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Fiscal policy:

Fiscal policy refers to use of government taxes and its spending to influence the economy. Through this
policy government adjusts its spending level and tax rates to monitor the economy. It is formed by federal
government (Ministry of Finance). John Maynard Keynes (18831946) believed economic performance
could be enhanced by adjusting tax rates and government spending. When the government has to take
decisions on the goods and services it purchases, distribution of the transfer payments, or collection of
taxes, it is likely said to be engaged in fiscal policy.
The major roles of fiscal policy are to
improve unemployment rates
control inflation
stabilize business cycles
Influence interest rates in an effort to control the economy
Stances of fiscal policy
The three main stances of fiscal policy are described as:
Neutral fiscal policy is usually undertaken when an economy is in equilibrium. In this
situation overall the budget outcome has a neutral effect on the level of economic activity
and Government spending is fully funded by tax revenue.
Expansionary fiscal policy occurs when government spending exceeding tax revenue,
and is usually undertaken during recessions.
Contractionary fiscal policy occurs when government spending is lesser than tax
revenue, and is usually undertaken to pay down government debt.
Methods of funding
Governments spend money on a wide range of things, from the military to services like
education and healthcare, as well as transfer payments such as welfare benefits. This expenditure
can be funded through different ways:
Seigniorage, the benefit from printing money
Borrowing money from the public or from abroad
Consumption of fiscal reserves
Fiscal Structure
Pakistans fiscal system is categorized by a weak tax base and an inequitable tax collection,
combined with structural rigidities on the expenditure side. The following points underscore the
vulnerability associated with Pakistans public finances.

Pakistans tax efforts had not attained its targets and remained poor its reflection could be
seen in tax-to-GDP ratio that is amongst the lowest in the region. This structural
weakness is due to low compliance, widespread exemptions, low coverage, and lack of
audit etc that directly accounts for low tax-to GDP ratio. Despite robust economic growth
since 2003, the tax-to-GDP ratio has actually declined to under 9.5%
Manufacturing sector held around 18% share in value addition but tax collection was
highest from this sector. While share of agriculture in tax revenues is estimated at only
1.2% being accounts for 23% of value-addition in the economy. On the other hand
Services held 53% in terms of contribution to total value-addition and it accounts for
approximately 26% of tax revenue. The bulk of tax revenue is collected from industry,
particularly from large scale manufacturing, which provides almost 63% of the annual

Sectors Value addition Tax revenue
Agriculture 23.3% 1.2%
Services 52.6% 25.6%
Manufacturing 17.6% 61.0%
Other 6.5% 12.2%

Sectoral share in value addition and tax revenue
Tax-to-GDP ratio fell from 11.1 percent in 2007-08 to 9.3 percent in 2012-13. Provincial tax
collection stagnated at around 0.5 percent of GDP. FBR tax-to-GDP ratio actually fell from 10.3
percent in 2007-08 to 8.5 percent in 2012-13. Pakistan yields one of the worlds lowest tax-to-
GDP ratios (ranks 115th out of 179 countries). The tax administration and structure are planned to
be reformed to contribute adjustment to the tune of 0.7 percentage points each year by reforming
existing tax system.
Tax gap is almost half of the actual tax collection. The reforms are aimed at de-politicizing the
recruitment, transfer/ postings in the FBR which must be based upon merit.
The tax department noted that the target for 2012-13 was fixed on the basis of Rs. 1,952 billion to
be collected by end of June 2012-13 but actually the collection for the year 2012-13 ended up at
Rs. 1,883 billion. Thus, from the beginning of FY 2012-13 the base was eroded by Rs 69 billion.
Deficit: On average, deficit was 6% of GDP during the decade of 1970s. It was 7.6% of
GDP in 1980s. During the year 2001-02, it has again surpassed 7% of GDP. For the
sustainability of deficit several revenue measures were introduced in the successive
budgets, along with reduction in development expenditures, however, all in vain. Budget
deficit in Pakistan has varied between 5.4 to 8.7% of GDP during last two decades. Now
government is trying to cut down the subsidies and struggling for improvement in tax
collection process but still it is 5.4% in 2011-12 and is projected at 6.5 % of GDP for end
Public Debt: Pakistans public debt stood at Rs. 12,024 billion as of March 31, 2012.
During first nine months of current fiscal year, total public debt registered an increase of
Rs. 1,315 billion which includes Rs. 391 billion consolidated by the Government into
public debt against outstanding previous years subsidies related to food and energy
sectors. Public debt as a percent of GDP stood at 58.2 percent by end-March 2012. At the
end of March 2012, servicing of the public debt stood at Rs.720.3 billion against the
budget amount of Rs. 1034.2 billion. A major cause of this increased debt is year by year
high deficit.
Reserves:Pakistans foreign exchange reserves reached to $ 16.5 billion at the end-April
2012 compared to $ 17.0 billion at end-April 2011. The exchange rate averaged at Rs.
85.50/US$ during July-April 2010-11, whereas it averaged at Rs. 88.55/US$ during July-
April 2011-12. The Pak Rupee depreciated by 3.4 percent during July-April 2011-12 over
the depreciation of 2.2 percent in July-April 2010-11 period.
Inflation: Inflation has always been the one of major problems of Pakistan. Historically
we can examine the trend of inflation, say, during 1973-1980; rate of inflation remained
high at an average of 14.3 percent. During 1980s the economy experienced a
comparatively moderate rate of inflation averaged at 7.2 percent per annum. But in the
90s it increased again having an average of around 10 percent per annum. In fact, fiscal
sector indicators also moved in the same direction during the sub-periods mentioned
earlier. Inflation is still in double digits (10.8), even more than target of 9.5%. Another
matter to b noticed that, Pak Rupee depreciated by 3.4 percent during July-April 2011-12
over the depreciation of 2.2 percent in July-April 2010-11 period.

