BCom Notes Part II Economy of Pakistan Budgeting

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Budgeting

Fiscal Policy

Fiscal policy of Govt. of Pakistan primarily deals with levels and composition of taxation, spending and borrowing by Government. Fiscal policy encompasses several fundamental policy issues, including the proper role and size of the State, role of Government in promoting growth, creating jobs, social development and redistribution of benefits of economic growth, nature and extent of public services and fairness between the present and the future generations.

Government’s fiscal policy has both micro and macroeconomic objectives.

Micro Economic Objectives

It includes an improved distribution of income and wealth, equitable access to social services, meeting the basic needs of poor, promoting investment in public goods and enhancing efficiency with which public and private sectors produce goods and services and their responsiveness to the needs of consumers.

Macro Economic Objectives

It relate to evolution of economy as a whole, national income and output, inflation and balance of payments. Fiscal policy must also ensure that level and structure of taxes promote equality and redistribution and do not interfere unduly in people’s investment and consumption decisions.

Central objective of govt. economic policy therefore, is to build a strong economy with a view to creating employment opportunities for all and improve the standards of living of the people of Pakistan. The policies pursued thus far have injected fiscal discipline, reduced the country’s debt burden, created a stable macroeconomic environment, revived economic activity and most importantly have created a strong platform of economic stability which is vital for building prosperity and achieving social justice. Economic stability allows business, individuals and the government to plan more effectively for the long-term improvement in the quantity and quality of investment. The Government is committed to locking in stability and investing in the country’s future, enabling it to meet the challenge and rise to the opportunities of the global economy.

A sound fiscal policy is essential for preventing macroeconomic imbalances and realizing the full growth potential. Pakistan has witnessed serious macroeconomic imbalances in 1990s mainly on account of its fiscal profligacy. Persistence of large fiscal deficit resulted in unsustainable levels of public debt, adversely affecting country’s macroeconomic environment. Pakistan accordingly paid a heavy price for its fiscal indiscipline in terms of deceleration in economic growth and investment and the associated rise in poverty. Considerable efforts have been made to inculcate financial discipline by pursuing a sound fiscal policy. Pakistan’s hard earned macro economic stability is underpinned by fiscal discipline.

Importance of Fiscal Policy

1. Attainment of maximum welfare of common man.
2. Increase in the employment opportunities.
3. Equitable distribution of national wealth.
4. Development of rural areas and reduction in disparity.
5. Control on inflation/price level.
6. Provision/development of health/education facilities.
7. Reduction in non-development expenditure.
8. Encouragement of private investment.
9. Fuller utilization of national resources.
10. Improvement in balance of payments position.

Taxation System of Pakistan

Tax policy is concerned with the design of a tax system that is capable of financing the necessary level of public spending in the most efficient in the equitable way possible. An efficient tax system should raise enough revenue to finance essential expenditures without recourse to excessive public sector borrowing and raise the revenue in ways that are equitable and that minimize its disincentive effects on economic activities. In developing countries, including, Pakistan, the establishment of effective and efficient tax system faces some formidable challenges. The first of these challenges is structure of economy that makes it difficult to impose and collect certain taxes. Economy of Pakistan is often characterized by a large share of agriculture in total output and employment, by large informal sector activities and occupations by many small establishment by a small share of wages in total national income and so on. All these characteristics reduce the possibility of relying on certain taxes such as income tax and to a much lesser extent on sales tax.

The structure of economy of Pakistan in association with low literacy and how human capital makes it difficult to develop a good tax administration. The staff of tax administration is not well educated and well trained, resources to pay good salary and to buy necessary equipment are limited, the tax payers have limited ability to keep accounts, the use of modern communication network is limited, it is difficult to create an efficient tax administration. The consequence of this situation is that Pakistan; often end up with too many small tax sources, too heavy reliance on foreign trade taxes and relatively insignificant use personnel income taxes. The non-availability of reliable statistics from the business makes it even more difficult for tax administration to assess the potential taxes that need to be collected. Uneven income distribution is also a major constraint in Pakistan’s efficient tax system. To generate higher tax revenue, the top deciles are supposed to be taxed significantly more proportionality than low deciles. But economic and political powers are concentrated in the top deciles, which makes the task of tax department rather more difficult to collect taxes from top deciles/rich people. This is one major reason that the number of income tax payers in Pakistan is very low.

Principles of Tax Policy

1. Widening the tax base by reducing exemptions, incentives and concessions.
2. Reducing multiplicity of rates.
3. Lowering tax rates.
4. Shifting the incidence of tax burden from production to consumption.
5. Moving away from excessive reliance on manufacturing.
6. Taxing all value additions including services.
7. Enhancing neutrality between present and future consumption.
8. Reengineering business process of tax system to overcome the culture of tax avoidance and evasion.
9. Change in tax administration.

Deficit Financing

Deficit budget means that Govt. expenditure is more than its income from taxes and fee etc. Resources for deficit budget are met by borrowing, which is called Deficit Financing. In Pakistan deficit financing is needed because development programs require huge finance whereas domestic savings and income from taxes are not sufficient enough for this purpose. Increasing savings habits, population control, elimination of corruption, decrease in non-productive expenditure and increase in agricultural and industrial products and remove budget deficit.

Reasons for Deficit Financing in Pakistan

1. Increase in development programs.
2. Lack of saving habits.
3. Increase in population.
4. Lack of fiscal discipline.
5. Political instability.
6. Low output of agricultural sector.
7. Tax evasion and corruption.
8. Increase in non-productive expenditure.

Advantages of Deficit Financing

Govt. uses borrowed money for increase in social and economic infrastructure such as schools, hospitals, power projects, dams, canals and a host of other development programs, which helps in the improvement and productivity of various sectors of economy. This expenditure of Govt. increases money supply, which increases price level in the economy. Increases in prices, increases profit margins of industrialists, who in order to gain profit further accelerate their investment. New factories are established and capital formation increases. Govt. expenditure and private capital formation creates more jobs opportunities in the economy. Increase in employment increases demand for goods and services and on the other side it fosters saving as well, which again is utilized for further investment. Thus cycle of progress and prosperity keeps on moving ahead.

Disadvantages of Deficit Financing

There is always a time lag between Govt. investment and the output from the projects. Increase in supply of money creates inflation, by which poor people are badly affected. Their purchasing power reduces to a greater extent whereas profit margin of businessmen increases. Society is divided between haves and have-not. Increase in prices of domestic goods causes imports of cheap goods whereas domestically produced goods high prices reduces the export earnings, which results in the adverse balance of payments position. Cost of production of industrial goods increases with the increase in prices of raw material etc., therefore foreign investment in the country becomes less attractive.