M.

Muneer Qureshi

FISCAL
IMPERATIVES IN
PAKISTAN’S
ECONOMIC
DEVELOPMENT
"THE MISD OF MAN IS CAPABLE OF
ANYTHING BECAUSE EVERYT'H ING
IS IN IT-ALL THE PAST AN13 ALL
T H E FUTURE"

JOSEPH CONRAD
 FISCAL IMPERATIVES IN
PAKISTAN'S
ECONOMIC DEVELOPMENT
 FISCAL IMPERATIVES
IN PAKISTAN'S
ECONOMIC DEVELOPMENT

PROGRESSIVE PUBLISHERS
ZAILDAR PARK, ICCHRA LAHORE PAKISTAN
 - -
ISBN 969 8064 04 4 - -
First Edition February, 1989 500 copies

Price: Rs. 250.00

Published by S. Raza Mehdi, Progressive Publishers, Zailditr Park,

Ichhra, Lahore-16, Pakistan

Printed in Pakistan by Sh. Zafar Mehdi, at Fisco Press (PVT) Ltd.

Zaildar Park, Ichhra, Lahore-16 Pakistan. Phone. 411142
 Contents

PART I
Preface
The taxation of Income: its concep-
tual basis

Tax rate structure

Taxation structure

Base Broadening: a leading issue in

tax reform

The Taxation of Business Profits-.

realignment of tax burdens among
different business entities

The tiixatiy of agricultural income-

rationale and alternative approaches

Tax legislation in developing

countries

The design of tax incentives

An appraisal of the scheme of fiscal

incentives incorporated in the
Pakistan Income Tax Code
Law and procedure controlling the
taxation of self assessed income in
Pakistan

The political dimension in taxation

Controlling tax evasion

The parallel economy-an overview

The economics of inflation

PART I1

The economics of growth-

Some important lessons drawn
from the historical experiences of
nations

Sources

LIST OF TABLES

Pakistanconsolidated govt. finances

Pakistanconsolidated govt. finances:

an analysis

Central govt. "current revenue" in

selected third world countries &
comparison with the N.I.C's

Central govt. expenditure in selected

third world countries & comparison
with the N.I.C's

Comparative burden of direct

taxes on agricultural & non -
agricultural incomes

Land utilization statistics-Pakistan

Distribution of cropped area-
Pakistan

Area, production & yield per

hectare of major cash crops in the
main growing countries

Area, production & yield per

hectare of major cereal crops in
the main growing countries

Area of crops covered by ground

Plant protection measures-Pakistan

Pakistan's position in various crops-

an international comparison

Money & interest rate in selected

third world countries & the N.I.C's

Macroeconomic performance of forty

one developing countries grouped
by trade orientation

Change in export prices and in the

terms of trade of the countries
of the third world

Origin & destination of manu-

factured exports of selected
third world countries.

Pakistan in the third world-com-

parative data for selected countries

Saving, investment & the current

account balance---selectedcountries

External public debt & debt service

ratio of selected third world
countries & the N.I.C's

The distribution of income in

Pakistan 26 5
 20. Population growth in the third world-
selectetl countries 277
I
I 21. Education in the third world-
selected countries - comparison
I
with the N,I.C's
I

! 22. Economic structure of selected

third world countries compared
with the N.I.C's

23. Structure of manufacturing in

selected third world countries
and the N.I.C's
 Preface

That the road t o economic development can be long and

arduous is made dramatically evident by the apparent futility
of the growth effort for the great majority of the third worlds
plethora of desperately poor countries that litter the economic
scene in a disarray that is a poignant reminder of the daunting
odds that have not been overcome.

In the post world war two era, only communist China

and South Korea-among the "major "developing countries-have
been able t o break away from the stranglehold of the anti-
growth forces and move on t o self sustained growth. Much of
their success is relatable t o a candid willingness t o come t o
grips with reality and t o learn from the historical experience of
other countries. They have shown time and again that when it
comes to making hard choices they will not be found lacking.
Indeed, the ability to identify the right alternate -- or the right
set of alternatescoupled with sustained, determined effort, is
a key feature of their success story. Their saga-and that of
others that honestly strive t o follow in their wake-forms part of
the inspiration for this book.

Effective resource mobilization is an obvious starting

point for any program of economic development. Many of the
hard choices we have referred t o above, have t o be made here.
That maximizing revenues - and keeping expenditures within
tolerable limits - is a none too easy exercise is one important
lesson that emerges from the experience of most countries. The
author has made an effort t o focus critically on the direct
 Fiscnl Impernrives in Pakistan's Econornic Development

taxation of income as a source of revenue for the public ex-

chequer. The system in vogue in Pakistan in terms of the
legislation in force is examined indepth and areas where reform
is called for are identified.

Besides the taxation of income the author has also made

explorations in related areas such as the parallel economy
and inflation. Lastly, an effort is made t o draw on the historical
experiences of other countries that have achieved successes in
their quest for economic development - both in the free world
and the regimented controlled economies. It is hoped that a
workable amalgam from their variegated policy prescriptions
can be seen t o emerge t o be put t o use by the powers that be
in the third worlds corridors of authority.

The author is indebted t o his colleagues an.d friends -

especially Mr. Mazhar F. Shirazi, Coordinator, Data Processing
Center, Income Tax Department, Lahore - f o r the assistance
and encouragement so graciously given without wh.ich it would
have been difficult t o complete the project in time. The author
is also heavily indebted t o those who laid the basis for his
studies in economics. Here, Mr. Amir Nawaz Khan, - Aitchison
College, Lahore, 1961-63 - Professors Hamid Yarnin Dar,
Muhammad Rashid and Fiza ur Rahman, - all at Government
College, Lahore in 1963-67- must find special mention. On
thq home front. the commendable patience with which the
authors wife and children put up with the many months of
computer assisted distraction - the book was composed o n
an " Amstrad " computer - cannot go unrecognized. The
authors greatest debt however is t o his parents -- who made
everything possible.

1st January, 1989 MUNIR QURESHI

Gulberg, Lahore.
 The taxation of Income:
its conceptual basis

A system set up t o generate revenue by levying taxation

o n income can be evaluated o n the basis of specific criteria.
The more important of these may be stated as follows:

a. Whether the system is "fair" in terms of treatment accord-

ed t o people deriving income and "similarly placed" with
regard t o quantum of income realized 2nd whether the
system is capable of reasonable differentiat,ion, accord-
ing t o their ability t o pay between persons in different
economic circumstances;

b. Whether the system is economically efficient in terms of

the quantum of revenue generated and he costs of rais-
ing the revenue. These costs are not only the costs of
tax administration but also the extra blurden that is re-
quired t o be borne insofar as a tax on i l ~ c o n ~isean addi-
tion t o the other costs that arise from the process in
which the income is generated. "Efficiency" is also re-
latable t o the impact that taxation of income has on
investment flows. What needs t o be seen here particu-
larly, is whether the taxation of incorne directs invest-
ment into channels that may not be the most productive.

Without coming t o grips with the more esoteric aspects

of the subject, it is possible to achieve a consensus with re-
gard t o the core meaning of "fairness" in taxation i.e. equal
7
Fiscol Itnpero fives in Pakistan 's Econofrlic L)eveloptr~cnr

treatment of similarly situated persons and reasonable dif-

ferentiation, according t o their ability t o pay, between per-
sons in different circumstances. The problem now would be
t o state the characteristics that are relevant t'or defining
similarity o r differences in circumstances.

The great majority of those who have looked into the

matter in any depth would agree that the most relevant cha-
racteristic here is the taxpayers (together with that of his
dependents) total income - or total consumption. Coming t o
the "ability t o pay" principle, there would also appear t o be
general agreement that a tax levied on income ought t o be
"progressive" with regard t o different levels (or slabs) of in-
come. Thus people fortunately placed t o enjoy higher abso-
lute amounts o f income would be required t o pay a relatively
higher amount of their income as tax vis-a-viz those not so
fortunately placed. Hopefully, over time, such an arrangement
would reduce the gap between those who have more and those
who have less.

Coming t o the "efficiency" criteria, ''supp1:v side" eco-

nomists regard taxes as inherently inefficient because they
weaken incentives and reduce production. Mainstream econo-
mists are more sceptical about t h e effects o n total activity.
They tend t o distinguish between taxes and t o judge a tax's
efficiency o r inefficiency by its influences on methods of
production and the composition of consumption.. An ineffi-
cient tax system may unnecessarily increase production cost
or result in a pattern of output and con sump ti or^ that yields
less satisfaction t o consumers than that obtained from another
pattern producible at the same cost. For example, taxation
is held t o be inefficient if it causes firms t o use eit.her more or
less capital t o produce a given output than they otherwise
would use. This is so because either overuse or underuse of
capital will increase production cost per unit.

Any t a x system that allows the effective rate of tax t o

deviate markedly over broad categories of investment will
cause investment decisions t o be based o n tax cc~nsiderations
instead of economic productivity. The social costs of such tax
related distortions can be enormous. They divert resources
from their most productive use - those with t h e highest rate
of return before taxes - into uses that are less productive but
 TABLE 1
PAKISTAN - CONSOLIDATED
GOVERNMENT FINANCES

194960 1960-61 1965-66 1972-73

---A- --
GROSS RECEIPTS 1422 4778 10830 16938

REVENUE RECEIPTS
-taxreceipts
-non tax

SURPLUS O F AUT-
NOMOUS BODIES

CAPITAL RECEIPTS
- surplus o n revenue
account (if any)
- external finances (Net)
'-domestic n o n bank
financing
-public sector surplus

EXPENDITURE
- current
-development

OVERALL POSITION -534 -138 1304 -1259

Source: Govenunent of Pakistan Economic Survey (Various Issues)

4 Fiscal lmpera n'ves itr Pah-isfank Ecotro fnicDevelopmetr r

yield higher after tax returns. The result is re'duced initial

output, lower productivity and sluggish economic growth.
When tax rules cause investors t o select projec1t.s that yield
less and t o give u p projects that yield more, then, the economy
as a whole loses. and its loss can be quantified in terms of
the extra return that would have followed the selection of the
more efficient project - and which is not now available.

There is t o be sure, the counter argument that given the

imperatives of capital formation and promotion of balanced
economic development in the country, distortions In investment
i.e, a deliberate deviation from what the dictates of market for-
ces would indicate, are all too often necessary and developing
countries might have no option o n the matter. It is argued in:
this context that the capital base of most developing countries
is so deficient and so localized is the existing pattern of indus-
trial development that only by offering a range of fiscal in-
centives can investment be attracted in projects that though
necessary from the economic standpoint may not; promise
returns (atleast in the short run or the immediate future) as
high as others that may not be so necessary in terms of acqui-
ring economic potential. Furthermore, investo:rs may never
move t o the far flung regions of a country unless a package of
incentives is offered, the net effect of which is t o make the
investment. attractive.

To be fair, developing countries certainly need t o build up an

industrial base and also t o achieve a degree of balanced regional
development if the aspirations of t h e less developed regions
are t,o be satisfied and if regional integration is to be promoted.

The F,esource Imperative : Does the Existing Tax System

Yield Enough Revenue

In order t o fuel the engine of growth effect'ively, adequate

resources are necessary. This would appear t o be so obvious as
t o require no emphasis. However, in the real world t h e genera-
tion of adequate resources in most developing countries is
an area of acute and persisting concern for the fiscal agencies
charged with conceiving and executing development projects.
The Taxation of Income :its concephral hasis 5

It must not be forgotten that besides the very real demands of

economic development the sheer expenditure of running the
government machinery has spiralled and itself imposes a con-
siderable burden o n the exchequer.

Non development expenditure other than the cost of

administration-especially expenditures t o fund the military
establishment-add t o the strains on government resources. In
developing countries the defence establishment typically
dwarfs most organizations in the country. Given the clout its
spokesmen wield, its "will t o power" ensures a steady flow of
resources t o it. The increasing cost of military hardware on
the international market, (quite natural in view of the diverse
competing demands),escalates costs and has been responsible
for dramatic increases in defence spending in recent years.

The government expects its fiscal agencies t o devise

ways and means of realizing the required revenue. Taxation
measures, both direct and indirect, yield p a r t . of the domes-
tic resource component. The latter is ofcourse the more signifi-
cant in most developing countries. This however is far from an
ideal situation. Indirect levies create a regressive burden that
does not augur well in alleviating and mitigating the social
tensions and cleavages that fester in the body politiqthreaten-
ing t o upset the precarious equalibrium that keeps the economy
going. That the direct tax component of the resource base is
quite unable t o make an effective contribution is dramatically
evident from the ever increasing size of the budget deficit.
This indicates that the tax system suffers from much more
than structural deficiencies. Huge deficits in 'the resource
availability position, stretching into t h e indefinite future, are
certain unless effective legislative action is taken t o restructure
the tax system so as t o broaden its b&e significantly and t o
give it the capability t o bring within its ambit rr~ostof the tax-
able income generated. An innovative approach is necessary
because for reasons that are obvious, resort to generation of
additional revenue by increasing the tax burden of existing
taxpayers is neither feasible nor expendient. Also, t h e develop-
ment expenditure will have t o be augmented t o accelerate the
pace of economic development as there is little possibility of
significantly decreasing the non-development; expenditure,
ncnnoiglltr t A n f n n n n anrl ~ l A m i n i c t r n t i n n
t h ~ nn
 TABLE 2
PAKISTAN -
CONSOLIDATED
GOVERNMENT FINANCES - AN ANALYSIS

INCOME TAX AS % OF:

-total tax revenue

Total revenue

G.N.P.

G,D.P.

TOTAL REVENUES A S %
O F G.N.P. 14.0 14.6 15.2 15.6 14.96 14.74 15.79 15.00 15.47 15.60

Source: Government o f Pakistan E m n o m l c S w e y (Various)

The Taxation of Income : Its conceptual hsfs 7

Budgetary deficits pose a greater problem for developing

countries than they d o for the developed. The rc?ason for this is
that the underdeveloped country has an underdeveloped eco-
nomy. The economic structure is as yet impel*fectly formed.
The linkages - both inter and intra sectoral exist only in a rudi-
mentary form. The capacity of the economy t o bear shocks is
poor because it cannot transmit the initial shock. The con-
sequential action that would follow as a matter of course
(responsive reaction) in a more developed econoiny is missing in
the developing economy. Much of the inherent rigidity is allied
with rigidities in data transmission. Since information in not
transmitted effectively between and within :sectors,;, decisions
cannot b e taken in time nor can the complexion of a situation
be properly perceived if decisions are taken in a void-as so
frequently happens in developing countries, these turn out t o
be whimsical and capricious. Another complicating factor of
great significance here is the operation of the parallel economy.
Considering its large relative magnitude vis-a-vis its counterpart
in the developed country, it represents an area of operation that
impacts significantly on the regular economy. The parallel
economy permeates the regular economy so that it interferes
with its operations. Its large absolute size removes a large seg-
ment of the national economy from the jurisdiction of the
fiscal authorities. Thus official policy stops short of the bound-
aries of the parallel economy. This happens so frequently
and in such diverse areas that the overall result of the inter-
ference is t o confuse and obstruct official policy. Thus effec-
tive control of the regular economy too becorr~esproblematic.

As the great crash of '87 so dramatically showed, the

trouble making potential of recurring budget deficits can be
much more than what is immediately perceived. This is be-
cause in a free economy government competes for available
savings in the economy alongwith the other economic sectors.
The government, t o be able t o attract available investible funds,
must offer an attractive rate of return (interest). When the
government, year after year, indicates an increasing need t o
mobilize the available savings, there is bound t o be an upward
pressure o n interest rates. A sudden increase in the size of thc
deficit o r an increase in government expenditure o n a significant
scale that heightens the significance of t h e existing deficit
insofar as government would appear now t o be compelled t o
offer extraordinary inducement - in t h e shape of higher in-
8 Fiscnl Impem tives in Pakistan 's Economic Developmen r

terest ofcourse - so as t o be able t o attract the loanable funds

in the economy, can provoke an economic destabilization
by drawing funds away from their existing deployment in order
t o be in a position t o place these funds at the governments
disposal where they are expected to fetch a much higher rate
of interest. It is thus this "expectation"of a significantly higher
rate o f return that can provoke destabilization in the economy.
The fickle nature of man is brought out vividly in d o c k market
gyrations provoked by nothing more concrete than rumours
based o n truths, halftruths and nonsense.

Tax Reform:

If one is t o think rationally about tax reform it is irnpera-

tive that one have in mind an ideal tax system against which
proposals can b e evaluated. Without such an ideal, one cannot
decide whether any proposed change is an improvement. Un-
fortunately, people disagree strenuously about what the ideal
tax system should look like. Many think that the tax system
should be used t o influence private economic and social choices.
Many others hold that frequent use of the tax system t o change
private incentives will lead t o inequity and unintended distor-
t io ns.

Disagreements o n t h e nature of the ideal tax system ex-

tend t o beyond the question of the systems purpose. They also
encompass the most fundamental issue for levying taxes: what
is the best way t o measure an individuals ability t o pay? Some
hold that annual income (measured as the sum of consumption
plus additions t o net worth over the year) best measures ability
to pay taxes. Others claim that income measured over many
years o r that annual consumption expenditures are better
measures.

This section examines many of t h e issues about which tax

reformers disagree and provides the necessary background t o
evaluate tax reform proposals. The issues raised here are im-
portant because it is really not possible t o think straight about
tax policy options without a thorough understanding of the
objectives sought in a desirable system.
 I0 FLrcol Impemtiws in Pakistan's EcononriC Development

"Fairness' In a Tax System

All taxes constitute a burden that people have to bear as

the tax levy has the force of law and is enforceable if necessary,
through coercion. The acceptability of a system of' taxation is
determined largely by the peoples perception of its fairness i.e.
how t h e system treats people placed in more or less similar
curcumstances. If the system is so structured that it is neutral
in its imposition between persons who are placed in identical
economic circumstance than it can be said that we have a fair
system i.e. the system does not have a bias towards; one o r the
other category of persons.

If t h e condition of fairness is violated, people will be

treated inequitably and what is very significant, incentives will
1 be created to base economic decisions on tax considerations
j rather than o n true economic gain. The critical issue however
is how to determine when people are placed in equal economic
circumstances. It would be useful in this context to divide the
I
I issue of fairness into a number of pertinent questions:
!
- What flows best measure ability t o pay?

- Over what period should these flows be measured and

taxed?
I
- Should taxes be levied only o n actual transactions or also
!
on accruals?
' 9

- How does inflation interact with the tax system'?

- What kind of savings impact on aggregate econqmic

activity and in what manner?

- What factors are pertinent in assuring improved taxpayer

compliance?

Ability t o Pay

Fairness requires that those with t h e same ability to pay

should pay t h e same tax. The question however arises as t o
what should be t h e basis for determining the relative ability
to pay of different taxpayers.
The Taxation oflncome : its conceptual basts 11

This question has been hotly debated over the years. The
debate ranges over two dimensions: t h e object t o be measured-
income o r consumption - and the period over which the
object should be measured - t h e so called accounting period.

Income Vs Consumption

Many economists hold that consumption is a better base

for direct personal taxation. They hold that justice requires that
taxes be apportioned on the basis of what 'people withdraw
from the pool of resources (consumption) instead of what
they contribute t o it (earnings plus t h e return t o savings). They
argue that consumption can be measured far more reliably and
simply than income. It is also argued that corisumption is a
more stable tax base because household consumption varies
less than household income.

Each of these propositons is debatable, but consumption

in our view is simply not an accurate measure of each persons
ability t o pay or of total economic capacity. Ac~:umulations of
wealth confer valuable economic and social benefits to their
owners even if the wealth :s not consumed.. Accordingly,
wealth accumulations should be incorporated into any mea-
sure of ability t o pay. Unlike a consumption tax, a tax on
income can reach accumulations of wealth that are not actually
consumed during the accounting period. For these reasons
we hold that income is the proper object by which t o measure
ability t o pay.

Having chosen income as the object of taxation, one must

devise rules for taxing it. Income can be measured in two ways:
as an outflow and as an inflow. As an inflow, income equals
the sum of earnings plus returns to capital, including changes
in the value of assets. As an outflow, income equals the sum
of expenditures incurred plus additions t o ..net worth. These
two definitions are equivalent to each other - rupees coming
in equal rupees going out or retained. The number of rupees
in the tax base is the same in either case.
 TABLE 4

CENTRAL GOVERNMENT EXPENDlTURE IN SELECTED THIRD WORLD COUNTRIES k COMPARISON WITH T H E N. 1.c.'~.

5% O F T O T A L EXPENDITURE

Housing. Amenitlen.
Defence
-
Educdbn Ecooamle Senna y$gGF OIbR Totd
erpemitlure
OIIRU m . u V 1 ~
dcrldt
( % o f GNP) ( % o f GNP)

PAKISTAN

NIGERIA

BANGLANDESH

INDONESIA

INDIA

PHILLIPINES

THAILAND

TURKEY

EGYW

s KOREA*

SINGAPORE

sourcw: Wodd Bank World Development Reporis- 1981.

G m w t h 01 p o p u l d b n . u r b . n l d b q t h e h n p e m t l r s o f defence haw all contributed t o a anp a r . l t i o n in l e r c b o f rrondew10Dmerrt.l go=rnment e r p m i l -

tma. So h m w b t h e d r h o n t h e exchequar t h a t e m r e n t revenues b u d y r u f t k e to mes( c-t e x p m d f u r e r c q u l r e m c n t . leadog UtUc (or notblas u 111) t o pu o n
to t h e L d a a l o p m t n t fund'.
 TABLE 4-A

NON DEVELOPMENT EXPENDITURE IN PAKISTAN

AS A % OF TOTAL EXPENDITURE

Period (%)

64 The steady increase in "non develop-

ment" expenditures is related to con-
62 tinueing high commitments for the
defence establishment and escalating
8 5 administrative expenses. The latter are
related t o increased population levels
58 and the greater role that the state
has come to play in the "management"
62 of the economy. Public utilities are
some of the biggest employers in the
68.5 country and all are state run. The
increased structural complexity of the
72 politico-economic format is also res-
ponsible for the increase in the cost
73 of administering the country.
 14 The faxation of Income :its conceptual basis

The Accounting Period:

Income can be measured and taxed over a day, a week,

a month, a year, or a period as long as the taxpayc?rs life. The
usual measurement period is twelve months. Furldamentally
however, there is no logical reason why a particular astrono-
mical regularity should be enshrined in the tax law.

T o be sure, there may be practical as well as historical

reasons for choosing one income definition and accounting
period over the other. Inflows rather than outflows may better
conform with conventional views as t o what income really is.
Similarly, there may b e practical and historical reasons for
treating equally individuals who have the same one year income
but not the same multi year or lifetime income. The main
point here is that one can favour income over consumption as
the measure of ability t o pay without necessaril!i favouring
a single year as the best accounting period for determining
equally situated taxpayers.

Accrual o r Realization:

The income tax rests on the concept that ann1.1al income,

when measured as an inflow, includes changes in the value of
assets. For practical reasons however, most personal income is
not taxed when it accrues t o the benefits of the ta.xpayer but
only when it is realized, generally in a market transaction.
This conflict between the definition of income in concept
and its measurement in practice is responsible for much in-
equity, inefficiency and complexity in the current tax law.
For example, capital gains and losses o n assets for which no
objective market price is available can only be estimated
crudely and laboriously. Gains and losses o n assets such as
stocks traded o n registered exchanges are easily counted and
could be easily taxed when they accrue. But taxing some
assets one way and some another would create unfair distinc-
tions among assets and among taxpayers. Instead, current law
taxes only realized capital gains o n certain classes of assets, thus
abandoning the principle that annual economic income should
be taxed. As a result, a different set of unfair distinctions is
created: taxpayers with accrued but unrealized capital gains
pay significantly less .tax. than d o others with realized gains,
,ltL,..mL thn- iAontioal
n n n n n m - n annnmoc ~ w o
I 'iscal Jmpemh'ws in Pakistarl 's Economic Development I -i

Why should capital gains be taxed the same whether

or not they are realized? Because it is not necessary t o realize
a capital gain in order t o spend it. If one pledges the appreci-
ated asset as security on a loan,one can spend the proceeds of
the loan and even deduct the interest payments on the loan,
thus reducing current tax liabilities. As long as the asset conti-
nues t o appreciate by an amount atleast equal to the after tax
interest cost, one can quite literally, have ones cake and eat
it too.

Inflation:

Proper measurement of income requires the valuation of

all quantities in real terms, that is, with full adjustments for
inflation. If such adjustments are not made, inflation changes
both the tax base and tax rates.

A simple example shows how inflation distorts the tax

base. A person who sells corporate stock at a profit will pay
tax on the purchase and sale, price differential. If the gene-
ral price level rose faster than the price of the stock, so that the
proceeds from the sale buy less than did the funds used t o
acquire the stock, the same tax will still be due. In this situ-
ation taxable income has little or no relation to economic
income and taxpayers in the same real economic circumstan-
ces may pay widely different taxes; thus the interaction of the
tax system with inflation undermines equity - and is also the
root cause of serious misallocation of resources.

Depreciation and Inventory Costs:

Deductions for depreciation are based on historic costs

if no adjustments are made for inflatiop. If depreciable lives
reflect useful lives and prices are stable, depreciation deduc-
tions based on historic cost lead t o an accurate measure of
income; and if firms set the same amounts aside in depreci-
ation reserves, they will build up a pool of funds sufficient to
replace assets as they wear out. If prices increase, however,
deductions fall short of replacement costs; the greater the
rate of inflation, the greater the shortfall.
 lo Th? Taxation o f l n c o m e ' i ~ 'corrceprrrol hosi(

true economic depreciation. This accelerated depreciation is

also invariably higher than the inflation rate. The measure is
designed principally as a fiscal incentive t o encourage busi-
nesses t o make investment in new plant and machinery ahd to
make replacement of worne out and obsolete plant at the
right time.

Interest Income and Expense:

Inflation also causes mismeasurement of real interest

income and expense. During inflation, interest payments
compensate lenders not only for the use of their funds but
also for the decline in the purchasing power of their funds
over the life of the loan. The real income of thc lender is the
interest received (or accrued) less the decline in the real value
of the loan principal outstanding. Similarly, the real interest
expense of the borrower is the interest paid, less the fall in
the real value of the outstanding loan.

Ideally, it ought t o be provided that the real value of the

loan on which interest arises (as income or expense for the
lender or borrower as the case may be) be worked out adjust-
ing fully for the prevalent inflation rate and then to calculate
interest with reference to this "adjusted" value. Practically,
however, implementation of this adjustment would be cumber-
some and would strain the resources of both taxpayers and
administration.

Distortions of Consumption and Saving:

The taxation of capital income at any positive rate reduces

the spending opportunities of people who wish t o consume in
the future by a larger fraction than it does the spending oppor-
tunities of people who wish t o consume income as it is earned.
A tax on capital income thus distorts personal decisions about
when t o consume.
The variation in tax rates among assets also distorts house-
hold decisions about which assets t o hold. In the pursuit of tax
advantages, individuals may buy assets'that are l e s productive
(in other words, do not have as high a before tax rate of re-
&..",\ ":,I.:,. ,."
lr.er 1;,..,,;,4 n+hPrw;90
+hnn wn,,lJ hP ,gPCirPlhlP
I'isral l m p e m d w s In Pakistan's Economic Development /7

Some advocates of expenditure type taxes claim that

deferring taxes o n all asset income until it is actually used
would increase household saving. This is also a major argument
against the annual income tax. While it is generally correct t o
say that tax changes can appreciably increase household saving
and that such an increase can contribute modestly t o economic
growth, however if we wish t o increase savings at the national
level there are more powerful and direct means of achieving this
goal. The increase in national savings from tax inducements t o
encourage household saving would be small relative t o the in-
crease in national saving that could be achieved by fiscal poli-
cies t o reduce the deficit or create a surplus. National saving
is the sum of saving by households, business and (government.
While household savings are positive, the federal government
may be dissaving. Even if tax changes boost household sa-
ving, the effect on national saving world be small compared
with the direct and certain effects of eliminat.ing the federal
deficit.

Tax policy as it impacts o n capital acquisitions can have

significant implications for savings. At the micro level, house-
hold savings have a variety of motivating factors. It cannot be
denied however, that a desire t o acquire long lived (durable)
assets mainly for their income yielding poteniial on a recur-
ring basis, is at the root of most such acquisitions. The
amount that an individual chooses t o set apart for investment
in such long lived assets in the future will be determined,to a
very significant degree, by the individuals pcirception of the
worth of such assets t o him - in the future when the acquisi-
tion is planned. If he perceives that the acquisition will entail
a financial burden other than the cost price,the usefulness o r
worth of the asset t o him would stand discounted to the extent
of the extra burden involved.

One of the reasons that people are prepared t o sacrifice

consumption in the present for consumption in the future
in t h e shape of long lived assets is that such assets are expected
t o appreciate in value over time. This "gain" makes it "worth-
while" for the investor t o postpone present consumption.
However it is this gain that also attracts the attention of the
taxman. Tax law generally incorporates some sort of special
provisions t o tax this gain. Usually the gain is taxed as it is
realized ~enerallyin a market transaction. As has been shown
 18 The Taxation of Income :Its conceptual basis

separately, in terms of economic power the fact of realization

of suah capital gain is not material. In other words it is not
necessary for the holder of such capital assets that have gained
in value to dispose off the asset in the marketplace to be able
to exercise the increase in their economic power resulting from
the gain in value of the asset. The holder can thus put up the
appreciated asset as collateral and use the resources thus acquir-
ed while at this same he retains possession of the asset - the
classic case of having one's cake and eating it too.

In any case the individual would not like to see this gain
eroded through a tax levy. If the tax statute incorporates pro-
visions that make it known to the individual now that any gain
that the asset he proposes t o acquire tomorrow is likely to be
heavily reduced by its taxation then depending on how pro-
hibitive he perceives the tax levy to be, saving for such an
asset will lose its normal attractiveness to him. Depending on
how broad the coverage of capital gains taxation is, such tax-
ation can actually reduce the quantum of savings of individuals.
What is of significance here is that the reverse of the situation
outlined above is just as valid in terms of its incentive effect
on the individuals proclivity to save. This means that if exist-
ing burdens are reduced or done away with, the worth of the
acquisition of 'such assets freed of financial burdens will be
enhanced and provided the incentive feature here is pronounced
enough it is actually possible that the individual will be goad-
ed into saving more presently so as to be able to acquire the
asset in the future. In this way therefore an increase in indi-
vidual (household) savings is possible.

While household savings are undoubtedly of much signifi-

cance, at the national (Macro) level the level of aggregate savings
in the economy are not likely t o be automatically increased by
all areas involved (government, businees and households) as
a result of incentive legislation of the type out.lined above.
Thus it is quite likely that while households save more, the
government could be dissaving - as happens ever so often -
resulting in escalating budget deficits. Looking t o the ever
increasing size of budget deficits, it is clear that meaningful
reductions in these deficits aimed ultimately at doing away
with them altogether would have a much more significant
impact as .far. as national savings are concerned. An imagi-
native policy geared t o eff~rtioo rnnhilization of revenues
1,'isccll Impemtives in Pakistan's Economic Devclopnrc~rr 19

across the full range of the economic spectrum coupled with

rationalization of expenditures - again at the national level -
is what is really required if economic policy is ever t o have a
perceptible impact towards betterment of the state of the
economy.

The tax system should be designed t o be fair, conducive

t o the efficient use of resources and easy t o administer. Any
increase in saving would be a positive but minor bonus from
reforms that should be adopted only if whollv justified for
these other, more important reasons.

Compliance and Administration:

Tax laws are not self enforcing. Taxpayers must go t o

the trouble and expense of calculating how much they owe.
The government must spend part of the proceeds of the tax
t o collect it and t o enforce it. Despite the efforts of a profes-
sional staff of tax administrators in the Deptt. of Income
Tax, taxpayers illegally evade a good part of the taxes they
owe. Also, they go t o enormous trouble and expense rearrang-
ing their affairs legally t o avoid taxes.

Tax reform holds out hope of improving compliance

through two separate routes-reducing marginal rates and simpli-
fying the system. Simplification in turn takes two forms:
"legal simplification" which would ease taxpayer comprehen-
sion, compliance and administration and "transactional simpli-
fication" which is the reduction of the number and comp-
lexity of transactions undertaken t o avoid taxes.

Improving Compliance

The key t o improving compliance and enforcement .is a

combination of lower marginal tax rates and ilnderst,andable
rules. For a given amount of revenue, the only way t o hold
down marginal tax rates is t o broaden the tax base.

In theory, economic power flows from a "persons" (i.e.

individual, AOP, Firm, Company etc) command over economic
"material". It follows therefore that the greater a persons in-
come the greater would be the command over economic ma-
tnrinl Thin nnmmsnd in thrnr t h a n n n n n m i n n n r r r n r nf t h o now-
 The Taxation of Income : its concepmal bast:

son. At the same time it should be quite clear that income as

a mere receipt cannot be t h e only determinant of economic
power for if such power is symbolized by a persons command
over economic material then in order t o be 1ogic:ally consistent
we have got t o acknowledge the periodic accretion in market
value of assets as also bestowing on the owner of such assets,
economic power that is equivalent t o that bestowed by the
receipt of an income. That this must be so is apparent from the
fact that this accretion in value is a realizable value because
the asset can be disposed off (sold) in the market o r can be
put up as collateral for securing a loan. In either. case resources
(money) become available t o the owner of this asset to acquire
available economic material, be it factors of production, raw
material, or finished products. For all practiciill purposes an
ideal tax law would treat both the recipient of income and the
owner of a "valuable" asset with escalating periodic market
worth in identical fashion. However much of real life is a far
cry from the ideal - and tax laws are notorious in keeping
their distance from this ideal.
 Tax rate structure

The tax liability of a person is determined by the rate

structure in force in a particular period. The rates of tax are
specified differently for each 'bracket' or slab of income. A
'constant marginal rate of tax' applies t o the income falling in
a particular bracket. The constant marginal rate applies t o each
addition to income within the particular slab. As income
rises and a person moves out of the slab he was placed in
previously the marginal rate of tax on the additional income
(which takes him to a different 'high' slab) will be higher.
Thus the marginal rates at succesively higher income brackets
are higher than the marginal rates at lower income levels. The
total tax one pays depends not only on the marginal rate
applicable to the income bracket in which one falls, but also on
the marginal rates applying to the lower levels of income, a
well. Consequently, in order to be able to calculate the total tax
liability, one must know the whole tax table.

An important question of tax policy relate to the degree

of 'progressivity' that ought to be built into Lhe tax system.
We know that that tax system is 'progressive' in which the
share of income paid in tax rises as the income rises above
the minimum exemption limit. Now is it possible to structure
a tax system in which the degree of progressivity incorported
can be said to be 'socially optimal?" In the opinion of many
experts in public finance it is not really practicable to structure
such 'optimization' in a tax system. If an exercise is made the
exploration would be purely theoretical. As Lewis points out,
22 Fiscal Ilnperahvrs in Pakistan's Economic Development

the determinants of tax rates, in practice, are more pragmatic

and political.

The importance of the 'marginal rate structure' in tax 6

policy arises from the fact that the important alllncation de-
cisions affected by taxation are made at the margin, where one
compares the consequences of one action o r another on the
after tax level of income. While high marginal rater; of tax for
the higher levels of income having a progressive rate structure,
it does not necessarily follow that high marginal rates of tax for
the higher income slabs are 'ideal'. For one thing this could
deter 'risk taking' by entrepreneurs both public as well as
private. In a 'mixed economy' (typical in our times) risks will
be taken if t h e anticipated profitability is high enough to
justify the risky venture. One of the important factors that
enter in an entrepreneurs assessment of the risk factor is the
amount of tax he must pay at given income levels. The high
the rate of tax t o which the venture would be subject lower
its profitability. Obviously if the rate of tax appears to be
prohibitive it would rule out an investment decision. Thus too
much progression at the higher income levels might not be
advisable if it were to put a brake o n risk taking.

High marginal rates of tax at the higher income levels

also provide a powerful incentive for tax evasion. P~tblicpercep-
tion of what is a prohibitively high rate of tax is important in
this context. Generally speaking in developing countries there
is little 'tax consciousness' and in countries with a colonial
background the negative attitudes vis a vis the central authority
bred in the colonial period persist after independence. Also
as governments in developing countries d o not have very many
clearly defined 'welfare functions' the common man (usually
illiterate o r at best semi literate) does not see a nexus between
payment of tax and receipt of a benefit. The effect of all this
in the aggregate is to condition the citizen negatively as far
as payment of taxes is concerned. In t h e face of this reality it
goes without saying that too high marginal rates of tax for
increasing levels of income are sure t o provoke attempts at
evasion. This is not t o say ofcourse that no attenapt ought to
made to inject progressivity into the tax system. What is ne-
cessary however is a recognition of t he 'ecology' of taxation and
t o structure tax rates keeping in mind the imperatives of the
reality.
Tax m te Structure 23

The basic system of corporate income tax in Pakistan

has been fairly stable over the years with an income tax of
30 % and a super tax of 30 % o n profits -- reduced t o
55 5% overall in 1983. Further relief was allowed for Public
Coys in that the aggregate (income tax and super tax) rate was
reduced from 50 % t o 40 % from assessment year 1986-87.
Similarly, in the case of personal income tax, the maximum rate
has been reduced from a high of 9 7 % in 1958 to 75 % from
1 9 6 1 through 1964, t o 7 0 % from 1965 through 1975, t o 6 0 %
in 1 9 8 3 through 1985 and 45 % with effect from asstt year
1986-87. Also the lowest slab has been reduced from 10 % to
5 5%. Furthermore, dividend income of taxpayers (other than
companies) from specified public companies has been totally
exempted from any charge of income tax.

While the trend towards reduced levels of taxation is a

step in the right direction and what is very important govern-
ment revenues have n o t fallen precipitously as many feared they
would, given the deeply ingrained hibit of tax evasion (infact
revenues have actually increased ( 1 9 7 9 8 0 onwards) the quan-
tum of revenues generated in the aggregate are much less than
what they would have been had base broa'dening: measures been
taken simultaneously with the rate reduction. In the absence
of the same revenues though much improved over the levels
achieved say, in 1977-78, are still far short of what they can be
given imaginative and determined policy decisions to broaden
t h e tax base effectively.
 Taxation - structure

In t h e age of tailor made turnkey systems it is unfortu-

nately, not possible t o shop for an ideal tax sjrstem t o buy and
instal with the expectation that it will ever take root and grow
in its new habitat as well as it did in the land that gave it birth.
A tax system might appear ideally suited for one kind of
people and geographical location. But it does not follow that
this system when imported by an allien people,, i.e. people other
than those who conceived and developed it. would be any-
where as effective.

The cultural/sociologica1 factor can be very important in

this context for it can define the operative parameters within
which any system must operate. The compatibility of a system
to its environment is thus a crucial factor. Unl12ssthe parameters
of this system are attuned to the circumstances of its environ-
ment there is every likelihood that a mismatch situation will
arise causing a rejection of the offending arrangement.

In an evolutionary context, t h e comple~nent,arityof a tax

system t o the operative circumstances of its txology can under-
go change with the passage o f time. Thus a system that ap-
peared t o be working stifactorily at one poirit of time could at
another time appear t o be ridden with factors that indicate an
asymmetry with its environment. Perhaps the most important
aspect t o be taken note of here is that the social values of a
people can undergo change over time thus altering their respon-
.
.
L
,.
.
."
- :- & L A-.I.,.- -C - ...--
ses. As a result of this often subtle and sc.arcely perceptible
In c.mtn- ihst s m m n s ~ a Atn ha
 26 Fi?i..c~?!!wpt~mtiws
in Pakistan's Eco,vomic Developmen t

perfectly adapted with the values of a peopl~tt can become

maladjusted.

The tax structure in an economy encompasses all the

diverse direct and indirect levies that governmc:!nt at various
levels (Central, Provincial, Local/Municipal) impo:ses t o generate
revenues. Infact the objective of a taxation levy can conceiv-
ably be other than mere revenue generation. Thus progressive
direct taxation of income and wealth would, besides raising
revenues, also aim at reducing the inequities in the distribution
of income and wealth in society. Whatever be the objective,
these levies in their totality constitute the taxation structure in
a given time frame.
A study of the taxation structure focuses on (a) shifts
in the taxation structure over time relative to various levels of
economic development (b) the size of the Government sector
and the level of economic development (c) the limits to tax
reform policy given the constrains of historical-institutional-
and sociocultural factors.