Taxation structure and trends
Macroeconomic stability depends to a large extent upon fiscal consolidation, particularly in the context of
emerging economies. Generating sufficient government revenues for provision of public goods and
designing progressive tax structures which address both efficiency and equity considerations are indeed
challenging tasks.
Our analysis should start with a brief description of how the tax structure has evolved since the early
years. The country, with customs duties on imports and exports of cotton and jute as the principal source
of revenue started with a tax to GDP ratio of four per cent.
By the end of the 1960s, with rapid industrialization, tax to GDP ratio rose to 6.4 per cent, with excise
duties as the major revenue source. Income tax, due to tax holidays to promote investment, as well as
sales tax taken over from the provincial governments since 1951, did not show buoyancy. It was the
decade of excise duties.
There was a quantum jump in tax to GDP ratio during the 1970s (14 per cent by 1979-80) mainly due to
an increase of four percent of GDP in customs duties as well as phasing out of tax holidays. The period
from 1970s-1980s referred as decade of custom duties.
Since the early 1990s, tax to GDP ratio has remained stagnant, with decline in the share of customs duties
being offset by improved performance of income and sales tax and it was decade of income and sale
Tax to GDP ratio averaged at 13.2 per cent during the 1990s and at 10.6 per cent during the period 2000
07. Adjusting for the effect of re-basing of GDP in 2000-01 after a long interval of 20 years, it is evident
that tax to GDP ratio has remained broadly unchanged. A comparison with tax revenue levels in
developing countries reveals a relatively low level of fiscal effort Countries in a similar income bracket as
Pakistan have an average tax to GDP ratio of 20 per cent.
The analysis of how major taxes have fared in relation to economic growth depicts that direct tax to GDP
ratio has improved from 1.85 in 198990 to 3.8 per cent in 2006-07. However, it is still much lower than
the developing countries standard of around seven per cent.
As a percentage of GDP, indirect taxes as a whole have declined from 12.4 of GDP in 1989-90 to 5.9 in
2006-07, and within indirect taxes, customs duties came down from 5.7 to 1.5 per cent, sales tax moved
up from 2.2 to 3.6 per cent, and excise duties declined from 2.2 to 0.8 per cent.
The share of direct taxes in total taxes has increased from 18 to 39.4 per cent in 2006-07, while the share
of indirect taxes declined from 82 to 60.6 per cent during the same period. Even within indirect taxes, the
structure has changed profoundly, with the share of customs duties declining from 45 of total tax
collection and 55 per cent of indirect taxes in 1990-91 to 15.6 and 25.8 per cent respectively. The share of
sales tax increased sharply from 14.4 to 36.5 per cent of total taxes and from 17.6 to 60.3 per cent of
indirect taxes during the same period. Central excise as a tax is being phased out; its share in total taxes
and indirect taxes has gone down from 22.5 and 27.5 per cent in 1990-91 to 8.4 and 13.9 per cent
respectively during the same period. This represents a structural shift in the composition of taxes on
account of reforms, which were initiated since the early 1990s and vigorously pursued from 2000
onwards. The base of taxation is rightly moving from trade and investment to income and consumption.
However, though the share of income and sales tax has increased, yet the quantum of increase is not so
strong as to offset the reduction in customs and excise duties. The incremental tax effort should, therefore,
focus on income and sales tax, which would not only enhance the revenue yield but also contribute to a
more balanced, equitable and buoyant tax system.
Fiscal policy rules
A rule-based fiscal policy has generally been associated with improved fiscal performance and
debt sustainability. A prolonged commitment to fiscal discipline may stem from a rule-based
fiscal policy.

