Winter is coming for the startups

OPINION

Ammar H. Khan

Exhausting already paying taxes incentivizes staying out of the system, and reallocation of capital towards the informal economy, rather than the taxed investing in the formal economy. Such reallocation of capital has an inadvertent and unfortunate impact on overall investment in the economy, and further Pakistan has had a consistently low tax-GDP ratio for decades, staying below peer countries and barely touching 12 percent in a boom year, only to fall back to single digit as the boom turns into a bust. Due to a worst in class tax-GDP ratio, Pakistan continues to grapple with perennial fiscal deficits, which are weakens the ability of the state to expand the tax net. It also weakens the ability of the state to effectively leverage fiscal policy, as any impact of changes in tax code does not really ripple throughout the economy, and only affects the formal economy. Contrary to experience in other peer and developed markets, the tax policy is also skewed towards consumption, and incomes, rather than capital. Most taxes collected in Pakistan are on the funded through borrowing, eventually crowding out private sector basis of consumption, making the regime largely regressive, and credit, and hurting formation of formal capital in the economy. anti-poor. The remaining taxes collected are a mix of corporate Availability of tax amnesty schemes every few years also sets a taxes, and income taxes, mostly deducted at source. Due to a precedent that it is perfectly fine to avoid paying taxes, because regressive regime, corporatization in the country has slowed down, there will always be yet another amnesty scheme through which as it is more tax efficient to conduct business as a sole proprietor, one can pay only a fraction of undeclared capital, and magically or as a partnership, rather than as a corporate. The incentives are become a taxpayer. In the presence of such distortion, there exists such that income accumulated in the informal economy eventually little incentive for anyone to pay taxes, unless the same is collected results in accumulation of capital outside the formal economy, forcefully on the basis of consumption, or through taxing the which is never really taxed, unless through an amnesty. As capital already taxed. accumulates tax free, the overall size (including both formal and The recent imposition of super tax is an extension of bad informal) continues to grow, but is never really taxed. In the tax policy decisions that have been taken over the years, whether country, there is no taxation of long-term capital accumulation, that was imposition of tax on withdrawal of cash (which result- whether that be in real estate, agricultural land, or any other asset ed in an unintended consequence of a perpetual and permanent class. This ensures that accumulation of capital is done in asset increase in cash in circulation), or whether it was availability of classes which are untaxed, further restricting the ability of the state various amnesties during last few years, or simply continuation of to expand its tax net. one-time super taxes for years at stretch. In such an environment The tax policy in the country requires a re-think. The same of uncertainty, it is difficult for capital allocators to plan for tax has been said and discussed innumerable times, but the only way efficiently, whether on an entity level, or even on a household level. out of a perennial fiscal deficit is a re-think of the tax policy which The uncertainty in the policy regime which largely targets those increases the overall tax-GDP ratio, and that cannot be done by taxing existing taxpayers more. It can only be done by bringing in more sectors and asset classes under the tax net, and by reducing the size of the informal economy. Economies across the spectrum of development have succeeded in doing the same, so there is nothing out of the ordinary here. There needs to be a shift from conThe writer is an sumption and income oriented taxes to capital oriented taxes, particularly through bringing in more capital in the independent formal economy. Deployment of capital in the formal economy needs to be incentivized, rather than be disincenmacroeconomist and tivized. Current taxation structure actively discourages incumbents from operating in the formal economy. Such energy analyst. an incentive structure needs to change. Taxation targets should be set in real terms, and relative to the size of the economy, rather than nominal terms, wherein inflation does most of the work. The policy needs to be progressive, and pro-investment, rather than being regressive, and anti-investment.