Tax Reforms Have Limited Success in Pakistan: Moody’s

Tax reforms have limited success prospects in Pakistan, given weaker tax compliance and administration, and structural economic factors that restrict reform potential, says Moody’s Investors Service.

Moody’s conclusions are contained in its latest report “Sovereigns — Developing Asia Pacific: Tax base broadening most likely to be effective in countries with strong tax administration”.

“Tax reforms are most likely to expand revenue bases in fast-growing economies with strengthening expenditure and debt management These include the Philippines (Baa2 stable), India (Baa2 stable), Indonesia (Baa2 stable) and Thailand (Baa1 stable). Conversely, for Bangladesh (Ba3 stable), Pakistan (B3 stable) and Mongolia (B3 stable), we see the most limited prospects for success, given weaker tax compliance and administration, and structural economic factors that restrict reform potential”, maintained in the report.

Indonesia, India and Pakistan have recently employed tax amnesty schemes. While such one-off measures are temporary in nature, effective use of the data collected on newly declared assets could ultimately serve to broaden the income tax base.


Moody’s Maintains Pakistan’s B3 Stable Rating

Developing APAC sovereigns continue to rank poorly in various aspects of tax administration. As a result, many of these sovereigns have corporate tax and total contribution rates that are below the APAC and global averages of 36.7% and 38.3%, respectively. They include Cambodia (21.7%), Mongolia (24.7%), Thailand (28.7%), Indonesia (30.0%), Maldives (30.2%), Bangladesh (33.4%) and Pakistan (33.8%). Only India (55.3%), Sri Lanka (55.2%), the Philippines (42.9%) and Vietnam (38.1%) have rates above the APAC 24-sovereign average.

For sovereigns with either low or significantly declining institutional strength – such as Bangladesh and Pakistan – tax bases have increased only marginally from low levels or narrowed further.

Among sovereigns with more modest government expenditure, Pakistan and Sri Lanka both have continued to run quite wide fiscal deficits, in part driven by growing interest payments from relatively large debt burdens.

Moody’s further states Pakistan and Sri Lanka have not experienced material reductions in their debt burdens, despite relatively robust economic growth. That fact is likely to limit the uplift from tax reforms on their fiscal strength, particularly if their historically high rates of growth were to slow materially. Further, and especially in an environment of rising interest rates globally, Pakistan and Sri Lanka also face government liquidity and external vulnerability risks related to the servicing of relatively high debt burdens, which could offset some of the positive credit impact from revenue reforms.

Since the end of Pakistan’s Extended Fund Arrangement with the IMF in September 2016, which had varying degrees of success, Pakistan has continued to target a host of reforms aimed at broadening the tax base. Since the Federal Board of Revenue assembled a comprehensive database on potential taxpayers, compliance has improved and led to a moderate increase in tax collections.

Most recently, Pakistan announced its first tax amnesty scheme that targets foreign assets and runs through June 2018. We expect the scheme to result in a one-off increase in government revenue of between 0.3% -1.0% of GDP depending on the program’s uptake.

In a country of more than 200 million people, only 1.2 million file income tax returns, of which only 700,000 paid taxes, according to the government’s latest estimate. Separately, the government has continued to maintain temporary tax breaks for the agricultural sector and exports, and effective for the fiscal year 2019 budget, has given the government the right to purchase properties that are undeclared by paying a premium and established three dedicated tax zones aimed at improving compliance, although the effectiveness of the former measures are unproven.

The government has also been reluctant to increase the sales tax on petroleum products amid rising global oil prices.

Overall, Moody’s anticipate limited, sustained positive impacts to Pakistan’s fiscal strength from ongoing reforms, given both the political pressure that the government faces on development spending, in addition to weak tax compliance and enforcement.

Moody’s projected high levels of development spending to drive recurring fiscal deficits, but to support robust economic growth along with China–Pakistan Economic Corridor related investments. Although the Fiscal Responsibility and Debt Limitation Act could provide some support to fiscal strength, given its focus on limiting public debt to GDP to 60% along with a target 10 percentage point reduction over 15 years, they do not consider the targets to be readily achievable