Dr Ikramul Haq[*]

It is a matter of great tragedy that our economic managers never thought of using tax policy as a tool of economic development, and their sole stress on revenue targets at the time of making annual budgets has resulted into economic chaos. The persistent failure of our financial managers and tax collectors to overcome fiscal deficit and remove fiscal imbalances has created a situation of an economic disaster. Our economic survival now lies in collecting taxes wherever due by abandoning the policy of appeasement towards the powerful and the rich. An unshakable determination, consistency and political will is required to curb the 54-year-old habit of defying tax laws along with complete purge in tax machinery.

This article outlines the major areas where the tax policy can be used as a tool for development strategy. The role of taxation and fiscal policy in development strategy has to be viewed against the background of the functions which it performs. The main functions of a tax system in relation to economic development are enumerated below.

1.         The primary function of a tax system is to raise revenue for the government for its public expenditure as well as for local authorities and similar public bodies. So the first goal in development strategy as regards taxation policy is to ensure that this function is discharged effectively. The performance of the Pakistani tax managers is highly disappointing as fiscal deficit remained high during the last decade and the revenue targets fixed annually were revised downwards many a times.

2.         To reduce inequalities through a policy of redistribution of income and wealth. Higher rates of income taxes, capital transfer taxes and wealth taxes are some means adopted for achieving these ends. In Pakistan there has been a gradual shift from equitable taxes to highly inequitable taxes. The shift from removing inequalities through taxes to presumptive and easily collectable taxes has destroyed the entire philosophy of taxes. This deviation has transferred the burden of taxes from the rich to the poor.

The equity principle in taxation implies that taxes should be imposed in accordance with the ability to pay. This has two dimensions:

–           Horizontal equity, i.e. similar treatment of persons in similar circumstances;

–           Vertical equity, i.e. different treatment of persons with different taxable capacity.

The equity principle can be held to be satisfied when the overall classification of individuals into categories is reasonable and broad enough to contain many individuals within each category and there is equal treatment within each category.

3.         For social purposes such as discouraging certain activities, which are considered undesirable, for example, excise duties on liquor and tobacco and special excises on luxury and semi-luxury goods. Such measures act as deterrents in avoiding a spill over of these items and creating disturbance in the society as a consequence.

4.         To achieve economic goals through the ability of the taxation system to influence the allocation of resources. This includes:

–           transferring resources from the private sector to the government to finance public investment programme;

–           directing private investment into desired channels through such measures as regulation of tax rates and the grant of tax incentives. This includes investment activities to attract foreign direct investment in to the country;

–           influencing relative factor prices for enhanced use of labour and economizing the use of capital and foreign exchange.

5.         To increase the level of savings and capital formation in the private sector partly for borrowing by the government and partly for enhancing investment resources within the private sector for economic development. In Pakistan we find a reversal of this principle. Recent years have experienced flight of capital, closure of huge industries and recession in the trade market. Lack of consistency in the tax policies have forced the business community to move towards safer havens depriving the country of invaluable capital. Similarly, foreign investors feel shy to make use of the tremendous Pakistani talent that goes to waste for lack of proper funding.

6.         To protect local industries from foreign competition through the use of import duties, turnover taxes/VAT and excises. This has the effect of transferring a certain amount of demand from imported goods for domestically produced goods. Pakistan is one of those very fortunate countries of the world that has an abundance of resources and a climate that is fit for simply any activity throughout the year. But unfortunately and thanks to our economic wizards, our dependence on imported products has been hit with an upward surge in the recent years. Due to the introduction of harsh tax measures and misadministration, turnover tax being one of them and non-issuance of refunds another; both our agricultural and industrial sectors have suffered so badly that instead of being able to export our goods we are forced to import in order to cater for the demands of the nation.

7.         To stabilize national income by using taxation as an instrument of demand management. Taxation levels could be used to eliminate an inflationary gap or deflationary gap in the economy. Taxation reduces the effect of the multiplier and so can be used to dampen upswings in a trade cycle.

