Taxation, Dependency Syndrome and the Pearl of Sovereignty

Pakistan emerged as a separate homeland for Muslims by assiduous hard work and enormous sacrifices of Muslims. The pioneers of Pakistan movement dreamed of a state that could offer a peaceful milieu, liberating Muslims from foreign rule and enabling them to live their lives self-sufficiently. It is very much disheartening to see that Pakistan is yet not a sovereign state, neither politically nor economically. By ‘sovereignty’ it is meant that a country has the ability and potential to take decisions according to its own core interests. In today’s globalized world no country is completely autonomous; in fact there exists a mutually beneficial interdependence among states. Sovereign states are those which develop their mutualist relationship in a way that maximizes benefits for them. Under this definition, the political history of Pakistan, foreign influence and its ongoing international policies undoubtedly suggest that Pakistan is by no means in position to bargain with powerful sovereign states. Since its birth, Pakistan has always been in need of foreign aids and powerful backing but the help has reached in a way always benefiting the giver and plunging Pakistan into further dependence and political suppression. The aim of this paper is to find the reasons for the prevalent dependency syndrome, the vices of foreign aids and proposing an indigenous way through which Pakistan can claim to be a real sovereign state.

Starting with the very concept of state, Max Webber defined the ideal state as “an organization, composed of numerous agencies led and coordinated by state leadership that has the ability or authority to make and implement the binding rules for all people as well as the parameters for rule making for other social organizations in a given territory using force if necessary to have its way” (as worded in Migdal, 1988:19). Real states fulfill this definition more or less and their degree of sovereignty also varies accordingly. For an entity to be called a state, it, at least, needs to be the prime authority in its territory (Malik 5). Being the prime authority puts various responsibilities on state government engaging it in several undertakings.

Any state, autocrat or democrat, weak or strong and sovereign or dependent performs some principal functions. According to Organski et al, political scientist, the principal functions of any state are “National Security, collection of resources to meet collective needs and mobilization of population for national purposes.” Charles Tilly also identifies similar basic roles for state governments. Maintenance of national security includes external defense and internal peace making and harmony. To fulfill this role state requires different institutions including military, judiciary, police and intelligence agencies. Collective needs include provision of equitable resources, state infrastructure and basic facilities of health, education and housing. This again requires some state financed non-profit institutions. All these institutions and whatever government may wish to do require resources and money. Thus, resource extraction is central activity of a state necessary to carry out its other basic functions.

The pattern of resource extraction differs among various countries. Broadly the means of extractions are divided into taxation, non-tax revenue (foreign aids and borrowing) and money printing. Revenue generated from taxation and government run profit organizations is earned revenue of the state however; the revenue generated from foreign aids, borrowing and money creation is unearned revenue. In reality a combination of both earned and unearned revenue is used to fund the government policies but the primary source of revenue extraction determines the extent to which a state is sovereign or dependent.   ((Problems of renteir states, developmental and rentier countries how Pakistan is a rentier state and dependent state))

According to Evans “developmental state engages in entrepreneurship and plays a needed role in economic transformation” and according to Hussain Mahdavy Rentier states are those countries that receive on a regular basis substantial amounts of economic rent. ))

When Pakistan was created it was fifth largest population of the world having enormous potential to overcome its problems. But size is relative term; the three of four most populous countries (China, India Russia) were located in the neighborhood of Pakistan. Furthermore, Pakistan not only considered itself an insecure small state but also as defensive and disadvantaged against the real threat (India) with its survival at stake. Thus, Pakistan’s initial foreign policy was aimed at getting strong foreign backing and economic and military support that could help Pakistan in case of one-to-one engagement with India. But Pakistan was unable to find any supportive hand, not even from the Islamic block, until it could rent out its ‘strategic’ land to United States for the containment of Soviet Union in early 1950’s. Pakistan started receiving military and economic aid from US and found itself at better position in dealing with India. During the same period USSR also started taking interest in Pakistan and Pakistani leadership managed to make bilateral equations with both US and USSR. The new policy was designed such that Pakistan could get economic rent and benefits from both countries and Pakistan did succeed in it.  

As such grants are always a matter of willingness of donor, they are never permanent. This happened to Pakistan is mid 1960’s when US and USSR both lost interest in Pakistan and stopped supporting it. US in fact cut off all the military supply during 1965 war and Pakistan had to suffer badly as it did not possess any more resources to wage war. The devastating results made it obvious to Pakistan that foreign dependence had jeopardized the national security.  However, instead of any decisive shift to promote self-reliance, Pakistan’s policy remained the same with adjustments to diversify international patronage (Malik 106).

 During the Afghan-Soviet war Pakistan got a chance to cash its geographic location and again started receiving economic rent and aid for the petty services it provided. However, after the Russian collapse and end of cold war, US started keeping Pakistan at arm’s length, once again cutting all the economic and military aid.

Although Pakistan was twice let down by the unreliable US but the post 9/11 events showed that it had not learned the lesson yet. The deep sense of insecurity and economic backwardness yet again forced Pakistan to ally with US against the war on terror. American aids and military supplies were enough to shut the mouths of Pakistani leaders and to keep the nation oblivious to the menace of the aids and military grants. Today, however, the results are in front of us Pakistan is still fighting war on terror which has now become indispensable, America is continuously demanding for doing more, terror attacks are destroying the peace and hampering foreign capital investment, state institutions have either crippled or at the verge of disaster and the country is suffering from severe economic  downturn. Unfortunately, the worst scenario is Pakistan is still demanding for more aids knowing the fact that each time when it arrives a part of the nation’s sovereignty is taken away. The budget deficit 2012-13, restoration of NATO supply and IMF loans clearly annotate that Pakistan is hankering after American dollars thinking that it has no other way out.