Taxation structure is of great significance in the context of

revenue mobilization. The effective mobilization of revenues
is crucial in any scheme of economic development. What pat-
ter the economic development program takes is not important,
for effective revenue mobilization is basic to all schemes of eco-
nomic development.

As economic development progresses government r e

venue shares of gross national product increase. This is what
experience teaches us and the logic of the situation suggests
that over time this government share of the GNP must grow
progressively larger so as t o ensure that full employment equili-
brium is maintained. This is so because the marginal propensi-
ties to consume, invest and export tend t o decline as income
levels rise. If follows therefore that unless the taxation struc-
ture is effective in generating adequate revenue government
will not be able t o d o its bit in ensuring maintenance of full
employment equilibrium.

II
1
The execution of a program of economic development
induces structural changes in the economy. The different
phases in economic development-Industrialization, 1Jrbanization
1
Specialization, Democratization, Secularizatiori - productivity
and income changes impact o n government shares of national
income. Thus independent of the ideological underpinning,
progressive development of the economy causes government
share in the national income t o increase over time. However
while this trend is universal, the pattern may not follow a
stereotyped or uniform direction. Thus while in one case
direct levies may be prominent in the flow of revenue t o
government in another case indirect levies may assume signifi-
cance. However it is to be noted here that in t.he early stages of
the execution of a program of economic development indirect
levies are of much greater significance accounting for anywhere
upto 85 5% of the aggregate government revenue. As develop-
ment progresses reliance o n indirect levies generally declines and
direct taxation of income assumes significance. If this does not
happen in the normal course o f events then it could point t o
structural deficiencies in the fiscal arrangements and t h e skewed
pattern could very well lead to social tensi.ons as the fiscal
burden of the underprivileged rises.

Besides the structural changes induced by economic

development refeered t o above, ideological change over time
too impacts o n resource mobilization. Ideological change will
be one of t h e determinants of the size of t h e government sector.
Thus a capitalist state with a socialist slant in Britain in the 50's
can bring big government in its wake and bring t o the fore
criteria like welfare committments that were not evident in
t.he earlier phases. Ideological committment:; (welfare o r secu-
rity and defence) will also determine what share government
would like t o appropriate of the aggregate national income.
A government committed in a big way t o pr'omotion of public
welfare or to national defence would have a greater absolute
need for revenue than another government -not so committed.

Changes induced by the ideological imperative however are

preceded by the changes that require the maintenance of a
complex, democratic, industrialized State. These maintenance
requirements necessitate that government function a t a certain
minimum level.

Changes i n the structure of taxation over time are relatable

generally, t o a number of variables. Per haps the most important
of these is t h e d w r e e of 'openness" o f tihe economy. This
points to the significance that can be attached to the foreign
trade sector. The larger the size of the foreign trade sector the
greater the prospect of the taxation structure being an induced
effect of the activity of the foreign trade sector.

The foreign trade sector is significant in terms o f the

possibilities that exist for the generation of revenues t.hrough
the levy of duties o n imports and exports. Depending on the
elasticity of demand of the products of this sec1;or and the
quantum involved levy of duties can yield steady revenue.
However the incidence of such levies is indirect andl so far as it
is the consumer that has eventually to bear the impact; of the
levy, the impact of such levies is regressive. Too great a depen-
dence on import duties can distract attention from other more
important areas of fiscal activity and can cause 1ast.ing damage
to the direct tax levies that in t h e final anlysis are of such
crucial significance in ensuring a more equitable distribution
of,income.

Per capita income is another variable that will induce

changes in t h e taxation structure. As an absolute figure the
figure for per capita income is an indicator of the economic well
being of the country. A steady increase in the per capita income
augurs well in that it & a pointer that the country is developing
economically in a positive manner. Per capita income will be
one of the determinants o f taxable capacity of the populace at
large. It ought t o be fairly obvious that the higher the per capita
income over the thereshold at which bare meaningful survival
is possible the greater the fiscal potential and pc.~ssibilityof
yielding revenues through levy of taxation. Just as obviously,
it follows that a level of per capita income that en'sures mere
survival is hardly capable of yielding revenues of any signi-
ficance.

It should be noted however that the absolute figure of per

capita income does not indicate fully the possibilities in the
fiscal context. Rather, the pattern of distributior~of income
would determine largely how far it is possible t o "squeeze"
the populace at large so as to extract the optimum or near
optimum tax revenues for the exchequer. A skewed pattern of
income distribution would not be promising in this context for
it would impact adversely o n the tax base. Now the narrower
the base the smaller the revenues that such a limited base can
Taxation Structure 27

be expected to yield-and vice versa. Third world countries

typically present a scenario in which we are c~onfrontedwith a
significantly skewed pattern of income distribution. One of
the objectives of the economic planners in such a. context is t o
change the skewed patterns of income distribution and replace
it with a more equitable and uniform pattern. In order to do
this the instrument of progressive rates of taxation on income is
a vital tool the proper and imaginative utilization of which can
go a long way in countering an inequitable, skewed pattern of
income distribution. Insofar as the pattern of income distri-
bution impacts on the issue of progressive direct taxation of in-
come, this is a cause of inducing tax structure change. Also,
insofar as the existing pattern of income distribution is the re-
sult of the incidence of levies on the income of the people the
pattern of income distribution will be an effect of the fiscal
arrangement.

Cultural style is the last important variable to impact on

tax structure change. The cultural style of a people will. deter-
mine the attitude and responses of a people to assorted fiscal
enactments and will be responsible in no small manner in
determining the effectiveness of fiscal meilsures. As cultural
conditioning is deeply ingrained in the individual psyche it is
of great significance in this context and itis adequate compre-
hension by the economic planners is essential if their planning,
especially in the context of the fiscal arrangements that are
made by them, is to meet with the degree of success that is
desired.

Cultural conditioning can be both postitive and negative

in terms of the receptivity of a people to change. A cultural
melieu that emphasis passive acceptance of the status quo o r
one that discourages much energetic effort due to a fatalistic
outlook and worldview would hardly be congenial t o a context
where significant, revolutionary change is important. Culture is
an amalgam of diverse influences o n the psyche and the impact
of cultural factors can be quite subtle and therefore, it may not
always be easy t o identify these factors and to work o u t their
significance individually. However religion is one of the impor-
tant factors. It is well known how Tawney has identified pro-
-
testant religion-or t o be more accurate, the protestant ethic as
a prime factor in shaping the destinies of a people wedded t o
Tawney has been carried away in his analysis by the c~verrinding
significance attached to religion, it certainly cannot be denied
that for the great majority of people in most countries and
especially in the developing world the importance of religion as
a motivating factor can hardly be denied - or overemphasised.

Tax structure - the Pakistan context -

The narrow base enigma has been a bane in the Pakistan
tax structure from the beginning. In 1987 when the popula-
tion of the country is a hundred million plus, the total number
of income tax payers are just over one million. Agri income
is exempt by statute in its entirety. A good part of the non agri
income enjoys either partial or total exemption under some
incentive provision. A host of deductions, exclusions, allowan-
ces further erode the taxable base. The net result of the situ-
ation obtaining is to yield a very narrow base indeed. The
revenue that this truncated base is capable of contributing t o
the exchaquer is bound to be poor.

Eesides the factors cited above the huge parallel economy,

whose size by one estimate has been determined to be half
that o f the country's GNF', is almost completely outside the
ambit of the fiscal operations of the regular economy and dep-
rives the exchequer of huge revenues while latching on parasiti-
cally as it were to, the distribution!marketing and other facili-
ties of the regular economy.

While resource mobilization remains a primary o'bjective

in the levy of income tax, of increasing significance, is the
provision of incentives through deliberate manipulation of the
income tax law as it impacts o n selected categories of taxpayers.
The scope of fiscal measures expressed through the direct
taxation of income is servely limited however, by the extreme
ly narrow tax base. This is apprarent from the fact that direct
taxes contributed only 13 % of the aggregate revenues in
1986-87down from 25 % in 1949-50 and 17 % in 1 9 7 9 8 0 .

The taxation structure of Pakistan is characterized by a

pronounced lack of any dramatic changefor better or for
worse. The pattern of revenues yielded are: more or less, the
same since independence. Over 80% of the tax revenues flow
from indirect taxes and duties on imports are the largest single
Taxation Structure 31

category here. Per capita income has increased from Its. 396 in
1959-60 t o Rs. 6,336 in 1987. However the tax per capita has
increased nominally. Considering that government expenditures
on administration and defence (the forced division of the
country in 1 9 7 1 notwithstanding) have escalated astronomically
the inability of the fiscal apparatus t o provide the required
funding has created a crisis state that by its very logic now
generates pressures for change that could prove t o be irresis-
table. T o be sure foreign assistance has baled out the country
for quite some time now. Yet the aid climate t o o is becoming
more and more difficult and this too can only exacerbate an
already bad situation. Fortutious political circurnstance in the
relations between nations cannot be expected forever to provide
avenues that become exit points from disaster situations.

That the fiscal scene is dominated by rampant Lax evasion

is frigheningly apparent from t h e brazen operations of the
parallel economy and the ease with which rt,.gular business
avoids the taxrnan.

Tax evasion in Pakistan is rampant-as would appear even t o

rhe uninitiated from the statistics given above. While due pay-
ment of income tax is not made by all categories of taxpayers
the evasion is chronic and widespread in the non corporate
sector. And ofcourse the by now monstrous proportions of the
parallel economy are outside the reach of the taxman virtually
in it.s entirety.

The magnitude of tax evasion can be gauged from the r e

port of the NTRC that estimated the total tax evaded income in
one year at Rs 50, 763 million with the total quantum of black
wealth amounting to Rs. 1,70,000 million. The abject failure of
fiscal agencies to deal with the problem is apprarent from the
fact that the total tax collected by the deptt of .income tax
in one year is just about 35% of the (potential) amount that
could have been brought in as revenue.

The basic system of corporate income tax in Pakistan has

been fairly stable over the years with an income tax of 30%
and super tax of 30% o n profits-reduced t o 55% overall in 1983.
The maximum rate of personal income tax has been reduced
from1 97% in 1958 t o 75% from 1961 through 1964, t o 70%
32 Fiscal Ittlpem t i w s it1 Pahisratr 's Ecorron~ic.Developttrorr

from 1 9 6 5 through 1975, 60% in 1 9 8 3 thru 1 9 8 5 and 45% in

1986.

In relation t o tax base, income taxes in Pakistan have been

estimated t o have an elasticity co-efficient of l . 5 2 over the
period 1952-53 t o 1963-64 and 0.83 over 1972-7'3 t o 1979-80.
This inelasticity is responsible for the fact that increasing GNP
is not automatically translated into proportionalbe increases ilk
revenue.

Progressive erosion of the already narrow tax base has

resulted from the fact that the zero bracket exemption limit has
been revised upwards from Rs. 2,500 in 1948, Rs. 6 0 0 0 in 1 9 5 7
Rs. 12000 in 1974, Rs. 18,000 in 1 9 8 3 and Rs. 24,000 in 1985.
Further, a variety of allowances, deductions, clredits, rebates
and other concessions have been allowed over th1.1 years. These
have caused a sharp diminution in the the effective rate of tax.
Originally designed as incentives for investment and industry,
many of these now appear t o have definitely outlived their
utility.

Structurally, the direct taxation system in Pakistan has not

shown much resilience and has not been responsive t o changes
in the GNP, t h e per capita income, the distribution pattern of
income among various sections of the population, the changing
composition and scale of foreign trade and similar other para-
meters. This has been due mainly t o an inherent rigidity in t h e
tax system. T h e inadequate coverage of the tax net due t o the
blanket exemption of income derived from agriculture coupled
with the plethora of so called incentive exemptions, deduc-
tions, allowances and assorted exclusions have dramatically
reduced the impact of the income t a x o n the aggregate of
incomes generated in the economy. Thus excelat for narrow
segments t h e income generated in t h e rest of t h e economy
cannot b e effectively subjected t o tax as there is no built in
"automatism" that would (automatically) mop up potential
revenues. T h e lacuna and loopholes in the t a x law are so many
and so evident that not much effort o r imagination is required
t o get away with a "token" payment.

T h e only discernible change of any significance is in the

fiscal incentives package that has been designed in various
phases of t h e development programme of the coun~try.
Taxation Strucmre 33

Broadly speaking, the package of fiscal incentives put t o

use in a particular period reflects an endeavour to help facilitate
achievement of the specific objectives that have priority in the
growth strategy for that time frame.

It needs t o be pointed o u t here straight away that by

themselves fiscal incentives cannot be expected to bring about
changes o n a meaningful scale. Such change will take place only
when the fiscal incentives package is correctly integrated into
the overall planning and development format structured for the
economy as a whole. Unless the incentive measures "mesh"
synchronously with the variety of disparate elements that make
up the development program of the country an asymmetrical
situation will result in reducing or even nullifying altogether
the designed efficacy of the incentive measures.

In Pakistan, unfortunately, integration has left much t o be

desired. Successful integration pre supposes long range pers-
pective planning. This however, is one of the most conspicuous-
ly deficient areas in our development effort with the result that
adhoc measures t o implement various policy decisions-including
fiscal incentive lawshave become the norm rather than the
exception . The net result of this has been that many of the
fiscal incentive laws are noteworthy only in their intention
rather than the results that have followed in %hewake of their
enactment.
 4
Base Broadening:
a leading issue in tax reform:

That there are just over a million income tax payers in

Pakistan is a perplexing enigma with serious in~plicationsf o r
resource mobilization. Considering that the total population
of the country now exceeds a hundred million, t h e taxpayer
population is clearly minuscule. What adds dramatically t o the
narrowness of this base is t h e fact that 60% (almost) o f t h e
aggregate income tax collections, emanate frolm the corpo-
rate sector. That the position here t o o is skewed is apparent
from the fact that a handful of multinationals and a smattering
of public'sector enterprises fund t h e entire contribut.ion of t h e
corporate sector. Thus the great majority of private limited
companies, as also a considerable part of publiic sector units
and multinationals exercise their t a x prowess o n paper-argueing
claims for exemption, allowances, credits and rebates, ex-
ploring legal loopholes in the statute, contriving continueing
losses, camouflaging acquisitions - in short doing everything
but paying tax o n their income. As for the vast multitude
in this tax universe comprising t h e proprietory businesses,
partnershi;, concerns (firms), individuals (partilers in firms,
individual recipients of property income, interest income,
lease money etc) & A.O.P.'s, the less said -in 1:erms o f their
relative tax contribution- t h e better. T h e wage earners and the
salaried class,by and large, contribute their bit t o the exchequer-
perforce. T h e deduction of income tax at source leaves them
no option but here t o o there does exist room for manouver
for the imaginative, bold and enterprizing -and there are quite
a few here who have these traits.
36 Fiscal In~pemdwsin Palcistan 's Econ<~rniCDevcloprnent

What are the root causes of the narrow tax base in Pakis-
tan? Are the people so improverished that only 1%of the
total population has the capacity t o pay a tax o n their earnings?

While Pakistan certainly falls in the category of a develop-

ing country and poverty is certainly an issue of' significance,
there is little doubt that the narrow tax base has nothing t o
d o with these aspects of the economy - atleast not t o the
extent that the base is narrow. There are two principal reasons
for the state of the t a x base; (1)The largest single economic-
sector in Pakistan, Agriculture, contributing about 30% by it-
self to the gross domestic product and employirlg 60% of the
total population, is outside the ambit of income taxation-
has been since 1947; 2) the burgeoning "parallel economy"
whose awesome economic potential is evident from the fact
that some estimates place the income generaled therein at
50% of the GNP of the "regular economy," is affected only
marginally by the income tax levy thus contributing practically
nothing t o the exchequer.

All income from agricultural activities has enjoyed sta-

tutory exemption since the inception of Pakistan and the
reasons for such preferential treatment are supposedly rooted
in the economics of the situation obtaining in the iagricultural
sector.

The arguments advanced by those advocating a continue-

ing exemption from the levy of income tax to the agricultur-
ists, revolve around the thesis that the burden of taxes that
the agriculturists bear is such that they just d o not have the
capacity t o suffer any additional t e a t i o n . Seccondly, it is alle
ged that t h e nature of the landholdings and their geographical
dispersal make it administratively difficult, if not impossible, t o
attempt to make assessments of agri. income to charge income
tax.
What is required now is an evaluation of the veracity of
the arguments advanced by the agriculturists lobby.

Available data on the burden of direct taxes on agri

shows that direct taxes on agri have risen at a :slower pace than
the growth in agri incomes. The percentage of direct taxes on
agri vis-a-vis the value added in aeri indibat~nt h ~ t h o w m o
has actually declined from 1.9% in 1972-73 t o 1.3% in 1978-79.
Other data indicates that while direct taxes on agri income have
increased by 78% between 1972-73 and 197'8.79, direct
taxes o n non-agri incomes have risen by 182%.
To be fair, direct taxes do not tell the whcrle story. Al-
most 8570 of federal revenues are derived from indirect taxa-
tion. The agriculturists argue that as indirect taxes are paid by
all, it should be assumed that the agri populatiorn (the highest
for any economic sector) bears the heaviest burden.

Strictly on merit it is either fair nor logical to make a

distinction between agri and non-agri incomes for purposes
of taxation. A distinction so made arbitrarily amounts t o cre-
ating a preference for one class of income over the other. In-
stead of creating such a preference for which there appears t o
be no economic justification, it is suggested by the counter
exemption lobby that just as incomes below a certain level are
exempted from income tax, the same principle should be exten-
ded t o agri income. This would take care of the subsistence far-
mers who would be automatically excluded.

Levy of income tax on agri income is also recommend-

ed to reduce the evasion of income tax in Pakistan which is by
all accounts, considerable. The availability of statutory exemp-
tion for agri income has resulted in the systematic exploitation
of this exemption by those enjoying non agri income. Through
the simple expedient of attributing part of their income t o
agricultural activity they are able to secure substantial tax
benefits. In reality ofcourse such people are not actually signi-
ficantly engaged in agriculture at all. Powever since they have
purchased agri land-which may be marginal land o r even waste-
land (banjar) for all they care- it is not too diffic1111tto hood-
wink the federal tax authorities on the bonafides clf the jnvest-
ments made by them and attributed t o the earnings of tiheir agri
holdings.

O n another and more subtle plane, the "phantorn" flow

of funds from agriculturists t o non agri business contrived
artificially through the creation of "ghost" liabilities, has pro-
vided legal cover t o substantial investments funded b y accumu-
lations of untaxed "black" money. Had agri income been sub-
jected to income tax then it would not have been so simple a
38 Fiscal Impemrives in PaMstan k Economic DewIopmen:

matter t o create such liabilities as the affairs of the agriculturist

would have been as much subject t o scrutiny iis the person
engaged in business. So far however, the income tax authorities
have no direct record of the agri activities. Only sketchy infor-
mation of dubious origin is relied upon to decide on the bona-
fides of a reported liability shown as owing t o the agriculturist.
Again, since bank accounts are as a rule not reported t o the tax
authorities - only those accounts are reported that "suit" the
taxpayer (or agriculturist) - the cash flow of funds constitute
an added impediment in this context as these cannot be moni-
tored.

Thus if income generated by agriculture were made tax-

able, the "facilities" presently available through the "devices"
mentioned above, for securing huge unwarranted, tax benefits,
would be negatived.

The feasability of mobilizing revenues from, thc: agri sec-

tor through direct taxation of income generatedl there is also
apparent from the fact that the agri income tax would be more
income elastic than land revenue. With a greater yield per acre,
higher procurement prices and mechanization, incomes in the
agri sector have risen considerably, but yield, in terms of
direct taxes from agri, has lagged behind appreciably. To illus-
trate the point, it is pointed out that between 1 9 7 2 - 7 3 and
1978-79, the yield from the direct taxation of agri (land reve-
nue and irrigation charges) increased by 7852, while value
added in agri,at current factor cost, increased by 1 5 7 9 ~ .

That the taxable capacity of the larger farmers (:who cons-

titute the rural elite) has improved over time is evident from t h e
considerable increase in consumption expenditure of the rich
farmers. According t o Alavi, even when there are adverse
changes in the terms of trade for agri, the rural e1it.e enjoy
considerably enhanced real incomes.

The conspicuous consumption of the rural elite is not

only an indication of t h e steadily increasing affluence of t h e
rich farmer but it is also a pointer t o another evil - that of
accentuating differences in income, distribution in the agra-
rian sector. Progressive rates of income tax, if applied t o the
income of this rural elite, could,over tirne,alleviate this malady,
the persistence of which can only bode ill for the social stabili-
Base Broadening 39

ty of agraria and for the politico economic well being of the

country in general.

However one looks at it, there appears t o be little justi-

fication for a blanket exemption for agri income. There is no
denying that the small farmer with a limited landholding
may not be able t o bear the burden of additional taxation.
However barring such exceptions, levy of an income tax would
appear to be fully justified - and even necessary if the revenue
needs of government are t o be met and if the federal govern-
ment is to put an end t o deficit financing.

An obvious consequence of bringing agri income within

the pale of federal taxation would be t o broaden the income
tax base considerably. This is obvious from the fact that more
than half the population of the country is engaged in agri
pursuits, Such base broadening would therefore mean more
taxpayers and that would mean increased revenue for the
federal exchequer. It ought t o be noted however that while
the number of taxpayers will certainly increase, the additional
income tax revenue realized as a direct consc.quence of doing
away with the exemption presently available for agri income,
would not necessarily be proportional t o the broadening of the
tax base. This is because a number of concessions would still
have t o be allowed to agriculture. This would be necessary t o
say, encourage modernization and compensate for deterio-
ration in the terms of trade.

As for countering the huge losses in revenue suffered as a

result of the depredations of the parallel economy, the matter
has been dealt with indepth separately, in chapter 13.
 The Taxation of
Business Profits

Realignment of tax burdens among

different business entities

Different Legal entities are treated variously by current tax

law. Thus the proprietory, t h e partnership, the Association of
Persons and the corporate forms of business organization all
suffer varying tax burdens for given levels of income. In addi-
tion the partnership and corporate forms are further differen-
tiated between registered and unregistered firms and between
Private and Public limited companies.

The present treatment of different legal forms appears not

t o have been designed to differentiate the tax load according to
any clearly discernible criteria. Prior to 198283 the registered
Firm category received preferential treatment. Thereafter the
preference stands reversed with the private corporate entity
best placed to effectively minimise tax burdens.

A uniform system for taxing business enterprize with

specific relief features for small business, irrespective of the
legal form of the business would facilitate greatly the struc-
turing of optimal marginal rates of taxation-opthnal in a manner
as t o balance revenue yield with equity. The objective ought t o
be t o identify a "small business" not on the basis of arbi-
trarily contrived legal form but on the basis of income size and
ownership characteristics.
41
I Implications o f a high marginal Rate of Tax:

In order t o appreciate all facets of the probllt?m it should

be recognized that there can be situations in which a high
marginal rate of tax can serve specific fiscal objectives such as
when it is the intention t o mop up supernormal earnings of
business generated by tariff protection, n~onopoly, inflation
etc. The high, marginal rate emerges in such situations usually
through the interplay of multiple tax rates on income, prin-
cipall y through an excess profits tax which is levied in addition
to t h e income tax. T h e need for such a levy (:an arise due
to new revenue needs such as for special purrlose develop-
ment activity or even during wartime. In the economic develop-
msnt context, high marginal rates can be theoretically justified
on the ground that they would encourage employers with
abnormally high income t o lower prices for t h e i ~products or
in the alternate t o raise wages. Thus where the tar takes a high
proportion of each additional unit of earning,, deductible
expenditures are cheap and additional net earnings have little
appeal. Furthermore a high marginal rate can serve as a symbol
of the governments resolve to take excessive profits out of
growth.

Despite the possible advantages of a high marginal tax rate

1 in certain situations it is also a fact that in a peacetime economy
! dedicated t o expansion and troubled by inflationary pressures a

I high marginal tax rate injects evident inequities, incentives to

waste cheap tax currency and disincentives t o growth and
I
i
efficiency. As far as multiple tax rates are concerned these are
generally considered obsolete in the context of future tax
1 planning. The verdict of fiscal authorities generally is that
they are conducive t o waste and inefficiency. Where the high
marginal rate emerges out of a high tax rate graduation of a
single tax on income, this can be seen as a misguided applica-
tion of the progressive ability t o pay principle that encourages
framentation and discourages the growth of business enter-
prizes.
A unitary flat rate would appear to have obvious merits
from the standpoint of simplicity and consequent adminis-
trative efficacy. Nevertheless, the fact remains that it would not
alleviate existing inequities in income distribution and could
conceivably even contribute t o exacerbate the same. There
would also b e considerable problems with working out an effec-
The T a x a t l a of Buslness Profin 43

tive unitary rate of tax that would ensure the same generation
of revenue as the present graduated rate structure and at the
same time reduce the burden of taxation. A true unitary system
would mean doing away with imputation of corporate income.
This would then mean loss of significant revenue from this
area. Infact for private limited companies this is the only .area
of revenue significance as far as t h e exchequer is concerned as
only nominal corporate profits are disclosed "as a rule."
(Because the company has a separate juristic c!ntit.y it is recog-
nized as a person apart from its directors. T h , ~ the
s tax, under
the present system, falls on both the company and its direc-
tors. Piercing the ccrporate veil however makes it only t o o
evident that in actual fact the separate identity of the company
is a fiction created by statute. The identity of the directors
merges into that of the company . It is the company that in the
final analysis pays the tax both for itself and its directors. In
this view of the matter imputation of its income subjects the
company t o multiple rates of taxation. A true unitary flat rate
system would therefore necessitate doing away with imputa-
tion). The corporate ability t o retain earnings and disburse sa-
laries t o its directors, rule out, given the present format of the
statute, disclosure of significant net pre tax profits for the pri-
vate limited companies which are under no pressure t o declare
dividends It would be difficult t o offset the revenue loss from
this area. T o o high a flat rate of tax would abruptly escalate tax
burdens especially for the small t o medium enterprizes . At the
same time the supernormal earnings of the larger enterprizes
would not be mopped.up by government which in the long run
would exacerbate inequalities in income disi,ribution. The deli-
berate planned quest for an egalitrian stxiety would thus
remain unfulfilled.

A complicating factor in the structuring of a unitary flat

rate tax system is the presence of many smcill o r new business
enterprizes that need preferential treatment in order t o be able
t o establish their roots and grow.Subjecting them t o a relati-
vely high flat rate would thus run counter to the stated objec-
tive of ensuring their survival and prosperity as it is these p r e
sent day small enterprizes that are ultimately expected t o grow
LIP into the mature medium and large size enterprizes of to-
morrow.
business enterprize is a generally accepted proposit ion, yet it
has been argued that there does not really exist a good econo-
mic case for the preferential treatment of small 1)usiness. It
is pointed out that the truly small business is econon~ically
inefficient and it does not make much sense t o tau subsidize
the inefficient. It is also pointed o u t that small busitless already
enjoys, directly o r indirectly, some kind of price umbralla
effect from the forward shiftin:: of heavier business taxes on
large enterprizes so that tax relief o n t o p of tax :>hift.ing be-
comes a kind of unjust enrichment. Attention is drawn t o the
fact that it is the new business that really warrants favorable
treatment and n o t merely the existing small business-and for
new business it may actually be advisable to give relief through
measures other than provident tax subsidies.

The countervailing arguments for according relief t o the

small business enterprize hinge on the recognition that inevi-
table gaps occur in t h e credit and risk capital supply svstem
and since small business depends heavily on internal funds for
growth some tax forbearance is essential. Furthermore, it may
not be at all practical t o attempt identification or "New
business" vis a vis the small business. Anexisting srr~allbusiness
in e ~ i s t ~ e n cfor
e a number of years c
a new business through change in!
is not t h e sort of "new business" thrat t h e statute would like
t o support and promote.
 The taxation of
agricultu ral income
Rationale and alterllative approaches

It should be self evident that sv.ccessfu1 implementation

of a meaningful program of economic dev~:lopment entails
mobilization of sizeable resources t o fund the effort. It is
not only t h e size of t h e program chai necessitates significant
mobilization of resources but also the fact that a rapid rate of
growth is required t o offset anti growth and growth limiting
factors and t o yield that crucial extra t o lift the economy t o
a threshold of self sustaining economic activity,

It is vital in the context referred t o above t:o first target

those groups - o r sectors - that have so far becn able t o escape
tax liability under current law. Especially important here is
the escapement of taxation o n income.

Income from agriculture is exempt in Pakistan because

the law governing the taxation of income ('I'he Income Tax
Ordinance 1 9 7 9 ) declares such income t o be outside the ambit
of taxability. The statute as presently in fo19ce was preceded
by the Income Tax Act of 1 9 2 2 (as adapted for use in Pakistan
by Act XI of 1 9 4 7 ) which t o o incorporated a similar exemp-
tion.

The continuation of this exemption for agriculturists not

only deprives the federal exchequer of significant potential
revenue but also sabotages attempts t o inculcate the ideal of
voluntary compliance which is central to t h e f~lnctionalefficacy
of any system of taxation.
 TABLE 5
COMPARATIVE B U R D E N O F DIRECT T A X E S O N AGRICULTURAL AND N O N - AGRICULTURAL INCOMES
( RP Mlllio

DIRECT T A X E S O N A G R I C U L T U R A L
INCOME (LAND REVENUE & l R R l G A T I O N
CHARGES).

DIRECT T A X E S O N NON - AGRICUL-

T U R A L INCOMES (CORP TAX. W E A L T H
TAX. W O R K E R S WELFARE T A X . G I F T
TAX. ESTATE DUTY).

S O ~ C Rashld
~ : & Arnjad - " T h e Management o f Pakistan's Economy 1947-82.

T h e t a b l e s h o w s t h a t while d i r e c t t a x e s c n agricultural h ~ c o m ehave incraosed b y 7 8 70 b e t w e e n 1972-73and 1978-79.direct taxes

non-agricultural incomes have risen b y 182 %.
48 FLrcal Imperatives In PaMstan 's Ec:onornic Developt~retlt

In terms of economic effects a progressive land tax

imposes penalties on the extensive cultivation of land. Logi-
cally, the greater the degree of progressivity in its structuring,
the greater would be the incentive for an intensive - rather
than an extensive - investment and productive effort.

Administering a progressive land tax however is not with-

out its problems. We consider these now.

The progressive land tax we envisage may be levied "In

Rem" or "In Personam." However, the land tax is generally
viewed as a personal tax and has not been t~ased"In Rem."
This aspect is problematic in that it is an obst,acl~to effective
enforcement of the levy as it can clearly hamper the collection
effort in litigous situations since delinquency could not be
countered easily by successful attachment of the land. Thus
while an "In Rem" basis would be clearly preferable for a
progressive land tax, nonetheless, in cases where the economic
circumstances of the owner are identified as,Jh e pivotal element
in structuring optimal progressivity, the tax ,would have to be
"In Personam" (i.e. personal).

The rationale for the progressive land tiax being what it

is - introducing a new progressive element into the tax structure,
countering land concentration and stimulating more intensive
land use - it would appear* reasonable t o entrust the :federal
government with its administration as all the objectives speci-
fied are objectives of national economic policy.

An important problem is that of determining the manner

in which progressivity is to be built into the land tax. In this
context a factor of relevance would be the objectives before
us that motivated the structuring of this levy. If the objective
is t o discourage the unproductive use of the land, imposing the
tax on each land "Unit" would serve the purpose. If on the
other hand the objective is to generate revenue and reduce
the concentration of land it would be better for the tax t o
fall on the owner.

Deciding on an adequate rate structure is difficult. The

rationale for greater progessivity is an improved redistribution
of income. Though laudable, realism dernands that public
perception of the matter be given due weightage. Quite often
people perceive a nominal rate as being high and ignore the
fact that the "effective" rate of tax may be quite low.

Generally, the relative ease of evasion and problems of

control make it difficult t o administer a progressive land tax.
Thus large landowners could adopt the simple expedient of
dividing their land into "Optimal" units - if the size of each
"Unit" is t o be the basis for taxation. It shoul0. be possible
also t o set up a number of corporate entities whose holding
would not be subject to the progressive rates.

Besides the administrative problems there could also be

political difficulties in structuring progressivity and enact-
ment of a suitable rate structure. The centraljai~thoritymay
find this aspect the most onerous considering the risk involved
of alienating an important part of the electorate. Keeping
this in mind, one alternative could be t o have a flat. propor-
tional rate of tax.

A Presumptive Income Tax

An alternate to the progressive land tax coilld be a pre-

sumptive income tax. This would facilitate curbing tax evasion
and stimulating agricultural productivity. Thus farmers who
were able t o realize returns less than the presumptive basis
fixed for the tax would have t o suffer higher taxation than
those dissimilarly placed. Thus the greater the productivity
of the land the less would be the impact of the tax. This by
itself would be a powerful incentive t o pitch produktivity at
the highest level possible. A desirable spin off of !.he tax would
be the reduction in speculative sales of land if the tax were
capitalized.

The major problem here is that of determining precisely

the presumptive basis to be adopted. One way would be t o
estimate a "Normzl" yield for a given unit of area. This would
require fixing a percentage yield considered "Fair."'

The "Forfait" system as applied in France is an interesting

alternate. Thus system entails estimating average income
per hectare for each kind of farm activity aarried on and using
this average t o estimate individual farm income by multiplying
the averasfo not i n f i n m a nay hontgrn h x r t h o nllrnhor n f hoctsrac
devoted to that farm activity. This does not ofcourse permit
individual evaluation of the particular circumstances of each
farmer. Rather farmers judged t o be similarly ~ l a c e d more
, of
less, have to accept placement in the same general category
with regard to a level of income considered reasonable. They
are thus placed at par with regard t o suffering taxation although
there would ofcourse be differences betweeri them. The assump-
tion however is (and it does not appear to be an unreasonable
assump tion) that such differences (between farmers similarly
placed) would be marginal and not substantial.

I t should be recognized however that successful imple-

mentation of a forfait system requires a high degree of adminis-
trative preparation. I t requires organizing an effective data
base. Notwithstanding the difficulties there is the decided
advantage of approximating closely the effective income - much
more so than one general rate of return.

A problem of significance that arises in the case of the

presumptive income tax is that of deciding whether the pre-
sumed income from agriculture should be "Integrated" with
the other sources of income or should be assessed separately.
The former appears t o be the desirable approach. However
it would have t o be seen in this context whether losses arising
from agricultural operations can be carried forward and offset
against other income. If the statute does not permit such
carry forward and offset then ofcourse "Integration" would not
be feasible. Ofcourse the actual possibility of deducting losses
from farm income from other income realized would be mini-
mal as there should normally be no question of loss in the
case of presumptive incomes. At the same time it has t o be
recognized that the law must make some provision for possible
losses arising due to extraordinary circumstances viz natural
catastrophes. At the same time care sho~mldbe taken t o ensure
that deduction of nonfarm income losses from the presumptive
income o n agriculture is not permitted.

The Feasibility of Strvcturing Incentives for the Agriculture

Sector:
There appears t o persist a continueing fascination with
the efficacy of incentives in increasing agricultural productivity.
Across the board availability of credit Tor agricultural activity
52 Fiscal lmpemn'ves in Pakisran 's Economic Lleve/oprnen~

per se, subsidies on fertilizer, allowances for investment in

.agri. machinery, for investment in variegated farm improve-
mentsl'structures etc. etc. are especially favoured. In actual
practice, however, the feasibility of these so called incentive
measures does not appear t o have been conclusive1y established.
Not only d o these incentives create problems in administering
the tax but actual practice does not appear t o support the
thesis that they necessarily lead t o increased productivity on
the farm. It is therefore desirable that incentives be structured
with great care and only where prima facie there is reason t o
hold that they would have a beneficial impact on productivity.

Concluding Remarks:

Agriculture will have to make a much higher contribution

to the federal budget given the imperatives of accelerated
economic development and meaningful structural transforma-
tion of the economy as a whole.

There appears t o be sound economic justification for im-

position of really strong taxation on agri. income -especially
on the big landowners. A progressive land tax combined with a
presumptive income tax could yield good resuits both with
regard t o generation of revenue and for achiewng other eco-
nomic objectives. However where political impendiments to im-
plementation of a progressive land tax are pronounced, other al-
ternatives can and should be explored and these include struc-
turing a fairly heavy proportional land tax. Whatever alternate is
chosen (or "Mix" of alternates) it should be recognized that
effective tax policy for the agri. sector will have to be formu-
lated in conjunction with other specific meaqures viz land
reform, technological change and specific measures t o improve
the lot of the small farmer.

The theoretical justification for levy of taxation on agri-

cultural incomes revolves around the thesis that there obtains
a potential capability in the rural sector t o generate surpluses
which can be tapped to yield revenues for the govi. However
this potential capability is not automatically translated into
revenues for the govt. Far from it, without deliberate policy
measures the ~largelyrsubsistence farming of the majority of
farmers in the rural sector in most third world c!ountries would
 TABLE 7
DlSTRlBUTION OF CROPPED AREA - PAKISTAN

Food Cash Pulaes Oil Veee- Condi- Fruit Others

Year Grains Crops Seeds tables ments

Source: Provincial Agriculture Departments.

5.1 Fiscal Imperatiws in Pakistan's Gconotnic D e ~ ~ e l o ~ ~ t t r ~ . ~ ~ :

continue the traditional farming stabilized a t a low level equili-

brium.

Characteristic features of the developing econcrmy include a

predominantly agricultural bias,a high labor-land ratio, disguised
unen~ployment, a substantial non--monetized segment, tradi-
tional farm technology poor access t o the market, inadequate
transportation and deficient credit facilities. Whatever small
surpluses are generated d o not find there way 1:o the market.
There is thus very little demand for non farm articles as the
resources for funding their purchase are deficient.. This restricts
the possibilities of demand generated industrialization.

The objective o f development is t o structurally transform

this predominantly agricultural economy and bring about indus-
trialization. This requires resources. As the orlly avenue for
generating resources is the agri. sector, ways and means will
have t o be found to extract these resources. This however is
easier said than done. As pointed o u t above, in most cases the
capability t o generate resources in the rural economy is 'poten-
tial' not 'actual'. Levying taxation and its energetic realization
however has been found t o be a necessary first step in initiating
change. As there is no way t o escape taxation the only answer
is increased productivity by cultivating available land more
intensively o r bringing additional land under cultivation. The
marketing of surpluses leads to monetization and commerciali-
zation of the agri. In order t o ensure that pro1:luctivity conti-
nues to increase, the extra labor on the land - the disguised
unemployment - has to be shed. These laborers must now
make their services available to the nascent industrial sector.
The surpluses reelased from increased agri. production and trans-
ferred t o the urban sector through the market, fund t h e wage
bill for the labor transferred and employed there o n projects.
Also funded from this surplus these newly set up projects begin
t o throw up their own surpluses which are then recycled into
new urban projects.
While it is true that the historical experience of Japan
lends strong support t o the need for effective taxation of agri-
culture, nevertheless it needs t o be recognized that significant
differrences exist between the situation in meili J a ~ a nand Dre
The taxatiotr ofagiiculrrcml income

sent day third world countries. The most marked difference is

between the exercise of procrustean authority in Japan and
the inability of most third world countries t o resort to such a
stance in the latter half of the 20th century when the great
majority of them have opted for democratization and popular
participation where strict regimentation and wholesale com-
mand measures are difficult t o enforce making it that much
more difficult for the executive authority to implement mea-
sures that might not find popular acceptanceand it goes with-
out saying that taxation - of any sort - has never been popular!

The political deterrent t o the exercise of procrustean

authority prevents a reenactment of the scenario of meiji Japan.
This does not mean however that the rationall:! for taxation o f
agriculture is not as valid today as it was in the 1880's in Japan.
The modalities are now required t o be different because o f a
changed political environment.

