Economic Performences 2007-08

Embed Doc
Copy Link
Readcast
Collections

CommentGo Back

i

Fiscal Policy Statement

2007-08

Debt Policy Coordination Office (DPCO)

, Ministry of Finance,Government of Pakistan Islamabad, January 31, 2008

I: INTRODUCTION

1. Over the last year there have been several political and economic events thatoccurred unexpectedly, for which the Government had to adjust its policies in order tocounter the effects on the domestic economy. Such events include sky-rocketinginternational oil prices, the domestic as well as global food inflation phenomena, thesubprimecrisis in the United States and the resultant slowdown of worldwide economicactivity, and the disturbed law and order situation in the country. An important tool thatthe Government can use to counter such events and minimize the impact of thesedevelopments on the domestic economy is to maintain financial discipline which isenriched in the Fiscal Responsibility and Debt Limitation Act 2005 (FRDL).2. Government typically aims to promote strong and sustainable economic growthwith a view to creating employment opportunities and lasting poverty reduction. It isgenerally argued that a sound fiscal position is key to achieving macroeconomic stability,which is increasingly recognized as critical for sustained economic growth and povertyreduction. A sound fiscal policy also helps to mobilize domestic savings, increase theefficiency of resource allocation, and help meet development goals. A loose fiscal policy,on the other hand, can lead to higher inflation, higher interest rates and crowding out of private investment, all of which can hamper growth and poverty reduction efforts.Economic growth and human development critically depend on accumulation of physicaland human capital, which in turn requires an adequate level of national savings. As private sector savings are often low in developing countries, a sound fiscal policy can play a central role in mobilizing resources by raising revenue on the one hand andreducing less productive spending on the other. The importance of sound and rule basedfiscal policy therefore cannot be over emphasized in a developing country like Pakistan.3. Pakistan has witnessed serious macroeconomic imbalances in the 1990s mainlyon account of its fiscal profligacy. Persistence of large fiscal deficit resulted inunsustainable levels of public debt, adversely affecting the country’s macroeconomicenvironment. Pakistan accordingly paid a heavy price for its fiscal indiscipline in terms of deceleration in economic growth and investment, and the associated rise in the levels of poverty. Considerable efforts have been made over the last seven/eight years to inculcatefinancial discipline by pursuing a sound fiscal policy. Pakistan’s hard earnedmacroeconomic stability is underpinned by fiscal discipline.4. There has been increasing acceptance worldwide that financial discipline over a prolonged period is essential for maintaining macroeconomic stability. There is also ageneral consensus that a prolonged commitment to financial discipline can only come

from a rule-based fiscal policy. What is a rule-based fiscal policy? The rule essentiallyaims to imposing durable fiscal discipline and overcoming the problem of “deficit bias”.Such rules attempt to impose an underlying constraint of varying degrees on fiscal policyand often on those that make it. The rule typically requires that the government commit toa fiscal policy strategy or to specific fiscal targets that can be monitored. Internationalexperience suggests that countries that have adopted well-designed fiscal rules andimplemented effective operational mechanism for enforcing them have made important2credibility gains, reflected by cheaper access to financial markets and greater electoralsupport.5. The Government believes that there is no alternative to a rule-based fiscal policy.Accordingly, a rule-based fiscal policy, enshrined in the Fiscal Responsibility and DebtLimitation Act 2005, was passed by the Parliament in June 2005. This Act ensuresresponsible and accountable fiscal management by all governments - the present and thefuture, and would encourage informed public debate about fiscal policy. It requires thegovernment to be transparent about its short and long term fiscal intension and imposeshigh standards of fiscal disclosure. Given the difficult past that Pakistan’smacroeconomic environment had reached by the end of the 1990s, a rule-based fiscal policy was considered essential for maintaining macroeconomic stability and promotinggrowth on a sustained basis.The present Fiscal Policy Statement is prepared to fulfill the legal requirement of Section6 of the FRDL Act 2005. The Act specifies that the Fiscal Policy Statement (FPS) shallanalyze the key macroeconomic indicators such as total expenditure, total revenues, totalfiscal deficit, revenue deficit and total public debt. The Act requires that the FederalGovernment shall explain how fiscal indicators accord with the principles of soundsfiscal and debt management. The Act also requires that the FPS, besides analyzing keymacroeconomic indicators stated above, must also contain:a) The key fiscal measures and rationale for any major deviation in fiscalmeasures pertaining to taxation, subsidy, expenditure, administered pricing and borrowing; b) An update on key information regarding macroeconomic indicators;c) The strategic priorities of the Federal Government for the financial year in the fiscal area;d) The analysis to the fullest extent possible of all policy decisions made by the Federal Government and all other circumstances that may havea material effect on meeting the targets for economic indicators for that fiscal year as specified in the medium term budgetary statement;ande) An evaluation as to how the current policies of the Federal Governmentare in conformity with the principle of sound fiscal and debtmanagement and the targets set forth in the medium term budgetarystatement in section 5 of the Act.