International experience suggests that countries, which have adopted well-designed fiscal rules
and implemented them effectively, have garnered important credibility gains and achieved higher
economic growth. Fiscal rules aim to prevent governments from taking short-sighted measures in
the light of election cycles and competing demands from special interest groups, by binding
policymakers to a fiscally prudent path.
Pakistan has experienced serious macroeconomic imbalances in the 1990s mainly on account of
its fiscal profligacy (budget deficit as percentage of the GDP has averaged almost 7.0 percent per
annum), and has accordingly paid a heavy price in terms of slower economic growth, rising debt
burden, and the rise in poverty. A rule-based fiscal framework was prepared in 2002-03 and
enshrined in the Fiscal Responsibility and Debt Limitation (FRDL) Act 2005, and was passed by
parliament in June 2005.

The purpose of the Act was to inject fiscal discipline in the country. This Act ensures responsible
and accountable fiscal management by all governments, the present and the future, and would
encourage informed public debate about fiscal policy. It requires the government to be
transparent about its short and long-term fiscal intentions and imposes high standards of fiscal

There are five keystones of the law.
1. Firstly, starting from July 2003 (2003-04), Pakistans public debt would not be more than
60 percent of the GDP by end June 2013 (2012-13). In other words, Pakistans public
debt had to be reduced from 75 percent to 60 percent of the GDP in ten years.
2. Every year the government would reduce public debt by at least 2.5 percentage points of
the GDP during the ten year period.
3. Revenue deficit would be eliminated by 2007-08 and a surplus would be maintained
4. The government would not provide guarantee to the borrowings of the Public Sector
Enterprises (PSEs) by more than two percentage points of the GDP in a given year.
5. Social sector and poverty-related expenditures would not be less than 4.5 percent of the
GDP for any given year, and the expenditure on education and health would be doubled
in terms of percentage of the GDP in ten years
This law binds the government to pursue a sound and disciplined fiscal policy.

From 2003-04 to 2006-07, the law performed very well. Public debt declined from 75 percent
to 55 percent of the GDP during the period. However, most of the critical elements of the law
have been violated in the last four years.
In particular, public debt, instead of declining, has increased to 60 percent of the GDP and
revenue deficit continues to prevail. None of the members of parliament has ever raised the
issue of violation in the House and Pakistans economy continues to suffer.
Deficiencies in taxation system :

According to the study conducted by The Network to check level of tax compliance in Pakistan,
the weak areas in taxation system are:
Taxpayer has trust deficit
lack of tax compliance culture in a society
lack of tax education
lack of effective complaint redress mechanism in tax system
Malpractices of tax administration.

Policy Recommendations
Fiscal Policy
Pakistan covers the fiscal deficit by issuing notes and borrowing from private sector. This leads to major
problems in the economy. Fiscal deficit can only be reduced by reduction of excessive expenditure by
government or increasing the level of government revenue.
Firstly there is a need of privatization in the economy, as many publically owned enterprises are
creating huge losses and these corporations should be privatized. And the process of
privatization should be done on merit and it should create perfect competition. Selling the
publically owned enterprises will create revenue for the government; this will help government
in short run to reduce some amount of fiscal deficit.
Secondly, it will also halt the amount that government spends to cover the losses of these
enterprises. Then there are other benefits of creating perfect competition among the privatized
firms through a regulatory body. This will increase efficiency, as in perfect competition greater
efficiency leads to higher profits and the firm does not have monopolistic power, so there wont
be any firm which will charge higher price.
Other policy is to reduce non-developmental expenditure, as it creates demand pressure on the
economy. By reducing this non-development expenditure, demand pressure will decrease and
increasing the developmental expenditure, more job opportunities can be created. This will
increase the employment level in Pakistan and it will create better environment for the private
owners to take part in investment. As the economy is suffering from higher unemployment rate,
this is will reduce the unemployment rate.
Another aspect of reducing fiscal deficit is to increase the tax revenue. In Pakistan, taxation structure is
not performing properly. There is corruption and influence of elites on the system which causes increase
in indirect taxes and major revenue is completed through indirect taxes. There is a need to reduce the
indirect taxes, as it causes the price level to increase. Reducing indirect taxes will mean reduction of
regressive taxation system in Pakistan. There is a need of proper and transparent taxation system in
Pakistan which will increase revenue generated from direct taxes. Main tax should on the income of the
public, which is considered to be progressive tax. Rich should be taxed more and poor should pay less
tax. Wealth tax should be re-introduced in the economy. And landowners in Pakistan are not paying the
amount of tax that they should be paying for earning the profits. Landowners should be taxed on the
profits it earns from selling the agricultural products in the market. There is a need to make Federal
Board of Revenue completely autonomous which will ensure that tax is collected in transparent way.
should increase the ratio of direct taxes, more taxes from
rich and less from poor. There should be proper allocation
of these revenues. Sustain trade balance is also key to
remove fiscal deficit. Government official like
parliamentarians should reduce their expenditure as much as
they can. More than 50% revenues utilized on these
expenditures and it increase fiscal deficit.