Before we proceed further o n the matter it must be

recognized that the argument for taxation of agri. is NOT based
exclusively on the thesis that the logic of t'he developnlental
model requires that such taxation be resorted t o in order t o
generate theresources to fund the effort - although ofcourse
this is not untrue. However this is not the fundamental reason.
That reason - which may not be immediately apparent - is that
there exists a slack in the agri. sector in terms of untapped
capability which the right set of policies can exploit t o re-
lease resources t o fund the overall develop effort. However
if it be correct that no slack obtains in the agri. sector then it
must follow that resort t o taxation would d o no good - indeed
would cause a lot of harm - infact would bring untold misery
for those who owe their existence to the land and might even
eventually dispossess them. Therefore before anything else is
done it must be shown t o the satisfaction of all that the agri
sector does infact have this slack. The reason why govts are
unable t o make headway in promoting a program of taxation
of agri is because they are not able t o marshal1 the evidence
that could conclusively clinche the issue in this context. It is
not that this evidence is not there but rather that govt is not
aware of what evidence to present and in what manner t o the
populace at large t o convince them that such taxation mea-
sures are not only desirable from the point of view of the eco-
nomic theoretician but also feasible. If that analysis can be
56 Fiscal Irnpera fives in Pakisrarr P Economic l > c v e l o p ~ ~ : . n r

TABLE 8
AREA, PRODUCTION AND YIELD PER HECTARE O F
MAJOR CASH CROPS IN THE MAIN GISOU'ING
COUNTRIES 1984-85
-
Country Area Product ion Yield
000 0 00 Kgs per
Hectare Tons Hectare
---.-----
------
-- --

1 - SEED COTTON (PHUT1'Y)

INDIA 8000 3750 46 9
USA 4233 7760 1833
BRAZIL 3321 1872 564
PAKISTAN 2242 3026 1350
TURKEY 750 15214 2032
EGYPT 440 1100 2500
MEXICO 28 3 65 2 2302

INDIA 3167 177020 55904

CUBA 1400 7 5000 53571
PAKISTAN 904 321.40 35 568
USA 302 254.27 84238
ECUADOR 80 6000 75 000
EGYPT 112 8500 75893
MAURITIUS 78 5'250 67308
-- .-
presented in terms comprehensible t o the man in the street -
or the village - things would become much mlore easy for t h e
govts finance wizards who want desperately t o levy t h e tax
o n agri but are unable t o d o so because their arguments are
just not convincing enough.

Taxable capacity o f a person is based o n the income he

can earn in a given period less the subsistence requirement
f o r himself and his dependant family. What remains after meet-
ing the subsistence requirement is t h e extra out of' which taxes
can be paid. In a society with skewed income distribution those
at t h e upper end of the skew will have t h e most capacity t o
meet taxation levies - notwithstanding the fact that their
subsistence requirements would be larger as their perception
of subsistence would be different from say a small farmer
with a limited landholding. Thus average per capita income
data is not really very useful in defining taxable capacity in a
given sector of t h e economy. We mu st know how this income is
actually distributed. Inequalities of distrib~.~tionmust mean
differences in taxable capacity.

Sectorally, t h e contribution t o the GDP, the total inflow

of public expenditures vis-a-vis t h e sectoral contribution t o
govt revenues are the relevant factors t o be considered in asses-
sing t h e fiscal performance of one sector. This performance
may then b e compared with that of other sectors t o see whether
all sectors are contributing uniformally - consistent with their
economic potential - t o t h e national developnent effort. An
analysis o n these lines will resolve crucial issues of intersectoral
and interclass equity.

Equity between different sectors in t h e economy demands

that relative t o their economic performance interms of total
income generated, total benefits received - public expenditures -
and economic surpluses yielded, different sectors must make
t h e same relative contribution t o national revenues. If one
sector contributes less because official policy discriminates in
its favor then intersectoral inequity results. Similarly between
classes of people - upper, middle, lower-placed in different
sectors considerations of equity demand that people similarly
placed in society in terms of their placement in a particular
class should be making t h e same relative contribution t o nation-
al revenues. If they d o not then those who are unfavourably
58 Fiscal Impemtlves in Pakistan k Economlc Development

placed would suffer from a situation of inequity.

Taxation levies therefore have t o be structured so as t o

ensure intersectoral and interclass equity so that a perception
of fairplay exists among the populace which perception is
vital t o the effective conduct of national development policy
which requires significant sacrifices t o be made by all strata of
society. Cooperation of the people is thus vital and this coope-
ration can best be ensured by actively promoting equity by
deliberately formulating policy in a manner as t o ensure that
burdens fall as equally as possible o n all classes of people.

In a developing country considerations oC agri produc-

tivity may acquire primacy over considerations of pure equity.

That there exists an actual slack in the agri sector in Pakis-

tan appears t o be indicated by various indices viz inefficient
cropping pattern, underutilization of fertilizer, inadequate &/or
improper use of pesticides/insecticides, improper use of irriga-
tion facilities and misutilization of private investible potential
in the hands of the farmers - all these are indicative of slack in
the agrarian economy.

Once the fact of slack being actually present is established

then additional taxation will mobilize this slack and result
in increased agri production because of the enhanced motiva-
tion for making up the income lost in additional taxation.

The case of levy of land tax in meiji Japan is a case in

point in this context. The heavy taxation of agri brought in
its wake an increase in land and labor productivity which is
unparalleled in the economic history of the world. Ofcourse
it was the successful harnessing of the dormant capacity that
led to the increased productivity.

The agri sector is being favoured over the non agri sector
as far as the fiscal operations of the govt are concerned. This
is evident from the fact that taxation ,of agri incomes has
enjoyed statutory exemption from the charge of income tax
since 1947. Furthermore, indirect taxation which generates
the bulk of the national revenues does not reach effectively
all segments of the agri sector because of the persistence of
The taxan'on of ag~lcultumli n c o t x

TABLE 9
AREA, PRODUCTION AND YIELD PER HECTARE O F
MAJOR CEREAL CROPS IN THE MAIN G1:IOWING
COUNTRIES 1984-85

Area Production Yield

Country 000 000 Kgs per
Hectares Tons Hectare

1. WHEAT
USA 26197
INDIA 23614
CANADA 13688
TURKEY 9000
AUSTRALIA 11959
PAKISTAN 7259
FRANCE 4832
MEXICO 1242
2. RICE (PADDY)
INDIA 42800
B' DESH 10500
THAILAND 9700
BURMA 4680
PH' PINES 3330
JAPAN 2315
 FIscal Imperariws in Pakistan 'S Econotnic Development

U.S.A. 1126
EGYPT 420
3. MAIZE
U.S.A. 29062
MEXICO 8864
INDIA 6000
INDONESIA 2500
ITAI,Y 963
YUGOSLAVIA 2360
PAKISTAN 809
TURKEY 550
CANADA 1192

S ~ I I ~ PAuririiltiiral
P. Statictirc nf Pakistan lQR5
 Fisml Imperatives in Pakistan 's Ecotlornic. Developnrent

There is reason t o believe that the lower classes in the

agri sector have not made as much a contribution to
national revenues as the lower classes in the other sec-
tors. The lower classes must bear a marginal tax burden
that is consistent with their marginal ability t o suffer
taxation. It has already been pointed out above that
the indirect tax burden is not as heavy in bhe agri sector
as it is in the rest of the economy - contrary (.o popular
perception of the matter - The overall picture, looking to
both direct and indirect tax levies, clearly indicates that
the tax burden on agri is on the whole marlkedly less than
the other sectors.

Subsistence:

Subsistence has different implications in the agri and the

other non farm sectors. This is because subsistence has a biolo-
gical as well as a sociological basis. In strictly biological .terms
it entails the requirement to keep body and soul together -
i.e. it is essentially a survival matter. In that narrow sense it
can be argued that the subsistence allowance both in caloric
and monetary terms would be roughly the same. The difference
in this context is immediately apparent however when we
consider the sociological dimension as well. WhLenwe do this
we take into the fact that families in the rural areas, in gene-
ral, do not spend as much on fuel, lighting, house rent etc
as do their counterparts in the other sectors. Infact the dif-
ference in the expenditure under the Heads cited can be quite
siginificant. Furthermore other "necessary" expenditure that
non agri families in general and urban families in particular
have t o bear is that connected with clothing, footwear, medi-
cine, education and even entertainment. In all these areas the
agri family escapes much of the high expenditure enigma that
the non agri family cannot - in varying degrees ofcourse. An
additional complicating factor is that non agri families have
to make the bulk of their purchases from the"marketw and have
thus to contend with service and marketing costs that add t o
prices.

In view of what is stated above it is apparent that "sub-

sistence" in the agri sector costs less than in the non agri sector.
That being so the incidence of indirect taxes - which generate
the bulk of govt revenues - is necessarily markedly less o n the
The taxaticm of agricultuml income

TABLE 10
AREA OF CROPS COVERED BY GROUND PLaANT
PROTECTION MEASURES - PAKISTAN --

Area sprayed Area sprayed

Crop As % of a.s % of
cropped area cropped area

PADDY
COWN
SUGARCANE
M m
OILSEEDS
FRUITrnGET
TOBACCO

OTHERS

Total 6.0 4.4

 Fiscal Itrrperariws i ~ rPakistan's Ecoruriri? Dcvc~loprrre~lf

TABLE 11
PAKISTAN POSITIONS IN VARIOUS CROPS -
AN INTERNATIONAL COMPARISON

Pakistan position Vl'o r ltl Tot a1

Wheat 7 8 Countries

Rice 5 El Cclurr tries

Maize 9 9 Countries

Seed Cotton 3 9 Countries

Sugarcane 7 'i Countries

Source: Agricultural Statistics of Pakistan 1985.

The data tabulated in Tables 6 to l ' k indicates that

there is a good deal of "slack" in Pakistans agriculture and
there is room for significant improvement in productivity
through extension of cultivated area, use of fertilisers and
plant protection measures (use of insecticidesipesticides). In
the opinion of many, levy of taxation on agricultural incomes
forces the otherwise complacent and conservative : agricul-
turist to increase unit output (productivity) to compensate for
the revenues lost t o taxation.
The mxation of agricultuml income 65

agri sector than elsewhere. This therefore adds t o the advantage

that the agri sector has through the income tax exemption. In
other words we can conclude safely that the tax burden there
is markedly less than in the non agri sectors. This is contrary
to what many commentators say - especially those who speak
"for and o n behalf" of the agriculturists - who would have
us believe that the tax burden is infact roughly the same for the
agri sector vis-a-vis the other sectors since indirect taxation
which everyone has to bear must have an exaggerated impact
in the agri sector as the majority of the population resides
there.

Lower subsistence requirements in the agri sector mean

a higher relative taxable capacity. That is why we say that
the agri sector has the potential capability to suffer much
higher taxation than it currently has to bear.

The incidence of benefits of public expenditures is an-

other important aspect t o be considered in the context of the
economic argument in favour of additional taxation of the
agri sector. An analysis of public expenditures on the current
and the capital account would reveal that the govt expendi-
tures incidence is much greater than the tax incidence on the
agri sector. This implies a net outflow of public funds both on
the current and the capital account from the no:] agri sector
t o the agri sector. What it boils down t o is the inescapable
fact that the agri sector is receiving much more monetary
funding than it is contributing. A case of intersectoral in-
equity is thus established.
 7
Tax legislation
in developing countries

In the modern era the continued improvement in the

material condition of a people has been a goal cherished by
many but practically achieved by a select few. In recent times
and especially since the cessation of hostilities among the
warring nations in 1945 a host of newly independent countries
have made their advent on the political map of the world.
Most of these countries, released from colonial bondage, found
themselves bogged down in the morass of pover1.y. IIowever
taking a (cue: from those amongst them who through concerted,
deliberate effort had succeeded in forcing change in the material
well being of their peoples, the planned quest for economic
betterment is now a ubiquitous phenomena. Different countries
have however met with varying degrees of success in pushing
back the rising tide of poverty. The common rc?alization is
however, that ordered development is a multi dimensional
effort based on many variables.

One of the key areas in planned econonlic develop-

ment is the fiscal dimension that focusses critically on ways and
means concerned with the generation and disbursement of
Government finances. It is generally acknowledged that tax
legislation and tax administration play a key role determining
both the pace and direction of economic development. Res-
tructuring the tax system has a high priority in countries faced
with inequitable distribution of wealth, inadequate domestic
resource availability and deficient fiscal machinery to curb the
fires of inflation and t o influence savings and investment
patterns.
68 Fiscal I t n p e m t l w r in Pakistan 3 Eccmornic l ~ e w ! o p r n e n r

Much of the interest shown by third world governments

in modernizing their fiscal opparatus stems frorn a desire to ac-
celerate the pace of economic development. The principal
areas of interest are those concerned with generation of re-
venues and include improved taxpayer compliance and the
search for new, hitherto unknown sources of revenues. Another
byproduct of the heightened interest in this; sphere is the
attempt to use the fiscal mechanism t o divert the flow of wealth
away from activities that hinder or obstruct economic develop-
ment and towards those activities that promote orderly, effec-
tive growth.

Development oriented tax legislation takes the form of tax

exemptions, subsidies, special allowances under the corporation
and individual income taxes for accelerated depreciation or
reinvestment. The objective in mar,y cases in which these "in-
centive measures" are incorporated in the statute through
specific legislation is the promotion of indust~:ializationwhich
is seen by most developing countries as the sine quo non of
economic progress. However a variety of non industrial activi-
ties are also promoted through these incentive measures cloaked
in the garb of tax preferences, Such activities include promotion
of private saving, construction of housing and the like.

As mentioned above, industrialization i an objective of

high priority in the developing countries plan of action drawn
up t o break through the poverty barrier and take the economy
onto a new higher threshold. For this reason tax incentive
legislation usually focusses critically on this area.

The most important objective is t o provoke, through the

impetus of tax incentive legislation, economic pressures for the
channelization of investment flows towardls manufacturing
activity identified as being specially desirable from the stand-
point of the structural transformation of the economy, acce-
lerated economic development and long term growth prospects.
This is not t o say of course that all these objectives are capable
of realization through the same measures but the general thrust
is towards their realization and the incentive measures are
consciously tailored with such objectives in mjind.

While tax reform measures focus o n generation of in-

creased revenue, eliminating arbitary or unfair differentials in
 tax burden distribution and ration4izing archaic procedures in
vogue in tax administration and modernizing tax administra-
tion through induction of technology and modem management
~ractices,the impact of tax incentives is t o erode tax revenues,
create new differentials in tax burden distribution and burdens
the administration with new pressures.
The negative features cited above notwithstanding, tax
legislation is perceived as contributing directly t,o an escala-
tion in investment activity that would lead t o heightened
economic activity and, over time, hopefully play a key role in
the development drive. Such 'induced investment' activity
would also lead t o increased generation of revenues. In this
manner therefore, incentives are seen as actually laying the basis
for greater long term generation of revenue i.e. once the gesta-
tion period involved in setting up an enterprize has elapsed and
the unit is capable of productive output and positive profits.
Tax incentive legislation is however not universally
applauded. For from it it is perceived as institutionalizing fea-
tures in the economic system that ultimately distort patterns of
investment t o create an undesirable bias towards capital intensi-
ty which directly contributes t o exacerbation of the labor
redundancy problems that beseige most developing countries
and furthermore - and more dangerously - make such en-
terprizes viable which without the crutches of tax incen-
tives would clearly not be viable. Thus inefficiency becomes
deeply ingrained in the economic format. The increased projec-
tion of revenue from the induced investment stimulus of
incentive measures are also seriously questioned. It is felt that
there realy is no, guarantee at all that there will infact be such
investment atleast on the scale necessary for benefits t o out-
weigh the costs.
There is one area however in which tax incentive
legislation can unquestionably lead t o benefical results. This is
when tax incentives become instrumental in actually leading to
tax reform. This can conceivably happen when the incentive
removes a factor in the tax system that militates against the
dictates of economic development. For instance there is no
doubt that generlized tariff walls that have a becomea seemingly
perpetual feature on the economic landscape will create hind-
rances in the way of economic development by preventing,
among other things, the importation of industrially necessary
I
1
machinery or equipment. Now incentive legislation that re-
moves the tariff generally or selectively will remove this artifi-
cally created bottleneck. In its effect it would coincide there
fore with tax reform measures that aim t o eliminate such
bottleneck choke points in the economic system generally that
inhibit; industrial development by making impossible a smooth
supply of vital raw materials and ancillary equipment,.

The rationale for tax incentives rests on tlhe presumption

that these render otherwise unpromising investments attractive
as they make possible accelerated recovery of capital and a
higher rate of return. Furthermore, tax incentives release inves-
tible funds that would otherwise have been absorbed in defray-
ing tax demand. Thus re-investment becomes possible and the
significance of this in the context of capital deepening and
widening can rardly be overemphasised. Besides these directly
relatable reasons, there is the additional fact that such incen-
tives contribute to improving the overall investmtmt climate and
are thus crucial in attracting funds that would i:n their absence
flow to alternate applications elsewhere where the investment
climate is relatively more conducive.

As a general statement much of what is statc.d above would

appear to be plausible. However a more rigorous analysis neces-
sitates that the relationships amongst the key parameters be
explicitely stated. That however is easier said than done. The
main complicating factor here is that it is not easy firstly t o
isolate the parameters that , in a given socio economic set up
would have a bearing on investment decisions and secondly,
even if all - or most - of these factors were actually identified,
even then it would not be practically possible t o establish a
precise cause and effect relationship between either the
totality of these factors and an invest decision or between one-
or a few - of these factors and the investment decision. In
other words it is really not possible t o quanify in any meaning-
ful manner, the net value of an incentive provision in terms of
its capacity for stimulating investment.

The "Mix" of factors that are of consequenl-e in determin-

ing the attractiveness of an investment decision include the
quality-besides the availability- of infra structure facilities. Also
significant are the investors largely subjective, (due to the
absence of adequate statistics) assessment of present and future
Tax leglslatlon in developing countries 71

market conditions, availability of labor, credit, raw material,

power, transportation, distribution facilities, skilled manpower
etc. Besides all these there is the added complication of the ever
present possibility of political ferment and up'heaval with its
atlendent highly adverse impact on economic stability. For all
these reasons the role of the tax factor is to a considerable
extent indeterminate and this would be true no matter whether
taxes are high or low as it is not at all axiomatic that high taxes
should necessarily and in all circumstances meian low profits.
Infact the profitability of a venture would appear to be more
directly linked to the quality and level of public services and
market facilities rather than the rate of tax per se. There is
ofcourse no denying that prohibit.ive rates of taxation can in-
deed be disastrous for profitability and therefore in the assess-
ment of prospective investment. But then it veyy rarely, if ever
at all, happens that a truly prohibitive rate tax schedule is
struc t u r d deliberately.

So varied is the ecology of tax administration that it is

not really possible t o make a meaningful comparative study of
the role of tax incentives in stimulating investrrient in different
types of political, social and economic environments. Thus if it
can be shown that certain types of tax incentives have been
useful in one country it does not follow that these woud also
be useful in another country - and this would be especially true
if the comparison were being made between a relatively less
under developed country and another that is rather more
underdeveloped.

From what is stated above it would appear to be rather

mystifying then as t o why have tax incontives been as popular
as they have been with most development planners. It
appears that the pressures for taking decisiorls to further eco-
nomic development being what they are in t,hird world coun-
tries tax incentives offer a relatively easy way out in the sense
that with their enactment planners and legislators both feel that
they have done their bit t o do something concrete which can be
cited as an achievement before the public at, large and before
international forums as well. The latter is es~~eciallyimportant
in the context of eligibility for foreign aid and it is widely
perceived that taking such decisions improves the aid climate
obtaining in a country thereby making it attractive for the
.
-I,
..
," ., ;,, , ..+
The rationale for exemption from income Tax:

The stimulus from an exemption from income tax mani-

fests itself in an increase in the prospective return that an invest-
t o r may be able t o realize from an investment opportunity.
Typically this occurs by an enhancement in the internal rate of
return. Thus, for example, the internal rate of return from a
given business venture could b e say 5% under a 50% income tax'
Now assuming that this 5% rate of return in not adequate as an
inducement t o invest what possible implication can say a five
year tax exemption have? Given a perpetual annual return of
Rs. 1000 deriving from an initial investment of Rs. 10,000 the
5 year tax exemption would increase the annual rate of return
by 305 ie t h e 5% internal rate of return would after the exemp-
tion, be pitched at 6.5%. This could then be the critical point
which would be sufficient t o induce the investor t o commit
funds for the prospective enterprize.

The stin~ulusvalue of exemption from income tax is mag-

nified when it is combined with exemption from other fiscal
levies like import duties. In actual practice the income tax
exemption is infact added t o an exemption from other such
levies.

While the exemption undoubtedly boosts profitability it

must be recognized that its precise impact in boosting produc-
tivity and therby making an investment opportu:nity that much
more attractive is but one aspect of the stimulus relationship.
Another, and probably eqllally significant, if not more, aspect
of the fiscal dimension here is t h e psychological impact of the
incentive measure in determining an investors pe,rception of the
investment climate in t h e jurisdiction where tliie incentive is
operative. Thus if t h e investor is suitably impressed by the range
.,f incentive measures in vogue his assessment of the potential
vorth of such investment may go beyond what a simple cost-
benefit equation would suggest. If such infact be the case then
tax relief would act as a psychological triggering device that
compels and draws capital and enterprize t o rriove t o where
such relief is available.

An important aspect in this context is the relation o f

income tax exemption t o incentives provided by special depreci-
ation allowances.
 JX legislnfion in dewloping coun Mes 73

Despreciation and t h e acceleration of depreciation, figures

prominently in the outcome of an investors decision t o invest
because it can dramtically alter the profitability position by
signiPicantly reducing taxable income. The method of depre-
ciation would be significant here for it would determine how
rapid t h e write off is. Needless t o say the more rapid the accele-
ration the more t h e tax base would be eroded.

Combining tax exemption and depreciation is however a

different proposition. As far as an enterprize is concerned dur-
ing the period of exemption the best results are (obtained with
the most decelerated depreciation technique. In this way most
of the depreciation allowances would still be available after the
expiration of the exemption period. Otherwise the bulk of such
nllowances would be consumedduring the period 1.heexemption
;s operative.

While tax exemption is a stimulus both for the domestic as

well as t h e foreign investor there is doubt as t o !,he magnitude
of t h e incentive measure. Investor gains take the form of enhan-
ced financial ability and increased incentive t o undertake busi-
ness operations in the exempt sector. Experience would appear
to indicate that the financial ability t o undertake investment is
most improved by exemption from import dutiesl' Refief from
income tax aids in the ability t o undertake further expansion
but would not appear t o play such a large initial role although
it could mean that loan capital is easier t o obtain since the
chance of having the means to amortize debt will be greater.
On the other hand the incentive to invest is increased by the
granting of income tax relief or the estimated prol'it picture will
generally look much better but there is little incentive for
further expansion unless the enlarged facilities also receive tax
exempt status.

While enhanced financial ability effects zre very

important for local investors who have difficulty in raising
sufficient capital t o operate an enterprize these might be less
important for the foreign investor who can more easily tap
capital funds o n reasonable terms in the home country.

Incentive effects that appear in the form ctf a rise in the

prospective rate of return are important for all investors who
emphasis profitability. They become very important for t h e
74 Fkcal Itnperarlws br Pakistan's Ir'co~romlcDewlopmetrt

local investor if they are strong enough t o raise the return in

manufacturing t o the point where investment in that. sector
appears more profitable than investment in some more tradi-
tional line. For the foreign investor however the incentive
effects assume significance only if they raise the rate of' return
over that which could be obtained in manufacturing in some
other country.

Tax exemption: R.evenue loss VS benefits:

Having acknowledged that tax exemption is infact a viable

investment stimulating device it would be desirable t o ascertain
the extent to which the benefits in the form of net new invest-
ment are sufficient t o cover the loss in revenue a:;sociated with
grant of such exemption. In order t o make such a comparison,
it is necessary t o distinguish between fiscal sacrifice, or the gross
revenue loss, and true or net revenue loss associated with the
extension of exemption to enterprizes that woulcl have in-
vested without the subsidy.

Viewing the exemption program in isolation, a possible

criterion with which t o attain the optimum structure of the
exemption system would be t o offer benefits to the point where
the incremental value of true revenue loss is just; equal t o the
incremental value of the investment induced by the st.imulus.
In other words, the aim is to maximize the difference between
net induced investment and net true revenue loss. In terms of
the criterion for maximization o f the difference between net
induced investment and net revenue loss the following equation
would help clarify the matter.

Change in total revenue loss -

Induced investment

change intotal investment Autonomous investment.

Thus if it is argued that for a marginal addition to total

investment the increment in gross revenue loss will just equal
it, so that the left hand side of theexpression above is unity,
and if it is further argued that half of the additioi~alinvestment
is directly induced by the exemption stimulus while half is auto-
nomous, (would have occured without the exemption), then
the exemption program will just be paying fok itself in the sense
that an added rupee of true revenue loss is associated with an
Tax legislation in developing c o u r ~ ~ ' e s 75

added rupee of induced investment in general. On the assump-

tion that gross fiscal sacrifice will equal gross investment, in-
duced investment must exceed autonomous investment in order
for net benefits t o arise.

Even if an exemption program were judged cln the basis of

the suggested criterion t o be a no gain proposition, it would
not necessarily follow that it should be rejected. In i3 dynamic
situation, the timing of investment under the exemption pro-
gram may mean that the economy will reach the stage of
self sustaining growth more rapidly with the program than
without it, even though the criterion indicates that no gains are
to be made. On the other hand a judgement of substantial net
benefits in terms of the criterion does not necessarily mean that
a tax exemption program should be accepted. ,qpplication of
this criterion simply indicates whether this part~culnrprogram
is worthwhile. It cannot indicate, without further information,
that some other program will not have an even higher yield.

Because of t h e many problems connected with income tax

exemption, it would seem highly desirable t o explore other
avenues of approach t o the problem of investment stimulation
via the tax mechanism. Schemes that might relieve tax burdens
in a more desirable fashion than the income tax exemption
measure such as the allowance of tax relief c.ntil the initial
investment has been recouped together with 7;arinus devices
that permit delay in tax payments (deferral) ol,ight also t o be
looked i n t o .

It must be remembered that manipulation of the tax

mechanism alone is not likely to produce astonishing results in
promoting investment in less developed countries. The barriers
to investment are complex and diverse and no panacea exists
that, will bring them down. It may even be doubt,ed that the tax
structure is important in the minds of undertakers of new busi-
ness enterprizes, although it may become more significant at
later stages of expansion. Insofar as this is the case, better
results might be attained by concentrating tax concessions in
the area of promoting desirable expansion by ex.isting firms and
attempting t o attract new enterprizes through other types o f
inducements.
76 Fiscal Iv~perativrsin Pakistan's Econotnlc Development

exemption program that the venture is not likely to be blessed

with great success in the form of vast increases in investment.
It should also be understood that tax exemption schemes al-
though relatively simple t o legislate, are difficult t o administer,
and that the use of this technique is fraught with the dual
dangers of loss o f equity in the tax system and the possibility
that the government will be unable t o finance needed expendi-
tures without inflation.

The second dimension relates t o the potential. for earning a

return on money not needed for immediate use-interest. The
time factor is of relevance here in that a higher earning of in-
terest follows the deployment of funds for investment over a
longer period. Profitability analysis takes this phe~iomenoninto
account by discounting sums that will be received in the future
and adding interest to sums that are received prior t o a reckon-
ing date. Thus, money benefits of equal amount will not be
termed equal if they accrue at different times. Amounts re-
ceived prior t o a reckoning date will be worth more, and am-
mounts received after such date will be worth less, than the
same absolute magnitudes received at t h e reckoning date. The
differential depends on the time interval and thc. interest rate.
In other words, it is possible t o find a rate of interest o r dis-
count that will make sums of different absolute magnitude ac-
crueing at different times equal in absolute amount.

Fiscal incentives that d o not directly reduce initial outlay

requirements may nevertheless affect financing indirectly
through their influence on prospective profits. If exemption
from profits tax is offered for ten years and if the tax rate is
50%, after tax profits will be 100% greater during the exemp-
tion period than they would have been without the incentive.
This goes a long way in facilitating expeditious capital re-
covery and as such constitutes an important investment stirnu-
lus. The same observation applies t o a variety ~:)fra.pid amorti-
zation (accelerated depreciation) schemes.

In order t o simplify the analytic format i t would usually

be necessary t o make assumptions about pertinent factors
having a bearing o n the operational aspect of the incentive
measure in general. Assumptions must be made about some o r
all of the following: future costs,revenues and irlvestment plans;
t h e timing of benefits; the relevant horizon (time span) for
 i.r legislotfon in developing c w n n i e s 77

evaluation of the benefits; the rate at which futurc:t returns are

to be discounted; the exact nature of benefits etc.

Assume that there exists an investment opportunity that

entails an initial outlay for the acquisition of equipment of
Rs.1000.To make the analysis simpler it is assume!d that these
are the only costs involved. The expected life of the equip-
ment is assumed t o be 1 0 years . Let it also be assumed that
Rs. 200 of the initial outlay consists o f import duties and that
the anticipated gross operating profit is Its. 200 per year and
that the income tax rate is 30%. The problem before us is t o
discover the potential rate of return o n the investment with and
without tax incentives.

The annual cash flows associated with the investment op-

portunity without any incentive in force would be Rs. 170.
(Annual gross profits Rs. 200 less annual income tax Rs. 30).
Thus over the ten year lifespan of the equipment net returns of
Rs. 1700 would be generated leaving a profit of Rs. 700 over
and above the cost of Rs. 1000. The rate of return implicit in
these data is that interest rate (rate of discount) which will just
equate the series of Rs. 1 7 0 per year to the irritial outlay of
Rs. 1000. In the present case the rate of discc~untwould be
11.1 %. Given a gross profit rate of 1 7 % it is clear that it pus-
tulates a profitability position that is in excess o f the discount
rate that would equate the future stream of Rs. 170 per annum
to the investment cost of Rs. 1000.
Now with incentives coming into play let us assume that
a waiver of import duties is ordered as is an exemption from
income tax. The first measure reduces the initial acquisition
I
outlay by Rs. 200 so that the equipment in question an now be
had for Rs. 8 0 0 instead of Rs 1000. The exemption from in-
come tax increases t h e annual return t o R s 200--from Rs. 1 7 0
previously.. The gross profit rate now jumps t o 25%. Over the
ten years lifespan of the equipment the investment will now
generate Rs. 2000 which will vield a profit of' Rs. 1200. Cost
can now-because of the incentives-be recouped in four y e m
instead of the 5.88 years without the aid of incentives.

From a practical standpoint it obviously makes more sense

t o choose that set - or combination- of inclentives that raise
the prospective rate of profit most.
78 FLrca[Imperarives In Pahisran's Ecorromlc Development

Depreciation of wasting durable assets a!;sum.es signifi-

cance in that it is the accumulation of such durable capital
stock in the shape of industry that is at the root of much of the
development effort of third world countries. It is widely be-
leived that in order to stimulate private investment in depreci-
able assets something more than a "normal" provision of depre-
ciation is required as a deductible expense item. This stimulus
measure most often mamifests itself as an accelerated depre-
ciation incentive measure that permits a more rapid write off
of an asset than its normal usage in a given activity ent.ails.

Among the various types of rapid write off methods, the

initial depreciation deduction which provides that a definite
percentage of an approved investment may be deducted from
income or profits in the first or early years of the life of assets,
is the most widely employed.

Tax systems in less developed countries are often not well

adapted t o the requirements of a modern industrial stxeity, and
this fact places limits on the usefulness of any particular incen-
tive device that is appended to the system. In practice, many
incentive devices that can be employed in more advanced
countries may not fall within the range of administrative
competence in less developed countries and other "incentives"
may in fact serve merely to offset obvious defects in a given
situation . Although no system is perfect, the (,ax systems of
less developed countries are too often composed of a patchwork
of provisions containing many flaws and imperfections.. In
some cases the letter of the law is not enforced; in others, the
law is not fully understood . On the other hand since the incen-
tives that willsbe considered here affect primarily enterprises in
the modern sector of the economy, it is likely that conditions
will deviate from those in more advanced economies much less
than might be supposed. In the modern business sector, much
higher standards of tax enforcement generally prevail than in
the traditional sector, and investors in this sector are likely
t o have access t o sophisticated tax counsel and t o be motivated
in much the same way as their counterparts in more advanced
economies.

A necessary condition for an effective tax incentive is a

substantial tax from which relief may be granted. While a few
countries in the less developed countries of the world may
Tax legiskztfon in developing countries 79

have rates that are too low t o meet this condition, the median
rate on corporate income of about 35% is sufficiently high for
meaningful incentives. Moreover, higher rates are not uncom-
mon.

Because accelerated depreciation means that deductions

for tax purposes may be taken at an earlier date than before,
even though the total amount of the deductions is in the case
of a single <asset,,thesarne as in the normal depreciation case,
the rate of return will generally be raised. Since funds that
would otherwise be turned over t o the revenue authorities
remain for a time in the hands of the taxpayer he may be
thought of as the beneficiary of an interest free loan, the pro-
ceeds of which may be invested at a profit. One met.hod of
measuring the effect of the loan is t o compare the expected
internal rate of return from a given opportunity with normal
depreciation and accelerated depreciation. For exa:mple, if the
pre tax rate of return is 5% and the statutory tax rate is 50%
the after tax rate of return o n an asset with a 20 year life span
will be 2.65% when depreciation is taken in equal instalments
over the life of the asset; and it will be increased t o 3.84% if
total depreciation is taken in equal instalments over the first
five years.

Variation in the treatment of depreciation allowances

for tax purposes may influence decisions t o invest in depreci-
able property because of its influence on three important
variable - The rate of return, risk and financial resources.

For purposes of investment profitability analysis the

present value of depreciation deductions may b e considered as
equivalent t o a reduction in the cost of assets From this point
of view, by offering depreciation deductions the treasury is in
effect helping t o finance capital outlays. When the present
value of the allowance is raised from 10% t o 32%,,the treasury
is actually reducing the cost of assets an additional 22% and it
is posible t o convert a reduction of this kind t o in equivalent
increase in the prospective rate of return from the investment.

In general, accelerated depreciation of the types most

frequently employed will act to increase prospective rates of
return by a few percentage p o i n t s
 .Fiscal Impemtlves in Pakistan r .liconomic Development

Accelerated depreciation involves changing the pattern

of discrimination in the sense that the new depreciation system
will almost invariably favor certain kinds of investment more
and other kinds less than the old one. A change from ordinary
straightt line de~reciationt o straight line with initial depreci-
ation deductions clearly favours longer lived investments,while
a switch from straight line to declining balance depreciation will
yield a pattern of discrimination which depends on the discount
rate, but which generally most favors assets with medium lives.

Unfortunately analysis of the effects of accelerated depre-

ciation on the rate of return cannot lead to any definite con-
clusions about the ultimate effect of accelerat:!on on investment
decisions. Before any predictions on this score can be made it
would be necessary to know the elasticity of investment de-
mand with respect to an increase in the rate of return. A priori,
however it would seem unlikely that investol. responses would
be highly sensitive to small increases in return rates and an
elasticity as great as unity would probably be an optimistic
asumption since it implies that an increase in the rate of return
from 10% to 11% (a 10% increase) will lead to a 105% increase
in investment demand. To achieve a response of this magnitude
there is no doubt that acceleration would haire t o operate in a
favourable investment climate that tends to minirnise risk
factors and provides adequate financial resources. Such con-
ditions do not generally exist in less developed countries, but
accelerated depreciation itself may help to create some of them.

While evaluating the influence of accelerated depreciation

on rates of return investors in the real world often rely on
simplified techniques or rules of thumb rather than- more
accurate and rigorous technical analysis such as the use of
compound interest calculations. Perhaps the most widely
employed device of this kind is the pay-of!! period approach
in which the acceptability of an investment is judged on the
basis of its ability to return sufficient profits (gross of depreci-
ation) in a specified number of years, generally less than half
the normal life of the investment, to repay the initial outlay.
In its pure form this technique uses no explicit discounting
procedures. Thus if an investment costs 100 and is expected
to last 10 years, returning gross profits of 211 per year, and if a
5 year pay off period is demanded, the investment will just
meet the requirement.
Tax legisbtion in developing counnles 81

To illustrate further the use of the pay-off period cri-

terion in making investment decisions in the context of fiscal
incentives structured to facilitate flow of funds to a particular
sector of the economy the following example maybe cited.

Suppose that a four year pay-off period is r equrred and

there is a 50% tax rate if an investment of 1 0 0 in a machine
promises t o yield gross profits of 30 per year over the 1 0 year
life of t h e asset. After tax this will be reduced to 2 0 per year
when depreciation is taken in equal instalments over the 10 year
span. Consequently five years will be required for t h e invest-
ment t o pay for itself and if a four year pay-off is demanded
the investment will not be made. Now if full depreciation is
allowed in equal instalments over five yearshowever,tti~eswill
amount t o 5 per year over the first 5 years leaving gross
profits of 25 per year towards paying for the investment.
Thus the four year pay-off period criterion would be met
indicating acceptance of the investment.

Factoring in "Risk" in making feasability assessments is

important for this is a key parameter albeit somewhat vague and
even indeterminate, some might say. The fact is however that
most business ventures are inevitably attended with risk. Some
risks1 can be insured against but not all risks are amenable t o
such insurance. The willingness t o bear this kind of risk or
uncertainty is at the foundation of entrepreneurial activity.
Because the group willing t o bear the responsibility for the
outcome of risky ventures is rather narrow in a developing
country, policies that reduce the degree of risk associated with
growth promoting investments are extremely imponant. Be
cause accelerated depreciation improves prospective profit rates
and rr~akesinvestment in depreciable assets more liquid it may
be said t o diminish risk in a general way when the problem is
viewed in a narrower context. However, it is not always true
that acceleration provides a greater stimulus for more risky
ventures than less risky ones.

In a very general sense it may be said that inv~storstend to

allow for risk by discounting anticipated future pr0fit.s with an
interest rate that rises as a function of the degree of risk invol-
ved. Thus more risky ventures will often be asked t o bear the
burden of a higher rate of discount.

Risk producing factors are likely t o increase with time and

the risk factor may therefore be accounteti for b y employing
a discount rate that rises with time. Since the crude pay-off pe-
riod approach implicitely posits a zero discount rate during the
specified pay-off period and an infinite one following that
period it may be thought of as a special liniting rase of the
discount rate that rises with time. More sp~cifically,the riskier
the opportunity, the shorter the p a y a f f period will be relative
to the life of the investment.

Finance:

It has been slated abovr that accelerated depreciation does

have the effect of raising the prospective rate of return from a
single investment. Uilder t h e usual circumstance obtaining in
the real world, and especially in third world co!intries, the offer
of accelerated de?retldtlon often aimour1i.s to a conditional
prornise of financial benefits that will arise ( j l l i ~in the future.
Even with initial depreciation deductions, the benefits may not
significantly influence the ability of a new firw t o finance its
original outlay, although an older t5stablis1,ied enterprize may
have sufficient income from other sources t o enjoy direct and
immediate financial benefit in a perfectly conlpetetive capital
market. T h e new firm would be able t o imrrcsv the amount
represented by the present value of the expected benefits, but
in imperfect markets, the existence of futu:e benefits may have
little effect o n t h e firms ability t o finance the initial investment
even though acceleration increases prospective profits. Where
the major problem of investors is raising sufficient funds t o
meet the original costs cf a new investmeni , a greater incentive
may be obtained with direct subsidies, low interest loans, relief
from taxes applicable t o investment out la:;^, or other similar
devices.

In the longer run, however accelerated depreciation can

significantly enhance the ability of the successful enterprize
t o undertake expansion o r replacement expenditures. Since
the successful firm will have a growing stream of investment
expenditures, the amount of the "loan" which it derives from
rapid depreciation allowances will increase steadily. This is so
Tax legi~lationin developing counm'es 83

because the larger deductions taken in the early years o f life

of the enlarged stock of new depreciable assets more than offset
the fact that smaller than normal deductions are allowed during
the later years of life of older assets. Contrariwis~?,if the firm
is not successful and shows a declining stream of investment,
the srnaller than normal deductions associated with older
assets will predominate so that the interest frets "loan" will
predominate. Finally, the firm that just maintains its stocks
of depreciable assets will neither increase nor decrease the size
of its "loans" once the stage is reached where depreciation
funds are used entirely to finance the replacements required to
maintain its capital stock intact.

From the analysis made so far it would appear that simple

tax rate reduction is not strictly comparable to a change in
depreciation systems. This is both a merit and a drawback of
accelerated depreciation. I t is a merit because a careful selec-
tion of a system can provide a desired discrimination even if
statutory tax rates are the same for all. It is a drawback be-
cause the extreme complexity of the discriminatory patterns
presenl.ed by various systems means that the ultimate effects are
difficult to anticipate.