Taxes affect growth in two ways. First, by influencing the aggregate supply of the main factors of production by raising or lowering their net (after tax) returns; and second, by influencing the efficiency of resource utilization (total factor productivity). Some of the main factors in this process are discussed below.

 

Tax revenue ratios to GDP

Level of taxation in a country is traditionally judged in terms of the ratio, which taxes bear to some measure of national income. This ratio is called tax-GDP ratio and the change in it is determined by variations in both the numerator (total tax revenue) and the denominator (national income).

There are various problems associated with the definitions of numerator and denominator of tax-GDP ratio. For example, should profits/losses of public monopolies form part of the numerator? Should social security contributions be included in tax receipts? The denominator of the ratio suffers from more ambiguities because there are various measures of national income. Among the alternative measures of national income, the important ones are: Gross Domestic Product (GDP), Gross National Product (GNP), and Net National Product (NNP). Should taxes be related to GDP or GNP or NNP, and whether at market prices or at factor cost?

In choosing from the alternative measures of national income, the important considerations are: (a) the measure chosen should be readily available, (b) it is widely understood, and (c) it is reliable. In view of these considerations, it is a common practice to use GDP at market prices as the denominator of the tax-GDP ratio. GDP is preferred because it avoids estimation of depreciation that is subject to various statistical conceptual problems. For example, the Organisation for Economic Co-operation and Development uses GDP at market prices as the denominator for comparing tax-GDP ratios among its member countries.

The study of tax-GDP ratio is important because trends in taxation in a country or group of countries are analysed mainly in terms of this ratio, and the composition of tax revenues. The latter may change owing to variations in tax-GDP ratio.

Tax-GDP ratio is generally regarded as an index of relative tax burden in a country over a period of time or when countries are compared for the same period (cross-section analysis). To describe tax burden in terms of tax-GDP ratio can be misleading because tax, though burden for individuals, are used to finance vital governmental activities and to make transfers to needy sections of society.

What then does tax-GDP ratio signify? Since tax-GDP ratio indicates the percentage of national income that is compulsorily transferred from private pockets to public exchequer, and hence the relative share of government in the disposition of national income, it signifies the economic role of a government in the national economy.

The ratio, however, does not reflect the importance of government sector as a final purchaser of goods and services because a part of tax revenue is returned to the private sector in the form of transfer payments like pensions and scholarships. If such transfer payments are deducted from the total tax revenue, the ratio of the remaining tax revenue to GDP will show importance of government as a final purchaser of goods and services. Since revisions are not uncommon, particularly in developing countries, and therefore they indicate a limitation of the use of tax-GDP ratios. These cautions must be kept in mind while interpreting tax-GDP ratios.

Since an adequate volume of government revenue is essential for public expenditure and economic growth, the ratio of tax revenue to GDP has been used regularly to measure and judge the success of a country’s fiscal management.

Tax-GDP ratio varies from country to country. What explains inter-country variations in tax ratios? The list of factors affecting tax ratio is almost inexhaustible. It includes a wide variety of economic, social, cultural, and political factors. Broadly speaking, the variables explaining inter-country variations in tax ratio may be grouped under two categories:

1. Quantitative or statistical factors, and
2.  Qualitative or institutional factors.

Among the quantitative factors the important ones are the following. These factors are crucial as they determine the tax base which government uses to raise tax revenues. They are also the determinants of tax levels most widely used in empirical studies. They are believed to exert a strong influence over the tax ratio through their effect on what are called capacity factors.

1. Stage of Development. Stage of economic development is the first and foremost determinant of tax ratio. Economic development is a multi-faceted phenomenon affecting quality of life and therefore cannot be measured precisely by single variable. Still, a variable frequently used a proxy is per capita income which, though incomplete, is by far the single best indicator of the stage of economic development attained by a country.

