The effects of growth-based fiscal policy

A recent study by John Merrifield and Barry W. Poulson measured the effects of fiscal policy variations in case of three US states: California, Montana and Utah. The study concludes: ‘A measure issue in the debate over tax policy is the supply-side impact of income tax rate cuts. Using the Poulson and Kaplan (2008) estimates of the negative relationship between marginal tax rates and state economic growth, we show that income tax cuts could significantly increase economic growth and that the resulting tax revenue growth would have offset much of the static revenue loss.’

Pakistan’s case is that of a bottled-up economy. Despite a huge potential to grow, the economy has had been subservient to political high-imaging. Having failed to decide in sixty-eight long years what political system suits us most, we have been treating economic issues like “also included in the agenda” thing. We keep talking about a low tax to GDP ratio but hardly come up with a forward-looking, sustainable solution to low-revenue issue.

On Pakistan’s low tax to GDP ratio, most of the studies tend to focus on issues like low tax contribution from agriculture, narrow tax base, sectoral imbalance, unorganized business sectors, corrupt administration, undocumented economy etc. While these issues have their serious implications, the biggest hurdle to high tax revenue continues to remain unaddressed that is: a below-potential economic performance.

Pakistan is tipped to become the 18th world economy by GDP by the end of first half of the current century. This hypothetical assessment of an economy’s future size can see the light of the day only if necessary measures are taken to open up the economy. A low interest rate, diversion of bank credit from government to the private sector, greater ease of doing business, new incentives to attract FDI and a tax cut for the corporate sector are the measures that need to be taken to accelerate economic growth. Our industry is the biggest tax contributor. Failure to control “business and industrial terrorism” has compelled our industrialists to take flight to alien lands. They need to be attracted back to their homeland to take part in nation’s economic development.

Pakistan’s tax to GDP ratio has improved from a low of 8.7 percent in 2008-09 to 11.1% in 2013, and this fact is sure to be taken into account by the budget authorities busy in formulating plans for FY15 budget. The rising trend is likely to be maintained with the use of “milking techniques.” The authorities would, however, do better by focusing on broad-based economic growth planning rather than resorting to short-term revenue upping measures. We need to focus more on commodity producing sector as economic growth based on improved productivity by this sector is lasting and more meaningful. The developed economies have thrived on a pumped-up services sector as they can afford to buy commodities from emerging economies. Pakistan should not be trapped by the idea of a false economic growth based on a bloated services sector.