In some important respects the differences between tax

rate reduction and accelerated depreciation are of greater
moment. Tax rate reduction offers an obvious advantage to
firms and they may adjust to it wtihout altering any funda-
mental accounting procedilres. Insofar as it achie~.esthe same
effects as acceleration, it is therefore the more efficient mecha-
nism. However, a general rate reduction willcappljr t o all tax-
payers, and it is not tied t o an act of investment in depreciable
assets. Particularly, when the aim is to stimulate purchases of
new, real capital assets, an incentive that is as general as rate re-
duction will appear inappropriate. One alternative h u e could be
short term selective rate reduction, but with this method serious
problen~sincluding criteria selection and administration, arise,
so that accelerated depreciation may be a better alternative.

Accelerated depreciation and investment allowances:

Among alternative accelerated depreciation procedures

initial d'epreciation deductions stand out not only as the most
frequently encountered but also as possessing characteristics
84 Flscol Impemrives in Pakistan's E c o n ~ m i cOewloprnent

that recommend them from an analytic point of view. Since

they are especially favourable for long term investment, provide
extra funds at an early date, and are conceptual1:y simple, it is
understandable that they have been chosen by so many less
developed countries as an investment incentive. Since initial
deductions however have the disadvantage of altering what is
likely to be the long term depreciation formula o r the formula
which would most probably be acceptable to the accounting
profession for a proper determination of enterprize income in
the books of accountscor~sequentlyit would be desirable if the
general features of the initial depreciation deduction are wanted
to find a device that wouid provide the same incentive and yet
not alter the normal depreciation formula. Since the investment
allowance which offers a special deduction proportional t o the
anlcunt of investment but without prejudice to ~:~orr?!al depreci-
ation, possessing the same basic properties as the initial depreci-
ation deduction and yet avoids the problem of accounting for
inco~rie with two formuias, it merits careful consideration as
a substitute for accelerated depreciation.

No single investment allowance can substitute directly for

a given initial depreciation deduction. If only the general incen-
tive features of the initial depreciation are desired it, may be
reasonable t o select h o or three values for the investment
allowance according to the life of the investmmt. For shorter
term opportunities like machinery and equipment an inves-
ment allowance of one third the size of the inilial depreciation
deduction might serve while longer term opportunities could be
accorded investment allowances of two thirds the size of the
initial depreciation deduction. With such a policy about t h e
same incentive effects would be attained through investment
allowances as through initial depreciation.

A question that arises is whether the achi~vmentof appro-

ximately equal incentives will cost more in tc?rms of revenue
loss with the investment allowance. Experience with the two
incentives would appear t o indicate that for both long and short
lived assets and for various growth rates postulated, initial
depreciation deductions that provide roughl!, the same pure
incentive as investment allowances will cost albstantially more
for a number of years. Conversely, were a fixed amount of
revenue sacrifice stated, it would be possible for a number of
years to provide a greater over all incentive with incentive
Tax leR;'slor(onin dewloping cotrnrries 85

alliowances than with initial depreciation. From either point of

view, t h e investment allowances stands out as the better alter-
native for countries wishing t o purchase the greinter incentive
per unit of revenue loss during the first 10 t o 20 years of an
incentive program. Since these years will usually be considered
the most important, the investment allowance m.ay be judged
the better alternative.

Revenue effects of tax incentives:

A question of significance in the context of' the structur-

ing of fiscal incentives is whether t h e invest men:!.^ k d u c e d by
tax incentives will, through additional profits taxation, be able
t o yield revenues that would offset the tax losses associated
with giving the incentives in the first place.

The revenue loss may be defined as t h e reduction in taxes

paid when accelerated depreciation or other incentives are gran-
ted, assuming that none of these funds are used by firms t o in-
crease investment outlays. The revenue gain is the addition t o
profits taxes that arises because some portion of the extra funds
available t o firms as a result of incentives is infact devoted t o
new investment expenditures that in turn generate taxable pro-
fits. The ratio of such gains t o revenue losses is usled as an index
t o indicate t h e extent of revenue recovery. Full recovery would
be achieved at t h e point where gains equal losses.. or where the
ratio equals unity. Full recovery of revenues is rather improb-
able. In most cases the degree of recovery is less in t h e short run
that in the long run.

It seems that tax incentives, even when they generate

favorable investment responses, will mean that revenues will
rise less rapidly than they would without incentives. In less
developed countries revenues will generally have t o be recouped
throu.gh the imposition of additional tax burdens at other
points in t h e economy.

Although the stimulus of tax incentives may be desirable

in economically under developed countries, the costs of such
incentives in terms of revenue sacrifices are of considerable
significance. Government expenditures for necessary overhead
projects in such countries are more likely t o be controlled by
revenue restraints than in economicallv more advanced count-
86 Fiscal In~pemnvt-sin Pakistan 's Econornic do re lop me?^ r

ries because in most developing countries it is singularly diffi-

cult t o increase the level of taxation significantly. Tax reduc-
tions in one sector, whatever their merit, are not easily matched
with offsetting tax increases in other sectors, and in view of
potential inflationary effects, an evaluation of tax incentives
must take the revenue losses into account. On t h e other hand
t o the extent that incentive programs are successful, the new
investment induced by them will raise taxable 1::apacity and will
tend to offset the tax losses.

It appears that in the absence of increased investment tax

rate reductions will involve a revenue loss since acceleration of
depreciation in an economy with a given rate of gr~wt:iof in-
vestment will provide larger deductions for profits tax. It ap-
pears also that there is a revenue reduction associated with this
stimulus unless the rate of growth is increased enough t o offset
this loss.

What proportion of the extra funds made available through

the introduction of incentives will be invested is difficult t o
ascertain. It seems reasonable t o assume however t'hat marginal
additions t o profits will be treated in very much the same way
as profits in general. If firms customarily retain 2 5 t o 5 0 % of
earnings for purposes of business expansion, it seems likely that
extra earnings resulting from the inwntives will also be handled
in this fashion.

On the basis of available evidence it appears that revenue

restoration is not likely in the long run in the case of long lived
assets. A 25% recovery appears t o be quite possible while r e
covery in the neighbourhood of half that arnc~untmight be ex-
pected with short lived assets For full restora.tion ofcourse the
gain loss ratio must be unity. Given the favorable assumptions
of a 40% tax rate and a 20% profits rate this would call for
lom investment of the extra funds provided by the incentive.
Accelerated depreciation will generally raise prospective
rates of return by one or two percentage points and with very
rapid systems such as expensing (immediate 1C)O% depreciation)
the prospective rate of return may typically. rise as much as
four percentage points.

Apart from raising the prospective profitability of invest-

Tax Ir@slafion in dewloping ~oiirirrics t? 7

mcnts acclearated depreciation can provide add[tio:ial financial

resources for investors in depreciable assets. Given a constant
compound interest rate of growth of gross investment outlays,
faster write offs mean that a larger proportiori of investments
can be financed through tax relief for an indefinite time.

Whatever the relative intrinsic merits of investment al-

lowances, accelerated depreciation or other similar devices
attached t o investment in fixed capital assets, it: sh(:~uldbe reali-
zed that the primary decision t o adopt such measzxes involves
the policy choice of favoring such investmenl:~over expendi-
tures for research, training and education, 1::eneral working
capital and other public and private goods and services, Whether
this particular variety (if discrimination is warrantetl depends on
che character of the obstacles to economic dew!!opment operat-
ing a t particular times in particular countrit?~and t o some
ext.ent on the type of economic development that is desired. In
the absence of a carefd study of all the major f:actors however,
it should not be assunled that special stimulatic;n for inves-
r;lents in fixed capital are necessary cornponer~tsof a develop-
ment program. In any case it is exceedingly doubt.fu1that they
xi11 ever be sufficient in themselves t,o launc:?. a wave of de-
velopment expenditures. U incentives of this ty:;e aie employed
t h e y should be closely integrated with ot,her pilases of the
effort to promote economic growth. Among t,l-~seare not only
general tax reform, but also the entire range oi' general and
firiancial control, public investments and otl-ier expenditures
1:nd generally the body of law and practice tl?iit i::f!uences the
investment climate.

Fiscal incentives will almost inevitably iesult in revenue

losses. Unless revenues are abundant, a situatiun rarely encoun-
te:ed in less developed countries, this will mezn rhat some
inembers of the community, perhaps those that are not placed
so high in the income and wealth heirarchy as the beneficiaries
of incentives, will usually have t o bear a greater burden through
either additional taxation o r inflation. If the result is inflation,
then even t h e beneficial effects of incentives o n investment may
be destroyed both because of the likelihood ol' misallocation of
investment expenditures and because of the inadequate provi-
sions for replacement that are likely t o be made with normal or
even somewhat accelerated depreciation methods. T o counter
these effects would require special controls over the invest-
88 Fiscol Irnpera tfws In Pakistan 's Econornlc Development

ment process as well as the introduction of depreciation sys-

tems based on replacement costs or at least periodic asset reva-
luations. These measures are ofcourse difficult t o administer
and are likely t o involve substantial costs for both business
and government. Moreover revaluations or 1:eplacement cost
depreciation which amount t o additional tax relief are surely
paradoxical measures for dealing with a sit1.1ation that arises
from insufficient taxation in the first place.
A type of incentive particularly adaptable t o agri or
mineral operations is the imposition of higher discriminatory
rates on inefficiently or underutilized holdings. Thus higher
taxes may be levied on idle land in order t o make underutili-
zation particularly costly.

In Pakistan there has been a .reluctance t o assemble and

think out the basic details which make up the foundation of
any worth while plan and t o be bound for long by a plan once
formulated. In addition there has never been adequate central
planning machinery. Numerous offices in various government
ministries and agencies have been provided with varying degrees
(of authority and influence over the industrial sector of the
economy but integration and central direction have been lack-
ing .

Lack of planning has been costly. It i:; generally felt that

the time has arrived for a comprehensive ;approach t o replace
"the project t o project" handling of Pakistam economic d e
velopment.

The lack of over all planning and integration of the

operation of the incentive provisions often has been cited as an
important contributing factor t o the failure of incentives in
Pakistan.

There appears t o be no instance in the recent past when

tax exemption was " The" decisive factor in an investment
decision. Even more importantly, it appears that in most cases
the tax exemption possibility is not even taken into serious
consideration when considering an investment. Many firms do
not consider it a t all. Those that do consider it seem t o classify
it as a windfall to be used if ultimately recieved; they cer-
tainly do not consider it worthy of justifying an investment
Tax !egishsbnon in dewloping countries

decision even in part.

Incentives instead of leading t o incresed reinvestment by

foreign investors may result in a net reduction of funds
available for reinvestment in thecountry. Unless care is taken
in their design the effect of these incentives may simply be t o
permit the foreign investor t o retain his previous level of rein-
vestment while increasing the amount of earnings that he re-
turns t o his home country.

Depreciation deductions in future years are not worth as

much as the equivalent deductions offered during the current
year because with the cash obtained with the curlrent years
deduction it would be possible t o earn interest which would
enlarge the fund before the future deduction becomes avail-
able. For this reason future deductions must t e discounted s o
that their present value is just sufficient given the rate of
interest t o provide the same total fund when the future deduc-
tion is actually taken as could be obtained with a smaller cur-
rent deduction. The interest rate used t o disco1.1nt future de-
ductions will depend on the investors views of the Suture and
the alternatives open t o him. The range of 5% tc) 20% however
is wide enough t o cover most situations. In general the larger
deductions offered in earlier years by accelerated systems will
raise the present values of the future deductions because of the
smaller discount that must be applied t o near tern? receipts.

There are other grounds for preferring tihe investment

allowance. From the point of view of formulation of legislation
the burying of an exemption in depreciation makes it easier to
adopt and harder t o remove while handling it :;eparately from
depreciation makes t h e exemption subsidy element more open,
more subject t o close scrutiny and more likely to be rescinded
and removed when appropriate.

Tax reductions associated with incentives should not lead

t o a failure of aggregate demand and thus t o unemployment of
productive capacity. If there is induced unemployment the po-
tential taxable income from new investments may not be
realized or may be offset by reductions in taxable income and
spending elsewhere in the economy. Governmental budgetary
policies designed t o counter such tendencies on the other hand
90 f-fscalItnpera rives in PaMstarr 's f co~iortiicDr~,rloprnerrr

able to assume that the chief problenl in developing rountries

will be excessive rather than deficient aggregate t1em;rnd.

The Puerto Rican experience

Income tax incentives though ubuquitous in their presence

on the fiscal statutes in most third world countrits, have not
really lived upt,o the hopes o i those who have de!;igned them for
these incentives have been found wanting in their ability t o in-
duce investment t o flow from the capital rich countries t o the
scarcity areas of the developing world.

According t o the theory given in the textbooks the care-

fully structured fiscal arrangements ought t o have been instru-
mental in provoking capital flows from the surplus regions t o
the deficient areas. That this did not happen ill actual prictice
could indicate flaws in the theoretical framework It appears
now however, that private investment can be quite fickle in its
perceptions of viability. Thus non tax consideration:; can indeed
play a significant part i ~ the
? private entrepreneurs evaluation of
the worth of an investment opportunity. F a c t ~ ~ liker s political
stability, infra structurs facilities, size and quality of the labor
force, geographical placement, availability of raw materials,
proximity t o port area etc etc' can loom larqe in the e n t r e
preneurs mind and will usually be crucial in any decision that
he makes. This should not be taken t o mean however that
fiscal incentives have c.o role t o play in invclstment decision
making. The experience in atleast one countl~y, Puerto Rico,
would clearly indicate that such incentives can indeed be in-
strumental in provoking the kind of investment flows that third
world planners would like t o see much more often than it is
their lot t o be witness to.

Perhaps if we were to examine the Puerto Rican experi-

ence a bit closely we might be able t o isolate factorj that can
help us understand the incentive mechanism better. We may
then be able t o make the sort of adjustments or changes that
could make a qualitative improvement in the fiscal design of
incentives in o u r own countries.

There is n o denying that Puerto Rico's special relationship

with the United States has played an irnpolrtant part in he
success of t h e fiscal arrangements that it has structured.
Tcx leg'slo tion in dewloping coun Mes 91

Puerto Rico as a self governing commonwealth territory of

the U.S. enjoys a special relationship with a highly developed
country. To start with, Puerto Rico was underdeveloped in
every sense of the word. Abundant manpower, relatively low
average wages combined with aggressively and irn aginatively
promoted tax incentives based largely on availab~lityof exemp-
tions linked to new industry plus the existence of' a market area
in close proximity t o the U.S. in its totality created the sort of
impact that successfully provoked investment flows from main-
land U.S. t o the peripheral area. Over time this has led t o sys-
tematic industrialization. Gradual emigration to the U.S. has
alleviated population pressures and has prevented their exacer-
bation. The excellence of its administrative machinery is in no
small way responsible for the success of the incentive program.
Insofar as laws and rules are administered by people, the ad-
ministrations role is pivotal in any program of ir:iplementation.
The inherent complexity of fiscalsstatutes make it all the more
necessary that administrative expertise be of a high order also.
Proper monitoring of the operation of fiscal laws rnakes con-
siderable demands on the administrative apparatus. It is essen-
tial that for optimal effect the fiscal laws be integrated into the
general body of laws and regulations in the stat(?.Adhoc arran-
gements where integration is the exception rathlt>rthan the rule
create disequilibria and contradictions that nelzative much of
the momentum that maybe initially generated by the fiscal
prorgram put into play.

The success of the Puerto Rican fiscal progym would, on

the basis of the available evidence, appear to be primarily due t o
assured stability, attractive incentives earnestly promoted,
imaginatively designed and skilfully integrated into the legal
framework of the country. All this coupled with administrative
expertise of a high order and the availability of a vast market
for the output of the newly set up industry have combined t o
ensure success for its fiscal program.
 The design of
tax incentives

Structuring tax incentives is not easy. As a stimulus

measure an incentive provided through deliberate interference
with statutory taxation measures is expected t o enhance profit-
ability sufficiently to increase competetiveness. On the nega-
tive side is the revenue that the exchequer loses as long as the
incentive remains in force.

Tax incentives have been considered important in the

context of promotion of industrialization. Tht: geographical
dispersal of industry is another important criteria kept in mind
while designing these incentives. The lack of adequate link-
ages hinder the smooth flow of factors involved in production
across the economic expanse. Tax incentives a:re expected t o
conlpensate for such limiting factors - atleast t o an extent.

In the opinion of many, while designing tax incentives

the long term objectives should have primacy over short term
goals. Disproportionate effort expended to redize proximate
intermediate goals can be counterproductive for eventually
such a (shortsighted) approach could interfere with and even
prevent the achievement of the more fundamcmtal objectives
of public policy.

Investment Incentives

The rationale for the deliberate encouragement of speci-

fic industries is that these could lead the way in the indus-
trialization effort by giving a cue t o other related and comple-
94 Fisml Inipemtiros in PaMsrar~'sEcor~ornlcLleveloprnenr

mentary activity through the externalities - linkages - that

thejr induce. Given an acceptance of such a scenario, t h e inte-
rest of the planners in designing the incentive measures is
easily understood. In their scheme of things efforts t o attract
capital t o the leading industries has high priority and tax in-
centives are considered a crucial component of the plan.

While increased availability of capital ~ ~ o u lcertainlyd

go a long way towards increasing the output of :.he specific
industry t o which the incentive has been targeted, in many
cases an unintended by-product is the s u b s t i t ~ ~ t i oof
n capital
for labor in the favoured industry. Over time chis could lead
t o generalized substitution of capital for labor over t h e full
spectrum of the entire industry. Considering that third world
countries are plagued with severe problems related t o labor
redundancy d u e t o over population, such a development
amounts t o a distortion in factor utilization and bodes ill for
the future economic format that would take shape as a result
of such incentive measures.

It would be recognized however that the real reason for

such selective subsidization of investment is obviously not
merely t o increase the capital stock of an industry targeted
t o benefit from the incentive but rather t o enl~ance the cap-
ability of the industry t o produce more of the desired output.
Thus it is the capability t o throw up increased output that
is the long term objective. When the incentive measure is
based upon output rather then upon investment in the select-
ed industry than it will have the effect of increasing capital
formation without distorting relative factor prices,. The mea-
sure then will not have the effect of creating a, bias for adop-
tion of techniques of production that result necessarily in
capital intensity (more capital per unit of output:).

General investment incentives have the serious defect

of underpricing capital in general. Considering: the fact that
developing countries are capital deficient the underpricing of
capital would intensify demands for capital goods. Most of
these would be machinery and allied items and the great ma-
jority of these would originate from already established indus-
try abroad. A greater chunk of the already scarce foreign ex-
change would thus be appropriated for importing such capital
goods.
 The only redeeming feature of a policy of structuring
general investment incentives would be the stimulus it gives to
foreign investment and t o domestic industry produci~ngcapital
goods. However in the majority of cases these benefils are not
likely to outweigh the disadvantages as it is increaAngly be-
coming evident that non tax benefits might weigh significantly
in the calculations of the foreign investor and in his scale of
parameters having a bearing on feasability these could have
primacy over the advantages confi?rred by tax benefits. PLS for
domestic industry producing capiti\l goods since this is already
an area that is sought to be develokted it would not be realistic
to expect that in the formative phases of economic: develop-
ment it would be sufficiently developed t o be able to make a
siginificant contribution thru production of adequate quanti-
ties of capital goods.

Among the many enigmatic problems that planners in

third world countries face is that of opening up backward
regions in the country by effecting a decisive change in the
labor-- capital mix and thus initiate dramatic chanj:es in pro-
ductivity. The objective clearly is to escalate wage l12velsfrom
their exsting depressed state to levels that are socially accept-
able and t o increase aggregate industrial output.

As should be evident from the statement made above

the problems posed by regional disparities in levels of econo-
mic development have multiple dimensions. Because of resource
constraints the government is unable t o uni1ate:rally make
investment in all the various undeveloped regions on a scale
that would lead t o meaningful change. The alternate plan
thus is to induce private investment to move into idhest.areas.
This however is easier said than done.

The less developed regions in a country are traditionally

characterized by lack of infra structure (means of communi-
cation, energy supply, education, healthcare etc) and an ad-
verse labor - capital mix in whatever industry obtains there.
The economic deficiencies insulate and isolate the backward
region from the more developed areas due to the weak linkages.
Over time, therefore, left t o themselves, the problems posed by
underdevelopment breed on themselves and exacerbate and
accentuate the original situation. As a direct sequel while the
rich in the country keep on getting richer the poor not only
96 Flrml Impemtiws in PaMstan s Economic Development

remain poor but slide downwards on the poverty scale.

Given the above scenario the reluctance of private enter-

prise to move into so forbidding a situation i~squite understand-
able especially as improvement of the condition of a people
is hardly the principal motivating factor in the calculations
of the entrepreneur when he makes an assessment with regard
to the feasability of an investment decision. The cost - benefit
equation is the key to a positive response from private enter-
prise and the costs being what they are, the benefits are not
likely to be a sufficient inducement for t h e enterpreneur t o
take on the daunting challenge that the backward region pre-
sents. However, if costs are lowered sufficiently, then it follows
logically that the benefits would appear to be more attractive.
Going a stage further, if it is possible t o lower costs and at the
same time increase the benefits the attractiveness of the situ-
ation improves dramatically.
Insofar as the tax burden constitutes a cost factor it
impacts unfavorably on profits. As in the final analysis it is the
profits that can be realized that loom so liarge in the mind of
the enterpreneur, a reduction in the tax birrden is expected to
do the trick in luring the entrep to the backward region. Taxes
are imposed through statute. They can thus be withdrawn
completely (exemption) o r held in abeyance (tax holiday)
or levied at a reduced rate. (preferential taxation).).

Most fiscal authorities today do not favor tax exemption

as a means of attracting private enterprize to the less developed
regions. It is increasingly being felt that most of these incentives
are in the long run counterproductive.

One of the reasons that such incentives are viewed with

disfavor is that these have been seen over time to lead to a
substitution of capital for labor. Considering that most third
world countries are labor abundant and capital poor it makes
much more sense t o use labor wherever .it is feasible to do so
i.e. wherever its use does not impact runfavorably. on produc-
tivity and lead t o deficiencies in output. Given the need t o
increase product^ ty, induction of capita!l is essential as there
are very real limitations to what labor alone (or labor with very
little capital) can achieve. In any case the use of more capital
is one of the aims of development policy. After all, industriali-
The design af &x incen fives 97

zation means putting machines t o work for man :;o in t.hat

context substituting capital for labor is inevitable. However
the continueing use of more and more capital per unit of out-
put perpetuates capital intensity in industry and ,this trend
once established is difficult t o reverse. The dangers inherent
in such a situation include exacerbation of existing labor
redundancy problems faced by the developing country. Addi-
tionally, labor is unable t o acquire the work experience that
in the long run is crucial t o instil capabilities that will have
the most long lasting impact in terms of enhanced pr~:)ductivity
of a significant segment of the total available labor force.

In addition t o the reasons given above, t a x e:remptions

distort information relevant t o quantification of the real cost
of economic development. Such quantification is necessary t o
evaluate and monitor the efficiency of a development program.
After all it must b e known what the execution of a develop-
ment plan entails. Insofar as t a x exemptions represent revenue
deliberately foregone, t o that extent it represents the cost of
bringing development t o the less developed region. However
the fact that a specific industry has come t o the target region
frequently clouds the cost involved. Again - and this is impor-
tant - it may not be at all clear that it was the tax incentive
that was actually instrumental in bringing the industry t o the
backward region. Infact the available evidence suggests strongly
that the exemptions actually constitute windfall gain:; t o indus-
tries that would have located in the region in any event.

One of the problems. with tax incentives is that once

enacted they tend t o become institutionalized. Over time
the beneficiaries get conditioned t o the incentive and find it
increasingly worth their while t o come t o their defence when-
ever they face a challenge. This vested interest will take great
pains - and even incur much expense - t o ensure that the in-
centives are retained irrespective of the fact that they might
be poorly designed, inequitable or ineffective.

Tax incentives manage 'to escape public scrutiny largely

because they are not treated as items of public expenditure
when infact they are really on all fours with the public ex-
penditures in that they consume potential public funds.

It is increasingly being felt that explicit subsidies achieve

98 Ftscal Imperatives in Pakistan 's Economic Development

more in terms of desired objectives (viz increased output,

employment and domestic value added in exports) without
creating undesirable distortions in resource allocation. Also
the cost of the incentive is much more evident when adminis-
tered through a subsidy. Thus the well-worn paths taken
by tax incentives - accelerated depreciation, investment credit,
initial write off etc - should be trod on not with alacrity and
blind enthusiaism but rather with extreme caution and may
be even reluctance so that the inevitable negative effects are
minirnised.
 An appraisal of the scheme of
fiscal incentives incorporated in the
Pakistan Income Tax Code

1
Pakistans Tax Profile
The Income Tax in Pakistan is a Federal Tax.. The Law
governing the charge of Income Tax and Corporation Tax is
codified in the Income Tax Ordinance of 1979 which super-
sedes the (Indian) Income Tax Act of 1922 as adapted in Pa-
kistan through Act XI of 1947.

Resource mobilization remains a primary objective in the

levy of Income Tax. Of increasing significance however, is the
provision of incentives through deliberate manipulation of
the Income Tax Law as it effects selected categories of tax-
payers.

The scope of fiscal measures expressed through the direct

taxation of Income is limited however, by the extrerrlely narrow
tax base. This is apparent from the fact that direct taxes contri-
buted only 13% of aggregate govt. revenues in fiscal 1986-87 -
down from 25 % in 1949-50 and 1 7 % in 1979-80. The bulk of
the income tax revenues emanate from the coopc~ratesector
(55 - 6 0 %). Salaried individuals contribute a further 20-25%.
What aggravates the "narrow base enigma" is the continueing
exemption for income derived from agriculture. Thus, while the
agri. , sector contributed 20 % to the GNP (at current factor
cost) in 1986-87 the federal exchequer received nothing by way
of income tax.
That the Income Tax base is indeed narrow is further
highlighted by the fact that'there were fewer that 1 million
tax~avers nationwide in 1986 - when the total nonulation
100 Flscnl Imperoflves In Pohdston's Il'conomic Development

(65% of which is still in the rural-largely ag:ricultural - areas)

approached 100 million.

The basic system of corporate income tax in Pakistan has

fairly stable over the years with an income tax of 30% and a
super tax of 30% on profits. (Reduced to 55% overall in 1983).

The maximum rate of personal inconne tax has been

reduced from 97% in 1958 t o 75% from '61 thru '64, to 7056
from '65 thru '75 / 606 from '83 thrn 1985 and 45 % in 1986.
The 'zero bracket' exemption limit was Rs. 2,500 in 1948,
Rs. 6,000 in 1957, Rs. 12,000 in '74, Rs. 38,000 in '83 and
Rs.24.000 in '85.
Income tax evasion remains widespread and it has been
estimated tliat the actual yearly collection is about 40% of the
potential amount. In relation t o tax base, income taxes in
Pakistan have been estimated to have had an 'elasticity co-
efficient" of 1.52 over the period 1952153 t o 1963164 and
0.83 over '72173 t o '79/80.2 This deterioration continues in
the succeeding years.
INTEGRATION O F FISCAL INCENTIVES WITH
THE ECONOMIC DEVELOPMENT STRATEGY. AN
OVERVIEW
Since 1947 the economic development program of fakis-
tan can be seen to have passed through various 'phases' with
a specific 'bias' evident in each such phase. Broadly speaking,
the 'package' of fiscal incentives3 put to use in a particular
period reflicts an endeavour to help facilita.te achievement of
the specific objectives that have priority in the growth strategy
for that time frame.

The first phase in Pakistan's growth strategy can be seen

to extend from 1947 t o 1958. The outstanding feature of govt.
policy in this period was a pre-occupation with building up
industrial infrastructure. As part of the effort to promote indus-
trialization, a variety of fiscal incentives were put into play.
These included accelerated depreciation allowances, tax con-
cessions on industrial profits and exemption for capital goods
from customs duties.

Gross monetary investment in the private sector increased

from Rs. 5 1 5 Million in 1949-50t o Rs. 1030 Million in 1954-55.
The largest increases were recorded in Industry, Urban develop-
ment and Traders stocks. As against this, public sl~ctorinvest-
ment lagged behind remaining at about half the private sector
level.

Phase-2 would be over the period 1960-65. This is also

the period of the second five year plan and the underlying
theme of the growth effort in this phase is illustrated through
adherence to the doctrine of "functional inequality" i.e. a
belief that in order t o buuld up savings and create entrepre-
neurial dynamism, a significant inequality in incomes is a
necessary evil in the initial stages of western style (capitalist)
economic development. As Pakistan openely "aped' the wes-
tern model class inequality was tacitly accepted as 'unavoid-
able'. The pro-industrial bias' in policy continued and the
fiscal concessions made available in phase 1 were extended t o
phase-2 with the significant addition of a 'tax hcrliday' scheme
providing an across the board exemption frorn income tax
for specified industries set up in the less developed areas of the
country. The accent thus was not only on industrialization per
se but rather on the geographical dispersal of industry consis-
tent with the pursuit of "balanced economic growth."

The Tax Holiday concession devised in 1959 continued

till 1972, when it was abandoned. Although it became a contro-
versial measure it offered nevertheless a significant fiscal conces-
sion and showed the seriousness of the government's resolve
t o aid "new industry." Private Sector investmerat in this period
amounted t o Rs. 3662 Million in 1963-64 and Rs. 4198 Million
in 1964-654 yielding a percentage increase of 14.64. The largest
increases were recorded in manufacturing, transportation,
housing and agriculture - in that order.

A major change in development strategy took place in

1965 with the implementation of the third five year plan.
This change was evident in the emphasis n0.w placed on the
development of intermediate and capital gocads industries as
against consumers goods industries and, what was much more
important, a heightened awareness of the need t o bolster the
agriculture sector. The latter came t o pass not in t,he natural
course of events but through the compulsions of repeated
disastrous crop failures.
102 Hscal Imperanws in Pakistan :r Economic Developmen t

The fiscal concessions package contrived for the third

plan in the context of Income Taxes showed no radical depar-
ture in content from what was already being implemented on
the launching of the third plan except that the concessions
were now targeted to the selective exparlsion of industries
geared t o agriculture and exports. Accelerated depreciation
allowances and tax holiday continued tcl be the principal
features of the fiscal package.

Gross fixed capital formation in this pcxiod was indicated

at Rs. 3231 Million in 1964-65 and which increased to Rs.
3493 Million in 1969-702. As against this public sector invest-
ment amounted to Rs.2831 Million in 1964-65 and increased
to Rs.3342 Million in 1969-70: In the private sector invest-
ment the largest increases were recorded in manufacturing,
transportation and housing.

The first radical change in policy since 1947 came in the

early '70's when a new govt. that did not espouse a capitalist
or quasi capitalist economic development philosophy, came to
power. It made its intentions clear by firstly, devalueing the
rupee in may 1972. This measure had the effect of cancelling
the 'subsidy' the industrialists had hitherto received as a result
of the overvalued exchange rate. Secondly, the abrupt increase
in the procurement prices of agricultural goods was clear
manifestation of the determination to change the pro-industry
anti-agriculture bias of the growth strategy adopted in the
past. The private investor was no longer viewed as the principal
vehicle for promoting industrial development. The State now
came to play a direct role in the establishment of 'basic indus-
try'. A wide array of industrial units were nationalized and
fiscal measures came t o focus more on 'resource mobilization'
and less on 'tax relief'.

For the first time in 1972-73 Gross Fixed Capital Forma-

tion in the Public Sector overtook the Private Sector Capital
Investment setting a trend that increased sharply in magni-
tude in the following years. The significance of this reorienta-
tion of policy is evident from the fact that whereas in 1972-73
capital formation in the public sector amounted to Rs.3920
Million against Rs.3726 Million in the private sector, by1976-77
public sector investment stood at Rs.18642 as against Rs.9215
Million only in the private sector. Thus public sector capital
formation had recorded an unheared of increase of 47170 over
the period 1971-72 to 1976-77 whereas private sector capital
formation in the comparative period had increased only by
157%. Also in this new 'era' the much touted ta.x holiday
scheme was withdrawn (in 1972) the experiment, begun in
1959, having clearly failed t o yield the desired results.

The current phase, begun in 1977 with the dramatic

exit of the Peoples Party govt. brought in its wake, once
again, a reversal of policy. The private sector came back in
favour and a fairly attractive package of fiscal and] non-fiscal
incentives was gradually assembled in order to promote pri-
vate investment in industry. The income tax corr~ponent of
this 'package' will be looked into in depth in the next section.

THE SCHEME O F FISCAL. INCENTIVES IN THE

INCOME TAX ORD., 19791

The Ordinance of 1979 is essentially an attempt at rationa-

lization of the body of Income Tax Law condifiedl in the Old
Act as it was widely recognized that repeated 'amendments'
incorporated therein had made it cumbersome and difficult t o
comprehend. The new Ordinance was however, a departure
from the past in that it incorporated some of the fiscal incen-
tives introduced by the new Govt. that had come to power in
1977, designed t o promote private industry. In this section we
examine, in some depth, the variety of fiscal incentives as these
find mention in the Ordinance. "Amendments" incorporated
in the Ordinance through 1986 are also examined.

a) Depreciation:

Since 1947, a key element in the fiscal package has been

the allowance for depreciation. Such an allowance has tradi-
tionally been allowed for the use in business of wasting assets.
However, it is the acceleration of the ordinary depreciation
allowance that makes it a significant fiscal incentive for it
enables a qualifying business t o minimise tax liability or even
avoid it altogether not only for the current year but for suc-
ceeding year(s) as well - depending o n the type and magni-
 1 114 Flscal Imperadws in Pakistan 3 Economic Development
1
t i
1 i tude of the investment made.

The legal sanction for the depreciation allowance under

the Ordinance is available in Clause (V) of sub-section (1)of
Section 23. Such allowance is available for buildings, machi-
nery, plant, furniture for fittings. The amount of the allowance
itself is t o be calculated in accordance with the stipulations
made in The Third Schedule t o the Ordinance. Normal (Ordi-
nary) depreciation is allowable under clause-2 of the Third
Schedule. The rate of such Ordinary depreciation ranges bet-
ween 5 and 30 percent for different classes of assets. A note-
worthy feature here is the 100 percent depreciation allowed
as Ordinary for below ground installations in mineral oil con-
cerns. Clause-3 allows multiple shift depreciation. However,
the really important part of the depreciation provisions in the
context of acceleration are contained in Clause-5 that incor-
porates a special incentive in the form of initial depreciation
allowed in addition t o the normal 'ordinary' depreciation.
Such initial depreciation is admissible at the rate of 25 per
cent for residential buildings for industrial labor as against
10% for other buildings. On machinery (olther than ships or
motor vehicles not plying for hire) the rate of initial depreci-
ation is also 25%. An added incentive here is that where a
'new' industrial undertaking commences c~ommercialproduc-
tion after 1st July 1981, initial depreciation is admissible at
40%. In such cases the total depreciation allowance can add
up t o 60% - assuming multiple shift operation.

As a result of an amendment made t o the Ordinance

through the Finance Ordinance of 1982 Clause (cc) was added
t o the Third Schedule which permits scheduled banks and
financial institutions t o claim initial depreciation at a rate of
40% of the written down value on machinery and plant leased
out by them. This is a somewhat novel arrangement8 where
by the bank or financial institution instead of loaning funds
on interest leases out machinery and plant; equipment bought
by it and earns lease money thereon. Ultimately the lessee
will buy out the assets. Till such time the lessor only claims
depreciation as the owner of the equipment. Lease money
received is assessable separately in terms of section 30(2)(d).

It is important t o point out here that under the law pre-

sently in vogue the sale price realized on the disposition of
Fiscal incentiws I US

any depreciable asset is directly deductible from the last written

down value o n record and any losses resulting from the sale
are ignored (i.e. not recognized) till such time as the entire
class of assets to which the said asset belonged have actually
been sold and there is an overall loss o n the sale. On the other
hand any gains made o n disposition are immediately recog-
nized. As a result it is possible that an asset having beell rapid-
ly depreciated as a consequence of acceleration may, before
the time it is sold, end up with a written down value of zero
or with a WDV that is lower than the amount realized on
the sale of that asset. Such a situation is quite conceivable
given inflationary conditions and the manner in which the
accelerated depreciation provision operates. Thus it is possi-
ble that the incentive of accelerated depreciation be actually
defeated-unless of course an organization keeps or] adding new
plant and machinery. As against this, under the ~xovisionsof
the repealed Income Tax Act of 1922 (Act XI of 1947) if the
sale of an asset resulted in a realization that was less than the
Written Down Value then an additional 'terminal allowance'
was allowed t o the taxpayer in terms of section IO(2Xvii)
of the repealed Act. If the disposition resulted in a realization
higher than the WDV then the 'extra' depjeciafion that had
caused the WDV t o fall so sharply was brought to tax-but
only t o the extent of the depreciation that had been allowed
originally. There was thus a 're-capture' of the 'extra' (acce-
lerated) depreciation allowed. Where no deprecialion had been
claimed o n an asset the excess amount realized oker the original
cost was not subject t o tax.

Under the present law therefore, the taxpayer may end

up worse off both if has suffered a loss on disposition and
also if he realizes a gain as in the first case the loss may not
be immediately recognized (till the entire 'class' of assets to
which the asset sold belongs has been disposed off) and in
the second, the gain is brought t o tax immediately as Ordi-
nary Income and not as a Capital Gain (which infact it is).

Ostensibly the objective of the whole arrangement is t o

block possible 'speculative' sales of depreciable assets but, as
has been pointed o u t above, an anamolous situation can con-
cievably arise for the taxpayer with consequences that would
effectively negate the 'incentive' aspect of the accelerated dep-
reciation provision.
106 r ' : ' , - . ~ l 3 r y r r ? t l wfxs Pakistan's L:conomic D-evelopment

(b) Hundred percent 'expensing' of all expenditure (includ-

ing capital expenditure) in the first .year of operation,.
in :specifically.designated activities.

This is a significant fiscal concession and the aim is t o

promote business related scientific research -(clause (xii) of
Section 23(1) -the setting up of any educa.tiona1 instiution
or hospital in Pakitan for the benefit of the employees o r their
dependants-(C1 (xiii)-and the setting up of any institute for the
training of industrial workers provided the said institute is
recognized by the Federal Government or any local Authority.
The object here is t o promote the building up of infra structure
in educatior! and medic21 facilities. Normally investment in
these areas is expected from the government. 'Where a commer-
cial establishment or industrial undertaking takes an initiative
in this context the govt. , through the provisions referred t o
above, would in effect be providing a subsidy by foregoing the
tax on income equal to such expenses. This incentive can also
be spoken of as a 'tax expenditure'.

(c) Incentives t o promote savings & investmerit

In order t o promote savings a whole range of incentives
are provided. These are contained in sections 3 9 through 46
of the Ordinance. Collectively, they form the 'Investment
Allowance.'

First, there is (in secticn 39) the allowar~cefor life Insur-

rance premium paid. The rationale behind the allowance is
not only t o encourage a middle class earner t o provide for the
future of his family but more significantly t o encourage capi-
tal formation. This is made possible by the f,act that the bulk
of the insurance premiums is collected by the State Life Insu-
rance Corporation. This Corp. is a major investor in the count-
ry, investing in the share capital of various companies approved
by the Controiler of Insurance. However the allowance here
is subject t o certain conditions. Thus if the annual premium
paid exceeds 10% of the sum assured no relief is admissible
on the excess. The object here is t o defeat possible manipula-
tion of the provision by say taking out a policy payable after
1 2 months and claiming relief on the entire sum assured. An-
other requirement prevents recognition of assurance where
the policy is surrendered or paid up within :36 months. Also,
Nsml tncentiws 107

if the premium or proceeds are payable outside Pakistan, the

allowance cannot be claimed - even by a person 'ordinarily
resident' in Pakistan. Section 40 of the Ord. pro.rrides for an
allowance for moneys contributed t o a provident fund (whe-
ther the fund has been set up for public or privateemployees).
Prescribed rules require that the funds so mobilized be invest-
ed in Government Secruities. This is obviously to thwart any
speculative use of the fund.