It is usually hypothesised that per capita income and tax ratio move in the same direction, i.e. they are positively related. Presumably, people in countries with high per capita income require a smaller proportion of their incomes to meet their basic needs, and hence are left with a surplus which may be conveniently taxed. It is also argued that income elasticity of demand for public goods is high at high levels of per capita income. Moreover, since development process is normally accompanied by increasing urbanisaiton, high literacy rate, widespread monetisation, public consciousness, and improved administration, the scope of taxation, particularly direct taxation, increases because all these factors are conducive to tax collection. However, in the context of inter-country comparisons, the use of per capita income as a determinant of tax ratio is subject to errors owing to the conversion of domestic currencies into US dollars. Moreover, the relationship between tax ratio and per capita income becomes decisive only after the latter has reached a minimum level, though it is difficult to define that level.

• Composition of GDP. Another determinant of taxation level is the composition of GDP or the industrial origin of national output. Normally, a higher agricultural share in GDP is indicative of a lower per capita income, and hence a low stage of economic development. Thus, the proportion of income generated in the agricultural sector provides another index of a stage of development. Two countries may have the same level of per capita income but differences in the composition of their national output will affect their taxable capacities and tax ratios. Preponderance of agricultural sector means lack of industrialisaiton, existence of a large subsistence sector and administrative difficulties in implementing tax laws. Moreover, there is effective political resistance to taxation of agricultural sector. All these factors explain the negative influence of the agricultural sector on tax ration.

Contrarily, the relative share of mining sector has a positive influence on tax ratio. As Roy Bahl has opined, “ the mining sector generally produces a larger surplus than any other sector, and therefore it is a positive determinant of taxable capacity. Because of the heavy fixed investment associated with mining industries, operations will tend to be confined to a few large firms, and accordingly it will be administratively easier to levy income or export taxes.”

Tax potential is greatly increased where industrial production dominates other sources of national income. Industrialisaiton is associated with urbanization, banking transaction, accounting practices, all of which facilitate levy and collection of taxes. Some taxes (e.g. corporation tax) are directly linked with industrial activities.

• Foreign Trade. Another determinant of tax level is the size of the foreign trade sector. It is presumed that taxable capacity increases with the expansion of external trade because it is administratively easier to tax trade inflows and outflows that internal transactions. Moreover, a relatively large size of external sector is indicative of greater degree of monetisation and organized industrial sector, both of which are favourable conditions for taxation.

There are three alternative measures of the size of foreign trade sector based on combinations of import and/or export share of GNP. These are: (a) import ratio (My), (b) export ratio (Xy), and (c) openness ratio, i.e. the ratio of imports plus exports (my + xy) to GNP. Theoretically, the use of openness ratio is justifies because it reflects the total trade base available for taxation.

• Composition of Government Expenditure. If public expenditure pertains mainly to welfare activities (educational and medical services), it will favourably influence the general standard of living and hence the taxpaying capacity of the citizens. Conversely, if a large proportion of expenditure is devoted to defence, and law and order, the taxpaying capacity will be reduced.

• Pattern of Income Distribution. Two countries with the same level of per capita income may have different taxable capacities if the pattern of income distribution differs. Thus, size distribution of income becomes another determinant of tax ratio. It is widely believed that scope for taxation is greater when degree of concentration of income and wealth is higher. This is not always true because economic concentration implies more political power with the rich who effectively resist additional tax burdens upon themselves. For example, in India the near absence of agricultural income tax is mainly due to the preponderance of landlords and other vested interests in state legislatures.

Among the qualitative factors, the important ones are: efficiency of tax administration, attitude of the citizens towards government and its laws, and ideology of the ruling party (e.g. left wing governments prefer a larger public sector). It is difficult to quantify the influence of socio-political factors on taxable capacity.

