World Bank for improving domestic revenue mobilisation, public expenditure efficiency

ISLAMABAD: The World Bank recommended Pakistan to improve domestic revenue mobilisation and public expenditure efficiency to generate greater fiscal space, which should be prioritised to expand social expenditure and targeted transfers and to improve fiscal equity.

The bank in its report, “The effects of taxes and transfers on inequality and poverty in Pakistan,” stated that as Pakistan has recently faced substantial fiscal challenges, natural disasters, and negative economic shocks (such as the Covid-19 pandemic), disparities in income, consumption, and access gaps to services are likely to have widened further for the poor and vulnerable.Fiscal incidence analysis (FIA) for Pakistan for fiscal year 2019 summarised in the report is the first study that models the joint distributional impacts of the country’s main taxes, social expenditures, and subsidy expenditures on households’ welfare, the WB added.

The bank stated that over the past two decades, Pakistan has struggled with low and increasingly volatile economic growth.

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Although Pakistan lifted about 46 million people out of poverty between 2001 and 2018 and halved the headcount poverty ratio in that time span, rural poverty remains twice as high as poverty in urban areas. Nationwide, the top 10 percent of the population consume on average three times more than the bottom 10 percent, and their incomes are five times larger, with no substantial change over time. These inequalities in income and consumption translate into unequal access to human capital development services and unequal access to economic opportunities, which further limits intergenerational mobility.

The report noted that the combination of taxes, social expenditures, and subsidies modeled increases the national poverty headcount while leaving inequality largely unchanged in fiscal year 2019. The Gini coefficient index of inequality is reduced slightly from 29 at prefiscal income to 28.6 at final income while the national poverty headcount increases from 23.3 percent at prefiscal income to 25.5 percent at consumable income.

Further most poor and vulnerable households are net payers into the fiscal system meaning that benefits received are smaller in magnitude than taxes paid. Only individuals from the poorest ten percent of the population can expect to be net recipients – or can expect to receive more in benefits than they will pay in taxes – with a net cash gain estimated 1.2 percent of prefiscal income. All other individuals can expect to be net payers in cash terms, with cash losses ranging from -1.8 percent in decile 2 to -5.5 percent in decile 10 (the richest decile). That deciles 2 and 3 are net payers of the fiscal system is consistent with the increase in the poverty headcount ratio due to fiscal policy while the fact that the cash losses are greater in the richer deciles is consistent with the slight reduction in inequality due to fiscal policy.

Further richer households capture a larger share of the subsidy and in-kind benefits available and pay more of total revenues collected from direct and indirect taxes. Estimating each decile’s share of the total subsidy benefits available or the total revenue from indirect taxes provides a summary of how concentrated benefits or taxes are in one group.

In Pakistan in fiscal year 2019, the two richest deciles capture 34 percent of total subsidy expenditure, 29 percent of in-kind education benefits, and 27 percent of in-kind health benefits, and pay 40 percent of total revenues from indirect taxes. The subsidy and in-kind benefit shares received by the two richest deciles are driven by the electricity subsidy, tertiary education, and inpatient health spending. The two richest deciles also pay just less than 90 percent of total direct taxes modeled while the two poorest deciles receive approximately 53 percent of the total direct transfer spending.

The general sales tax (GST) has the largest negative impact on the poverty headcount; the Benazir Income Support Program (BISP) has the largest positive impact on inequality reduction. Estimations of the marginal contributions of individual fiscal instruments – or the additional impact that individual fiscal instruments have on poverty or inequality when all other fiscal instruments are included – demonstrate that GST has the largest marginal contribution to the national poverty increase. GST is allocated roughly in proportion to consumption expenditure and therefore is neither strongly regressive or strongly progressive; however, GST payments account for over seven percent of households’ pretax expenditure which leads to further impoverishment among poor and vulnerable households.

The BISP transfers and direct taxes are the most cost-effective fiscal policy tools for reducing inequality while protecting poor and vulnerable households; in contrast, indirect subsidies are relatively ineffective.

The report noted that among comparator middle-income countries, Pakistan has the highest poverty increase and the lowest inequality reduction from the sample. This result can be explained by the fiscal facts in Pakistan, namely: (1) tax collections overall were relatively low at 13.4 percent of GDP, and (2) were generated in large part from impoverishing indirect taxes, while (3) the vast majority of domestic revenues and other sources of financing were dedicated to rigid expenditures like debt service, the government’s wage bill (including pension payments).

The bank stated that fiscal sustainability could go together with fiscal equity if additional revenues collected from GST harmonisation, for example, is used to compensate poor and vulnerable households through well-targeted cash transfers. Similarly, public expenditure efficiency reforms (for instance, moving from generalised ineffective subsidies in the energy sector to targeted social transfers) could improve fiscal sustainability along with fiscal equity. Further expenditure reforms to improve the accessibility and quality of public health and education services in Pakistan could have long-term impacts in terms of poverty and inequality reduction.

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