Section 41 of the Ordinance provides for an allowance

on account of investment made by noncompany taxpayers
in specified areas including the share capital of approved Pa-
kistani investment Companies and (approved) Pakistani Tndus-
trial Public Companies provided the allotment of shares is
made directly by these companies. A minimum holding period
of three years is prescribed for all such investnlents except
Invest. Corp. of Pakistan Mutual Fund Certificates and shares
of approved companies. The allowance facilitates mobilization
of capital by the Invest. Corp. of Pakistan and the approved
companies referred t o above. Also the holding period require-
ment prevents early encashment of 'open ended' certificates.

Incentives to encourage retention of the shares of pub-

lic companies and certificates of Mutual Funds by the investor
include exemption s f dividend income upto Rs.15,000 = from
income tax. Furthermore, capital gains realized cln share tran-
sactions stand exempted under the Second Schedule t o the
Ordinance. Also, the realized value of Defence Savings Certi-
ficates is exempt from income tax.

A blanket exemption from income tax t o the profit made

from investment in various sa~lngsschemes introduced by the
govt. encourage channeling of funds t o these schemes by the
small investor. However no rebate from tax is allowed on the
original investment in these schemes. Only the profit stands
exempted.

Section 43 provides an allowance t o non-c::ompany tax-

payers investing in Pakistani Undustrial Public Companies
owned atleast partially and managed and controlled, directly
or indirectly by the Federal Government.
paid by an individual subject to the overall limitation laid
down in Secti0n45~whois not entitled t o any pension benefits,
t o secure a contract of annuity with the State Life Insurance
Corp. of Pakistan or the Pakistan Post Office Life Insurance
Deptt. Section 44A has been specifically provided t o enable
professionals not having the benefit of a providend fund or
a pension scheme t o secure an annuity. With a view t o en-
courage liberal donations for education and charitable insti-
tutions the govt. has made it possible for a taxpayer t o donate
even his entire income and yet enjoy and exemption from tax
on the entire amount. This is possible through the machinery
of section 47 of the Ord. However the law requires that the
recipients of such 'largesse' be approved institutions. One such
approved recipient is the Quaid-e-Azam Memorial Fund.

The major incentive for exports from the income tax

side is the 55% rebate on income tax and super tax payzble.
Almost all categories of exports qualify for the rebate except
raw cotton and a few other specified items. Exports also receive
generous concessions on the indirect taxes side (customs duty &
sales tax) so that the aggregate fiscal incentives package plays
a vital role in coiisolidating their competitive position inter-
,lationally. That the encouragement provided has paid ,, off
dividends is evident from t h e fact that Pakistan's exports
have increased from Rs. 1700 mill. in 1,700 t o Rs. 10,286
mill. in 1 9 7 4 7 5 and t o Rs. 63,268 in 1986-87 (in current
prices). Thus Pakistani exporters have not only got o a r the
"shock' of the loss of the East Pakistan market but have been
able t o make significant inroads in larger and much more com-
petitive markets

The "export" of manpower has, since the mid seventy's,

been an increasingly important source of hard currency. The
remittances from PAistanis employed abroad, especially
the middle east, now is in the region of 5 Billion Dollars (U.S.)
annually i.e. 'both' from official and 'unofficial' channels.
Remittances are now the single most important category of
foreign exchange earnings for the country and have partially
compensated the loss of foreign markets for traditional Pa-
kistani exports due t o stiff competition froin South Korea,
Taiwan and India. The entire remittan~eis statutorily exempt
from Income Tax. However this area has not received the
attention that it deserved. Much of the Rupee equivalent of
the remittances has been dissipated in conspicuous consumption
and in real estate creating significant inllationary pressures.
There is a pressing need for structuring of effective incentive
measures t o ensure the channelization of these funds into
meaningful investment. The problem assumes heightened
significance from the fact that avenues for employment
in the middle eastern region are becoming more limited by the
day caused partly by declining oil revenues due to a fall in
the price of crude and increasing military budgetary require-
ments resulting in much reduced outlays for the d.evelopmenta1
projects of the type on which most of the Pakistmi manpower
has been engaged.
(d) SPECIFIC INCENTIVES FOR THE CORPORATE
SECTOR:
(I) Partial exemption for Industrial profits.
Specified industrial undertakings viz those engaged
in manufacturing, processing, shipbuilding or the genera-
tion and supply of energy are allowed an exemption from
tax equal t o 10% of the capital employed provided the
undertaking is new and does not employ plant or machi-
nery previously used in Pakistan for business purposes.
Also, the undertaking must not have been formed by the
splitting up or the reconstruction or reconstitution of
business already in existence.

The requirement that 'all' the machinery employed

in such an undertaking be used for the first time in that
unit in Pakistan is clearly unreasonable as it would dis-
qualify an undertaking employing even nominally any
machinery previously used in Pakistan. It is hardly realistic
t o debar an undertaking in so drastic a manner. As for
determining the amount of capital employed for purposes
of calculating the allowance some discretion is available
t o the assessing officer which conceival:,ly could create
complications in sorne situations.
The exemption from tax is avialable in the first five
years of commercial production. If the profits are not
adequate t o cover the exemption no deficit can be carried
forward. This can defeat the intent of the legislation as
after availaing the benefit of accelerated depreciation
I10 Ftsml Imperatives in Pakistan's ,4'conomic Dewlopment

allowance very few undertakings would be disclosing sig-

nificant profits in the first two or three years of operation.
The benefit of the legislation would th1.1~be lost for this
period as against the five years contemp1ati:d by the sta-
tute. Section 48 of the Ordinance Contro:ls this exemption.

(11) A TAX CREDIT FOR BALANCING, MODERNIZA-

TION AND REPLACEMENT O F MACHINERY -
and also for extension of plant capa~::ity.

Section 107 allows a tax credit at '1 5% of the cost of

machinery and plant installed for balancing, moderniza-
tion and replacement of the equipment in use in an exist-
ing industiral facility. The credit is allowable in the year
of installation of the machinery and not in year in which
commercial production commences. Any unabsorbed tax
credit can be carried forward t o two subsequent years
only. Although no separate approval of' the C.B.R. is re-
quired here, the requirements of rule-42 have to be
satisfied. These require a certification from the Director
of Industries as t o -the category of machinery intended
to be installed. Bureaucratic red tape can create prob-
lems here especially as the said official has no direct liaison
with the tax deptt. and moreover is under no legal obli-
gation t o issue such a certificate. Valuable tirne can thus be
lost simply in persuading the Director that the machinery
is intended fcr a use covered by the ~xerr~ption statute.
In actual fact every conceivable prartical situation is
already covered by the exemption and it is difficult
to visualize any other reason for use of such machinery.
It may be pointed out here that no such certificate is re-
quired for preferring a depreciation claim for the machi-
nery.

(111) A Tax Credit for companies investing in the share

capital of other Pakistani Companies.

Under section 106 of the Ord., a tax credit is avail-

able t o companies investing in the shares of other Pakistani
companies. Of course the investment has t.o be made in
approved companies. The tax credit is available at 30%
for the so called underdeveloped areas viz Baluchistan,
the Tribal Areas, the Northern Areas, h a d Kashmir and
Fiscal incentives 111

at 15%for the rest of the country except Karachi, Lahore

and Faisalabad for which areas no credit is available. The
minimum holding period for such shares is five years
otherwise the relief is liable to be withdrawn. In case the
undertaking does not disclose positive income the credit
can be carried forward for any number of years.

There seems t o be no compelling reason for pro-

viding for the holding period of five years. Onctt a 'share'
is purchased its subsequent sales on the stock market
does not amount to 'dis-investment'. The holding period
requirement thus does not appear t o be rational. Another
mamolyhere is that the credit is only available from the
date of commencement of commercial production. The rele-
vant rules require that the undertaking issuing ,!he shares
give a firm date in this context. If for any reasorr it is
subsequently not able to adhere t o the schedule an-
nounced any credit already allowed to an investing com-
pany is liable t o be withdrawn. This appews to he ~ a t e n t -
ly unfair insofar as the investing company has no means
of forseeing any delay in commencement of production
and can only rely on the schedule and projections given
in the fezsability study. Withdrawal of the cr~bditunder
these circumstances w ~ u l dclearly appear to lie a n un-
warranted penalty on the investor.

( W )Tax Rebates.

Under the first schedule rebates in 'super tax' (also

called Corporation tax) are allowed to certair. companies.
Thus there is a rebate of 5% merely for getting ,; company
listed on the stock exchange. This is t o encourage the
liquidity of stocks and thus provide an incentive for in-
vestors to hold shares and consider them convertible
into cash at short notice. Additional rebates of 5% are
allowable t o such companies the paid up capital plus
free reserves of which do not exceed Rs.500,000. If these
exceed half a million rupees but do not exceed one mil-
lion, a rebate of 5% will be admissible only if it also
owns an industrial undertaking.

If the original cost of the fixed assets, exc:luding

land, owned by even a private Pakistani company, does
112 Fiscal Impemlives in Pakistan 'S .l:conomlc Developmen t

not exceed Rs.5,000,000 it will still be entitled t o a

rebate of 5%.

A rebate of 10% is allowable t o a E'akistani company

on profits and and gains derived from processing, freez-
ing, preserving and canning of food, vegetables, fruit,
grain, meat, fish and poultry.

A rebate of 15% is allowable on the income, profits

and gains earned abroad and remitted into Pakistan.

(V) Exrnption for dividends

Subclause 80 (c) of the Second Schedule exempts

totally dividends of new public companies distributed out
of the profits of new industrial undertakings. The exemp-
tion is available for the first five years starting from the
year of commercial production.

(VI) Exemption for Foreign Technical Personnel

Pakistani companies have frequently t o employ

foreign technical personnel in the first few years of a new
industrial undertaking equipped with sophisticated modern
technology. However approval from the State Bank and
the Commissioner of Income Tax has t o be obtained.
The remuneration received by the foreign person so emp-
loyed will then stand exempt from tax for three years.
In case the period of employment exceeds three years
another concession is available in that tax paid by the
employer on his salary will not be treated as a perquisite.
Industrialists may thus be able t o negotiate favourable
salaries for the foreign personnel employed by them.
This will obviously impact favourably on their cost of
production.

(VII) Other incentives for the corporate sector include

an exemption for all capital gains arising from the dis-
posal of movable assets. The exemption holds good for
the assessment years 1975-76 through 1988-89. A tax
credit of 50% is available on the amount invested by
Pakistani companies in the shares and debentures of
the Equity Participation Fund. The entire income of an
! Fiscal Incentives 113

investment company registered under the Investment

Companies and Investment Advisers Rules 1 9 7 1 stands
exempted from Income Tax. Also, the income of a regis-
tered company equal t o the face value of bonus shares
issued by it standsexempt from 1977-78 through 1987-88.
This is another concession aimed at enlarging the capital
base of companies. Furthermore, dividend income dec-
lared and paid by public companies registered between
1st July 1978 and 30th June 1982 out of its; profit for
any income year ending o n or before 30th June 1 9 8 2 is
exempt and the dividend income received from public
companies engaged in an industrial undertaking and
registered between 1st July 1978 and 30th June 1983
is exempt for a period of five years beginning from the
year in which commercial production commences. For
t a x holiday companies falling in this category the con-
cession has been extended for a further five years through
the 1983-84 budget. Finally, inter-corporate! dividends
are taxed at a reduced rate of 5% in the case of Public
Companies and at 15% for foreign companies. For pri-
vate companies the rate is 20%.

(e) INCENTIVES TO ATTRACT FOREIGN CAPITAL.

(I) The Tax Holiday Scheme.

The first 'experiment' in giving a tax 'holiday', begun

in 1959 ended in 1972. In 1977 the 'holiday' was revived
though of course in a modified from. As p,t?r the new
scheme, a blanket tax holiday is allowed t o all. new indus-
try starting commercial production uptill the 30th June
1988 for a period of 5 years, located in Baluchistan,
certain areas of the frontier province and Azad Kashmir.

A tax holiday has also been allowed t o certain speci-

fic industries irrespective of their geographical location.
In this context priority has been given t o agro-based
industry especially that engaged in the manufacture of
agricultural implements, poultry farming and dairy far-
ming. Industry with an export potential such as that
engaged in garments manufacture has also been included
here. Such 'holiday' is also available t o the (data proces-
sing industry.
 Fiswl Imperadves in PaMstan's Econon~icDevelopment

Besides the above, a tax holiday has also been granted

to an industrial undertaking located in an 'industrial
estate' approved by the C.B.R. Iocated in the so called
'less developed' areas of the country. Also, the holiday
applies to companies set up between 1st ,luly 1981 and
30th June 1985 and engaged in the em;ploration and
extraction of specified minerals.

(11) The Export Processing Zone, Karachi.

Industry set up in this zone will enjoy a blanket
exemption from income tax for five years. This includes
an exemption for the income of any foreign personnel
employed in the industry. The exemption is further ex-
tendable by govt. depending on the initial performance.
Also, any capital gains realized o n sales of assets and shares
also qualify for the exemption.

(111) Other incentives for foreign capital include an

exemption from income tax t o interest paid (a) t o a non-
resident o n a private loan used on a govt. approved
project in Pakistan; (b) by an industrial undertaking in
Pakistan under an approved agreement with a financial
institution in a foreign country: (c) on m:>ney borrowed
abroad (with the prior approval of the gov:.) for purchase
abroad of plant and machinery; (b) to an agency of n f o -
reign govt. or an approved foreign national for loans made
to the Federal Govt. or to other persons in Pakistan under
an approved arrangement; and (e) by the authorized banks
in Pakistan on their foreign accounts.

CRITICAL EVALUATION

An important objective of fiscal policy in Pakistan has

been to increase the savings rate so as t o be able to channelise
funds into investment o n a magnitude that would impact
decisively o n the overall growth rate of the economy. It thus re-
mains to be seen now how far the fiscal concesdons offered so
iarsas discussed above, have been successful. In the context of
economic development strategy, capitalist philosophy has tra-
ditionally relied o n high concentrations of income in a society
characterized by marked inequality of income distribution, t o
release entrepreneurial leadership and finance for investment
in the early stages. Pakistan, relying o n the wester11 'model',
sought t o duplicate the western economic experience by tole-
rating concentration of income1' in a few hands and even
encouraging it so as t o build up the level of investmt~ntin the
initial period of development. From 1947 through 1969 the
private sector was looked up t o as the 'engine of growth' in
Pakistan. Liberal credit and a variety of fiscal incentives fueled
the engine' while savings were recycled back into investment
(atleast a major part thereof) and the 'arrangement' sustained
the sector and even gave it a degree of dynamism. Gross domes-
tic savings, in real term, that amounted t o 4.6% of the GNP in
1949-50 rose t o 6.8% in 1954-55, 12.2 % in 1964-65 and high
of 12.5 in 1969-70. Gross fixed investment in this period
amounted t o 4.6% of the GNP in 1949-50, 7.9% in 1 9 5 4 5 5 .
21.1% in 1964-65 and 15.6% in 1969-70. Of the aggregate gross
fixed investment private sector investment amounted to 7=* in
1949-50, 72 % again in 1954-55, 54% in 1964-65 and 52% in
1969-70. The significant role of the private sector :IS further
made evident by the data for Domestic Fixed Capital Forma-
tion which goes t o show that the private sector corltrobuted
39%, 54% and 52% in 1959-60, 1964-65 and 1969-70 respec-
tively, of the total gross domestic fixed capital formation which
rose from Rs 2014 Mill, in 1959-60 t o Rs. 6746 Mill, by
1970.

In t h e post 1970 period when a reversal of national po-

licy took place and the private sector lost its pre-eminent
position, private sector investment declined t o 5.6% of the
GDP in 1972-73 and t o 5.2% in 1976-77. Of the aggregate gross
fixed investment the private sectcr contributed 49% in '1972-73,
32% in 1974-75,29% in 1976-77 and 34% in 1981-82.

Hrr the P.P.P. era (1972-1977) government was clearly not

enamoured with fiscal incentives and appeared t o be sceptical
of their efficacy in promoting the accelerated structural trans-
formation of the economy. It was (correctly) percieved that
fiscal concessions had not facilitated the geographical dispersal
of industry but had led t o concentration of industria.1 owner-
ship and had badly eroded the already narrow tax base.
The 'revival' of the private sector in 1981-82 paralleled a
reversal in national policy in 1 9 7 7 when the left leaning Pa-
kistan Peoples Party government was replaced by a rightist
military gavt. that seorned the socialist leanings of the govt.
it replaced.
From the data given above it is apparent that the private
sector did infact respond positively to the incentives it receiv-
ed over the period 1949-50 t o 1969-70. How much of this
'r8esponse' can be correlated statistically t o tho package of
incentives bearing on income tax and Corp. tax is a question
whose answer can only be inferred and that too in very general
tt:rms given the constraint of data limitation.

A study made in the 70's concludes that the tax 'holiday'

scheme1' which was an important fiscal concession over the
period 1959-1972 cost the exchequer upto Rs.1293 Mill. At
the same time the 'holiday' itself resulted in a high degree of
concentration of economic power and encouraged the forma-
tion of uneconomic units. The highest benefit!; accrued to those
inidustries which were already earning very high profit margins
and in terms of a greater regional balance the effort was mini-
mal. The tax holiday per se was seen to have motivated invest-
ment in only 20% of the cases and most of the investment
took place in the relatively more deve1opl::d regions of the
country - where ofcourse the holiday was for a shorter period.

The tax holiday scheme was revived in 1977. In its opera-

tion over the the period 1977-83 it has been seen that the in-
vestment actually made in tax holiday area::, coiistituted 14%
c:~f the total investment in this period, 71% of the inveStment
so made has been in areas that are not the most underde-
/

beloped in the country. Further, the ' approved' investment

in tax holiday units constituted 26.1% of the total approved
investment. Also it has been observed that the actual realiza-
tion of investment in tax holiday industries has been 22.8%
as against 41.5% in non tax holdiay areas.

It is probably too early t o comment on the effectiveness

of the "revived' holiday. However tentatively, it appears that
the response so far, is at best, lethargic.

Probably the single most important factor in the fiscal

incentive package discussed above has been the accelerated
depreciation allowance. It is almost jmpo'ssible, because of
data constraints, to quantify precisely t h e actual impact but
the significance of this concession is evident from that fact
that given multiple shift operation a new industrial under-
Fiscol incentives 117

taking can expect t o recoup its entire capital inkestn~entin

the first 3 to 5 years. Together with the additional
concession of partial exemption of income that would be
available in most cases, the impact of the allowance is further
enhanced. However it needs to b e pointed out here that the
nature of the operation of the depreciation allowance has
created an inducement t o invest in industries that ,:ire re1at'ive-
ly 'capital intensive.' This has not only aggravated the un-
employment problem but has contributed significantly in
turning the terms of trade against the agricultusre sector in
the country thus adding t o the stagnation in that crucial area
of the economy. At the same time it has t o be recognized
that there is really no truly 'appropriate' technology for a de-
veloping country. The best technology that is available has
got t o be imported and that happens to be capital ir-tensive.
It enables efficiency in production enabling a developing
country like Pakistan to maintain a competitive posture
internationally and to convert the technical efficiency of the
imported machinery into significant investible surpluses thus
making possible a 'second round' of investment. 'The solution
t o the enigma here is therefore, not easy.

In the post 1977 period two of the most, significant

fiscal incentives appear to be the B.M.R. Credit (for Balanc-
ing, modernization replacement and extension of existing plant
capacity) and the partial exemption of income. During 1977-78
t o 1981-82 a total investment of Rs.12.8 Mill. was approved
for the areas entitled t o partial exemption of income. This
constituted 33.5% of the total Invest. Out of this, investment
amounting t o Rs. 3.90 Miil. constituting 28.9% of I,he approved
investment actually materialized.

As for the B.M.R. Tax Credit, available statistics reveal

that the total number of industrial units availing the credit
increased from 130 in 1979-80 to 1 6 7 in 1981-82 with credit
amount indicated at Rs.103.77 (Mill) in 1979-80 and Rs.135.16
(Mill) in 1981-82.

While the B.M.R. Tax credit appears t o be an extremely

important fiscal incentive it has been observed that in practice
more and more units are making increasing use of the credit
for the extension of existing capacity. The prolalems created
by the existing high concentration of industry in many indus-
118 Flscal Impemftves In Pakistan s' Ec,onon~lcDevelopment

trial towns have thus been aggravated. Taking cognizance of

this trend the credit was withdrawn for existing industrial
units located in the developed regions of Karalzhi, Hyderabad,
Lahore and Faisalabad in 1983-84.

Foreign capital has not so far shown much inclination for

investing unilaterally in large scale industrial ventures. In the
early years lack of necessary infrastructure inhibited such move-
ment. Later, an adverse political climatediscouraged foreign
venture capital from moving in. A more favoirable climate for
the foreign investor now obtains and espe~iall!; with the nego-
tiation of serval Double Taxation Avoidamle Treaties and
various fiscal concessions an improved response can be expec-
ted.

CONCLUSION

Fiscal incentives, especially accelerated depeciation allow-

ances and, in the post 1977 phase, the B.M.11. T'ax Credit do
appear t o have had an impact on both the quantum and type
of investment. In general, these have encoui:aged investment
in relatively large scale, short gestation, capital intensive pro-
jects. While such incentives are not the only determinants of
investment, however, insofar as they impact on the overall
profitability of an enterprize they d o enter into investment
decision making. It is necessary though, that tihe govt. monitor
on a continuous basis, the operation of these incentives so that
any attempt at perverse exploitation of an incentive (as hap-
pened in the use of the tax holiday incentive in the period
1959-1972) be checked and defeated in time. It is also impera-
tive that a concerted effort be made t o enlarge the tax base
significantly. The present narrow base woulc1 appear t o deter
structuring ofs effective incentive measures :ISmch incentives
impact unfavourably on resource mobilization.
Fisml incentives 119

NOTES
-..

1. Because of deficiencies in the data base, especially for the

1950's' the statistics compiled by govt. agencies have t o
be interpreted cautiously. For the 1950's the data as
collated by the Central Statistical Office (tilie CSO) with
regard to gross fixed investment for all sectors was based
mainly on a 'commodity flow method' and that was an
important reason for deficiencies creeping in. Some sec-
tor estimates even today, as for the non-monetized invest-
ment in agriculture, may still be considered as kough ap-
proximations'. *
2. The macroeconomic identities of key variables cited in
relation .to savings and investment are clarified as Under:-

Ciross Fixed Invest. = Gross domestic savings plus

external resource balance(i)

Elxternal resource = Imports of goods and non-

balance factor services minus ex-
ports of goods & non fac-
tor services.(ii)

Gross domestic savings = Gross Fixed Invst. minus

(as 5% of GDP) external resources balance
(iii )

Gross national savings = Gross domestic savings plus

(as % of GNP) net factor income from
abroad (iv)

Gross fixed investment = Gross national savings plus

external resource balance
minus net factor income
from abroad. (v)

3. The observation that the private sector responded 'posi-

tively' t o the incentives received by it does not ofcourse
mean that the response was 'adequate'. Infact., the over-
all savings rate in Pakistan has never been consistent with
the requirements for "take-off." but rather, has been
 Fiscal I m p m n ' w s in PaMston 's Ecoi~omicDevelopment

deficient by atleast 1 0 % at the best of times,.

4. The declining elasticity coefficient means that tihe income
tax structure is, over time, losing its abilit,y t o 'mop up'
significantly the incremental additions to revenue that
ought to result from expansion of the tax base as a sequel
to normal economic growth.
5. The fact that private industry has received preferential
treatment in Pakistan should not be taken to mean that
agriculture has been completely ignored. Inl'act the conti-
nueing 100% exemption from income tax on all income
arisirg from agricu!ture is in itself an indication of the
'sacrifice' that the federal exchequer has b'een forced to
make in terms of revenue foregone. Furthermore, direct
subsidies for key agri inputs and support prices for agri
produce have been an almost permanent feature in Pakis-
tan. Also land reforms by !rationalizing the size of land
holdings and improving thereby the lot of the peasantry
have all resulted in improved agri productivity. At the
same time, however, it is true that all that has been done
has not been enough. Perhaps a crucial "li(1istake" made
has been the dissociation of the agricultural sector from
the industrialization experience of the rest of the count-
ry. Agro-based industries have never received the atten-
tion they deserved and thus the self re-inforcing "feed-
back" (from agriculture to industry and vice versa) neces-
sary for the "symbiotic growth" of these two sectors
has: been lacking leading inevitably t o the isolation and
stagnation of the agri sector.

6. The ability of (West) Pakistan industry t o find alternate

markets abroad after the secession of the (.astern half of
the country in 1971 is an achievement whose significance
is often ignored. That together with the 'fortuitous'
(considering the time period) employment of thousands
of Pakistanis in the Middle East in the mid-seventies -
and continueing till the present day - surely saved what
remained of Pakistan from imminent economic collapse.
Although the government played a significant role in
facilitating developments, it goes t o the credit of the pri-
vate sector that it was able t o rise t o the occasion and
wize opportunity as it arose often in a highly compe-
titive, and even at times, hostile, environment.
 Fiscal inceentiws

REFERERCES/EXPLANA TIONS
I. Coijt. o f Pakistan Taxation Structure of Pakistan 1980-81 P 20.1'
Got-t.of Pakistan Pakistan Ecor~ondcSurvey 1986-87
2. Viqr~r& A mjad The hfana~ctnento f Pakistan economy I94 7-82 - 0 UP 1984

3. Thr Afa~~agement
of Pakistons Econotn), 1947-82
Viqar Ahmad & Roshid Anljad Oxford Crniv. Press 1984 Pp 65-1'04

4. In 'current prices '.

. In 1959-60 c o ~ ~ s tprices.
a~~t
6. In 1959-60 corlstant prices.

7. (Repealed) Inconle Tax Act 1922 (ACT XI of 194 7 - ar~lcndcd-

Pakistan Inconie Tax Ordir~arice19 79 (XXXI) of 1979 Finorrce Orilblo~ice
I980 t h m '86. Inconle Tax Lars. S A SALrinf 1986-87.

8. This has been pro~joked,in large part, b ~the

. '~sla~on~izatiot~"
n~eo~~rrasofrhe
post 1977 period that uew Irterest' as being specifical1.y prohibiied as a
receipt under Islartiic teaching

9, Sectior~45 limits the total brt.estrr~entallou~ance(sectio~i3';' thrcrrgh 44) t o

a rriaximum of 1/3rd of the Total Incorrre or Rs. 50.000 - rc~/!;clrrl~?r
is hixhcr.

10. Rashid A~r~jad Irrdustrial Corrcerltrariot~ m ~ dFcor?omic Potc~rin Pokisrar~

L1niv.. o f the h r ~ j a bLahore 1947
L White Ind~istsrialConcentration & Econ. Porc3erin Pakista?~Pn'tlceron 19 74

1I . B. A. Azhar - Tax Holiday for Iridus. Delielop - An emlltorior~t'ukismn Eco-

nomic Jo~rmal1973-74 Fp 72-85
E'iqar & Awljad - The hfanagemenr of Pakistan Econo~nj~
194 7-82
0 U P 19.34 Pp 2 72-3
 Law and procedure controlling the
taxation of self assessed income
in Pakistan

INTRODUCTION OF SELF ASSESSMENT IN PAKISTAN

The first fifteen Years
Self assessment of income, in the context of its taxation
by the government, has had a chequered history in I'akistan.
After independence in 1947, Pakistan adopt? the old Income
Tax Act of 1922 (Act XI of 1947). This statute controlled the
federal taxation of income till June 1979 when a new Income
Tax Code, the Income Tax Ordinance of 1979 (No XXXI of
1979) superseded it. Between 1947 and 1979, two attempts
were made t o introduce self assessment of incolme in Pakistan:
the first in 1964 and the second in 1977.
The Scheme of 196485
In his Budget Speech for the fiscal year 1964-65 the
Finance Minister referred to the Self Assessment Procedure as
a departure from the 'dilatory and cumbersome' system of
universal audit that had 'been in operation for over half a
century.' Rule 46 was added t o the income tax rules, vide
SRO 84 (R)/64 dated 28th August 1964 tn lay down the
procedure f o r self assessment. The broad features of' the Scheme
were:
(a) it was applicable t o all 'persons' except 'firms' that
had not yet been granted 'Registration,' partners of

*The Sel Arm, procw underwent significant chnnge through Ute F~nanceAct 1988. TM
stcdn, d w m i coNldn these cMngcs and ImY( appraiwl upto ouU year 1987-88 on@
I24 Ffscal .Impc.mtfves in Paktstan 's Economic Development

such firms, partners of Registered firms whose total

income exceeded Rs. 25000 and cases of persons
deriving income from a business, profession or
vocation whose total income exceeded Ks. 25,000:

(b) it was also applicable t o individuals deriving 75%

of their income from salary, irrespective of the
amount of total income;

(c) The prerequisite for eligibility under the scheme

was that the total income declared by ;I person in
the Return filed was not less than the income on
which he had been assessed under section 2 3 of the
(repealed) Act in respect of the laliest assessment
year wherefor the assessment had beer1 made.

In 1965 .the scope of the scheme was enlarged t o include

all persons deriving at least 75% of their income from rent,
interest o r dividends. However where the only source of income
was business, profession or vocation, the return would continue
t o be ineligible if the income exceeded Rs. 25,000.1. Another
'concession' made was that although clause (d) of rule 46 was
not deleted, nevertheless the preconditon for eligibility under
the scheme that income disclosed currently not be less than the
latest assessment on record, was waived retrospectively.

Although by 1966 the number of taxpayeirs had increased

to 3, 10,486 from 2, 19, 432 in 1964, the main objective of the
schemeto create an atmosphere of trust and !confidence bet-
ween the taxpayers and their assessors - could not he achieved.
The 'quality' of the returns - in terms of both the quantum of
income disclosed, especially for business income, and com-
pliance with the provisions of the statute and rule 46 - failed t o
register any significant improvement. Rather, it appeared that
more and more taxpayers sought t o 'exploit' the scheme by
filing deflated returns and taking their chances in acceptance by
the assessing officer. The assessor on the other hand found
himself under no obligation - no change whatsoever had
been made in any of the provisions of the Act - t o 'accept' a
return even when it was 'eligible'. The result was that after
1967 less and less was heard of the 'scheme.' The old system of
universal audit soon pushed out whatever remained of the
scheme.
Self Antr. Law & Procedure I25

The Scheme of 1977

Ln 1977 a fresh attempt at introducing self assessment was

made. The following amendments were made in the Income
Tax Act and the rules made thereunder:-

(i.) Sub-section (1) of Section 23 was substituted by a

new sub-section which provided inter-alia:-

(a) Where return of income was furnished under

sub-section (1) of section 22, the Income Tax
Officer "may determine" the income on the
basis of such return: [ Emphasis mine]

(b) where discretion is exercised by the income tax

officer under sub-section (1)of section 2 3 he
must pass the order in writing before t.he end of
the assessment year; and

(c) while determining the total income, the income

tax officer may make necessary adjustments
including adjustments in regard to 'un-absorbed
depreciation' and 'losses' t o be carried forward
to the following year.

(ii) By adding the word 'or the total income and the
t o t d world income and the tax payable has been
determined under sub-section (1) of section-23' in
sub-section (1) of section - 34, the provisions of
section 34 were made specifically applicable t o the
assessments made under section 23 (1): and
(iii) By adding the words 'Except in case in which an
order has been made under sub-section (1) of section
23, in the second proviso t o sub-section (1) of section
- 34, the two prerequisites for re-opening an assess-
ment namely 'definite information hasing come into
the possession of the income tax officer' or the prior
approval of the inspecting assistant Commissioner of
Income Tax were both rendered superfluous.

Another change brought about was the :substitution of

Rule-46 by Rule30 through SRO 794 (1)/77 dated 22 August,
1977. The main feature of the new Rule-30 (prescribing the
 136 fiscal Inlperariws tn Pakistan's Eccinorn~cDeveloptnent
1

I
I
procedure for self assessment) was that where a person derived
income from a business, profession or vocation, the require-
ments in regard to the filing of copies of manufacturing/
I
trading account, profit and loss account and bidance sheet etc.
were dispensed with-except in those cases where the sales or
! receipts declared aggregated t o Rs. 500,000 o r more.
1
Proviso to the new Rule30 provided' that the Rule shall
i not apply:
i

(i) in respect of the assessment of any year where no

return was filed for the year irnmectiately preceding
that year; or

(ii) in respect of assessment of any year for which a firm

makes an application under section 26 A,,or

(iii) in respect of assessment for the year for which the

income declared is less.

The Central Board of Revenue through Circular No. 11

o f 1977 dated the 25th September, 1977 waived the disqua-
lification contained in IClause: (I) and modified the disability
embodied in Clause (111) of the proviso t o Rule-46.

Thus the only 'persons' ineligible under the new scheme

were 'unregistered firms' and 'persons' declaring loss,that was
not on account of the allowance for depreciation. The scheme
of 1977 was certainly an improvement over the scheme of 1964
mainly in that it had a wider scope and also because of the
amendments made in sub section (1) of section 2 3 the asse
sing officer could now accept a return under self assessment
and yet take cognizance of expenditure incorrectly claimed as
a deduction by recomputing the total income of such taxpayers.
However the feature of the scheme allowing wide discretion t o
the assessing officer t o reopen an assessment already made
under sub section (1) of section 23 through recourse t o section
34 (sub section - 1 ) was received very adversely by taxpayers.
They were convinced that given the wide latitude, the assessing
officer would be inclined to make recourse to section 34 on
the flimsiest of pretexts because his didretion in this context
was not fettered by any specific explicit statutory requirement.
The IT0 was not even required t o make sure that he had
Self Asstt. Law & Procedure 127

'definite information' available with him nor was he required t o

make a reference t o his supervisory officer (the IAC) o n [.he
matter. There was thus a perception that the I T 0 had been
invested with unlimited powers with regard t o cases falling
under self assessment. This negative perception was enough to
make taxpayers highly sceptical of the value of the scheme t o
them. The credibility 'gap' between taxpayers and assessors
remained as wide as ever. The tax lawyers in Pakistan criticised
bitterly this aspect of section 34 and considering the close
rapport they had with the taxpayers, their stance was respo1:isi-
ble in no small measure in eroding very badly the edifice of the
latest scheme for self assessment.

The Scheme of 1979

With the repeal of the Income Tax Act of 1922 (No. XI: of
1947) and the enactment of a new Income Tax 'Ordinance'
(No. XXXI of 1979) the self assessment of income was :not
only retained but the substantive .law relating t o such assess-
ment was formally incorporated i n b e code itself and laid down
in section 59 of the Ordinance of 1979. Within one year of the
implementation of the 'Ordinance' it was made mandatory for
the I T 0 t o accept a return filed under self assessment where
it met the stipulated requirements. This was indeed a rad:ical
departure from all previous schemes for self assessment ar; it
did away with all 'discretion' on the matter thus ensuring the
acceptance of all qualifying returns. Further, except for speci-
fied cases t o be formally notified by the C B R ( and whose
number would not in any case exceed 5% of the total number
of returns filed) self assessment would embrance all 'taxable'
income, whatever its source and would also not be restricted
by any specified 'ceiling' for the quantum of income.

Another uirique feature of the scheme is the concept of

'immunity' 'A taxpayer now wishing t o ensure that his return of
income is not selected for 'detailed scrutiny' provided that the
taxpayer is not found t o be guilty of deliberate tax fraud for
that would automatically oust the return from the ambit of
self assessment - may disclose an amount of total income
for the year that is at par with a level prescribed by the C B R
and arrived at a n the basis of specified criteria. By doing so, the
taxpayer would in effect have 'purchased' immunity for himself
for the duration of the assessment year in question. This feature
128 FLrcal lrnpemtives in Pakistan ". Economic Development

of the &heme does however have some !interesting aspects

which will be dealt with later.

The present scheme aims at compreltiensive self assess-

ment and limits drastically the authority of the I T 0 t o oust a
return from self asstt., - even when 'immunity' has not been
'purchased. Thus with its greatlyenlarged scope and the novelty
of its features aimed at induceing voluntary taxpayer com-
pliance with the provisions of the scheme, this latest attempt
certainly appears t o make a clean break with the past. However
both the substantive law as well as the prescribed procedure per-
tinent t o self assessment is evolving from year t o year.

EVOLUTION O F SELF ASSESSMENT LAW AND

PROCEDURE - 1979-80 t o 1987-88

The substantive law relating to self assessment has for the

first time since 1964, been laid down in the statute controlling
the taxation of income i. e. the Income Tax Ordinance. Section-
5 9 of the Ordinance [ sub-sections (1) ( 3 ) and (4)] forms the
statutory sanction for self assessment. Subsection (1) of
section-59 is crucial to the scheme for, as amended by the
Finance Ordinance 1980, it directs the 'mitndatory acceptance'
of a return of income filed under self asses:sment not in conflict
with the stipulated requirements and not otherwise disqualified
for any reason. The sub section also makes reference t o the
scheme of self assessment devised by the C: B R for the year in
question. Further, the sub section makes c'lear that is the return
of income filed 'voluntarily' that is t o be taken up for process-
ing under the scheme.

The original sub section (1) incorporated in the Ordinance of

1979 did not mdce express reference t o either a return filed
voluntarily, - 'suo moto' - or to the mandatory acceptance of
'any' return o r t o a self assessment scheme. Rather, the an-
nounced intention of the government notwithstanding, the sub
section appeared t o retain the discretion of the assessing officer
in disposing off a return as it provided that::
LL
. . . . . the Income Tax Officer "imay", by an order in
writing . . . . . determine the total income of the asses-
see. . . " [Emphasis mine]
Self Assrt. Law & Procedure 129

In the substituted sub section (1) the words "shall assess" found
prominent mention and the C B R clarified that ". .. . a return
which qualifies t o be processed under the scheme has now a
right t o b e so processed "*I

T h e only other change made in section 5 9 is through for

the addition of an "Explanation" that clarifies that revised
returns of income d o not qualify for self assessment. The other
change is the insertion of a new sub-section after sub-section (1)
and called sub-section (1A) through which the C B IU is formal-
ly empowered (as is any Authority designated by it, ) t o select
returns of income for detailed scrutiny.

-
Sub section 2 was omitted by the Finance Ordinance
1980 and was simultaneously incorporated in the Ordinance as
section 6 0 (Provisional Assessment t o be made on .t.he basis of
the latest completed assessment under section 62, 63, 65, 59,
or 59A).

Sub section - 3 empowers the I T 0 t o make such adjust-

ments as may be necessary, including those relating t o addback
of inadmissable expenditure - if any - claimed by the taxpayer
and also other adjustments under the law relating t o set off of
losses, earry-forward of losses, credit for tax paid etc.etc. when
the I T 0 accepts a return of income under self assessment and
passes an order under sub section (1) of section 59.

The only change made in sub section -3 has been the

deletion of reference t o subsection - 2 as a con:;equence t o
omission of subsection - 2 from section 5 9 through the Finance
Ordinance 1980 and its simultaneous incorporait ion in the
Ordinance as section 60.

Sub section - 4 of section 5 9 specified the limitation of

time laid down for an assessment t o be made under section 5 9
(1). Thus a an order of self assessment under section 5 9 (1) is
required t o be passed by the 30th of June next following the
year in which the return has been filed.

Section 5 9 (A) together with sub sections (1) and (2) was
inserted in the Ordinance through Finance Ordinance 1980 t o
deal with the possible contingency of a return subrriitted under
assessed for any reason by the end (30th June) of a given
assessment year. Also under sub section-1 of section 59 A an
IT0 has been empowered t o 'accept' a return even though it
may not qualify for self asstt.

SELF ASSESSMENT PROCEDURE -

Each fiscal year, concurrently with the Finance Bill, the
C B R announces the scheme of self assessment to b e imple-
mented. The procedure to give effect t o the provisions of the
scheme is also specified therein. Since 1 9 7 9 , the format of the
scheme has remained more or less, the same. Typically, each
years scheme specifies:

1. The scope of the years scheme with regard to existing

and new t a ~ p a y e r s ;

2. Requirements of the Return that must be fulfilled in

order t o qualify for self assessmerit;

3. The specific disqualifications that would oust a return

from the ambit of self assessment;

4. Procedure for selection of cases for detailed scrutiny;

5. The categories of cases that are not t o be taken up

for scrutiny (immune cases);

6. Procedure for processing of cases under self assess-

ment:

7. Procedure for processing of ca.,es set apart for scru-

tiny;

8. A statement declaring that cases involving conceal-

ment of income fall outside the purview of self
assessment;

9. An announcement by the CBR of the 'classes' of

cases that it has selectedfor scrutiny; (these 'classes'
pertain t o particular businesi categories or even
r n m m n r ~ i n lonntnn-cl
SelfAssrr. Lc;'\v & Procedure 131

Announcement of the scheme is accompanied by issue of

"circular instruct ions" clarifying specific aspec ts of tk,e sc heme
and detailing further the procedure t o be followed in :particular
situations. While t h e broad format of t h e scheme each year is
as indicated above changes in the scheme are made each year in
terms of both t h e procedure t o be followed and t h e law to h e
implemented.