II: PRINCIPLES OF TAX AND EXPENDITURE POLICYII-

i:

Principles of Tax Policy

6. It should be the continuing endeavour of the Government to implement thefollowing principles of tax policy: (i) widening the tax base, (ii) reducing exemptions,

(iii) providing incentives and concessions wherever required, (iv) reducing multiplicity of tax rates, (v) lowering tax rates, (vi) shifting the incidence of tax burden from productionto consumption, (vii) moving away from the excessive reliance on manufacturing and3taxing all value additions including services, (viii) enhancing the neutrality between present and future consumption, (ix) enhancing the neutrality of the tax system to formsof business organizations and sources of finance, (x) re-engineering the business processof the tax system to overcome the culture of tax avoidance and evasion, (xi) effecting business process changes in tax administration to establish an effective and efficient taxsystem. These are the guiding principles of the tax policy which the Government shouldfocus on and employ.7. The current phase of high growth provides us an opportunity that should be usedto improve the fiscal health of the country. We must increase our revenues withouthurting the growth momentum. It is Government’s intention to undertake major taxreforms to improve the tax-to-GDP ratio, expand the taxpayer base, increase taxcompliance and make tax administration more efficient. Government is moving to a taxsystem that is based on moderate rates and wider base through rationalization of exemptions. Despite recent reforms, the tax effort remained modest in Pakistan owing tovarious structural problems. The administrative reforms envisaged by the FBR, especiallymoving toward a functional organizational structure, has helped to enhance taxefficiency, as well as improving the tax climate and governance. However, expandingtaxation gradually into the agricultural and service sectors would bring greater yields, andwould help reduce tax evasion.8. Why is tax-to-GDP ratio in Pakistan low in comparison to many developingcountries? Why amidst highest ever growth performance in recent past Pakistan’s tax-to-GDP ratio has fallen in 2004-05? The answer is simple, nominal GDP grew at a faster pace than tax revenue but actually one has to look into the anatomy of economic growthto find the answer. Table-1 gives some break-up of the contributions of variouscomponents of GDP in overall GDP and taxes for financial year 2004-2005. Although thefigures are for a different year, sectoral composition of tax contribution has remainedalmost unchanged and the numbers can be used to make significant inferences. Almostthree-fourth of contribution to real GDP growth (8.6%) came from agriculture (1.5%) and

Table-1: Sharing Tax Burden among Various Sectors(FY05)

DescriptionShare in GDPShare in TaxesPointContribution toGDP GrowthAgriculture 22.5 1.2 1.5Manufacturing 17.9 62.2 2.2

Construction 2.1 2.9 0.4Electricity & Gas Distribution 3.5 5.3 0.1

Transport, Storage & Communication 10.4 4.5 0.4Wholesales & Retail Trade 18.6 2.8 2.0

Finance & Insurance 4.0 3.9 1.0Public Administration & Defense 5.9 5.0 0.04Social & Community Services 9.5 7.8 0.6

of 00

Leave a Comment