Recently, Vito Tanzi has called to attention the connection between tax levels and macroeconomic policies such as exchange rate, import substitution, trade liberalization, inflation, public debt, and financial policies. He believes that changes in tax levels cannot be attributed to traditional determinants alone, and greater attention should b devoted to the relationship between these macroeconomic variables and tax levels.

Factors influencing tax-GDP ratio are many and a variety of permutations and combinations can be used in empirical analysis. The choice of actors and their application is, however, constrained by the availability of data in a country.

Limitations of Inter-Country Tax Comparisons. Are inter country comparisons of taxation levels meaningful? Some fiscal experts have sharply criticized these attempts. According to critics, the economic, political, and institutional characteristics of individual countries are so different that neither theoretical nor empirical studies provide useful information of policy relevance. Tax-GDP ratios do not consider the fact that some countries are more favourably placed to levy and collect taxes than other. For example, Lotz and Morssan analysed a sample of 72 developed and developing countries to examine the relationship between tax ratio variations and differences in per capita income and degree of openness. The sample included a wide spectrum of dissimilar economies ranging from Nepal to Singapore. It is prima facie erroneous to compare Nepal’s high rural and agricultural economy with a high commercial and industrial city-state of Singapore.

Generally the tax revenue to GDP ratio in developed counties has been high and in the less develop countries low. Table 1 gives the tax/GDP ratios for selected countries in 1999.

TABLE 1

Country                                                                          %

Belgium                                                                                               43.3

Netherlands                                                                                         42.9

Germany                                                                                             26.6

United Kingdom                                                                                 34.2

United States                                                                                      19.1

Malaysia                                                                                              19.2

Thailand                                                                                              16.1

Pakistan                                                                                               12.3

Sri Lanka                                                                                             16.0

Source:  IMF – Government Finance Statistics.

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The higher ratio for the industrialized countries is primarily due to the higher level of revenue from social security, payroll taxes, corporate taxes and taxes on domestic on consumption while the taxes from international trade and non-tax revenue are lower. In contrast, in the developing countries the major portion of revenue comes from the indirect taxes, particularly the taxes on international trade and domestic consumption, while the direct taxes have a lower share. Pakistan GDP-tax -ratio is even below than Sri Lanka and Thailand, which proves beyond any doubt the failure of fiscal managers and tax collectors.

 

Tax rates, savings and capital formation

It is difficult to establish a direct and precise statistical correlation between tax rates and private capital formation due to such factors as the time lag, changes in the tax base and other externalities determining investment.

Nevertheless historical and statistical trends tend to suggest that savings and private capital formation have been sensitive to effective tax incidence. It has increased during periods when taxation, particularly direct tax incidence, is low.

Therefore it seems logical to conclude that in order to promote savings and capital formation, the reduction in income taxation has to be considered a necessary, though not by itself a sufficient, condition.

Table 2 indicates Pakistan’s comparative position in these respects in relation to selected Asian countries. These indicators also confirm that our rulers have failed to improve the lot of the poor people and over the years there has been increase in poverty levels.

 

 

TABLE 2

Economic Growth Indicators – Selected Asian Countries

Country	Years	Gross National Product (GNP (USD million)	Growth rate (%)	Per capital GNP (USD)	Gross Domestic Capital Formation	Domestic savings
Sri Lanka	1990	7,973	6.2	469
	1995	12,859	5.5	710	25.7	15.3
	1996	13,701	3.8	748
Pakistan	1990	41,130	4.6	366
	1995	59,432	4.4	456	18.7	15.7
	1996	60,650	6.1	452
Malaysia	1990	40,902	9.7	2,303
	1995	83,092	9.5	4,014	43.2	39.5
	1996	93,545	8.2	4,412
Thailand	1990	84,369	11.2	1,511
	1995	163,921	8.8	2,760	43.3	36.2
	1996	179,837	6.7	2,997
Korea	1990	251,868	9.5	5,875
	1995	452,473	8.9	10,089	37.0	36.8
	1996	480,627	7.1	10,622
Singapore	1990	37,590	9.0	13,871
	1995	85,636	8.8	28,641	33.1	50.8
	1996	94,874	7.0	31,625

 

 

Tax elasticity and buoyancy in development

A principal fiscal aim in any development strategy is to increase the elasticity and buoyancy of the revenue system. Elasticity reflects the built-in responsiveness of tax revenue to movements in national income or GDP. Buoyancy reflects the total response of tax revenue to changes in national income or GDP including the effects of discretionary changes in tax policies over time.