TAX RATES AND SELF ASSESSMENT -

T h e basic system of corporate income tax in Pakistan has

been fairly stable over t h e years with an income tax of' 305%and
a super tax of 30% on profits - reduced t o 55% overall in 1983.
Further relief was allowed for public Coys in that t h e iggre-
gate (income tax and super tax) rate was reduced from 50%
to 40% with effect from the assessment year 1986-87. Sirndarly,
in t h e case of personal income tax, t h e maximum rate has been
reduced from a high of 97% in 1958 t o 75% from 1 9 6 1 through
1 W , t o 70% from 1965 t h r o ~ h1 9 7 5 and 60% in 3983. T h e
latest change made is through the Finance Ordinance 1 9 8 5
(effective assessment year 1986-87) when the rate stands
reduced Further t o 45% for t h e highest slab. Also, the lowest
slab has been reduced from 10% t o 5%. Furthermore, dividend
income of taxpayers (Other than companies) from specified
"public" companies has been totally exempted from any charge
of income tax.

It does not require much insight - t o establish that pro-

hibitive rates of income tax "eat into profits" anti' become
thereby, powerful disincentives for private investment. Further,
it appears that in developing countries especially, high rates of
income tax have been a factor, and an important one at that, in
provoking systematic t a x evasion. In the opinion o f r71uny
therefore, the ultimate fate of a scheme of self assessment
might depend as much on the operative rate structure as on uny
other factor.

Inspite of t h e apparent "truism" of t h e statement made

above it is not easy t o postulate in "optimum" rate scl~edulefor
t h e taxation of income. It can however be show11 through
examples, that in Pakistan, atleast before t h e changes made
...
through t h e Finance Ordinance 1985, t h e rate of tax o n income
. . . .. . ..
132 Fiscnl Imperadves in PaMstan's t ronornic Develoymerrt

T o illustrate the proposition made above: in assessment

yt)ar 198243, taking the case of a private Limited Company
declaring a net profit of Rs. 2,500,000, having ten shareholders/
Gross Tax Liability of the company and itsI~irectors/sharehol-
ders (and assuming no investment allowance for t.he Directors)
would amount to Rs. 2,164,910. With an assumption of maxi-
mum allowance for investment for the ten Directors admiss-
able under the law, their personal tax liability wil! stand redu-
ced by Rs. 239,500 reducing the 'aggregate' tax liability (of the
company and its directors) t o Rs. 1,925,4:1.0. In percentage
terms this means that fully 77% of the company's profits will
go towards payment f taxes.

Similarly, in the case of a Registared Firm declaring a

net profit of say, Rs. 2,920,000, having ten partners each
contributing equally t o the capital of the firm, the gross tax
liability of the fim: and its ten partners (and assuming the
maximuni allowance of investment for the partners) would
come t o Rs. 1,728,875 - which is 59 7c of the net profit
shown.
Again, in the case of a proprietory cmcern declaring a
total income of Rs. 2,920,000 the tax liability (with maximum
investment allowance) would compute at Rs. 1,869,318 i.e.
64% of the net profit.

It might be pointed out here that the assumption of

maximum investment allowace is at best "heroic" as is obvious
from the fact that making such an investment involves an
outlay that takes up 1/3rdi (almost) of each Directors Total
Income (in the case of the Company) and 25 5% of each partners
total income (in the case of the Registered Firm).

Given the illustrations given above, it is apparent that

the tax rates on which the calculations have been based, are

* k1.A. Ab bast - "Burden of Income Tax".

T a r oh.server- K s r a r h l - M a v 19PA
rather high - "eating" away a big chunk out of the profits, the
business made thus leaving very little for reinvestment, moder-
nization, replacement (of plant and machinery) expansion of
capacity, research and development, building up reserves etc.
etc. The "ob~ious" solution here (given the "realities7'of the
'ecology' in which the taxpayer is placed such as a weak tax
administration without access t o meaningful technology that
would permit effective monitoring of economic activity) might
be t o simply "evade" taxes. This is d s a what infact has actually
happened.

Although empirical studies t o determine the extent; of

tax evasion are not available at the present time, it is clear .that
significant Isax evasion is infact present. Such a conc1u:;ion
follows from the trends in GNP, tax base statistics and the data
for tax actually collected.

Total Income Tax revenues in 1 9 8 4 8 5 are indicated at

Rs. 10,000 hilillion. The total taxpziyers in this year are about
I million. The GNP in 1984-85 (ill constant prices of 1959-69)
is shown at Rs.80045 million. As against this, in 1977-78 (our
'base year for p.urposes of comparison) total income tax revenue
stood at Rs.2,833 million with total taxpayers at some 400,000
and the GNP at Rs 52074 million.

Thus with a tax base in 1984-85 more than twice as lxrge

as in 1977-78, tax revenues increased by 253% while the CihT
in this same period registered an increase of 54 at an anrlual
average percentage rate of over 6% Looking t o the expansion
in the tax base and given the fact that the sectoral appropriation
of the GNP is ~kewedmarkedly in favor of business and incius-
try, the fruits of the growth in GNP go heavily t o private
business thanks t o a distribution system biased in its favor.
Given these facts it is clear that the increase in revenues aver
this period is not consistent with the growth in GNP and the
expansion in the tax base. My appraisal of the matter would, be
that tax revenues in 1984-85 ought t o have been atleast
Rs 20,000 million. Infact looking t o the tax base expansion
revenues should have been even higher . It would thus apea:r to
me that revenues actually collected in 198485 are less tlhan
50 % of the potential revenues that ought t o have been collec-
 Fiscal Iri~perafives irl PaMstan 's Ec,,~r~orr~ic
Developmcrr t

ted.

While it would clearly not be proper to attribute all the

tax evasion t o a high tax rate structure, it does appear that
a primary motivation here is to protect the profits otherwise
lost t o high taxes That being so, the changes made in 1983
and 1985, reducing the aggregate corporate t.ax and t h e personal
income tax, are steps in the right direction Hut are these
changes "adequate?" I t would appear to nle that they are not.
I would like t o see both corporate incom,e tax and super tax
not t o exceed 30 % for public and 40 ';70 for private Coys.
Similarly, for proprietory businesses, the top marginal rate
ought not, in my opinion, t o exceed 40%.

The 'need' t o reduce taxes is actually recognized by many

more than would appear at first. The difficulty however in
actually implementing significant rate reduction is the appre-
hension that there could b e a time lapse of some significance
before businessmen come out with reasonably correct declara-
tions of income and in the intervening period the govt. might
have t o contend with sharply reduced rel,enues. This analysis
assumes ofcourse that the tax base remains as it is presently
structured. If o n the other hand there is a significant expansion
of the base - such as could happen if say income from agricul-
ture were brought within the scope of income taxation -then
ofcourse the revenue availability would be much better. But
most people see little possibility of this happening atleast in the
foreseeable future. It is pointed out here that the last attempt
to tax income from agriculture (in 1977) was defeated before it
could be implemented and that occured inspite of the fact that
the 'plan' devised t o tax agricultural income allowed extraordi-
nary concessions t o landowners, such as the deduction of capi-
tal expenditure (as that involved in the p u l ~ h a s eand use of trac-
tors and other agricultural machinery etc) from current revenue.
Thus without any base broadening of any significance, it is
feared that the initial loss in revenues following a rate reduction
would result in t o o large a resource 'gap' for the govt. t o b e able
to bear.The apprehensions expressed above are not without
substance. At the same time the fact remains that the "hard"
decisions ( t o enlarge the tax base by subjecting income from
agriculture t o tax o n the same terms as income from business,
to revise the rate structure downwards, t o d o away with such
fiscal incentives as might have outlived their utility etc. etc.)
Self A s s r t . Law B Procedure 13.5

will at some point of time 'have' to be taken if the income tax

system is ever t o come t o terms with reality.

What has been stated :above? does not take cognizance of

the host of so-called "fiscal incentives" -- which have been
discussed in detail elsewhere - which go t o depress the non~inal
rate of tax so that the "effective rate of tax" is signific~intly
lower. If one is to consider the full impact of these ''in~ent~ive"
provisions for those classes of taxpayers that qualify,-it would
be apparent that effective rates of tax for qualifying taxpayers
are presently not ~rohibitivelyhigh. This should not be taken to
near that there is no scope for a (further) reduction in tax
rates. However the reality of the situation should not be
ignored.

SELECTION OF RETURNS FOR SCRUTINY

The procedure adopted by the income tax department.

in Pakistan for selection of taxpayers cases for audit remz.ined
virtually unchanged over the period IY79-SO to 1984-85. Basi-
cally, it involved firstly, a 'matching' of advance intelligence?
regarding the taxpayers activities having a bearing on the
income tax assessment with the information available or1
the taxpayers return. Such information was made available
largely by the Survey and Colation Organization whose role iri
this context has been alluded to above. Intelligence could
also have emanated from the Federal Investigation Agency,
the Vigilance Wing of the Central Board of Revenue or even
from professional informers. Also, the assussing officer hirfiself'
might, during the course of the year, have collected pertinent
details say, during the conduct of external survey or he might
simply have picked up information while engaged in an exa-
mination of another case.

The assessing officer was expected t o be particu.larly

vigilant in the scrutiny of returns claiming immunity and
these were the cases that were examined first and with the
greatest care. After this examination the other returns were put
t o scrutiny. All those returns where discrepancies were evident
became potential audit cases. The balance returns available with
the ITO were then screened for clues that pointed to tax
evasion. Thus cases where there had been a significant infusion
of new capita1,cases where the business fell in a category known
136 Ftsinl Impemdues tn Pakistan 's E~:onornicDevelopment

t o be yielding supernormal profits or inconsistencies in report-

ing etc. were the returns that were sorted out. 'These cases were
then discussed by the I T 0 with his supervisor (the I A C ). In
the next phase the matter was discussed by the 1:AC and the
I T 0 in Committee with the Zonal Commissil:)ner of Income
Tax. Those cases indicating most potential for enhancement
of income were picked up in respect of each charge in the zone
and the consolidated list made up in a prescribed proforma was
then sent to the CBR for approval.

It might be mentioned here that only a limited number

of cases could be selected for audit. This was in keeping with
the announced policy of the govt. t o subject not more than 5 70
of the total returns received t o audit. Upto 1983-84 the lists of
cases in respect of each 'zone' (i.e. a territoriali area headed by
a CIT and for Company cases a charge having specific jurisdic-
tion over specified company cases) were sent t o the CBR for
approval directly by the CIT. From 1984-85 however, the
consolidated list in respect of each zone in a REGION (an
administrative unit created to decentralize cont1.01and direction
of field units) was initially scrutinized by the REGIONAL
COMMISSIONER who then in consultation wiih the CBR
approved a final list in respect of each charge in the Region
that he headed. After the finally approved !list was received
back by the zonal CIT, formal intimation was sent t o each
taxpayer whose case had been selected for audit. Thereafter
the assessment process would commence.

The 'system' described above entailed individual inspzction

of each return by the Income Tax Officer, the Inspecting
Assistant Commissioner, the Commissioner of Income Tax and
t h e Regional Commissioner. All the data tabulated on profor-
mas in the course of the selection process was done manually
by the clerical staff. Considering the workload this did not
promote efficiency. IvIistakes inevitably crept in the mukitude
of proformas prepared by each charge involved which was even-
tually reflected in faulty selection of cases creating problems
when t h e assessnent cycle started. More seriously, the system
gave rise t o malpractices involving departmental functionaries
at various levels.

The selection of cases for audit requires that complete

secrecy be maintained at the time that individual returns are
S P l f A s ~ t tLaw
. & Procedure 137

being examined. Because of manual procedures aild heavy

cierical dependence this was impossible to enforr:e. The result
was hat unscrupulous elements within the department would
keep close liaison with taxpayers keeping them fully informed
about the 'progress' of the selection. This was vary >mportant
for those taxpayers whose returns were not covered by immuni-
t y as they were fully aware that by not 'buying immunity' they
had become potential audit cases. No sooner dld a taxpayer
receive 'intelligence' from his 'sources' and 'contac ts' within the
department that his return was being coi~sidereclfor asdit all
sorts of pressures were brought t o bear on the functionaries
involved in the selection process. In some cases even records of
cases were tampered with to attempt interpolation of infor-
mation data o r substitution of records appended with returns.
Allegations were also made of functionaries approaching q d
harassing taxpayers holding out promises of preferential and
'sympathetic' treatment in the course of the selection process -
at a "rice' ofcourse.

From fiscal year 198586 the department introduced

a fund.mental change in the process of selecticln of cases for
audit. It was then decided to conduct a random ' ballot'
of all returns held t o qualify for self assessmer~tthrough the
computer availablewith the Survey and Collation Organization.
TJnder the procedure the computer is programmed to make a
random selection of a predetermined number of non-immune
returns identified through their "National Tax Numbers (NTS's)
only. The whole procedure is implemented by the Survey and
Collation Organization and not by the authorities charged with
assessment work.

Thz change in selection procedure descrilned a h v e was

expected to remove most of the adverse aspects of the proce-
dure previously in vogue. However the new procedure created
some problems of its won the foremost being that the non-
immune "lot" of N.T.N.'s fed t o the comput,er had a very
high percentage of petty (marginal) cases whose revenue sig-
nificance was nominal. Furthermore, many "lmmune" cases
were also fed t o the computer due t o improper processinglana-
lysis of the returns and which had to be-"deleted" later on.

The citation of 'Tetty" cases in the detailed scrutiny list

randomly selected by the computer, drastically eroded the
IZS I.'iscal Itrrpcra rives irr PaMstnt~'s E c o ~ r r o t t ~D:r~w l o p tnenr

revenue potential o f the total audit cases selection and limits

the efforts of the assessing officers t o detect and bring to tax
significant tax evasion as most of these "marginal" cases were of
tax payers not maintaining proper accounts and conducting
business o n a relatively limited scale. Such a consequence was
inevitable given the " h n m u n i t ~ " facility which was "greddily"
availed by all taxpayers having access to supernorntd profits.
All things considered, the only practical way out here would
appear to be resort to a system of parametric selection of cases
for total audit rather than the purely random ballot method.
A deterrrent factor here however would be tkLelimited exper-
tise of tax administration as a result of which it may be difficult
to devise the complex formulate necessary tcs make a para-
metric selection of cases for total audit such as is routinely
done in more advanced tax administrations viz. U.S.-4. , Japan
etc. However, since access to computer based technology is
now a reality even in developing countries it is possible to at
least explore the system of parametric selection step-by-step,
- if not in its totality.

THE CONCEPT O F "IMMUNITY''

The ability of a taxpayer t o 'purchase' immunity from an
audit is certainly a unique feature in the scheme of self assess-
ment in Pakistan. All that the taxpayer has t o d o is ignore the
actual income that he has infact realized in a given income year
and instead 'declare' an income that is in cc)nform.ity with a
prescribed standard for grant of 'immunity'.
The philosophy behind the measure appears to be that
bypurchasing immunity for himself the taxpayer is in effect
buying peace of mind which is considered sufficiently attractive
in his scale of preferences to induce him t,o declare higher
income than that previously declared cor~sistent with the
"immunity formula". The interest of revenue is (supposedly)
safeguarded in this manner as by capitalizing o n the deterrent
effect of an audit the government might be ;able to ensure the
generation of 'good' revenue without going through the hassle

"With eJfecr ar 1988-89 ir i s no longer porrible fi~r an assessee ro urcharr

i m m u n q . " a C " ~ &her
t ~ ihan i h s e of Companiex) drclanog lnconie below I lac -
and nor orherwire dirqual~jiedunder anv other provlrion of thr. scheme - are hable to be
accepred ar declared. AN other Rerunts of lnconre are ro be subje.:.rt3dro derarled scrurritv by a
panel of rhrre oficers. Ir appears rhar [he glaring de-nierirr of [he immuniry fearure finall!
pro~~okedirs repeal.
SelfAsrrt. Law & Procedure

of an actual audit in a large number of cases.

Several questions arise here that need tl:) be answered
before one can comment o n the merit, if any, of ,the feature.
These are: (a) Does the measure actually p r o n ~ o t e"tax con-
sciousness" - without which there can be no true 'voluntary
compliance? (b) Does not the measure actually institutionalize
the 'misreporting' of income? (c) What category ~:)ftixpayer has
the maximum inducement t o avail of immunity -- the one
enjoying an 'average' level of profits or the one enjoying super-
normal profits o r the o n e whose profits are infact less than
'normal?' (d) Is it 'reasonable' for govt. t o lay clowrl a uniform
criteria for immunity for all categories of taxpayers?

Actual operation of the scheme to date would appear t o

indicate that the taxpayers have reacted 'enthusiastically'
in 'exploiting' the immunity provision to the hilt.

In any system of voluntary compliance, tax consciousness

is crucial to its success. The system of voluntary compliance
structured must be such as to incorporate built-in checks to
deter violation of the law and actively promotecompliance of
the statutory provisions. In this context it is necessary to point
o u t that should the statute contain obvious lool;~-holesresulting
either from defective enactment or due t o deli'berate insertion
of provisions t o achieve specific objectives, the objective of
pro'motion of tax consciousness suffers as a necessary con-
sequence.

The immunity provision, is in the opinion of many, an

obvious loop-hole in the self assessment law. I:t offers the tax
payers clear opportunity not t o declare the correct income
arising in a given period and to substitute the same by an
arbitrary figure of total income derived by esclating prior in-
come in a given manner so as t o quality for immunity from
detailed scrutiny.

The implicit assumption made in designing the immunity

provision appears t o be that a sufficient numt~erof tax payers
would be under a strong inducement to puirchase immunity
by erring o n the side of revenue and not against it. The ex-
perience so far would appear t o indicate that while a fair
number of tax payers have in fact purchased such immunity it
is noted that most of them fall in the category of the taxpayers
that have actually earned income significantly more than what
follows from the escalation formula devised. In other words, it
is the tax-payers earning "super-normal" profits who are most
attracted t o this provision. By granting them immunity the
Government thus looses an opportunity t o probe their affairs
and identify the evasion that they have contriiied. The extra
revenue arising as a result of the purchase of imrriunity by such
tax payers does not appear t o be a substantial amount and in
any case is not consistent with their actual potential. There is,
therefore, good reason to believe that all that the measure has
succeeded in achieving is to institutionalize the mis reporting of
income. It is indeed ironic that the greater the compliance with
the immunity provision the greater is the mis-reporting.
This is inecitable considering that the immunity in-
come is rarely if ever, pitched at a level higher than the actual
income arising to a tax-payer. Indeed irz actual prac tzce it has
been found that the i??z?rzunityirzcome hardly e v r c,lpproaches
tlze ucrual irzcome.

The worry-some aspect here appears to be! the negative

conditioning of tax-payers. Thus the higher the actual income
and the greater the gap between the base year income and the
current year's total income the greater is the incentive t o avail
of the immunity provision and secure an exemption from
detail+ scrutiny by paying a relatively snall anlount of extra
tax. Over time, tax-payers have become so condi.tioned to this
facility and have hecome so used to the enormol.ls tax benefits
that arise there-from, that it is now difficult, indeed painful,
for them to visualize a future in which the facility is withdrawn
or modified drastically. In this sense therefore, it is evident that
the objective of tax administration t o bring t o tax the actual
income arising (or as close t o the actual incorr~eas possible)
has bee-n futile. T h e utility of the immun.ity provision
as a viable fiscal measure thus appears extremely doubtful. This
is especially so in the peculiar context o f a develo'ping economy
where t h e mobilization of adequate resources ought to have
high priority.

However, there are those who advocate continued reten-

tion of the immunity clause in the self assessment scheme as
it facilitates curbing the arbitrary exercise of discretionary
powers by the assessing officers. Furthermore, it frees tax-
payers from the whimsical exercise of delegated authority by
Self Asstt. Laiv & Procedure 141

various levels of subordinate tax officials. In this context the

measure is seen as a step that checks the spread of corruption.

Considering the obvious weaknesses of tax administration

in under developed countries it is indeed a fact that universal
audit of all tax returns, as was in vogue before the self' assess-
ment scheme in its present shape took root in 1979, giive rise to
the arbitrary exercise of authority by all tiers in the tax ad-
ministration hierachy. It also led t o much litigat,ion arid over
burdened appellate authorities. Recovery of tax payment
created through such universal audit was also hindered by the
fact that the bulk of such demand was placed hefore various
appellate forums. So long as final adjudication was nct announ-
ced (tvhic h process could become extremely delayed due to the
limitations resulting from the inablity of appellate authorities
to dispose off appeals expeditiously) tax-payers were reluctant
t o pay up the tax demand raised against them. Resort t o coer-
cive action was also difficult in such circumstances.

While there is little doubt that the system1 of universal

audit has considerable deficiencies of its own and its replace-
ment by a scheme of self assessment is in the opiniori of most
authorities definitely a step in the right direction, yet the in-
corporation of a specific provision for grant of irr~munityfrom
total audit in the scheme of self assessment appears t o have
made available so obvious a loop-hole as t o have largely nulli-
fied the impact of legislation introduced t o deter tax evasion.
Especially glaring is the facilitv of having a uniform immunity
provision for most classes of tax-payers. The inimunity pro-
vision as it is presently structured does not differentiate mean-
ingfully between different categories of tax- payer:^. Thus while
it may be common knowledge that particular cilasses of tax-
payers aie enjoying abnormally high profits :yet since the
immunity provision is uniform for most classes, tax-payers
placed in this particular class enjoying abnormal profi.ts would
reap unwarranted benefits simply because the in1munit.y pro-
vision does not take cognizance of the fact that ::.hey are very
advantageously placed viz-a-viz other tax-payers. This is a
considerable flaw in the structuring of the provision and de-
tracts from much of its supposed efficiency as an inducement t o
taxpayers t o pitch income levels at revenue significant levels.
142 kiscal Ittiperatives if1 Pakistan's t c i ) n o t r l i cL)c.wloprnent

there is little doubt now that there has been a systematic abuse
of t h e immunity provision by all classes of tax-payers especially
those that have access currently t o super normal incomes and
whose base year incomes were pitched at relatively low levels.
It is high time therefore, that a serious rethinking is done o n
this aspect. Ideally, its repeal would appear tc:, be indicated.'
However, if that is not considered feasible, the criteria for
immunity for different classes of tax-payers ought t o be dif-
ferently structured. This is essential if the revenue losses inevit-
able under the present system are t o be avoided.

ASSESSMENT Y E m S 1983-84 & 1984-85 - ALTERED

CRITERIA FOR "ACHIEVING" IMMUNITY - PROBLEMS
RESULTING THEREFROM:
From assessment year 1983-84 a new twist was given to
the concept of immunity in that whereas previously in order t o
find out t h e figure of total income that woulcl enable him t o
claim immunity, a taxpayer had simply to take either the
average of the preceding three years assessed income or the
highest assessed income in this period (- depencl ing o n whether
o r riot he had claimed immunity in these three years - ) and
then escalate the same by a given percentage I( 1 5 % l or 2 0 %
depending in which category the taxpayer was placed). However
with effect from assessment year 1983-84 the scheme of self
assessment for the year (and also that for 1984-85) also r e
quired that in order t o qualify for i m m u n i t . ~ ,the income
returned currently be at least marginally higher than t h a t shown
in the latest assessment o n record. Furthermore, the ratio of net
profit t o sales evolving currently, was required t o h e the same
as that indicated for the latest assessment year, assessment
whetoof stood finalized at the time the return was filed.
T o illustrate t h e altered immunity criteria described
above and t o appreciate its implications, the folliowing example
may be considered.
Consider the case of a taxpayer who has not declared immunity
level income in any of the three years preceding 1983-84.
Assuming that t h e highest assessed income of this taxpayer
has been that assessed for 1 9 8 2 8 3 at Rs. 100,000. Sales for
1 9 8 2 8 3 amount t o Rs. 10,000,000. Now the net profit dis-
closed a s per accounts for 1983-84 is taken at Rs. 125,000
I T;;.,n..ro d r r 10.QJ7 h n r F;nnll%:
nrkimruri rknr
with sales for the year shown at Rs. 20,000,000.

The situation being as given above immunity can be claimed by

the taxpayer on the basis of the criteria laid down in 1 9 8 2 8 3
by escalating the income assessed for 1982-83 by 20 5%. This
would amount t o an income of Rs. 120, 000. By declaring a
net profit of Rs. 125,000 in 1983-84 the incon-~edisclosed
would appear to be immune as it is higher by more than 2 0 %
of the highest income assessed in the period 1980-81 t o 1982-
83. However clearly immunity from 1983-84 wo~lldonly be
available if the alternative requirement for immunity as laid
down in the scheme for 1983-84, (referred t o in para-1 above)
is satisfied.

The 'alternative requirement' for immunity requires that

the ratio of net profit t o sales/ receipts in 1982-83 be the same
again in 1983-84 -- and that the income declared in 1983-84
be higher than that assessed for 1982-83. On this basis the
immunity level of income in 1983-84 would amount to
Rs. 200,000 calculated as under:

Assessed Income of 1982-83 X Sales shown in 3 983-84

- -.

Sales shown in 1982-83

Rs. 100,000 X Rs. 20,000,000

- = Its. 200,000.
Rs. 10.000,000

Thus as per the alternative requirement provision ir~troclucedin

1983-84 (and retained in substantially the same form in 1 9 8 4
85) the immunity level income amounts to R.s. 200,000.
Against this the taxpayer has disclosed net profit as per books,
at Rs. 125000 and this cannot get him immunity. Now suppos-
ing that the taxpayer is determined t o 'buy' i r ~ m u n i t yfor
himself. That being so the taxpayer decides t o make an (adhoc)
addition of Rs. 75000 t o the declared income of Rs,. 125000 t o
increase the same to Rs. 200,000. He has now achieved the
immunity level income calculated above. But does this infact
buy him the immunity that he desires? The answer is No! -
and that is because again as per the scheme, any a d h w additions
mad^ t n r o t l ~ r n d inrnmo aro r ~ ~ l ~ t~ni hp
r dr n r ~ v o r t d i n t n
144 Fisscnl Impemtives in PaMstan 's Economfc Development

sales which are then deemed t o have been suppressed by the

taxpayer. These 'suppressed sales' are then t o he added t o the
sales declared by the taxpayers currentty. After doing so the net
profit t o sales ratio of the preceding year is t o be applied t o
the aggregate value (i.e. declared plus the s~~lppressed sales)
of the current sales. In our above example the limpsurn adhoc
addition of Rs. 75,000 made by the taxpayer converts to
Rs. 4,687,500 in suppressed sales.
Thus: 125000 X 75000
20,000,000
= Rs. 4,687,500

In our above example the net profit to sales ratio in

1 9 8 2 8 3 is 1 %. This is the ratio that will now have to be
applied t o the agregate sales of 1983-84 which are not
Rs. 20,000,000 but that plus Rs. 4,687,500 calculated as above
i.e. Rs. 24,687,500. 1% of these aggregate sales will come to
Rs. 246,875. This is the figure of Total Income t h a t the tax-
payer is required to show given an adhoc addition of Rs. 75000
to the book profits. This ofcourse places the taxpayer in a
quandary. No matter how much he enhances the amount of
the adhoc addition he cannot really ever achieve immunity
because the amount of 'suppressed sales' requireti by law t o
be derived from the adhoc addition so made would keep on
increasing and that would ofcourse escalate the immunity
level income given these enhanced sales when the preceding
years net profit t o sales ratio is applied t o the aggregate sales.
In other words the taxpayer is trapped in a vicil:)us circle (if the
original book profit disclosed by him was not enough t o buy
him immunity from audit.

In introducing this aspect of the immunity provision the

objective was clearly t o convey the message t o taxpayers that
an increase in sales in a given year should be accompanied by a
proportionate increase in income. This was considered neces-
sary because it had been observed that when current sales in-
creased vis a vis a previous period the increase in income was
less than proportionate t o the increase in sales. However be that
as it may, it certainly appears that the requirennent for immuni-
ty had been defectively structured in that it clnnflicts with the
'facility' otherwise allowed to taxpayers t o increase income
disclosed as per return by making an adhoc addition so as t o
SelfAsstt. Law & Proceciure

pitch it at a level consistent with immunity.

This aspect of the immunity provision stands deleted with

effect from assessment year 1985-86: '
THE CREATION OF ADEQUATE "DE'fERR,ENCE".

In order to successfully implement a progrrzrn o f self

assessment o f income it is essential that there be adeqrtate
visible deterrence against tax evasion. I f the average taxpayer
perceives that self assessment is available to him \vitholct effec-
tive arrangements having been made to create machinery to
systematically monitor economic activity, collect :zrld collate
data and to feed information t o the executive 'arm"o f the tax
apparatus, then he might find the benefits of tax (evasion too
real to be ignored.

The govt. was quite aware of the necessity for adequate

deterrence when it decided to introduce comprehensive self
assessment in 1979. It therefore organized a separate Survey
and Collation Organization within the department of income
tax, its function being to collect, collate and disserninate data
and intelligence to the field offices charged with actual assess-
ment of income tax. The basis was thus laid for a data matching
program i.e. comparing the information appearing. on a tax-
payers return of income with data, facts and figures indepen-
dently collected by the income tax department.

Since its inception the Survey and Collation Organization

has endeavoured to collect information from banks regarding
interest payments made, from the controller of imports r e
garding the quantum of imports made by individual importers,
from various authorities disbursing payments to those engaged
in execution of contract assignments, * from the property
tax authorities regarding house and other property held by
different persons and from a host of other agencies, institu-
tions and departments.

A serious shortcoming in the working of the Sunley and

Collation Organization has been the absence of modern data
9 1 Finance Ordinance 1985.
1 especially construction and supply contracts.
I46 Fiscal Imperatives in Pakistan's Ecor~onricDewloprnent

processing equipment which has hampered rts effectiveness

in the efficient discharge of the functions with which it has
been charged. Also the liaison that this organization has been
able to establish with the different outside agencies identified
above leaves much to be desired and there is considerable room
for improvement here. Ideally, the S & C Orgn. should be able
t o monitor information of tax significance as soon as an 'event'
occurs. To illustrate as soon as an importer receives a consign-
ment and documentation is processed by Customs, the S & C
Orgn. should have all information relevant to the import in its
possession. This should then be passed on t o the place of
assessment of the taxpayer with the minimum of delay or
better 1 still should be put in storage and 'retriev~d'when the
taxpayer files his return. The information (alongwith other
'bits' of information collected and collated during the year)
should then be immediately 'matched' with the information
appearing on the taxpayers return and the I T 0 informed of
any discrepancies, omissions and anatnolies noted.

What happens at the present time is however a far cry

from what is envisaged above. There is usually a, significant delay
in collection of the information and its transmission t o the ITO.
The S & C Orgn. presently has no data base of its own and so
there can be no true collation of the data collected. It is left to
the 1TO.s office to d o the matching required. As an army of
clerks, literally, handles the information passed on by the S &C
Orgn. there is ample scope for manipulation by interpolation
or even destruction of data.

While matters are still far from ideal it does appear that the
S & C 0%.has infact made a: healthy impact o n the taxpayers
perception of the efficiency of the department. The Organi-
zation has recently undertaken an ambitious program to build
up its data handling ability by installing its own mainframe
computer at Karachi with mini computers at Lahore and
Rawalpindi. Key personnel are being given specialized training
both within the country and abroad. The basis for building up
a data base has thus been laid.

DETERRENCE THROUGH THE LEVY OF PENALTIES

UNDER THE STATUTE

Under the the Income Tax Ordinance 1979, levy of

Self Asstt. Low & Procedure 147

penalty and even prosecution leading to imprisonment has been

prescribed for various defaults. The object here is both t o
punish the 'defaulter' as well as t o have a deterrent effect on
other taxpayers to stop them from behaving lkewise. The
penal provisions having a bearing on self assessment procedure
are summarized below.

Section 108 of the Ordinance prescribes a penalty of

Rs. 100 per day for failure t o furnish return of total income
and prescribed statements, within the statutory time allowed
for the purpose.

Section 111 authorizes, in all cases of 'coincealment of

Income' o r the 'furnishing of inaccurate particulars thereof' the
levy of a penalty amounting to a sum not exceeding two and a
half times but in no case less than the amount of tax which
would have been avoided if the income as returned by such
person had been accepted as the correct income.

Sub section-2 o f section 111 defines concealment to

include:

(a) the suppression of any item of receipt liable t o tax

in whole or in part;

(b) claiming any deduction for, or showing anu expen-

diture not actually incurred and

The scope of section 111 was enlarged considerably by

a n h amendment made through the Finance Ordinance 1984
which made 'unexplained investment'to be also liable for
penalty. Prior t o this, unexplained investment, though deemed
to be income did not attract levy of p n a l t y . However advelse
reception of the provision by taxpayers forced its repeal
through Finance Ordinance 1987

'Failure ( a ) deducr and remu rar liable ro be withheld at source, ( b ) ntuke advance
lo
p a y v n t of tax, (c) pay admitted
tax liable alongwirh the return, in rzccordance wirh law,
enrarLF a mandatory chmge of "addrrional tax" bur not levy of penalty.
148 Fiscal Impemtiws in Pakistan's Economic L)evelopment

Section 112 prescribes a penalty for failure t o give notice

of discontinuance of business or profession, not exceeding the
amount the tax payable for the income year i n which the
business was discontinued.

Resides the levy of penatly described above for 'conceal-

ment of income section 119 prescribes prosecution which on
conviction will lead t o imprisonment for a tern1 which may
extend to five years, or with fine, or with both.

The governments determination t o obtain information

from all quarters pointing to concealment of incclme by a tax-
payer, with a view t o take deterrent penal action as well as
initiate prosecution proceedings, is reflected in the willingness
of the Income Tax Department t o even enter into 'negotiations'
with professional informers holding out a * promise of mone-
tary 'reward' if pertinent information leading to confirmation
of a finding of concealment is made available by them. How-
ever as these informers were understandably reluctant t o
furnish information that could conceivably lead .to their own
indictment (as is possible in the case of a former employee of a
taxpayer) the government sought for itself the authority t o
grant immunity from prosecution t o those collaborating H ith
the department of Income Tax in unearthing c:.ases of deli-
berate tax evasion. This was accomplished through the ma-
chir,ery of section 128 of the Ordinance which specifically
enables the Federal Government to tender immunity to persons
such as those described above.

The combined effect of the vigilance exel-cised by the

Survey and Collation Organization and the use of statutory
provisions permitting the levy of heavy penalties and even
prosecution leading t o imprisonment does appear t o have had
a somewhat salutary effect in detemng tax evasioln. This is not
t o say that the 'problem' of tax evasion stands resolved. HOW-
ever the quality of the returns being filed and the revenues
being actually generated through the levy of income tax d o
point t o a somewhat heightened perception of the ability of
the department t o detect tax evasion and also fo the serious-
ness of its resolve t o bring tax evaders t o book. At the same
time, in order t o reassure taxpayers that action will not be
initiated on whimsical grounds or flimsy evidence it has been
provided for that penalty of for concealment of income will
Self Assrt. Law & Procedure 149

only be levied in cases of 'deliberate' tax fraud and not other-

wise. Also, if a person knowingly furnishes false evidence t o the
department o r makes a false deposition simply t o harass a tax-
payers, such person himsslf shall be liable t o be proceeded
against under the criminal procedure code.

"DEEMED INCOME" UNDER THE ORDINANCE -.

Implications for self assessment -

As per the self assessment scheme of 1982-83, it has

been made obligatory for a taxpayer t o include "deemed"
income in the composition of receipts making up the total
income for t h e year. Now what exactly is 'deemed income?'
Section 11 of the Ordinance envisages deemed income to in-
clude within its ambit,income which does notUactually"arise to
a taxpayer in a given income year,but which is supposed "no-
tionally" t o so arise. In other words the 'receipt' of such income
is a fiction created by statute. T h e most important 'deeming'
provisions in the Ordinance relating t o income are those cited
in section - 13. These may briefly be summarized a!; under:

Deemed income includes, under:

Clause (a) : Unexplained cash credit found in the books of

a taxpayer;

Clause (aa) : t h e value of an investment/iuticle/money

owned by a taxpayer and not satisfactorily explained
(in the context of the finance funding the acquisition);

Clause (b) : t h e value of an investment mad.e by the

taxpayer but not recorded in the books of accounts or
the statement of wealth;

Clause (c) : the value of any valuable article o r money

owned by a taxpayer when t h e valuable article o r money
finds no mention in the taxpayers books cbf accounts or
statement of wealth;

Clause (d) : that part. . of. the value

. .of .an investment
. .. made
 Fiscal Impemtiws in PaMsran 's Ecotromlc Developmenr

Clause (e) : the amount of an expenditure actually incur-

red by a taxpayer but not disclosed in the books of
accounts;

Tlze important thing t o note kere is tkat z r z the absence

o f the deeming provisions cited tfze acqriisitior~ of' assets or
rrzaliing o f irzvestrnents described above cou Id not constitute
'income' as these are not revenlie receipts. Infact most of them
are capital assets or expenditure. Yet legislative intent here is
clearly t o empower the I T 0 t o treat them as revenue items.
This provision has considerable practical significance in that it
enables the I T 0 t o get a handle on assets acquired through
funds that have not suffered taxation and have thus been built
up illegitimately. At the same time however ir is imperative
that these vast powers be exercised judiciously. A valuation
whimsically made by the I T 0 can easily impose an insufferable
burden of tax. In order t o prevent this from happening it has
made mandatory that the additions made t o total income by
invoking these provisions meet the prior written approval of
the supervising officer (the IAC).

Besides the deeming provisions cited in section 1.3, section-

12 also contains various citations of income "dt!emed " t o have
arisen.

