PUBLIC FINANCE

Resource Mobilization and the

Structure of Taxation

Introduction
One of the major functions of the

government: collect revenue by taxing

people who make profit
Why tax?
Running the govt.
Provision of law and order
Defence
Infrastructure and social development
Build roads, schools, hospitals, dams etc.

Introduction
Taxation structure varies from country to

country
Pakistan: a well-defined constitutional
framework determines the nature of
resource mobilization and the
responsibilities of each tier of the govt.
Objective: examine the salient features of
Pakistans taxation structure

Legislative Functions
The constitution of 1973 specifies the

functions of the federal govt. and the

provincial govt.s
The federal govt. has exclusive
responsibility for undertaking functions
under the Federal Legislative
Includes functions of a regulatory and service

nature

Defence, external affairs, currency, stock exchanges,

national highways, strategic roads and railways etc.

Legislative Functions
Concurrent Legislative List
Functions which can be performed by either

the federal or the provincial governments, or

both.
Population planning and social welfare, tourism, and

education

Residual functions are the responsibility of

the provincial governments

Agricultural extension, irrigation, justice and

police

Legislative Functions
The existence of local governments is

not a formal part of the Constitution

Although the 17th amendment to the
constitution, based on the LFO of 2002,
requires provinces to establish and
empower local governments, it does not
recognize local government formally as
the third tier of the State
Table 10.1

The Structure of Taxation

Almost all major taxes worth any real

potential are with the federal govt.

The provincial govt. collect taxes that
the federal govt. does not collect, and
the local govt.s collect the residual
taxes
Local govt.s cannot meet their fiscal
needs, and therefore, rely heavily on
revenue transfers from provinces
Due to no constitutional protection
ordained to the local govt.s, the
provincial govt. can direct local govt.s to
increase or reduce any tax or to abolish
it.

Inter-Governmental Fiscal Relations

Before 2001
Local govt.s were extensions of the
provincial govts
Great deal of overlap between these 2 tiers
Provincial tax machinery used to collect

some taxes on behalf of the local council

Sophisticated procedures involved in the

assessment of liabilities of some taxes

Realize significant economies of scale

Inter-Governmental Fiscal Relations

While provincial governments received

revenue from the federal govt on the

basis of population, the local
governments received revenue on the
basis of collection
Provincial govt.s used to have access to
revenue-deficit grants from the federal
govt. that bailed them out, but no grants
existed for local governments
Local govt.s made further payments
and transfers to provincial govt.s in the
form of revenue, e.g. octroi

Inter-Governmental Fiscal Relations

Elaborate mechanism of fiscal transfers

from the federal to provincial

governments
Mechanism is sanctified by the
constitution
NFC: constituted by the President of
Pakistan, which is meant to devise the
revenue sharing formula for the divisible
pool of resources
It is supposed to announce an award
every 5 years
In practice it is not constituted every 5
years

Inter-Governmental Fiscal Relations

NFC award of 1991:
Distributes 80% of income tax, export duty

on cotton, excise duty on tobacco and sales

tax from the federal to the provincial govt.s
The federal govt. has the responsibility of
financing any residual deficits of the
Provincial governments in their recurring
budgets
Share of each province
Cross-subsidization

Inter-Governmental Fiscal Relations

1997 NFC Award:
Unconditional transfers
Revenue sharing on the basis of population
Straight transfers, based on origin, and include
revenue from royalty and development surcharges
on gas and crude oil, and profits from hydroelectric
projects
Special grants made to Balochistan and the NWFP,
as these are less developed than the other two
provinces

Public Finance: The Basic

Facts
Table 10.5
Main source of revenue: customs duty
Despite rapid industrialization in the 60s, the

contribution of income and corporate taxes

actually declined
More than half of total expenditure being
spent on defence

Public Finance: The Basic

Facts
Table 10.7:
Revenue from taxation is far greater than
that from non-tax revenue
Indirect taxes are many times as large as
direct taxes
Import duty used to be the largest in indirect
taxes; today sales tax is the largest source
Table 10.8
Development expenditure is far less than
non-development and current expenditure
Defence and interest payments account for
more than half of all government expenditure

Public Finance: The Basic

Facts
Table 10.9:
Total revenue has not grown substantially over
the last decade
Table 10.10
Defence and interest payments have shown
positive increases
Proportion of development expenditure in total
expenditure, has continued to fall
Table 10.14:
Indirect taxes still account for 2/3rd of total
taxes
Share of IM duties declined and that of sales
tax increased

Issues in Federal Taxes

Key features and problems of the federal

tax system:

Over-all level of fiscal effort is low and the

tax-to-GDP ratio has remained almost

stagnant => high budget deficits
Overdependence on indirect taxes =>
increases regressivity of the tax system
Within indirect taxes, there is domination of
taxes on international trade => distorts
allocation of resources and encourages illicit
trade
Narrow tax base due to a wide range of
exemptions and tax evasion
Primitive and out-moded tax administration
and procedures => corruption and
inefficiency

Issues in Federal Taxes

Suggestions given by the World Bank:
revenue generation should be given special
emphasis in any sort of SAP
Strengthen the tax base to increase budget
potential
Increase the elasticity of the tax system by
shifting the emphasis of indirect taxes on
domestic consumption
Agricultural income to be subjected to
taxation
Change the structure of indirect taxes: VAT
Cut the excessive number of concessions

Issues in Federal Taxes

Problems in the introduction of a VAT:
Absence of proper accounting and
documentation of transactions
Reluctance to accept tax invoicing of inputs
and outputs by the manufacturer
Political reluctance to levy GST on tea,
vegetable ghee etc.
Constitutional restriction on the extension of
sales tax to services by the federal government
Sales tax at 15% has been imposed
42% of govt. revenue comes from sales tax and
only 15% from customs duties

Issues in Federal Taxes

Income Tax:
Narrow tax base
Only 1.5 million income tax payers in a

population of 150 million

The evasion of income tax is almost 5 times
the collected amount
Necessary to have proper documentation and
to streamline the taxation structure so as to
make it easier to catch tax offenders

Issues at the Provincial Level

Problems in the provincial resource

mobilization structure

Limited scope of resource mobilization, as the

large and relatively buoyant taxes have been

pre-empted by the federal govt.
Provincial govt.s have not been able to exploit
the agricultural income tax and tax on value
added in the services sector
Elasticity of provincial taxes is low => low
growth in tax revenue
Incentive environment has not been conducive
to a higher fiscal effort => Automatic access to
ad hoc revenue deficit grants
Poor tax administrators

Issues at the Provincial Level

NFC of 1991 stopped the provision of deficit

grants to the provincial governments

Broadened the provincial tax base
The incremental burden of most of the taxes

lies on the higher income segments

Increased the progressivity of the tax system
Urban immovable property tax still needs

to be addressed

Local Govt. Revenues

Areas of reform:
The provincial govt. collects most of the tax and

hands it over to the local govt.s => no

incentive to reassess the tax rates
Provincial governments have pre-empted a
number of taxes which fall within the fiscal
powers of the local govt.s, e.g. motor vehicle
tax
Check transfers from the local to the provincial
govt.s, since this mechanism is instrumental in
the retardation of expenditure growth at the
local level