity and, in the context of Pakistan, poor tax administration and large-scale evasion and smuggling makes them very capricious. Although quantitative studies on the effective incidence of taxation in Pakistan are not available, it would appear that the tax burden is borne disproportionately by the lower-income groups of the society. If the underground economy, which is estimated at about 22 percent of GDP in an IMF study, is included in the analysis, the incidence of taxation would appear to be even more regressive.

The data on composition of government expenditure provides no better a picture from the point of view of alleviation of poverty. The bulk of expenditures are claimed by defence, debt servicing and large development projects, but the benefits of these expenditures are derived more by the rich than the poor. Expenditure on social sectors like health, education, sanitation, etc., has been low in relation to requirements and whatever expenditure has been incurred has benefited the relatively rich people more than the poor.

There is an urgent need to restructure the public finances of the country to promote horizontal and vertical equity, bring about efficiency in the allocation of resources and encourage savings and work incentives. On the taxation side, equal incomes must be taxed equally and all tax loopholes need to be plugged. At the same time, effective progressivity of taxation needs to be ensured. To achieve these objectives, Pakistan needs to move towards a broad-based income tax, a generalised consumption tax and increased local taxation directly linked with expenditure on education, health and other community services.

In addition to improving the tax structure, it will be necessary to improve the composition and effectiveness of public expenditures, including a shift towards greater investment in human capital. There is need for making educational programmes more cost-effective and beneficial for the poor. We spend a larger share of our education budget on higher education than the fast-growing Asian economies, some of which have kept the share of higher education in the education budget low. Focusing government expenditures on primary and secondary education is more efficient — the social rates of return are lower on higher education — and it is more equitable. Similar considerations apply with regards to public spending on health. There should be movement towards primary health care or basic health services that cater to the needs of many people, as these are most cost-effective health interventions by the public sector than the building of high-tech public hospitals which would be used primarily by privileged groups. There is also the question of distribution of public expenditures between urban and rural areas, because poverty rates are higher in rural than urban areas. Even within rural areas, there is a need to target public expenditures to particular regions because there are significant disparities as to the incidence of poverty.

We may conclude by saying that poverty alleviation should not be seen as an act of charity but an imperative and a necessity for the country to sustain economic growth, promote social cohesiveness and ensure political stability in the country.

Source: Poverty Alleviation in Pakistan: Present Scenario and Future Strategy, Mohibul Haq Sahibzada. Republished with permission.