An elastic system will automatically raise revenue at the same or at a faster rate than the growth of national income (or GDP) and facilitate a sustained increase in necessary government outlays. It would also reduce the economic uncertainties associated with frequent discretionary changes in taxes. Frequent ad hoc changes in tax policies create uncertainties among taxpayers and affect investment and production adversely.

In Pakistan it has been estimated that both the elasticity and buoyancy coefficients are below unity, hence the tax system is inelastic to reflect changes in GDP or national income.

Taxation and demand management

Taxation has often been used in many countries as a tool in countering inflationary and deflationary pressures on the economy. Such pressures affect development through a lack of external balances and/or in a spiral of changing prices and employment. In mitigating the effects of cyclical pressures, monetary policy though traditionally more effective is often limited by the structural nature of an economy and therefore tax policy assumes major importance.

In Pakistan inflationary and deflationary pressures take three major forms:

–           Price inflation due to rises in import prices;

–           Inflationary financing by government during boom periods and a consequent pressure on the balance of payments; and

–           Deficit financing during periods of deflation resulting in balance of payments pressures.

Tax policy is aimed at reducing or checking undue private consumption expenditure by the taxation of excess incomes. Income tax being a progressive tax has been well suited to this purpose. Of the indirect taxes, import duties are not as flexible, as these may have the effect of transferring inflationary pressure to domestic prices. Export duties, however, have been far more effective in siphoning off excess income before it gets into the hands of producers during inflation or acting vice versa in times of deflation.

Tax incentives in the development strategy

Tax and investment incentives have in recent times become a favourite tool in development strategy both for domestic investors and for attracting foreign direct investment (FDI). The rationale for their use is that they constitute an important, if not a major element in determining investment behaviour.

Incentives increase the net of tax rate of return and thereby reduce the need for large initial capital investment and also reduce risk. The availability of incentives tends to make otherwise unpromising and risky ventures more profitable. They are also valuable as an indirect stimulus to investment because they publicize and enhance the country’s investment climate.

The role of tax incentives in determining investment behaviour has, however, been controversial. According to current studies, incentives by themselves do not play a major role in determining investment vis-à-vis other factors such as infrastructure facilities, cheap and easy credit, access to markets, reliable and skilled labour force, political and economic stability, etc. They have also been increasingly called into question on several grounds.

One is that they distort investors’ decisions and thus produce a less than optimum allocation of resources. They erode the tax base and affect tax revenues and provide a fertile ground for tax avoidance through “ tax shelters”. The cost of incentives (sometimes called “ tax expenditure”) it is therefore felt outweighs their benefits.

Nevertheless, tax incentives are in place in a large number of developing countries including Pakistan and form a significant part of the development strategy being adopted. Even Indonesia, which in its tax reform of 1983 did away with all tax incentives in favour of a broad based low tax rate regime, has abandoned this policy stance and reintroduced a range of tax incentives recently.

In Pakistan tax incentives were used from 1959 onwards and after 1991 became a major instrument of development policy. Though an attempt is being made to reduce their scope and coverage recently under pressure from IMF investment incentives, these continue to be a major instrument in Pakistan development strategy.

