KARACHI: Pakistan’s plea for billions of dollars to recover from this summer’s floods has sparked pressure on the country to reform a tax system that collects very little money, even from the rich.
The country’s biggest donor, the United States, has issued one of the strongest warnings, saying the world will only be able to fund a quarter of the tens of billions of dollars it will take to rebuild — and it will be difficult to get American taxpayers to help if Pakistanis aren’t footing their share of the bill.
But many economists fear the threats are hollow and the U.S. and others will once again bail out Pakistan without insisting on necessary economic reforms because the nuclear-armed country is so important in the war against Al-Qaeda and the Taliban.
"Pakistan can say, ‘If you don’t help us, the economy crumbles, the Taliban takes over and there goes your war on terror,’" said Akbar Zaidi, an economist who recently published a report on Pakistan’s tax system for the Carnegie Endowment for International Peace. "They don’t want to alienate the government, so they will let them off the hook."
Despite years of international pressure, Pakistan has one of the lowest effective tax rates in the world, equal to about 9 percent of the value of the country’s economy, according to the Carnegie report. In contrast, the U.S. equivalent is more than three times as high at about 28 percent.
One of the reasons Pakistan’s rate is so low is because many people avoid paying taxes. Fewer than 2 percent of the country’s 175 million citizens pay any income tax, according to the report.
Also, some sectors of the economy like agriculture — a major money maker for the elite — are totally exempt from tax, and the rich have pushed to keep it that way.
"A small elite comprised of the military, land owners, and the rising urban upper and middle classes, is loath to give up any of its wealth (some of which is illegally accumulated)," said the report.
Ishrat Hussain, former head of the Pakistan central bank, estimated that better enforcement of current tax policies and the elimination of key exemptions should produce an effective tax rate of 15 percent — generating nearly $10 billion in additional revenue per year.
That money would go a long way toward repairing devastation from the floods, which affected more than 18 million people and damaged and destroyed over 1.8 million homes. It would also provide the money necessary to begin fixing Pakistan’s crumbling school system and health infrastructure.
"This is a time we have to tell people that we have to all pitch in and mobilize our own resources," said Hussain. "Why should the international community come to your rescue if you are not doing your part of the bargain?"
He said donors should keep up the pressure on Pakistan, but advised against directly linking reconstruction money to tax reform, predicting the move could backfire in a country where animosity toward the West, and the U.S. in particular, is extremely high.
"It wouldn’t be a very smart move because people here would consider this as an intrusion on their sovereignty, and the debate would then be muddied," said Hussain.
The U.S. and other countries have donated around $1 billion for emergency relief, and international financial institutions have provided about $2.5 billion in emergency loans. Donors are scheduled to meet in New York this weekend to discuss raising additional aid.
Washington has promised more money for reconstruction, but the U.S. special envoy to Pakistan, Richard Holbrooke, warned during a visit to the country this week that the international community could only fund about 25 percent of the bill. He said the U.S. would not condition reconstruction money on tax reform, but cautioned that American generosity has its limits.
"I don’t want to withhold money they need, but I think we have to be clear that the Congress is going to be reluctant to give money if the money is filling in a gap because people are not paying taxes," he said.
Earlier this month, the International Monetary Fund held back more than $1 billion of funding because Pakistan had not met a number of economic criteria, including reforming its tax system. The money is part of a multibillion loan Pakistan took out in 2008 to stabilize its economy.
It’s unclear if the IMF’s tough stance will last. The organization has provided funding to Pakistan in the past when it didn’t meet its loan criteria — a move that some Pakistani economists believe was driven by international pressure because of Pakistan’s strategic importance.
Pakistan had promised the IMF it would introduce a new tax scheme in July — moving from a general sales tax to a value added tax — but ended up delaying it until the beginning of October because of disagreements between the central government and the provinces, especially Sindh province.
Kaiser Bengali, a senior adviser to the Sindh chief minister who is responsible for negotiating the tax deal with Islamabad, said it seems unlikely that the government will be able to reconcile its differences with the province by the revised deadline.
"I wouldn’t do things simply because the donors are asking me to do it," said Bengali.
If Pakistan does not reform its tax system and the donors fail to bail the country out, it is unclear how the nation would come up with the money necessary for reconstruction. The government has proposed a one-time tax on urban property and agricultural land not affected by the floods, but it is uncertain whether it will be implemented and how much money it would produce.
Hussain, the former central bank chief, said that even if the one-time tax was implemented, he was worried the elite would simply use their influence to avoid paying anything as they have done in the past.
"The system has given power to the thieves to monitor themselves," he said.
Additional reporting by Ashraf Khan and Asif Shahzad