Deemed income includes here:

Under sub section - (7) :!Ithe q o u n t of interest charged

o n a loan advanced by a taxpayer that is less that1 the bank rate
of interest plus two per cent;
Under sub section - (13) : any amount paid by a tenant
t o the owner of the premises obtained -rent that is not ad-
justable against rent paid by the tenant;

Under sub section - (16) . t h e amount received by a

taxpayer for vacating possession if a premises reduced by the
amount, if any, which was originally paid for acquiring the
premises;

Under sub section - (9) : in the case of a Company, the

* 1 Deleted b y the Finance Ordinance 1985.
SelfAssft. Law & Rocedure 151

amount of 'bonus' or the face value of a 'bonus share' declared,

issued or paid t o shareholders out of reserves or profits or
accumulated profits;
In a separate category, under section 79 of the Ordinance,
where a resident carries on business with a non-resident, and in
the opinion of the I T 0 the business is transacted between them
in a manner as to understate the true profits arising t o the
resident, the I T 0 will determine the true profits of the resident
and the difference between the amount so determined and the
amount declared by the resident in return filed shall be deemed
t o be the income arising t o the taxpayer and added to total
income determined for the year;
Again, in a different category, under section-25 of the
Ordinance when a deduction has been allowed for any loss,
bad debt or expenditure incurred and where the amount in
question has been subsequently recovered the amount so
recovered shall be treated as the deemed income in the income
year in which the recovery was made. A similar position obtains
in respect of allowance claimed for a trading liability. It is
pertinent also to point out here that (under clause (c) of this
section) where a trading liability disclosed by ZL taxpayer re-
mains unadjusted after the expiry of three years of the income
year in which it was allowed, the amount of such liability will
be treated as the deemed income of the tarpayer in that
income year.
In the context of self assessment of income it is signi-
ficant to note that per Finance Ordinance 1984, under clause
(c)' of sub section (2) of section 111, any deemed income
found to have arisen to a taxpayer under clauses (aa), (b), (c),
(d) and (e) of sub section-1 of section-13 that is not disclosed in
the return filed will suffer a maximum of 25 % penalty just
as the concealment of other income arising under the Ordi-
nance. Also, concealment of any amount of deemed income
will automatically oust a taxpayers claim for acceptance under
the self assessment scheme, including any immunity claim.
However it is only the deemed income arising under section 13
described above that is liable to suffer penalty under section
 Fiscol Impemrives in Pakistan 's Economic l)evelopment

111. Deemed income other than that cited in section-13 is

outside the scope of section 111. Similarly, prosecution under
section - 119 of the Ordinance for concealment of the deemed
income indicated in section-13 is indicated, leading to possible
imprisonment, or fine or both.
While the deterrent effect of the provisions referred t o
above are obvious, it is t o be noted that in actual practice
recourse t o the provisions of section-13 is made quite frequent-
ly by 17'0's and much of the criticism is directed t o the al-
legedly unwarranted zeal shown in making the additions under
this section. The fate of such assessment orders in appeal
appear to bear out some of the criticism made. Apparently
this is an area where the discretion available t o at1 assessing
authority is not tempered by careful conduct of enquiry and
judicious appraisal that is required keeping in mind the poten-
tially serious conseguences that can follow for the taxpayer.
Perhaps mindful of deficiencies in this area Finance Ordinance
1987deleted clause-C of subsection-:! of section 111.
A QUESTION O F "FINALITY"

When does an assessment framed under section 59 become

final? Per section 65 of the Ordinance as amended by Finance
Ordinance 1987, the time laid down before an order of assess-
ment can be 'reopened' ( t o remedy a 'deficiency' evident in
the said order resulting from income escaping assessment or
being underassessed, or assessed at too low a rate) is five years.
Within this time span, an assessing officer can invoke the
provisions of section 65 'Suo-m oto' if definite inforniat,ion is
available on record 'or7 with the prior written approval of the
IAC. The authority t o reopen a completed assessment is thus
limited by time and by the per requisite of prior approval
from a higher autherity where 'definite information' of es-
capement or under assessment of income is nor available to
an ITO. It can not thus be said to be 'unbridled'. And it is
certainly much more limited in scope than the powers avail-
able to an I T 0 to reopen an order of asstt made under 23(1)
of the Repealed Act - when the IT0 could reopen an asstt so
made o n his own if he in his discretion considered that the
justification for such action was there.
The ten year limitation laid down in section 65 prior co
T-4 l..l-. 1 0 Q 7 .-..C#.-.-A L-.-.-. .-.":+:.-.:- C"-- + ~ - - O . ~ ~ I . C It h n A
SelfAan. Low & Procedure 153

the I T 0 could only make recourse to section 34 within six

years of the completion of the assessment sought to be r e
opened - when action for concealment of incorne was con-
templated. Other than for remedying concealmen.t, the limita-
tion was reduced to four years and then only two years. It
was thus urged that widening dramatically the scope of section
65 would keep assessments framed under section 59 as only
'provisonally assessed' till the expiry of ten year:; when they
would attain finality. In the interregnum taxpayers would have
to suffer the unease of having the proverbial 'sword of Demo-
cles' hanging over their heads as they would have to contend
with the possibility of sudden action under section 65.
Taxpayers apprehensions here do appear tfo have been
exaggerated. After all the I T 0 had been permitted to proceed
under section 65 on his own only when 'definite information'
was available on record.
'/

The long standing demand of the taxpayers I'or reduction

in the ten year limitation period appears t o have been satisfied
through the amendment made by the Finance Act 1987 in sub-
section (3) of section 65 by adding a proviso the result of
which is t o reduce the limit time for reopening an assessment
or bringing escaped income t o tax from 1 0 t o 5 years.
The Finance Act 1987, has. significance in the evolution
of tax law in Pakistan in-so-far as a number of enactments
(potentially) of far reaching consequence were announced. Two
of these deserve special mention. The first relates t o treatment
accorded to certain loans.
Through a new sub-section (18) introduced in section
1 2 in the Income Tax Ordinance, 1979, certain loans were
declared to be treated as deemed income for tax Ilurposes. The
amendment stipulated that in case an assessee claims, or shows,
any amount as having been received by him as loan (s) during
any income year commencing on or after the 1st July, 1987,
from any person (other than a banking company, or a Finance
Institution notified by the CBR for this purpose], the amount
of such loan (s) shall be deemed to be income c~fthe assessee
for the said income year, if (a) the total amount of loan or
loans received in the income year exceeded Rs. 50,000/-; and
(b) the said amount is not received through crossed bank
cheque (s).
154 i,ls:.c: i.ii;)i m tives in Pakistarr 's Eow~o?rricL)ewloprner~r

This amendment in law had been introduced t o remedy

a deficiency in t h e Income T a x law which enabled uncor-
roborated loans t o be admitted. Such a facility dlowed tax-
payers t o build up capital artificially by contriliing loans from
persons whose income enjoyed statutory exemption, such as
agriculturists. In actual fact, of course, no loans were invol-
ved b u t by making a declaration t o this effect in collusion
with a bogus creditor an infusion of funds was rnanouvered
thus providing a ready conduit for "laundering" of t h e black
money resources of a taxpayer. The obvious loop-hole in law
is responsible for having caused enormous darr(age t o revenue
and has rendered helpless the assessing a u t h o r ~ t y'3s a simple
uncorroborated declaration from the (bogus) creditor usually
sufficed t o authenticate the arrangement. The lenient treatment
accorded by appellate authorities further exdcerabated the
situation for t h e assessing authority.

T h e requirement for routing such amounts through bank-

ing channels would have gone a long way in rr~akingpossible
the deduction of suspect flows o f credit.

However, the positive effect of the amendment in section

1 2 was quickly nullified as subsection (18) introduced in sec-
tion 1 2 through the Finance Act, 1987 was withdrawn [after
t h e Finance Bill had been ratified] in the wake of wide spread
public agitation.

Another amendment made in sub-section ( 1 ) of Section

13 b y introduction of a new proviso therein would have enabled
t h e .assessing officers t o bring t o tax any unexplained asset,
investment, expenditure etc. discovered by the I T 0 after t h e
assessment of t h e relevant income year had been made b y
treating it as deemed income under section 13 and to include
t h e same in t h e total income of the income year relevant t o
t h e assessnent year in which such discovery was made. Thus
il' say, an investment was made in t h e income year relevant t o
the assessment year 1985-86 and t h e fact of s ~ l c hinvestment
was discovered b y t h e Income Tax Officer during the assess-
ment year 1987-88, after the assessment for 1955-86 had been
completed, the deemed income under section 13 in respect of
the said assessment would have been included in t h e total
income of the income year relevant t o t h e assessment year
1 9 8 7 8 8 and not of the income year relevant t o the assessment
Self Arst!. Law & Procedure 155

year 198586. However, if the assessment for 198586:asess-

ment year was still pending at the time of discovery, the deem-
ed income would be included in the income of the income
year relevant to the assessment year 198586.

The amendment made above under section 13 was

also subsequently withdrawn again in the afterr:lath of agi-
tation.

The practical implications of the above amendment

would have been far reaching as it would have in fact nullified
the restrictions on the assessing authority resulting from amend-
ment made in sub-section (3) o f swtion 65 in-so-far as "dis-
c o v e r ~ " of unexplained investment having been made "cur-
rently" would no longer be required to be taken c~gnizanceof
in the income year relevant to the assessment year t o which
such investment actually pertained. Considering the frequency
with which section 13 is being invoked it is now of considerable
significance in the context of yielding additional revenue
through levy of tax on deemed income. Much of the invest-
ment in immoveable property attracts the provisions of section
13 in-so-far as the legal instruments of purchase/ sale executed
declare a value signigicantl~lower than the bona fide market
va!ue of the property. The arrangements in this context are
invariably of a collusive nature. Previously the levy of capital
gains provided a powerful incentive to the seller to under-
state sale value. With the repeal of the capital gains tax, this
aspect is no longer of significance for the seller. However, in
order t o facilitate expeditious sale of immoveable property
the seller even now does not object to understatement of
value in the sale instrument - which ofcourse evables signifi-
cant stamp duty.

It has been noticed that a good deal of inveslment has

flowed into immoveable property and the same is in many
cases not funded through bona fide sources. The reduction in
limitation for invoking the provisions of section 65 as a result
of amendment made in sub-section (3) of section 65 by Finance
Act 1987 has certainly hampered the jurisdiction of the Income
Tax Officer in cases liable for action in this coritext. The
amendment in section (1) of section 13, as discussed .above,
if allowed t o have remained Zn force would have facilitated
he task of the assessing authoritv considerably.
 1 56 Fiscai Itt7::: 5:rs
.( !PI Pakistarr 'r k'cor~ornicDevelopment

APPELLATE RECEPTION OF SELF ASS'IT LAW -

Taxpayers contesting assessments on factual and legal

grounds are required first t o file appeal before the Appeals
Commissioner and thereafter t o the Income Tax Appellate
Tribunal whose decision o n matters of fact is final. The tax-
payer can gain access t o the superior courts (the High Courts
and the Supreme Court) only if a point of law emerges from the
Tribunals decision. A taxpayer may also invoke the revisional
jurisdictional of the zonal Commissioner of Income Tax but
that is rarely done as by doing so the taxpayer forfeits the right
t o file any further appeal in the case and the Comlnissioners
decision becomes binding. The superior courts may hear an
appeal in an income tax case directly only if it falls within
their extraordinary writ jurisdiction --- as would be the case if
say, a constitutional question arises such as when furldamental
rights are affected or where a 'prima facie' case of malafide' is
established.

The main objection of taxpayers with regard t o the self

assessment law enacted and incorporated in the Income Tax
Ordinance of 1979 has been with regard t o the selection of
cases (both individually and by 'classes') for 'detailed scrutiny.'
Soon after the scheme was first put into effect tihe extra-
ordinary writ jurisdiction of the superior courts was invoked in
a number of cases o n the grounds that sub section (1) s f section
59 of the Ordinance "required" that where a return of income
satisfied all the requirements laid down in the self assessment
scheme it was "bound" t o be accepted and processed as filed
irrespective of the fact whether it was covered by 'immunity'
o r not. In other words such a return could not be set apart for
scrutiny. It was specifically urged in this context that the pro-
cedure for selection of cases for scrutiny was arbitrary and
illegal because the substantive law relevant t o self assessment as
,laid down in the Ordinance made no mention of selection of
cases for scrutiny. It was further alleged that the pro.cedure of
selection of cases for scrutiny was also violative of 'natural
justice' as a firm objective basis was not evident in the selec-
tion procedure and gave unwarranted discretion t o the income
tax functionaries involved.
 Self Asstt. Law & Procedure 157

Section 65 of the Ordinance has also come under attack in

appellate forums because it permits the I T 0 to reopen assess-
ments already finalized under section 5 9 (1) of the Ordinance
(in specified cases of underassessment or incorr~e escaping
proper assessment) within the preceding (prior t o Finance Act
1987) ten years. It was contended here that the stipulation of
a ten year period was unjustifiably protracted.

With regard to the self asstt. scheme itself, the Lahore

High Court (Punjab) in disposing off writ petition No. 3574
of 1984,*1 upheld the authority of the Central1 Board of
Revenue in laying down a "scheme" providing fc~rthe selec-
tion of cases (both individually and by "class" i.e. 'category')
for detailed scrutiny. Earlier, the Sind High Court in the case
of Cannon products Ltd. Vs. ITO*' had held that the CBR
did not have the authority to select cases or classes of cases for
detailed scrutiny. However in the matter of the writ petition
referred t o above, the Lahore High Court had pointed out that
with the introduction of sub-section (1A) in section 59, the
legislature had expressly authorized the CBR to e:l:ercise such
power ( t o select cases for scrutiny). It was further held by the
Lahore High Court, that the criteria applied for selection
of cases for scrutiny ". . . . . . . . . . . . . . did not appear to be
arbitrary, unreasonable or unfair. It is therefore difj;ndt to
agree with the peitiouers that the 'schenles ' are beirlg operated
discri~~zinately or that the power given t o the Boaru' under sub-
section ( I - A ) o f section 5 9 o f tlze Ordi?zance is brirlg arbitra-
rily exercised.'' "(Emphasis mine). .

Prior to the insertion of sub-section (1-A) tihrough the

Finance Ordinance 1985, it had been the opinion of the depart-
ment that the scheme of self asstt. being essentially a 'policy
measure' designed t o give effect t o self asstt. law laid down in
the Ordinance, the C B R being the policy making ' a m ' of the
income tax department was 'implicitely' invested with the
authority to select cases for scrutiny. As has been pointed out

* 1 Mohammad Asghar etc Vs Central Board of Revenue etc.

[ (1986) 5 3 Tax 1 0 9 (H.C. Leh)]
[ In the Lahore Hlgh Court. Lehore I
4 r (1985) 5 1 Tax 1 1 4 (H.C.Ker.)]
I In t h e Sind High Court. Karachi]
158 Fiscal Irnperatives irr Pakisrorl 's Ecorrorrlic Dt~!~cl~~ptrretrr

above, however, such a view did not find fav01.1r with the
Sind Iiigh Court and although its expressed opinioc! is not
binding or. federal functionaries operating outside its terri-
torial jurisdiction the (federal) govt., considered it expendient
t o stipulate expressely through sub-section (1-A) t.hat the
CBR (and any authority subordinate to it to whom such autho-
j
rity mily be delegated by the Board) was empowered t o select I
cases for scrutiny. Also, by giving retroactive ap:plication to
the legislation, legal cover was given simultaneously t o the i
I

previous exercise of such authority by the CBR.. This may

therefore be said to be one example of judicial pronouncement
provoking specific legislation.

The case of Cannon Products Ltd. Vs. ITO, has added

significance in the evolution of self asstt. law in Pakistan, in that
it has been f$her held by the Sind High Court in its cited
order, that a 'revised' return of income (i.e. a return revised
after the original had been filed) did qualify fox, acceptance
under a scheme of self asstt.provided it vsas not disqualified
under any other provison of law. This 'finding' of the Court
conflicted directly with the department's view that only returns
that were filed voluntarily by the 'due date' wen:, eligible for
consideration under the self asstt.scheme and all other returns
were outside its ambit. Such a~viewwas considered t o be con-
sistent with the language employed in section 59 ( I ) which
made mention only of returns filed under section 55 - which is
the section dealing with the voluntary filing of returils. There
was no mention of returns filed under section 57 (revised
returns) and therefore by implication such 'revised' returns
were considered ineligible for self asstt. The Sind High Court
however did not concur as, it being the vested right of a tax-
payer to revise a return prior t o assessment, such rclvisecl returns
in its opinion, could not be ousted from consideration under
self asstt. simply because section 59(1) made no mention of
them.

The insertion of an EXPLANATION in section 59 (1)

through the Finance Ordinance 1985 however effectively
neutralized the impact of the courts decision as the amendment
provided that 'revised' returns would be debarred from con-
sideration for self asstt. T h e amendment was also given re-
troactive application. Here again therefore it was the action
nf thn o n ~ ~ ~
t htl tr fnrnnrl tho I n n ; c l ~ t ~ r m
tn 9rnont-l thn c ~ ~ h -
SeTf Ass!t. Law & Procedure

stantive law obtaining on the matter.

Prior to Finance Act 1987 the ten year limitation period

for re-opening of an assessment already finalized under section
59 (1) had been a point of controversy. The superior courts in
general frowned upon, what was considered to be, an unwarran-
ted 'extension' in the time lapse here enabling action under
section 65 to be initiated anytime within ten years from the
date of completion of an asstt. under section 59 (1).This
" u n e w " of the superior courts is evident in the decision of
the Lahore High Court (Punjab) in the case o f "Riaz bottlers
Ltd. IJs ITO"*' wherein it had been observed. . .

'. . . Indeed to dlow "them" (i.e. the ITO's) t o wield

i.

'"t" (i.e. the power under section 65) for a period of long ten
years is something extremely unusual. It has the effect of
giving them "a handle of oppression" vis a vis the assessees. . ."
(Emphasis mine). This is strong language indeed but the
court made no attempt t o strike down the legislation o n a con-
stitutional ground. Perhaps it expected the government t o take
immediate notice of the observations made and reduce the
limitation period under section 65. But that did not happen.
Rather, the specific relief provided by the court t : the
~ taxpayer
in this particular case was nullified by amending sub-sectjion 3-A
through the Finance Ordinance 1984 and by mak!ng the amend-
ment applicable retroactively.

The Department of income tax appearecl t o have got

away with amending the law laid down in sections 59 and 65
'and' by making the amendments applicable retroactively, as
only the "machinery" provisions of the substantive law had
been affected. Indeed were it not possible t o give such cover
to the affected assessments made under the ::.elf assessment
scheme since July 1979, the scheme for the earlier years could
conceivably be placed in jeopardy.

* 3 In the Lahore High Court h h o r e .

Writ Petition No. 3590 of 1982
decided: 3rd Mnrch 1984.
100 Fiscal Impemtives in Paklsran 's E'conomlc Development

IMTACT C F SELF ASSESSMENT ZN'PAKISTAN -

The impact. that self assessment has made in Pakistan can

be appraised in terms of specific criteria viz 1 ) promotion of
administrative efficiency within the department of income tax,
2) promot,ion of tax consciousness among taxpayers, 3 ) expan-
sion of the tax base, 3) quantum of revenue ge:nerated.

One of the problems that plagued the department of

income most before the enactment of the Income Tax Ordi-
nance of 1979 was an alarming inefficiency in all major areas of
work. Over the years the number of taxpayers (assessees) in
each ITO's charge had increased appreciabl!;. With universal
audit the norm before the introduction of self assessment that
meant that much more paperwork and with procedures and
staffing patterns remaining virtually unchanged since 1922
(when the Income Tax Act came into being in the then undivi-
ded British India) the workload was fast becoming unmanage-
able. As ITO's attempted t o scrutinize each and every return
filed they ended up not being able t o scrutinize any significant
number properly. More and more assessments came t o be made
'summarily' and many taxpayers familiar with departmental
'routine' would simply ensure that their return was taken up
for scrutiny toward the close of the fiscal yeinr as that guaran-
teed the most summary of all assessments - and afforded the
maximum scope for evasion of tax. With record keeping still
organized on the old "linked file" system Inany offices ap-
peared t o be buried in a mountain of tattercd files. The I T 0
had almost no direct access t o the records of his own office
and became pathetically dependant on an army of ill paid, ill
educated ill motivated clerks who nevertheless acquired con-
siderable notoriety as petty tyrants without whose goodwill
neither IT0 nor assessee could ever hope t o have much accomp-
lished.
With universal audit came virtually universal filling of
appeal and that meant departmental appellate functionaries and
the Income Tax Appellate Tribunal getting so bogged down that
many appeals did not complete the full appeallate cycle (from
the AAC t o the Tribunal) even after a lapse of three years. In
the meantime, successive ITO's kept on repeaking t h e previous
assessment pattern (that had given rise t o the appeal in the
first place) and that in turn would ensure a a second 'round' of
Self Asstr. Law & Ifocedure

Since the introduction of comprehensive self assessment

in 1979 (actually 1980 when the scope of the scheme was
enlarged) an immediate result has been a dramatic reduction in
the daily workload of departmental functionaries. ITO's now
are required t o scrutinize only a fraction of the number of cases
they previously had t o examine. This ofcourse means much
more time being available for indepth examination of individual
cases. An interesting development here has been the increasing
number of assessments finalized by the assessing officer "in
agreement" with the taxpayer with the taxpayer forfeiting his
right of appeal. It appears that more and more t;ixpayers find
it both more convenient as well as more econoniical t o agree
t o being assessed at a ]figure! higher than that :.hewn in the
return in agreement with the I T 0 rather than contest every
attempt at determining a deficiency by the I T 0 during the
course of an audit. This saves them the hassle of the appellate
cycle and the extra tax assessed in audit would appear t o be
more than offset by the savings resulting from avoiding the ap-
peals process. Besides taxpayers feel that they get a better deal
when a compromise assessment is made than if a 'regular'
assessment order is framed as in the latter case the IT0 is incli-
ned to assess at the highest figure possible and that can easily re-
sult in a harsh assessment being made. As only a few assess-
ments are made by the ITO's even fewer assessnellts are contes-
ted in appeal as many of them are compromise assessments.
This has come as a boon t o appellate authorities who now for a
change-find that they have the necessary time to dispose ap-
peals after adequate consideration of the taxpay,>rs and the de-
partments points of view.

Given the improved work environment a qualitative

improvement was expected and has infact beccrme evident in
the work of the functionaries charged with assessment and
appellate duties. A good number of cases invoilving detection
of tax fraud have been finalized during audit In the last few
years. Similarly the quality of appellate orders has improved,
perceptively.

Thus as far as the first criterion listed above is concerned,

the self assessment scheme has been a success.
162 FIscol Imperatives In Pakistan 's Econoraic Development

Tax consciousness among taxpayers means simply an

awareness of tax law combined with a wil1ingnes.s t o comply
with the provisions of the statute - both in letter and spirit.
Voluntary compliance with the law laid down controlling the
taxation of income is thus the key issue here.

In order t o help the ordinary taxpayer without access

t o expert legal counsel of any significance, the government has
sought to 'educate' the public in fundamental matters of tax
law and procedure. Advertisements prominently placed on an
attractive format are reqularly taken out in major newspapers
and periodicals especially before the deadline for filing of re-
turns and the stipulation of the law is made clear in simple lan-
guage. Television and the Cinema have also been so used to
reach out t o the public. ITO's have been encouraged (and even
'ordered') t o go out in their jurisdictions and meet with their
assesees face t o face and explain tax matters and answer their
queries.

A society 'conditioned' as it were t o practice tax evasion

(a carryover from the colonial era perhaps) will not change its
ways simple because the administration was showing its serious-
ness in "teaching" them tax law. Perhaps mindful of this
reality, the government very early decided t o show its resolve
in dealing with tax evasion by creating adequate deterrence for
those given t o practice tax fraud by making instituional arrange-
ments to monitor pertinent economic activity in the country
and ensuring the feedback of intelligence so gathered t o those
charged with assessment work. It was thus that the Survey and
Collation Organization was set up within the department of
income tax. A special economic enquiry unit has been created
within the Federal Investigation Agency. The CBFt has created
a Vigilance Wing staffed with technical personnel especially
t o detect and report on tax fraud of any kind anywhere in the
country. Additionally, the department has begun t o make more
frequent use of the penalty provisions in the Ordinance.

The end result of all this has been that there has been
a perceptible increase in voluntary compliance which is evident
from the following statistics regarding returns filed voluntarily.
SelfAsstt. Law & Roeedure I63

The fact that non-filers (those who have not been filing
returns of income although they are required to clo so) are
showing a willingness t o come forth and declare their taxable
income is especially encouraging. Although there has been no
'flood' of such declarants, their numbers are not insignificant
given t h e tax ecology of the country. Figures available for
three years in this area are

That there has been a qualitative improvemc:nt in the

returns is evident from the fact that as many as 135,328 returns
filed in 1980-81 voluntarily by existing taxpayers tihowed an
improvement in the quantum of income declared, vis a vis
1979-80, as against 45,750 returns showing a decrease in
income. Furthermore, the number of cases qualifying for im-
munity by declaring enhanced income consistent with the
standards laid down by the CBR' increased to 60,659 in 1!381-82
as against 22,128 in 1 9 7 9 8 0 .

The trends cited above are maintained in the following

years. We can say therefore that as far as can be said on the
basis of the existing data, tax consciousness certainly appears to
be on the increase and is relatable t o the operation of the self
assessment scheme as devised in 1979 and as improved there-
after.

Looking to the population of the country (arn estimated

100 million in 1985) the taxpayer 'population' of 1 million is
a paltry 1 5% and clearly translates intda very narrow tax base
indeed. But that is attributable in no small measure t o the
failure of the government to go through with legislation making
agricultural income subject to income tax. Even so, it is true
that the existing tax base built up on the businc::ss, service,
manufacturing, and construction sectors and ofcourse on those
deriving salary incomes is narrow. Considering that the zero
bracket exemption limit is very low (currently Rs. 25,000 but
previously Rs. 18,000 for quite some time) a very l a q e number
of potential taxpayers/especially those engaged in small scale
retail business, remain outside the tax net. However, since
1979. the tax base ha.. e x n a n d 4 and much of the exoansion
1 64 Fiscal Irnpemtlves in Pakistan's Ecor~omicDevelopment

is attributable to the vigorous conduct of external survey by

the 17'0's *1 and also due to the efforts of the Survey and
Collation Organization whose activities resultled directly in
unearthing many cases of non filers.

To illustrate the improvement in this area it needs to be

noted that in the first year of the operation of the self assess-
ment scheme 200,000 non filers were detected and brought on
record. In 1980-81 another 210,000 such cases were 'booked'.
As a result of the yearly improvement in this area the number
of taxpayers in 1985 were indicated at 1 million as against
less than half that number in 1978-79. The 'improvement'
here is thus self evident though it is yet a fact that many non
filers remain there to be brought within the fold of the income
tax laws of the country.

A primary objective of enacting legislation for the taxa-

tion of income is to generate revenues for the government. This
does not ofcourse mean that such legislation does not have
other objectives but only that mobilization of revenue remains
a very important objective, especially for the government in a
developing country which is always short of cash.

Prior t o 1979 two experiments with partial self assess-

ment (in 1964 and 1977) had shown that universal self assess-
ment would most probably result in a precipitou:; fall in income
tax revenues. This had a lot t o do with the negative tax menta-
lity of the public with whom tax evasion appeared t o be a deep-
ly ingrained habit so that self assessment would give them a
unique opportunity t o indulge in this pastime (of tax evasion)
especially because the tax administration was so weak and
without access to any economic intelligence gathering apparatus
that could enable it t o detect tax evasion.

Thus when the government went ahead with the scheme

for comprehensive self assessment in 1979 there were many
who were deeply apprehensive of its impact on revenues. How-
ever in introducing the scheme the government took two major
decisions which in my opinion prevented the feared fall in
revenues. Firstly, the government introduced a truly 'compre-
hensive ' scheme of self assessment --one that embraced all

1 w b now had the time available t o conduct such m y .

Self Ass tt. l a w & Procedure 16.5

categories of taxpayers in both the corporate and non corpcrate

sectors. Secondly, the government created adequate deterrence
to tax evasion by making instibutional arrangements t o gather
and utilize economic intelligence effectively. The first measure
improved the taxpayers perception of the goveruments credibi-
lity in fairly implementing a program of genuine self ,assessment.
In this context it needs to be noted that the previous attempts
at introducing self assessment were conspicuous in their 'partial'
nature. Only very limited categories of taxpayers were covered
by it and it did not appear (atleast the governm12nt did not
make it appear so) that there would be any major change here
in the immediate future. This probably disenchankd the tax-
payers with the scheme at its very inception. It is fcood that in
1979 this 'deficiency' was not recreated.

The second measure (creation of deterrence) appeared to

have convinced the taxpayers somewhat of the seriousness of
the governments resolve in not allowing self assessment t o give
a free hand to those practicing tax evasion.

As a direct result of the two mesures referred to above/

Government revenues did not fall. Rather each year, 1979-80
to 1986-87 there has been an increase. Thus Government in-
come tax revenues increased from Rs. 3,354 million in 1978-79
to Rs. 5,177 in 1 9 7 9 8 0 to Rs. 7,028 million in 1980-81,
Rs. 9,071 in 1 9 8 4 8 5 Rs. 9,591 in 1985-86 and 13s. 10,200 in
1986-87. So even by the last criterion given above the scheme
appears to be a success although it is also a fact that income tax
revenues have been placed as it were on a "plateau" since 1984-
8 5 with little hope of any significant increase in the near
future so long as the basic fonnat of the Income Tax law
remained what it is presently. In the furture the Government
should endeavour to rationalize procedures within the depart-
ment of income tax and to give the department ready access to
modern computer based information storage and retrieval
systems which would go a long way in further enforcing volun-
tary compliance and to enable a meaningful data matching
program to be instituted on a continuous basis. And ofcourse,
the existing narrow tax base has got to be broadened meaning-
fully by bringing income from agriculture within the fold of
federal taxation.
 11
The political
dimension in taxation

The evolution of tax laws is a complex process that reflects

changing political, social and economic cross currents. While tax
levies basically seek to raise revenues for government, in the
modem era, fiscal enactments also seek to influence the course
of economic activity. Thus, by altering the relative level of tax
burdens, tax laws can actually 'promote' activity in a particular
area or sector of the economy. Typically, in developing coun-
tries tax laws may be designed with the specific objective of
promoting industrialization - including the geographical dis-
persal of industry. This is an area in which struggling third
world countries have a marked deficiency.

On independence in 1947, Pakistan inherited the British

made Income Tax Act of 1922 - adapted for application in
Pakistan as Act XI of 1947. This statute conferred an exemp-
tion from the levy of income tax t o all income arising from acti-
vities in the agricultural sector of the economy. It thus retained
a principal feature that the colonial government had built into
the income tax law. That (colonial) authority had been influ-
enced by a number of factors in allowing such exemption. For
one thing undivided India was predominantly an agricultural
colony. Its agriculture .was practiced in a highly traditional
manner and a 'rural elite' of large landowners had a strangle
hold in this sector. The British augmented the numbers of the
rural elite by bestowing large tracts of land to those loyal to
the crown - especially where the loyalty was shown in times of
crisis. Thus over time, the British gradually befriended this elite
and through them ensured the continued sublservience of the
167
168 Hscal Impem tiws in PaMstan 's Economic Deielopmenr

rural population. Other than this painstaking1 y cultivated

'special relationship,' it was also realized that, by and large,
agriculture continued t o be a sector of fluctuating fortunes,
heavily dependent on the vagaries of the weather. I t was abIe.to
feed the population of India - and yield a surplus'in a good
crop year. But except for the big landowner, ownership of land
did not by itself ensure a significant, 'steady' income. In any
case the farmers were all subject to taxes of vario1.1~kinds pay-
able to the local authority. Looking at the matter in its totality,
it was not considered expedient' by the then colonial govern-
ment to subject the agriculturists to an additional lev,? payable
to the central government. It was felt that such a step would
not only burden the agriculturist but also that it would need-
lessly alienate the elite whose favor the government assiduously
cultivated.
The 'background' given above is necessary to understand
the context of fiscal enactments in the subcontinent prior to
independence that allowed income from agriclrlture to be
statutorily exempt. After independence, the 'special relation-
ship' referred t o above no longer obtained. There was no
ostensible need for the government of the day t o 'cultivate'
the rural elite any further. In actual fact, however, this elite
immediately set about making manouvers t o establish a
power base in the free country. The legacy of procrustean
control that it had established over the rural population stood
it in good stead now and the 'experimental' democracy of the
newly independent country gave them ample scope to secure a
'tilt' in their favor in the countryside - where the bulk of the
country's population lived. Thus the 'logic of nun] bers' guaran-
teed t o this elite a commanding political position. Having
secured an entry t o the legislatures it was a relatively easy
matter for them to make sure that their positiorl of eminence
was not disturbed - atleast not in any significant manner. A
continued exemption from the levy of a federal. tax on their
incomes was thus not difficult t o secure considering the politi-
cal clout that they wielded.

The statutory preference for agricultura'l income did

ofcourse provoke a response from the non-agriculturist who
could not comprehend why he should be treated any differently
from his compatriot in agriculture in the matter of taxation of
his income by the federal govt. However, every attempt t o
T" political dirrension in mxation 169

'reform' the tax system by doing away with this exemption was
deftly blocked by the agriculturists who by dint s f their num-
bers - and their wealth - found it a simple matter to negative
the efforts of the non-agriculturists in their attempts at fiscal
reform.

The tug-of-war between the agriculturist and he non-

agriculturist culminated in the federal govt. in January 1977
levying income .tax on agricultural income - albeit in a 'mild'
manner - through the finance (supplementary) Ordinance
1977. The Ordinance was later approved by the National
Assembly when it passed the finance (supplementary) Act of
1977. This legislation withdrew the exemption granted t o
agriculture. However, before the implementation of this law,
martial law was promulgated and the new legislation was first
suspended and later its implementation was cancelled. The
Income Tax Ordinance of 1979 later restored the old exemp-
tion.

While no plausible reason presently obtains t o warrant a

continued retention of the exemption of agric~llturalincome
however, the political power of the rural elite is even today a
factor of significance in the politics of the country and their
'clout' in the law making forums continues to assure them a
posit ion of eminence:

While the agriculturists have done all that they could

to retain their privileged position in the matter of taxation
of income, those deriving income from business have not been
behind in monouvering t o have such fiscal laws, framed as gave
them an opportunity to reduce their income tax burden to the
minimum. Capitalizing on the governments eagerness to pro-
mote industrialization the private sector has extracted special
fiscal concessions whicn include across the board tax holidays,
accelerated depreciation allowances, tax credits, rebates, deduc-
tions, allowances etc that in the aggregate hake had the effect
of pitching the 'effective' rate of tax much below the nominal
rate. This ofcourse has meant sharply reduced revenue for the
federal exchequer. In other words the already narrow tax base
has been further narrowed.

The manner in which this package of benefits was got

structured reveals how adept the private sector has been in
1 76 Fisccl Imperatives in Pakistan's Econotnic Development

securing fiscal benefits of its own. It cultivated a lobby for itself

in the echelons of government that spared no ct?ffort t o project
its viewpoint at every forum. This lobby had too its extra
territorial supporters in the aid giving countries and institutional
agencies that sought t o establish the private sector on a firm
footing in the country. This ofcourse added considerably t o
the leverage of the private sector. The net effect of' it all was t o
so puncture the fabric of tax laws through ii plethora of so
called fiscal "incentive' measures as. t o result in. the ridiculously
narrow tax base that has now become an enigma.

It follows from what is stated above that both the private

business sector and the agriculturists have been responsible in
their own way in making a farce of the fiscal framework of the
country, exploiting it at will, almost, to limit their burdens t o
minimal levels. However, while each has an axe to grind in
furtherance of its self interest the private business sector has
shown its discomfiture at the privileged position of the agri-
culturist on many an occasion. It can now b'e relied upon t o
continue its efforts for withdrawal of the exemption of agri
income. Apart from the discrimination inherent in the present
arrangement the same prevents the lowering c:)f tax rates that
the private sector keenly wants t o see.

While the private business sector can be expected t o be

in the forefront of any movement t o revoke the exemption of
agri income, it is not alone in this endeavour. [nfact 'academia'
in Pakistan has been quite articulate in pleadi.ng for reform in
this area. And, very significantly, the countries and institutional
agencies that 'fund' Pakistans developmental effort are exas-
perated at the complacency of the policy makers in the matter
of mobilizing meaningful domestic resources by effectively
broadening the tax base. Both, the exemptioln of agricultural
income AND the plethora of -so called 'fiscal incentives' are the
target of attack by these quarters.

A cumulation of forces is thus gathering momentum that

could ultimately bring sufficient pressure t o bear on the execu-
tive authority t o force fiscal reform on positive lines.
 Controlling tax evasion

No programme of fiscal reform can be effective unless

adequate arrangements are made t o check tax evasion the
magnitude of which is most disturbing in Pakistan - t o put it
mildly. The extent of deliberate evasion is apparent from the
oft cited statistic that no more than 35 5% of the potential tax
revenue is actually collected by the Department of Income
Tax. The balance 65 % goes waste. Much of it (perhaps 75 76)
represents the loss due t o evasion. Another 2!5 % or so is lost
due t o inefficiency of tax administration andl represents bad
detailed scrutiny assessments in which obvious avenues for
raising revenue are overlooked, poor collect.ion of revenue
demand, both current and arrear, especially the latter, in-
adequate enforcement of laws relating t o at-source deduction of
tax etc.

While it would be idealistic t o think of putting an end t o

tax evasion, there is no doubt that a lot can be done t o control
it.

As far as the statute goes, aleast some of the evasion is relatable

to the relatively high rates of tax (particularly for the higher
income brackets) that have been prevalent, especially in the
years prior t o 1983. Although there has been a significant
reduction in the rate of personal taxation and even the cor-
porate tax has been reduced, the rate structure still offers an
impetus for evasion as the benefits of such evasion are too
real t o be ignored. The administration is aware of the problem
but finds itself unable to order further reduction in view of the
1 72 Ftso~lImperatiws[n Paldstnn's Econonric D w l o p m e n r

extremely narrow tax base. Too much revenue would thus

have t o be sacrificed, given the existing tax base, if t.ax rates
were reduced meaningfully as the reduction of rates would
not automatically lead to improved quality of returns of in-
come-atleast ,not in the short run. Considering the governments
chronic-and often desperate--need for revenue the possibility
of- significant revenue loss in the interregnum(after reduction
in tax rates and the time when taxpayers file qualitatively better
returns) is too daunting for any government t o face up to.

A major part of tax evasion in the country takes place

due t,o weaknesses in tax administration. Archaic and cum-
bersome procedures (that have not changed much in substance
since 1922 when the Income Tax Act came in the field) coupled
with wholly inadequate policing, data collection, storage and
collation arrangements and a lack of political will t o take tax
evaders t o task has made systematic tax evasion too 'profitable'
not to be indulged in. A deficiency of visible deterrence to
evasion is thus a major factor to be reckoned with.

Fiscal reform must include energetic measures t o counter

the administrative weaknesses indicated above. R.ationalization
of procedures would thus appear to be a mandatory require-
ment. The creation of an adequate data base together with the
capacity t o analyse data and institutional arrangements t o
collect data continously from all relevant areas are a l l vital
steps without which tax laws cannot really ever be properly
enforced. The precise chaiges required to be made in this
context are outside the scope of this paper. Suffice it would
to point out that modern computer based data processing
systems constitute the essential technology in this area and
armed with which the taxman can confidently tackle many an
ingenious evader. The fact of the matter is that public percep-
tion of the capabilities of tax administration is heightened
immensely if it is seen that the administration has facilities at
its disposal with which it can actually monitor the activities of
taxpayers that are relevant to a proper assessment of their
income. While the technology is not cheap it is readily avail-
able and it can be tailored to suit the specific requirements of
a particular tax administration. And it more than pays for
itself (many times over infact) in the additional revenue it will
h r i n ~in and through the vastlv imnroved efficiencv of the
Co11nollb1gtax ewsion

administrator.

To be fair some steps have been taken in this direction in

Pakistan but these are mostly tentative and 'adhoc" in nature.

The lack of a political will t o take tax evaders t o task is

another glaring deficiency in our system. It is astonishing that
in a country in which tax evasion is (admittedly) rampant not
a single tax evader has actually been sent to prison for con-
cealment of income since 1947. It is not that t h e law does not
provide for such penalty. It does. But thedepartment just does
not have the nerve t o g o ahead with prosecution and force a
showdown o n the issue. The 'AL Capone's" of Pa.kistan (and
there are many!) thus have a field day and need !not * worry
of being incarcerated in a penitentiary.

Effective executive support is the only way that the will t o

act decisively can be built into the fiscal system of the country.

The policy regimen relevant t o countering tax evasion-with

special reference to the parallel economy -is dealt with indepth
in chapter 13.
 The parallel economy
An Overview

Broadly speaking, economic activity embraces four dif-

ferent areas involving the production, consumption, exchange
and distribution of the output that is the end result of the
cooperative application of factors of production. When such
activity occurs within the f o r q d parameters pertinent t o the
economic system in vogue in a particular time and place we may
speak of activity within t h e "regular economy". However it is a
fact that economic activity also takes place outside the formal
parameters. When this happens we refer t o the "inform,al"
economy mode. Generally speaking, the informal economy
encompasses trading without documention (making a ;sale
without issueing a sale receipt) and includes financial transac-
tions outside t h e banking system (remittances from abroad
through the "Havala" system rather than through normal
banking channels). Besides this informal economy, there is the
"black economy" based o n activities that are outside the pale of
the law and include snuggling, dealings in narcotics, profiteer-
ing through hoarding etc. The "informal" and the "black eco-
nomy together constitute the "parallel economy".

A feature of significance common t o both the "informal

economy" and the "black' economy" is that the transactions
and the income generated as a result of these transactions are
not reported formally i.e. t o the Income Tax,Customs, Excise,
State Bank and other authorities t o which, normally, reporting
is statutorily due.
1 76 Fiscal Impemtlws in Pakistan's E c n o m i c Dmlopment

Informal Mode

Thus the manner in which things get done im an economy

is not always consistent with the formal format of the system.
Rather,functional modes are frequently devised t o circumvent
the formal format by substituting in its stead a.n informal or
irregular mode.

The circumstances that provoke such improvisation can

have complex sociologial ramifications or, in the alternate,
may be simply a reaction .reflex t o the sheer 'ctnerousness' of
officialdom. There is also a more sinister facet (and in many
cases a dominant one) -thzt of deliberate crirniniality that seeks
lpurposefully t o thwart the formal procedure and laws so as t o
force abnormal monetary gains of a magnitude impossible in the
normal (formal) format.