Taxation, black money and the informal economy

A sound development strategy seeks to reduce the size of the informal economy and bring into the open the resources that lie in the form of black money. Apart from such mechanisms as foreign exchange and tax amnesties and exercises such as demonetizations, taxation has been used as a tool to tap the resources inherent in these areas. Large-scale tax evasion and the existence of a large black economy while resulting in loss of revenue to the state, tends to reduce the built-in elasticity of a fiscal system and to the extent that the tax evaded income is spent on goods and services, help to generate inflationary pressures and raise the prices of real property.

That there is a considerable informal economy and black money in Pakistan is undoubted but few in-depth studies have been undertaken to quantify its magnitude and extent. Dr. Aqdas Ali Kazmi, Joint Chief Economist, Planning Commission has stated in his research paper Tax Policy and Resource Mobilisation in Pakistan that  70 percent part of economy consists of 36 percent ‘pure’ black economy, 18 percent exempted economy, 9 percent illegal economy, 4.5 percent unrecorded economy and 2.5 percent informal economy (unreported economy). His study says that the problem in the low resource mobilisation is the rigid system of taxation, and the emphasis of the government to increase revenue, ignoring the details of the long-term policy measures.

The Laffer Curve

The Laffer Curve indicates the effect of tax rates on government tax revenue.

Briefly, the proposition of the Laffer Curve takes as its starting point the simple notion that tax revenue is zero if the tax rate is either zero or 100%, with a smooth relationship between tax rates and tax revenues connecting these two polar points. The existence of such a relationship suggests that if tax rates are sufficiently high, “ the prohibitive range”, then a reduction in tax rates could lead to an increase in tax revenues.

The Laffer Curve analysis leads to the following conclusions:

–           high rates of taxation act as disincentive to work and thus reduce output and employment;

–           an increase in tax rates does not always necessarily lead to increased revenue. There is a crucial point (point E in Annex 1) beyond which an increase in tax rates leads to decreasing revenues and national income;

–           there  are always two tax rates available (A and B) which can produce the same total tax revenue, one a higher rate and another a lower rate. Governments therefore need not necessarily choose a higher rate to achieve the required quantum of revenue.

Studies of selected countries also seemed to indicate that those that imposed a lower effective average tax burden achieved substantially higher rates of growth in real gross domestic product than did their moiré highly taxed counterparts.

The Laffer Curve, however, has had its critics like Paul W. McCraken, Paula Krugman, Robert Lekachman and John Kenneth Galbraith. They have questioned the assumptions and theory behind the Laffer Curve and proved that it is not as scientific as it appears. The supply side cuts of the early 1980s do not appear to have raised work effort or saving and they unquestionably increased the deficit. Empirical studies carried out in two countries (Jamaica and India) where tax changes relevant to the Laffer Curve had been implemented have also concluded that the assertion and tax reductions would lead to revenue increases should at best to be treated with caution. (Ebrill, 1987).

While there is no doubt that excessive rate of taxation act as a disincentive to savings and capital formation and retard investment and growth, there is no real evidence that mere reduction in tax rates by themselves would increase investment and growth. The level of taxation is only one factor in the complex process of development which is influenced by many variables both endogenous and exogenous. Hence it is doubtful that tax cuts could ever serve as a “ quick fix “ for a sick economy.

Further, this approach to development has its social ill effects. The “ trickle down” theory of development on which it is based has in practice been found to be not as effective as anticipated. The benefits have not trickled down to the lower segments of society and the supply side vision, as David Stockman said, was simply a cover for the reduction of taxes of the upper income tax brackets. The Reagan and Thatcher experiments in supply side economics with the resultant tax cuts and reduction of government expenditure led to mismanagement and has become discredited. An analysis of the patterns of income distribution in countries like Pakistan has shown that the upper deciles have benefited more and the lower deciles have reduced their incomes through these policies. This has also been confirmed by the Gini ratio that measures the degree of income concentration.

Role of tax administration in development

Finally, development policy requires the existence and functioning of a sound and effective tax administrative machinery. No amount of development planning would have the intended effect if the required stability and level of administrative resources were not invested in their implementation.

