Public Finances

It is an established fact that investment and economic growth have a positive relationship but no consensus has been developed on the type of investment. The study investigated the relationship of PSDP, FDI and Private investment for Pakistan’s economy, and the results reveal that all the three forms have a long-run positive relation with growth where private investment has a strongest impact and FDI has a least impact. Moreover, it is the private investment and growth of Pakistan’s economy which leads to increased public development projects which means increasing private investment in the economy has two folds impact on PSDP; increase in economic growth increases development projects, increased revenue generation through taxes create more resources for PSDPs.

Economic Growth is a course of action in which production capacity of an economy is flourished bringing out increased national output and income. Economic growth is also related to bring out full employment level of the economy through investment as its key determinant, where literacy level, capital stocks and technology is enhanced.

Investment and production of goods and services ultimately help generating wealth and add in to growth of an economy. Positive relationship between economic growth and investment is an established fact but there is no consensus on whether it is the public investment or private investment which plays the stronger or no role in growth of an economy.

Shortfalls in revenue generation and inefficient or non-development government projects have caused large fiscal deficits and low economic growth in Pakistan, to fasten the pace of growth, government invests in some development projects for the public under the head of Public Sector Development Programs (PSDP) which utilises a significant portion of the budget every year funded by borrowing or tax collected.

The rationale behind spending on public sector development projects is that it not only generates positive spill-overs in the economy through the provision of education, health, basic scientific research and physical infrastructure, and it may also crowd in private investment thereby enhancing economic growth but there also exists the argument that these government funded projects increase government outlays and crowds out private sector, thus stifling economic growth.

Fiscal decentralization represents devolution of spending responsibilities from higher level to lower level of government accompanied by transfer of fiscal resources and administrative authority. The rising demand for decentralization in developing countries in recent years is a consequence of broader process of liberalization, deregulation, and urge for democratization with a need to bring the government closer to people for articulation of their needs and preferences. There is an increasing demand from regional and local leaders for more autonomy and taxation powers to support their expenditures.

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This paper argues for a paradigm shift in assignment of tax bases. The decentralization of tax bases currently assigned to the federal government will increase the net revenue collected at the national level. The decentralization of tax bases will reduce the magnitude of transfers from the federal government to the provinces however transfers cannot be done away with altogether. Transfers from the federal government to the provinces are undertaken through the National Finance Commission which is constituted every five years decide upon the distribution of national financial resources among the center and the provinces and among the provinces. The NFC has faced deadlock several times during the past 65 years. To take care of the deadlock over distribution of national financial resources, this paper first offers an alternate institutional mechanism to make a decision on a resource distribution.

Macroeconomic framework2 and how an optimal level of receipts and expenditures can be achieved at federal and across provinces is one of the fundamental issues the prevailing National Finance Commission (NFC) negotiation is figuring it out. The optimal level of receipts and expenditures can help the provinces to maintain fiscal balance. Similarly, the optimal level of receipts and expenditures will also help to develop the homegrown macroeconomic framework. To avoid the complexities involved in the macroeconomic framework, and remain in line with NFC discourse we focused our discussion on the fiscal side of the macroeconomic framework. Over the years, narrow tax base, heavy concessions and exemptions, challenges in tax administration and inadequate tax compliance have resulted in a low tax-to-GDP ratio. To address these challenges and weaknesses, there is a dire need to introduce necessary fiscal measures. Fiscal reforms are needed to ensure a fair and efficient tax system to generate sufficient revenues, which however seems a big challenge in the presence of substantially low tax-to-GDP ratio.

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This paper proposes a formula for resource distribution between provinces-horizontal distribution- under the upcoming National Finance Commission (NFC). We maintain that the formula offered in 7th NFC is predominantly need-based and the (equity) indicators, whatsoever it has, by very construct, fall short of capturing full essence of equity. Further, we argue that existing indicators of efficiency, the size of provincial tax revenue, is not adjusted for size of the provincial economy thus fails to capture the efficiency part of resource collection, the tax effort.

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All politics is local. So goes an adage from US politics referring to the profession’s demand of public office hopefuls to immerse themselves in the community they represent; know the places, the people and their unique problems, and win them over by either solving those problems or by presenting a solution before asking for their votes.

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Taxes impose a burden on those taxed and the burden can be proportionate or proportionately higher or lower relative to income. The burden is termed as incidence and is designated as progressive if the burden of the tax is higher on the rich and regressive if it is higher on the poor. Generally, direct taxes, i.e. taxes on income, wealth, property, etc., are found to be progressive and indirect taxes, i.e. sales taxes, customs duties, excise duties, etc., are found to be regressive. A tax regime that is progressive is said to be equitable and fair.

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Pakistan’s federal democracy is evolving; the 18th constitutional amendment, the passing of the 7 th NFC Award and local government elections are some recent positive developments. However, while local government framework and the ensuing elections are fraught with problems, the NFC Award too is not backed by strong evidence. The NFC is seen to be marked with lacunas that causes delays and deadlocks in the passing of new awards; at the other end both vertical and horizontal revenue distribution is seen falling short of fairness while also lacking carrots and sticks to further revenue generation and to strengthen democracy at sub-national level.

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PRIME Policy Report is a monthly publication that provides actionable intelligence at both micro and macro levels of the economy. Each report is segmented into Business Climate Review, Market Analysis, and bird-eye view of major Economic Indicators. It is a one-stop information hub for business leaders, SMEs, Corporations, trade commissioners, MNCs, Institutions, and Individuals aspiring to understand the policy dynamics, business prospects, and interpretations of key economic indicators.

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