Pakistan continuously relies on foreign and domestic loaning to finance
This will contribute to budget deficit of the country again as $10.3 billion
reserved for debt servicing in year 2010-11.
Means Pakistan is raising debt to repay debt, while its positive impact on
overall economy is not registered. So reliance on foreign financing should be
avoided through generating domestic resources
Then there should policies to create incentives for greater number of exports from Pakistan. In recent
past, exports of Pakistan have increased but not to the same level of imports. Proper policies should be
made to increase the level of production by domestic firms and to increase the efficiency of production.
Subsidies should be given on importing the machinery for better production rather than taxing the
imports. There shouldnt any tax levied for producing goods for exporting. As the soil of Pakistan is
better for agricultural, incentives should be given the increase the production of agricultural products,
so that it can be exported to other countries and more revenue can be generated for the economy.
Pakistan also requires foreign direct investment to increase its revenues. The multinational companies
should be given incentives to increase foreign direct investment in Pakistan by creating a clean and
favorable environment. This will bring foreign currency in the country and it can be used to reduce the
gap of imbalanced trade.
In Pakistan there is a huge need to spend higher amount of money on human capital. Education
expenditure has been around 2 or 3 percent of GDP. High investment in human capital can lead to
productive and efficient work force which will increase productivity. Minimum expenditure on education
should be 5 or 6 percent. There should higher expenditure on secondary or tertiary educational
institutes so that Pakistan better work force. And there is a need for increased amount of expenditure
on health sector as well, as healthy labor force will in turn give better productivity rate.
Moreover in case of the agriculture reforms, across the rural and urban areas to improve the
dreadful malnutrition situation, it is vigorous that the government should move their care to
encouraging farming of food crops appropriate to original environments instead of cash
collecting and receiving foreign exchange by agricultural trades.
It is a need of time to offer the rural poor more access to land and the requisite support services
to assist them come to be viable farmers, attaining food sovereignty will stay an mysterious
goal, and the grassroots in our republic will endure to practice hunger, its associated health
problems, and various forms of social disturbance.

The majority of political leaders last year failed to submit any income tax returns despite lecturing
citizens on the need to improve revenue collection in a country with a yawning financial deficit.
Fiscal strictness should be imposed by curtailing all unnecessary
expenditures of the government. The total expenditure was Rs. 1874 billion
in year 2007-08 which has increased to Rs. 3259 billion in 2010-11. This
continuous increase in expenditure is unjustifiedat all if we look at miserable
performances of the various government departments. Reduction in
cabinetsize is the first step towards this. Austerity measures should be
adopted by all at all levels.
The study, published by the Centre for Investigative Reporting in
Pakistan, found that only 20 of 55 cabinet ministers had filed returns,
while 49 senators of 104 paid income tax.
militarisation in south Asian states has come at the cost of the health and education sectors.
egion's countries spend billions of dollars on arms and ammunition despite 40% of the world's poor
living in South Asia.
tax rates on urban immovable property in the main cities of Pakistan are
kept low because ownership is concentrated among the elites

The top eight public sector organizations alone incur annual losses of more
than 250 billion rupees, an amount higher than Pakistans development
budget. These loss incurring Public sector enterprises should be privatized or
their expenditures should be controlled, except an improved,
rationalizedand updatedprogram is launched
Economys overall growth and development in the form of improvement in
GDP growth will definitely leaves positive economic affects. It also helps in
reducing the fiscal deficit. Political stability, maintenance of rule of law,
transparency, general security etc will encourage domestic and foreign
investors. Improved business conditions, solution to the current energy
crises are important in improving productivity and growth in the economy

Change the general perceptions of citizens which are negative to tax culture in society.
There is a strong need to change knowledge aptitude and practices (KAP) of the tax payer to
build a sound tax compliance culture in the society.
Broadening of the tax base was intended to ensure the fair distribution of the tax burden
among various sectors of the economy.
There are various segments of Economy, such as Agriculture, wholesalers, distributors
and retailers, real estate, stock exchange, etc. which are not contributing towards the tax
revenue in proportion to their contribution in Economy. There is a dire need to make
necessary corrections in the tax system to have equitable distribution of tax incidence on
all sectors of the Economy.
Typically traditional bureaucratic method for raising revenues is to increase the rate of
tax and number of taxes which is always counterproductive and leads to tax evasion and
makes the tax base shrink.
Wealth Tax was abolished in 2000 under the pressure of powerful who did not want to
pay Wealth Tax on their properties and plots, despite of its rates were quite low. It is an
important tool of a fiscal policy which endeavors to establish equitable economic
justice. Due to rising trend of investment in non-productive sector like properties, it
would be advisable to impose Wealth Tax on all immovable properties at a fixed rate to
be paid at the time of purchase/transfer.