The purpose of tax administration is to fully implement the government’s tax programmes and proposals effectively and efficiently. In the short run, this means optimizing the revenue collectible with the resources, which the government makes available to the administration. In the long run, it means collecting all the legislated tax with the minimum of cost. All this requires an efficient and sound administrative machinery and effective coordination between the fiscal policy making body and the administrative mechanism.

The above sections dealt with some of the main components in the relationship between taxation and development. While there is often no direct perceptible correlation between tax policy and actual development performance due to the prevalence of a variety of variables, the links between fiscal policy and economic growth are there. Often this is indirectly operating through the capital, labour and product markets.

Taxation affects the amount of capital available by encouraging or discouraging savings and foreign investment. It may also divert investment and labour from one sector to another. It affects the level and productivity of employment by influencing individual choices between work and leisure, the intensity of effort on the job and employers’ decisions on technology. Taxes affect a firm’s ability to diversify and expand through their import or input costs and managerial behaviour. They may also have a bearing on less tangible factors such as entrepreneurship and technical progress. Some empirical evidence also suggests causal relationships between the level and types of taxes and key growth determinants in the areas of investments, export, employment, productivity and innovation (Marsden, 1986).

Finally, another important reason why taxation is essential in getting macroeconomic policies right is that alternative ways of financing government expenditure – money creation, mandating larger required reserves, domestic borrowing and foreign loans can have very harmful effects on the economy.

It is painful to note that the successive governments in Pakistan have resorted to presumptive taxation that has complicated the poverty problem of Pakistan. According to a recent study of Asian Development Bank, the tax system of Pakistan, which was progressive till 1990, was converted into regressive regime in 1991 with the introduction of provisions like section 80B, 80C, 80CC and 80D in the Income Tax Ordinance, 1979 and VAT-type tax in the Sales Tax Act, 1990. The result is that during the ten years’ period (1991-2000), the tax burden on the poorest households is estimated to have increased by 7.4 percent, while it declined by 15.9 percent for the richest households. This study of ADB is an eye-opener for the target-oriented policymakers who in the frenzy of showing higher figures to donors have put intolerable extra burden of taxes on the poor of Pakistan.

Like civilizations, tax systems evolve over centuries. Harley Hinrichs in his book General Theory of Tax Structure Change During Economic Development has mentioned five stages through which tax structure has changed historically as economies have developed. These are:

First Stage. A traditional society relies primarily on traditional direct taxes like taxes on land, livestock, water rights etc.

Second Stage. Society breaks away from old ways and indirect taxes become more important, especially external indirect taxes (i.e. taxes on foreign trade).

Third Stage. Traditional direct taxes decline relative to national income and governmental revenues.

Fourth Stage, Domestic commodity production increases and internal indirect taxes (excise duties and sales taxes) grow rapidly to replace customs duties.

Fifth Stage. Economy gains maturity and modern direct taxes like personal income and corporate profit taxes become dominant

Pakistan is still far behind from Fourth Stage, not to talk of coming closer to the last stage. It is high time that our economic managers revaluate the entire tax system and policy and take immediate steps to use tax measures as a tool for economic development rather than fixing of irrational targets and creating problems for the local industrialists and businessmen. The economy will never revive through harsh and illogical tax measures. We need to develop a national consensus on tax policy. The potential of Pakistan is much higher than presently fixed by fiscal managers. We can easily generate tax revenue between Rs. 600-800 billion provided taxation is made through representation, by a democratic process and after soliciting national consensus.

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[*] Dr. Ikramul Haq, a leading international tax counsel, is a well-known author specialising in international tax, press, intellectual property, corporate and constitutional law. He served for 12 years as Deputy Commissioner of Income Tax. He studied literature, journalism and law, for his Masters and Doctorate degrees. He has written many books on various aspects of Pakistani law and global narcotics trade, some of which are co-authored with his wife, Mrs. Huzaima Bukhari.