However, a deeper look into Pakistani society and its economy allude to the real problem of the state. Since its birth Pakistan has been suffering from economic depression and regrettably successive governments in Pakistan have always capitalized its location to carry out their expenses. And if the rented-revenue ever fell short international borrowing and other resources were located to meet the needs. During 2007-2010 Pakistan remains the third biggest drawer of IMF loans, borrowing US$ 8,735,566,000, and having only Romania and Ukraine above in the list (World Bank). The circular debt has increased to disastrous level.

 The problem lies in the prevailing system of resource extraction, the key activity of state. The domestic extraction, revenue collected in form of taxes, is merely 10 percent of the GDP. And Pakistan, throughout its history has never been able to attain a tax to GDP rate of more than 10%. The countries with better tax to GDP ratios are China 34.7, Denmark 34.3, Norway 26.9, United Kingdom 26, Hungry 23.9 and Turkey 20.5. Pakistan can only be compared with countries like Afghanistan 8.3, Bangladesh 8.6, India 9.48 and Bhutan 9.2. Tax to GDP ratio also determines the wealth of country. It can be deduced from a World Bank’s report on GDP per capita (domestic product divided by midyear population) that countries with better Tax to GDP ratio have  more money to invest in productivity enhancement and thus better income for their individuals (GDP per capita). Denmark, Norway, Hungry, Turkey and UK are above the average GDP per capita of the whole world. However, countries like India, Bangladesh, Pakistan, Afghanistan, Bhutan, are all below the world’s average figure. Pakistan has GDP per capita of only US $1194.328 and is the 34^th poorest country of world. [http://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS]

The causes of low tax to GDP ratio are quite obvious in case of Pakistan. Pakistan is a kind of state where extreme economic discrepancy can be found among its classes. According to World Bank more than 60% of population of Pakistan lives below US $2 a day with more than 22% population living below poverty line. On the other hand 39.3% of income or consumption is shared by richest 10% of Pakistani population [https://www.cia.gov/library/publications/the-world-factbook/geos/pk.html]. The dilemma is poor don’t have enough money to contribute properly towards national revenue, rich don’t want to contribute and middle class is already very little in number which is further reducing because of ongoing Industrial downturn.

The incongruous income difference among classes further upsets the tax revenue and tax collection policy when the elite class also becomes a part of government and policy making. Such overlapping has been in Pakistan since its birth, the clash of interests has caused its leaders and policy makers to opt for their personal interests rather than nation welfare. The influence of powerful elite over taxation policies has always aimed at keeping the direct taxation as low as possible. An example of such influence is abolition of Wealth tax in 2003. Thus rich never give taxes and poor always have to bear the brunt of them. The countries with higher tax to GDP ratios always use a system of progressive taxing (taxation at rates with rise in income) but in Pakistan due to extensive pressure from elite the whole emphasis is on indirect taxation.

Indirect taxes are quite easy to collect and no one can escape it. Currently the government is collecting most of the revenue by taxing necessities including petrol, gas, diesel, telecommunication services. More than 50% of tax revenue is collected from sole manufacturing sector which have a share of less than 25 % in GDP. The tax on services sector is below potential despite having a share of 53% in GDP. Agricultural sector has a share of 22% in GDP but there is almost no tax on this sector. Similarly contribution of livestock (providing 50% value addition), horticulture and sprawling orchards is missing. The tax net is further reduced by undocumented economy (undeclared income earned through any economic activity). According to an estimate the undocumented economy of Pakistan is three times the regular economy and has potentially has no share in tax revenue.

According to fiscal sociology direct taxation is the best way of resource extraction but it requires more structural arrangements and efforts to collect it. People try to escape it where ever possible. On the other hand, indirect taxation does not permit leakage and being easy to implement seems an easy option to government. However, there is a limit to which people can be taxed. Tax can be applied only if economic transaction takes place. When tax rate exceeds a certain limit the economic transaction simply tends to cease and thus diminishing all three: producer surplus, consumer surplus and tax revenue. Pakistan has already reached a level where further indirect taxation would only cause bigger dead weight and hamper economic activity. Excessive reliance on money creation causes inflation and currency depreciation. Pakistan has one of the highest inflation rates (13.7) in the world and is ranked at 205^th position [https://www.cia.gov/library/publications/the-world-factbook/rankorder/2092rank.html?countryName=Pakistan&countryCode=pk&regionCode=sas&rank=205#pk]. International borrowing and grants are doing no good. They are just making Pakistan more dependent.

In a nutshell, Pakistan needs to extract resources itself from its own people if it wants to be a sovereign state. Such an indigenous solution is expansion of tax base and imposition of direct taxation. As the saying goes ‘every dark cloud has a silver lining’, similarly with the prevailing loopholes and paucities there exists an undiscovered potential for enhancement and improvement of tax system of Pakistan and hence its resource extraction.  A political will and decisive shift of abandoning foreign aids, minimizing borrowing and money creation is will play vital role towards sovereignty of Pakistan.

Written By;-Fahad Khurraam