Colonial Hbritage

In developing countries with a colonial heritage anti-

pathy to Government is often rooted in haunting memories
of the exercise of procrustean authority by the colonial autho-
rity. Such memories are refreshed by harking back to the
old fimes through literary expression and a penchant for attri-
buting responsibility for present day ills t o (real and iimagined)
past misdeeds of the colonists. This persisting alienation of the
ordinary citizen from government is at the back of much of
the opposition to contributing to the exchequer,

While third 'world sociology is undeniably a factor of

significance, it is certainly not the only reason for the overt
behavour that has led to the emergence of the parallel economy.
Rather, an increasing obsession with the accumulation of
riches not possible through the conduct of "normal" business
activity, motivates the great majority of tho'se who are the
keenest participants in the rat race. This has spawned a whole
range of activities outside the pale of the law.

The formal and informal facets, though clearly distinguish-

able, often operate side by side (in parallel) but more common-
ly, merge in a manner as t o render separate identification diffi-
cult. Infact one of the problems of dealing with the parallel
situation is its thorough permeation of the regular --formal-
The Pmlkl eccnomy an OveMew 177

economy. So enmeshed is it with operative facets of the regular

economy that targeting the parallel economy strains the in-
genuity of the best of policy makers.

Government and the informal economy.

Of considerable interest here is the governrn.ents parti-

cipation in the informal economy. Prices fixed by Government
for public utilities are usually on the basis of criteria other than
purely economic. The result is that these prices do not a d e
quately reflect relative scarcities and d o not evolve out of
supplyidemand equilib. It is for this reason that prices so fixed
have been dubbed as "pseudo prices". Revenue knowingly
foregone is equivalent in its economic effect t o revenues evaded
or avoided. As a result, the public at large is invested with extra
purchasing power. The exchequer loses that much revenue.
Reventies have thus been evaded. However, here it is the govern-
ment that has, wittingly facilitated the evasion.

While the object here is clearly t o benefit the public at

large, the fact remains that the government by ignoring relative
scarcities as reflected through 'market prices' is guilty of arbi-
trary fixation of prices for public utilities. The distortive
effects of such arbitrary economics destabilize tihe economy
and lead to a revenue loss and also to possible faulty ecnono-
mic planning.

Why worry about the parallel economy? After all, as a

phenomena it is undeniably ubiquitous-seen even in the com-
munist bloc countries. The answer is that the operations in
the parallel economy induce distortions that destabilize the
-
regular formal - economy in a manner detrimer~talto orderly
econ'omic growth.

Distortiors induced by the parallel economy.

a. Huge surpluses generated in the black economy fund

A'
conspicuous c o n s h p t i o n W o n a grand scale. In third
world countries much of these supernorrnal profits are
sunk in real estate. The palatial mansions and commer-
cial plazas that dot the landscape are pointers t o the
quantum of black resources generated ~land~estinely.
 I 78 Fbml Impemtfws In Paktstan S Economic Dewlopmenl

The intense demand in these areas of conspicuous con-

sumption bids up prices in a manner wholly dispropor-
tionate to the aggregate demand in the regular economy.
The powerful minority of the black economy thus suc-
ceeds in pinning a price perforce on an area of interest t o
it. A direct consequence of this is that the people of the
regular economy find it increasingly cliffioult t o partici-
pate :meaningfully in areas of economic activity where the
black economy has made inroads. Economic usurpation
by sheer imposition of will is thus a phenomena with
which increasing numbers of the regular economy have
been affected adversely.

1;;
z , *
b. Existing inequities in income distributilon are exacerbated
as the profiteers of the black economy build up their
l : ? surpluses unchecked, paying no taxes on their spiralling
!j Ii : i Iincomes.

c. When institutional arrangements are not utilized optimally-

or are utilized perversely - decay of such institutions is
inevitable. The circumvention of foma! institutional
arrangements through bypasses arbitrarily structured puts
such institutions into a state of disuse atrophy making
them inefficient and even in some cases redundant. Thus
where the basic economic framework is that of a mixed
economy in which the market plays a cruciirl role, the
less than efficient functioning of the market hinders
economic development.

d. Businesses engaged in systematic tru: evasion build up

their capital base and in the absence of an effective tax
administration, come to acquire enough clout t o elbow
out those who are not so engaged.

e. The often frenetic activity in the parallel economy has

the potential to fuel dangerously the fires of inflation. The
amount of currency in circulation is determined with
reference t o the level of transaction demand in the entire
economy. If the parallel economy is a largely unknown
factor, it may not figure correctly in the official calcu-
lations made in this context. The voracious appetite of
the parallel economy for cash can bid up significantly
The Pnmllel economy an Owndew \ 79

the velocity of circulation of currency, adding therby

t o inflationary pressure.

f. The flow of investible funds is influenced by projections.

of profitability. Since areas of investment in the parallel
economy offer such a high rate of return these areas
fascinate the potential investor and induce the commit-
ment of funds although, in the context of the require-
ments of the proper structural transformation of the
economy, these are not the most desirable areas.

g. The most obvious effect of the operation of the parallel

economy is the way in which it deprives the exchequer of
its share of tax revenues. Placed out of the jurisdiction of
the taxman, the extra legal activity of the iparallel econo-
my decisively robs the exchequer of funds vital for the
countrys program of economic development.

h. The progressively increasing role of the parallel economy

undermines, through its unhindered extra--legal activity,
the "rule of law" . This subversion of statiltory authority
has far reaching implications in developing the "world
view" of the common man, t o whom, the law looks more
and more "like an ass". This bodes ill for the orderly
conduct of policy.

i. The emergence of an underworld elite in the irregular

economy parallels the affluent class of the regular econo-
my. Over time these rich people keep on getting richer.
Such growth in family fortunes is an eyesore for the
public at large. Of greater importance however is the fact
that the existing skewed distribution of income in the
economy as a whole remains skewed with weakened
governmental authority helpless at altering the skew.
j. Sectoral composition of GDP as consolidated in the na-
tional income accounts is based on reported data. Seg-
ments of the unobserved economy not reporting back
on activity transacted therein systematic:ally understate
the GDP and also distort its sectoral compcrsition.

k. A capability t o project present trends correctly into the

future is essential t o effective planning. However the
correct extra~olation of existine trends Dresumes avail-
 1 80 FLrcal Impemtlves in Pakistan 3 Economt.- Developmenr -

ability of authentic data. If the data is corrupted the

projections will be misleading. The greater the corruption
the more misleading will be the projections. The opera-
tions of the parallel economy corrupt data and therby
contribute t o defective projections thus interfering with
the planning process.

1. The ability of government to implement mexcures aiming

at restructuring of the taxation system so as l o be able t o
realize revenue optimally and at the same time bring
desirable changes in the structure of the economy can be
seriously limited by the operations of the pa~rallelecono-
my. The unobserved economy being outside the pale of
the law is unresponsive to measures enforced through
statute.

MORE ABOUT THE "BLACK ECONOI,IY9'

In most third world countries, the black ecozomy is a

buoyant sector - it is not merely doing well but is actually
thriving. This aspect is of significance in that while the black
economy is a ubiquitous phenomena, its increasingly aggres-
sive posture in terms of rapid growth and assertiveness vis a
vis the regular economy, is largely a third world phenomena.
Much of this is due t o the fact that the institutitsnal monitor-
ing of economic activity is weak here, making i t relatively
I (easy for the participants to get away with syste1:natic non
I
reporting of income.

Spiralling Cycle

That black money (usually) breeds more black money

follows from the fact that the cycle of black money operation
iescalates progressively, corripounding the orit~ina! act that
started the cycle. To illustrate the proposition consider a
person who makes an investment in real estate utilizing black
money funds. Naturally he does not report the transaction:
Now sometime later he disposes off the asset and makes a tidy
profit on the investment. He will now also not report the
,profit so made-because he did not report the original invest-
Iment. The original omission is therefore instrumental in leading
to the subseauent non reporting. Black activity is thus self re-
-
ihforeing and not only ensures that there will be a second
The Pmlkl economy an O m t e w 181

round of black activity but also that such activity will with
time snowball - adding more and more t o its magnitude as
it rolls across the economic landscape.

Susceptibility of the mixed economy.

We know that the black economy is p r t e n t in almost

all countries whatever the doctrinaire basis of the institution-
al arrangements t o regulate their economic activity. It is how-
ever a fact that the black economy thrives particularly well
in the so -called free economy format economic system. While
the controled, regimented, command economies of the socialist
bloc of countries are certainly not free of the scourge, its dep-
redations there are much less damaging and limited t o forays
much restricted in scope compared t o the free wheeling runs
possible in the freer environment of the mwket (or mixed)
economy.

Third world countries make especially fertile ground for

black economy operations mainly because of deficient institu-
tional development. So many black transactions go unreport-
ed simply for the fact that the arrangements irn force t o monitor
economic activity are either technically deficient in themselves
as a result of which the degree, of comprehensiveness in their
coverage-which is a sine-quo-non for their effectiveness-is
lacking, or else the technical support and back-up which is
necessary t o ensure their optimum application is not available.
Take the example of the (federal) revenue n~obilizationappa-
ratus in Pakistan. Normally, "effective" tax laws are a powerful
deterrent t o Mack economy operations. Since the income tax
statute requires that taxable income be reported and since
all income, legal and illegal, is covered by the requirement,the
income tax authorities are expected t o be aware of the areas
where income is being generated. They are also expected t o
have the capability not only to keep such xeas under active
surveillance but also to be in a position t o take measures if
necessary t o enforce compliance of the tax statute.

Statutory Limitation in Pakistan

Income tax law in Pakistan has a major deficiency in that

the entire income generated in a major sector of the economy,
agriculture, is outside the ambit of taxability having been dec-
182 Flsml Impemiiws In Pakistan's Econ,!~mlc
Development

lared exempt statutorily - since the very inception of Pakistan.

The consequences of this are much more momentous than
would at first seem apparent. The exemption has become a con-
duit t o funnel in black money into the regular economy with
,impunity by simply giving it the guise of an agricultuial.source.
This has not been difficult t o manage. Thus it is that "loans"
from agriculturists, contrived artificially of course, have come
to fund a good part of the accretion in wealth and capital that is
actually the result of black money operations. Similarly, returns
from the cultivation of agricultural land have been arbitrarily
pitched at levels that conveniently make available the required
"extra" funds t o launder the available black money. These two
devices have been brazenly deployed to launder a major part
of the black money injected into regular business especially
in the non-corporate area where the incidence of t.ax evasion has
been the highest.

The exemption granted to income emanating from agri-

cultural activity has enabled such income t o escape detailed
scrutiny simply because the requirement of detailed record
keeping has been largely dispensed with in actual practice.
Thus a business declaring a liability to an agriculturist is not
required t o show infusion of funds.through the media of a
banking channel and a fairly bald statement from the creditor
suffices in the great majority of cases to establish the bona-
fides of the creditor-debtor arrangement. This would be under-
standable if say it were a fact that agriculturists, especially the
relatively well t o do (who are shown t o be advancing the loans)
did not have ready access t o banking facilities or were not
usually inclined t o keep there money in safe custody there.
While it is a fact that the demand for liquid funds may in
general be higher among the rural populace the fact remains
that contrary t o what may be propagated, large sums of money
are not commonly hoarded at home and banks are the main
avenue of deposit.That being so, there should not be any real
problem for a genuine debtor t o show receipt of funds through
the banking channel. That in practice much clamor is made
whenever an attempt is made t o impose such a requirement is
evidence of the suspect nature of such arrangements. The
fact that legislation in this context duly approved by parliament
has been defeated due t o an inspired public outcry, is clear
proof of the lengths to which the vested interests will go t o
ensure that their privileged position is not disturbed.
t h e Pamlkl economyan Overview 183

The bulk of the black money generated from business

ncome manifests itself in the simple non-reporting-of business
receipts and the inflation of business expenditure. Thus turn-
Iver is systematically understated and expenditure is padded.
The net result of the exercise is t o drastically curtail net profits
with consequential huge tax savings. Such gains when reemp-
toyed in the conduct of business fuel a second round of black
earnings and so the cycle goes on unabated.

To be sure the opportunity for realization of extra legal

supernormal profits by non reporting of income varies from one
area of economic activity t o another. The intensity of market
demand is responsible for abnormal mark ups which so long as
the demand lasts ensures abnormal profits. Looking t o the
relatively high tax rate structure-notwithstanding the fact thr:
as a result of th2 many exemptions, allowa~~ces, credits etc.
the effective tax rate is undoubtedly less than the nominal
rate of tax - the tax savings by withholding disclosure from the
income tax authorities are too real to be ignored and this factor
is responsible t o some extent in provoking the understatement
of profits. However the crucial factor here is not the tax rate
structure 'per-se' but rather the ease with which it is possible
to circumvent the statute and evade the scrutiny of the income
tax authorities. The weakness of tax admirlistration is attri-
butable partly to lack of procedural rationalization due to
retention of archaic procedures wholly inadequate t o deal
effectively with the vastly increased workload and the increas-
ing sophistication of taxpayers and their counsel in finding
loopholes in the statute. An additional factor of significance
here is the deficiencies in technical back-up~facilities to assist
the assessing authority. Given the limitations in the manpower
employed in the income tax deptt. and the fact that the quality
of this manpower in terms of training and technical expertise
and motivation leaves much t o be desired, the deficiency can
be offset considerably if access to modern data storage, colla-
tion and retrieval facilities-computer basecl ofcourse but also
including micro film-were readily available. Although begin-
nings have been made in these areas, these are only tentative
and cover only a very small part of the work spectrum. The
most prominent shortcoming here is the absence of any data
base which renders scrutiny, analysis, data matching and sur-
voillrrn~nt h g t rniinh mnrn rliffim.lt if nnt ;*x~nns;hln Tn nnm,
 Fisml Impemtfves in Pakistan ':: Ecorromic D w l o p m e n t

which permits persons with little or no aptitude for tax work

t o man key positions of authority. Add to this the paradoxical
position of vast power invested in a poorly paid officer class
I conditioned in a lore of elitism of days gome by, encourages
I
corruption making it even easier for scheming taxpayers t o
1
1I: avoid the tax net.

Supernormal profits, which are a principal ingredient of

the black economy, are generated with relative ease in a market
that is largely imperfect with hoarding, pricc! manipulation and
the ensueing profiteering, inevitable. Besides the abnormal
profits, there are the bribes, 'commission's and kickbacks that
make up the black money available t o the vast official bureau-
cracy.

Where Black Money Goes

The principal destination of black money in Pakistan has

been real estate. A good deal of it has also found its way abroad
t o be stashed away in secret bank accounts. Also, some of this
black money exfiltrated abroad has found its way back t o the
country - attributed t o a person different from the sender and
one who is resident abroad - t o provide the wherewithal t o
finance assorted business ventures without having to face
.. :
potentially 'risky' interrogation by the inca'me tax authorities -
; i ;
i
.. 1-
.#
,
risky because if an explanation in the context of investment
; r made is found t o be suspect in that the so~nrcel'sof investment
98 i% i
.are not considered 'bona fide', then the amount so found is
? f not only liable t o be added t o total income but also stiff penal-
I : '
ties, over and above the regular tax demand, become payable.
l i :: Remittances from abroad enjoy a considierable advantage in
1F ? i
that these are usually accepted as bonafide -without any interro-
gation - so long ofcourse as the funds arise to a taxpayer from
I ;
4

12 :: :

I someone resident abroad engaged in some kind of activity

. :
~
.<
.
there t o lend a facade of credence to his ability to make the
.
.
.
.
necessary finance available.

As stated above, the principal beneficiary of the generation

of black money has been real estate. As a direct consequence,
the value of property, especially commercial property, h e
witnessed a sharp escalation in recent years. The original black
money invested here has been multiplied manifold as a result
-
of speculative sale and purchase. The huge profits arising from
The Parullel economy an Overview 1 85

such speculation have generally escaped taxation as these have

rarely - if ever - been reported correctly to the taxman. Despite
some measures taken, the sale price of real estate - as well as
built up property - is invariably understated a.nd grossly so.
The mechanics of the distortion is quite simple. A.11 that the two
parties t o a transaction have t o do is t o agree t o a mutually
acceptable - sharply deflated - figure of the sale price. A deed
of sale at this arbitrarily reduced price is then drawn up and
formally executed before the concerned authority. Since the
two parties t o the transaction affirm the same, the authority
accepts the document drawn up as valid.

To be sure the income tax authorities are not bound t o

accept the value indicated in a deed of sale especially where
the variation vis a vis market price is marked. However there
is precious little that can be done by way of ]remedial action.
Attempts are frequently made t o refer to the market value
and bring to tax the difference between the declared value
and the bona fide market value but the the app~:?ilateauthorities
have, in the vast majority of cases, frowned o n such attempts
usually because it is so difficult t o get hold of hard evidence
t o back up and substantiate the finding of the income tax
authorities that value has been understated. It has not there-
fore been possible t o build up useful 'case law' o n the subject.

The abolition of capital gains taxation o n sales of immove-

able property (since this is a provincial subject it is outside the
purvew of the income tax law) has removed a "hindrance" that,
if effectively structured, might have succeeded in countering
atleast the more blatant cases of understatement.

We know now that the black economy is today virtually

a ubiquitous phenomena. No economy, no matter what its
doctrinaire basis, is entirely free from the scourge. Also, the
black economy is invariably a thriving sector - again almost
everywhere. But the fact remains that third world countries
based o n the mixed economy format in the structuring of their
economic system, are particularly fertile lground, for the black
economy which is increasing in magnitude at an alarming
pace and, in some countries atleast, appears to be posing a
threat t o the viability of the formal "regular" economy.
18, Fh... :.i:.~,+*~.
,i:.
;
:, xs i.7 Pakistan 's Econon!icDeveL~pment

countries is relatable t o a host of factors, many of them with

a complex sociological basis, it does appear that .weak moni-
toring of economic activity prevents government from collect-
ing and collating economic intelligence comprehensively and
from initiating effective intervention t c ihwart the circum-
vention of the formal, regular economy.

Third world countries are especially poor in keeping

tabs on the conduct of economic activity in different sectors.
Thus opportunities for quick profit making arc easily and
skilfully exploited by elements specializing in this area and
5y the time government decides to move in by enacting legis-
lation and alerting fiscal authorities, especially the income tax
people, . a good deal of damage has already been done and the
black marketeer has established himself on a firm basis 1'1,:
which it becomes increasingly difficulty to dislodge him. What
is pertinent to note here is that it is not the transaction of
business activity per se tnat is objectionable (unless ofcourse
outrightly criminal like drug dealing). The really undesirable
part is that the black market operator succeeds in easily con-
cealing the manner in which business is actually transacted
by him and which enables him firstly t o enjoy supernormal
profits and secondly facilitates the non reporting of all or
most of these profits.

Windfall for the O.E.P.

An illustration of how black activity takes root is the
functioning of Overseas Employment Promotela in Pakistm.

The opportunity for overseas employment first appeared

in a big way in Pakistan in the early t o mid '7Q's when bur-
geoning revenues of mid-east oil produce:rs were instyu-
mental in launching development activity based both on
infra structure development and industrial projects with a view
to structural diversification of the economic base looking t o the
day:-still quite some time in the relatively distant future to be
sure, but nevertheless inevitable ultimately .. when the oil
revenues would no longer be there - or if there, would no
longer be economically significant.

Political ties forged with the Arab world, especially those

The Paallel economy an Overview 187

manpower placement orders t o Pakistan. At first the emigration

of manpower was largely unregulated. Recruiting teams came
to the country and selected the required personnel on a case
by case basis. A significant increase of "agencies" specializing
in job placement for the horde of blue collar workers became
inevitable as they were largely unable t o resolve on their own
the complications inherent in the situation. For the foreign
employer too it was much more convenient t o look for labor
through an intermediary well familiar with local conditions and
able to scout for manpower and t o deal with the procedural
routine independently.

It was'nt long before this area was recognized as parti-

cularly lucrative in its potential for supernormal profits for the
employment promoter - or recruiting agent as the promoter
was commonly known to the public at large. Intensification of
the competetion amongst intending emigrants was a godsent
opportunity for the recruiting agent t o begin a sustained
~

compaign for the extortion of "on money" earnings from the

eager emigrants. Depending on the area of placement, wages/
salaries and fringe benefits negotiated by the agent, '"on
money" was extracted brazenly and with virtual impunity
)from the law especially because no specific law existed then
to regulate the affairs of these enterprizing but rapacious
agents. By the time the need for providing statutory cover
to the operation of manpower employment promoters was
recognized, receipt of "on money" had become firmly
rooted and is prevalent even today despite efforts made to
bring it to the fore by the income tax authorities belatedly
recognizing the losses in potential revenue to the federal ex-
chequer through non-reporting.

It was only in mid 1979 that statutory control of the

operation of recruiting agencies became possible when the
emigration ordinance came into force. A fairly elaborate licen-
sing system for O.E.P.'s was announced and a "watchdog"
administrative arrangement structured t o (supposedly) safe-
guard the interest of the emigrant and t o ensure that he was not
"exploited" in any way - both by the agency as well as the
foreign employer. The terms of employment were required
to be put t o close scrutiny by the "protector of emigrants" and
i t was only after formal clearance had been granted by the
 FLc-A:-if*,- - - 7.e.:in Pakistan's Econorni'c Development

protector that the emigratit was permitted t o proceed abroad

t o take up his new assignment. The State Bank of Pakistan
monitored closely the receipt of foreign commissior~income by
the Q.E.P. wit.h each recruiting agency required by. law t o file
an annual declaration with the State Bank detailing the in-
flow of commission income from the foreign employer on
whose behalf the agency had recruited and sent abroad the
required manpower. Defaulting agencies were interrogated by
the Federal Investigation Agency which, incidently, also investi-
gated complaints (if any) of extortion of extra legal payments
("on money") levelled against specific agents.

The Government guaranteed t o the recruiting agent a ser-

vice charge of Rs. 2,000 per worker recruited payable by the
intending emigrant. Of this an amount of Rs. 550 per worker
was deducted and credited to the Workers We!fa.re Fund so
that the a,gent received a net payment of Rs. 1,450 per worker
recruited. This was besides the commission received by the
agent from the foreign emp'loyer. The commission component
varied and was generally higher for the higher qualified skilled
manpower than for the blue collar labor. Against such remune-
ration the agent was expected t o maintain a cclerical' staff
t o process the paperwork, interview the applicants, arrange
their examination in specific skills where such formal evaluation
was stipulated by the foreign employer, to maintain liaison
with the foreign principal and t o finalize arrangements for
passage t o the country of destination. The foreign passage was
required by law ( the emigration ordinance) to be borne by
the foreign employer who did so generally by malcing payment
abroad through "miscellaneous cash orders" and sending the
same t o the agent in Pakistan for being exchanged for regular
tickets.

Tn theory the entire arrangement was apparently' a model

of orderliness and effectiveness and it was difficult t o visualize
any significant wrongdoing within this format by the O.E.P. In
practice, however, things were not so clean and orderly as the
Gtatute contemplated. As stated above, the practice of re-
ceiving extra legal "on money'"ayrnent by the recruiting agent
from the emigrant had become deeply ingrained in the system
as it had evolved prior t o the promulgation of the emigration
ordinance of 1979. In most cases, however, no coercion was
involved as the intending emigrant was more than willing t o
 l 2 e P m l l e l economy an Overview 189

pay an amount over and abcve the service charge and pro-
vided that the "on money" demanded was "reas0~nable1',
there were usually, no complaints.

"On hrIoney9'Bonanza

For the income tax authorities the non reporting of "on

money" become an enigma that defied resolutdon. A good
deal of effort was however expended t o establish that extra
legal payments were infact being received by the :lgenl: and the
focus was on analysing the over all activity of the agent. The
department was able in quite a few cases t o establish delibe-
rate "padding" of the expenditure statements fur!~ishedby the
agents. It became known slso that in actual practice very
little expenditure was actcdly incurred by the aqent. The
usual practice was t o direct the emigrant t o beig the miscel-
laneow exp ensesespecially chose connected with securing
visas and forms - and even the airport tax . Mt.ciic;i exami-
nation charges and special testing fees were aiso thrust on
the emigrant. As the agent did not maintain a very e!aborate
administrative set-up1 t o process the paperwork, the "office"
expenses were minimal. The agent was thus able to "save"
most of the expenditure that he was required bv law to bear.

Besides such "savings" the agent through his ingenuity

usually contrived t o "appropriate" the foreign passage payment
made by the foreign principal abroad. T nis he tiid by "direct-
ing" the emigrant - who usually viewed the agelit as his ticket
t o i'eldorado"- to buy hk own passage too!! The agent then
'kncad~ed" the M.C.O.abroad (refund could ]lot be claimed
locally) by claiming a refund-on the ground lhat the MCO
had not been utilized. Such encashment abroacl was made by
the agent himself during the course of his frequent "jaunts"
(business trips) abroad and there is reason to believe that
collusion exists between the agent and the foreign principals
staff abroad.

All told therefore the O.E.P. ended up making hefty

additions t o the legally stipulated service charge and commis-
sion that was his due and since the income tax people could
only pin down a very small part of such additions, the lar-
gesse was (largely) tax free.
190 Fiscal Impemtiws in Pakistan 3 Economic Development

What did the recruiting agent d o with his ill gotton wealth?
Well he sunk quite a bit of it in real estate and property acqui-
sition. There was even some investment in smalll t o medium
sized industry and some money was funneled abroad for safe-
keeping in secure secret accounts. But because there was no
clear cut uniform pattern followed by all - or most - recruit-
ing agents and because the official apparatus t o mclnitor econo-
mic activity and gather economic intelligence has been weak
and because the socio cultural ethos encouraged collusion
and connivance - and corruption - violations of law are
extremely difficult to establish.
The example of recruiting agents has been cited to illus-
trate the emergence of black money earnings in an area of
economic activity of relatively high market demand with the
"seller" placed uniquely to "fix" quite arbitrarily and in collu-
sion with others in the same line of business, a ','price7' that
varies sharply from that "determined" - just as arbitrarily -
by the official regulatory authority.

The economist would point out here that the 1:tlack market
has come t o be established here because arbitrary rczulation
ignored the play of free market forces. An obvious solution
here could have been for the government t o take cognizance
of the fact that intending emigrants were willingly parting with
the huge sums involved in the extra legal payments made t o the
agents. The government could thus have simply directed that
henceforth each emigrant w ~ u l dpay an amount at par with the
"on money" figure for particular destinations and specific jobs.
This would have ensured that the hitherto tax free takings of
the agent became subject t o regular income tax and the losses
in revenue that the exchequer has been forced t o bear would
then have been minimized.

Ofcourse the "solution" given above while feasible tech-

nically could not have been applied in practice - for political
reasons. No government in a third world country could ever
have mustered enough courage t o announce such is "punishing
official price" for labor intending t o go abroad.
7'he Pmallel economy an Overview

The magnitude of the extra legal "on money" payments

realized by the recruiting agents can well be gauged b , r the fact
that for each emigrant going abroad anything from %b.10 to
1 5 thousand to Rs. 20 to 30 (or even 35) tilousand is extract-
ed depending as stated earlier, on the destination and the tspe
of job secured. Jobs in Saudia had the highest potential here.
Thus an agent sending abroad say 500 to 1000 persc~nsa year
- not at all unheard of in the days before the s1u.m~in oil
prices - could be making anything between Rs. 5 rnillion to
Rs. 1 0 million (for 500 persons sent abroad) or even Rs. 1 5
million I! For 1000 persons the figures would ofcourse double.
These are indeed staggering figures especially when one is
to consider the fact that these extra legal payments supplement
the regular earnings made up of not only the service charges
and commission payments but also the passage money "appro-
priated" by the agent as described above and the expenditure
"saved" by making the emigrant bear most of the business ex-
penditure that normally the agent ought t o have borne. All
told it added t o an awesome total. Just as impressive ofcourse
were the losses in potential revenue that the exchequer had t o
suffer as no part of the extra iegal earnings were ever reported
- quite naturally - and also because the government did not have
the fiscal agencies and apparatus that could monitor .r he flow o f
funds effectively - including the conspicuous consumption ex-
penditure that many of t!?ese "nouveau rich" indulged in
blatantly.

How Business Generates Black Money

The emergence of black money in the business sector is

widespread and businessmen in Pakistan are adept practitioners
of the dubious art of concealing earnings from forrnal aut.hori-
ty. The case of recruiting agents has been cited only t o drama-
tise the extent of suppression of earnings and the ease with
which interrogation is avoided. In actual fact any area of
business activity that is in a position of yielding ~~upernormal
earnings is fair ground for black money t o emerge.

Most businesses invo'lving sales of finished goods sup-

press turnover as a matter of routine. This is achieved simply
by ,not recording sales - which are usuallv unvouched. For this
192 Fisml Impemtives In Pakistan's Eilonornic DeveIopment

reason suppression is not much of a problerr~when it comes

t o writing the account books: only those sales obviously
.are entered in the books that are vouched. That there is -to-
date - no statutory requirement that would enforce mainte-
nance of documentation to substantiate positilon of sales made,
is an added advantage and certainly encourages the under-
statement of turnover.

Once turnover is arbitrarily understated the next step

in the presentation of fabricated accounts is adjusting direct
expenses so as t o evolve a "reasonable" rate of gross profit.
The G.P. rate is the standard initial check that the Income
Tax Authorities make to appraise the results of a business.
Since a deficiency in the G.P. percentage can provoke the
ire of the taxman and lead t o many unplcbasant queries,the
exercise of "massaging figures" t o achieve the e t ~ dof coming
up with a ,"suitable G.P. rate" is taken up ir! all seriousness
and while it is felt that the stress laid by the income tax deptt.
on the gross profit as an index of overall p::ofitability is res-
ponsible for the "adjustment" of the trading account by busi-
ness, the fact is that Pakistan is not the only country that
relies on the G.P. rate for quick appraisal by the taxman. In
France "normal" G.P. rates for different businesses are deter-
mined 'periodically and results disclosed by businesses falling
in these categories are checked against the "srandard" rate
applicable. Any significant deviation is seen as warranting
investigation. However this practice has not been seen there as
having led directly t o any systematic attempt at artificial
presentatioil of accounts. Tax evasion certairJy exists in France
but the "forfait" systen, as it is known there, is not seen as
being a factor of any significance in the '.doctoring" of ac-
counts that could ultimately lead t o tax evasion.

Not only is the G.P. rate artifically determined in many

businesses in the manner described above Sut the net profit
rate is also - in quite a few cases - artifically contrived by
debiting such expenditure as can be shown t o be incidental to
the conduct of that business. The thrust is on artifical "pad-
ding" of indirect expenses and since conclusive documenta-
tion is not always insisted upon, the clever businessman - and
there are many who can be so described - usually gets away
with little or no documentation produced before the taxman.
7he Pamllel economy an M e w 1 93

A great deal of black profit is being generated in specula-

tive transactions especially in commodity trading. Delibe-
rate hoarding of goods leads inevitably to profiteering with
"staying capacity" being a principal determinant of the t.ime
frame of holding goods by the speculator. By the very nature
of business transacted in the speculative markets, documenta-
tion to substantiate purchase and sale is almost totally lacking
and this by itself facilitates considerably non-reporting of
income formally to the taxman - or to any other authority for
that matter.

Speculative trading has picked up in recent years and is

often the preferred activity vis a vis say manufacturing. It is
felt that not only are profits higher here and more easily gene-
rated but the hassle that is associated with manufacturing ac-
tivity, especially that connected with managing labor and
procuring raw materials and securing needed financing at
reasonable terms, is avoided. For the businessman, therefore,
speculative activity appears to be much more attractive and
this is responsible for much of the spurt in this area in recent
years.

As a class, professionals, viz doctors, lawyers, architects,

chartered accountants and the like are responsible 'for gene-
rating black money on a truly '"epic" scale. Take doctors for
instance. Most doctors in private practice-and especially top
flight specialists with foreign qualifications and having consul-
tants status - have a vast clientele. This is but to be expected
looking t o the adverse doctor-patient ratio - a feature common
to all developing countries. The consultation fees are often
fixed arbitrarily and the patient has little option in the matter
of choosing his doctor as suitable alternates may just not be
available. This clears the way for virtual extortion. And of-
course there is no receipt. The doctor reports only that part of
his earnings that he chooses to intimate. The rest is simply
pocketed. The same is true of lawyers,, professional account-
ants etc. As a class therefore, .the professionals are a step ahead
of their brethren in business when it comes to generating black
prof its.

Bribes, kickbacks & "commissions" (to use an euphem-

ism) are another major source of black money. The vast official
bureaucracy can be tyrannical when it comes to the exercise
I 94 Fiscal Impem dws in Pakistan s' L'conomlc Dewlopment

of authority. The maze of rules and regulations, complicated

and confusing, cumbersome procedures, m o ~ ~ n t a i nofs paper-
work, competing jurisdictions, slow difficult legal redress and
very limited formal accountability, all cor:stitute a fertile
ground for the arbitrary exercise of authority. [n a scenario
such as this, corruption becomes almost inevitable especially
when one considers that the buraucrat though Invested with
significant authority relatively early in his career - when he (or
she) is still rather immature, is also underpaid and has hardly
any official facilities (residence, conveyance t?tc). T h e fact that
Ire often has pressing family obligations t o meet, most invol-
ving a significant outlay of finances, comp1ic:atet; the situation
immensely.

Policy Regimen t o Counter the Black Econom!y

The black economy is a fact of life in our times. We live

with it and yet we are all too painfully aware that it is indeed
a scourge that causes a lot of harm t o the orderly development
of the economy and to the people at largc. So the question
arises whether it is at all possible t o do anything about it. Can
we counter the forces that give an impetus t o the growth of
the black economy? Can we take measures clirectly that would
stop and even reverse the encroachment of the black econo-
my o n the domain of the regular economy?

Fortunately, the answer t o all the qur:?stions listed above

is in the affirmative. -4 policy regimen 'can' he devised that
would achieve, t o a considerable extent, t'i~eobjectives stipu-
lated above. Let us now consider such a regimen.

Structuring a Credible Deterrence

-4 citizens perception of the ability of fiscal authorities

to take effective action against those who fail to report their
earnings will go a long way as a deterrent measure t o counter
the non reporting of income. In countrits where there is a
direct tax on incomes -the great majority in the free world
fall in this category -deterrence is usually 1:)uilt into the statute
controlling the taxation of income through the enactment
of specific provisions that provide for levy of penalties, both
mandatory and discretionary, for tax evasion through con-
The Pamllel economy an Overview 195

cealment (non reporting) of income both directly and indi-

rectly. The latter takes care of "devices" that a taxpayer may
employ t o arbitrarily understate the true income that arises
t o him such as is done by deliberate inflation of expenditure
wrongly shown t o be incidental t o the conduct of a business.
Most jurisdictions are not content t o raise a financial charge
only against those who fail t o report their earnings correctly.
The assessing authority thus also has the op1:ion t o initiate
proceedings t o launch criminal prosecution of a defbulter. A
conviction would thus entail a jail sentence.

Fear of incarceration in a penitentiary is a powerful

deterrent t o the non reporting of income. However it is not
the statute itself that will instil such fear in the defaulter.
%'hat is pertinent here is how the law is implemented. The
defaulter will see how many of those who violate the law are
taken t o task by the income t a x authorities. The number of
criminal prosecutions launched and their fate in the courts
will go a long way in shaping the defaulters perception o f the
efficacy of the tax people in discharging their responsibilities.
The oft cited example of the ignoble fate that befell gangster
boss A1 capone only because o f the perserverance, committ-
merit and vigilance of the internal revenue service of the United
States - and ofcourse the fact that the statute contained the
necessary provisions that made criminal prosec~ltionpossible -
has served as effective deterrence t o many a tax evader - ie non
reporter-since t h e 1930's when A1 capone was I'inally humbled
by the law. It is effective even today because the IRS has
continued t o launch successful prosecutions regularly of those
in default of the law-and it has'nt spared persons holding high
office-or those with political clout. T h e high rate of successful
prosecutions has served t o enhance its repuration for high
professional excellence.

Deterrence through the Levy of Penalties under the Income

Tax Statute

Under the t h e Income Tax Ordinance, 1979, levy of

penalty and even prosecution leading t o imprisonment has been
prescribed for various defaults. The object here is both t o
punish t h e 'defaulter' as we1.l as t o have a deterrent effect on
other taxpayers t o stop them from behaving liktwist..
 Fiscal I~rzperatiwsin Paldsran 's L-cot~otnIcDc3velopment

The Governments determination t o obtain information

from all quarters pointing t o concealment of income by a tax-
payer, with a view t o take deterrent penal action as. well as
initiate prosecution proceedings, is reflected iin the willing-
ness of the Income Tax Depit t o even enter into 'negotiations'
with professional informers holding out the promise of mo-
neta.ry 'reward' if pertinent information 1ead.ing t o confir-
mation of a finding of concealment is made available by them.
However as these informers were understandabky reluctant to
furnish information that could conceivably lead t o their own
indictment (as is possible in the case of a former employee of
a taxpayer) the Government sought for itself the authority
t o grant immunity from prosecution to those collaborating
with the deptt of Income Tax in unearthing 1::ases of delibe-
rate tax evasion. This was acr_.omplishedthrough the machinery
of section 128 of the Ordinance which specifically enables
the Federal Government t o tender immunity t o persons such
as those described above.

Thus the law t o punish non-reporters exis':s. But as stated

above, the actual impleme~itationof the statutlz has not borne
out the oft stated resolve of Government t o punish tax evaders.

Comprehensive Statutory Format

Income Tax law in some countries requires the reporting

of certain categories of income only. Thus in Pakistan income
from agriculture is not required t o be reported - where it is
the "only" source of income-irrespective of the quantum-since
it enjoys statutory exemption. It does not matter that a person
may be deriving, say, a million rupees from i~griculture- as a
good many d o especially those having orchards and cultivating
cash crops like rice and cotton. Also, the many categories of
"exempt" income such as that derived from poultry farming,
manufacture of agricultural implements, manufacture of gar-
ments etc. enjoy the privilege of non scrutiny of returns filed
and thus get away with the deliberate "overreporting of in-
come". These exaggerated accumulations of "white" money
can then be used t o explain away investment that has been
The Purollel econor?~
an Overview 197

actually contrived through black money funding.

It is obvious that unless the income tax law makes it

mandatory for all income to be reported, statutory coverage
will only be partial and persons enjoying the privillege of
not reporting their income will be able t o fictitiously "make
availsble" their (real or inflated) exempt money hoardings t o
finance projects in the regular economy when inl'act black
money has been invested. Efforts of the income tax authori-
ties t o make a meaningful probe of investment are thus easily
thwerted and taxation cf black money avoided. The launder-
ing of black money with such ease not only encourages indul-
gence in operations that give rise t o black money but also
nprov..de a convenient way cst for the black marketeer.

De-Monetization of Currency

All money, both black and white, is required to be kept

as currency o r embodied in some asset. Where blaclt money is
not embodied in an %set (viz real estate) and when such black
money does not lie in deposit in a Bank-as it would not be f o r
fear of detection unless ofcsurse it is kept in s fictitious ac-
count/ then it is obvious it would b e available in currency form
and kept "in hand" stashed away in a safe deposit locker or any
other place that the holder feels is secure enougn. Such money
may be put to use in a variety of ways but the aim usually
worrld be t o maintain its liquidity. Now if the Government
wen? t o order de-monetization of currency (without any warn-
ing ofcourse) the hojders of such black money accumulations
would be forced t o come up and get their hoardings converted
Into the new currency. As the Government wou.ld - hopefully-
have taken "effective" measures to prevent obtainkg of "false
cover", in theory the black money holder would inevitably
"get caught".

The "solution" t o countering black money accumulation

and circulation thus simply involves changing the currency
periodically. In practice however, this is easier said than done.
In the first place, changing the entire currency of a country
is a mind boggling operation. The massive printing of notes
of various denominations is not only costly but practically,
an extremely difficult operation - especially as no compro-
198 Flscal I m p e m f f w sin Pakistan ':I Economic Developmen I

mises can be made as far as the "quality" of the new paper

money is concerned. Needless t o say, it is not at all feasible
t o even consider using coins as principal currency on any
meaningful scale. Furthermore, it has t o be recognized that
most third world countries are short of the type of administra-
tive resources that would be required t o oversee a de-moneti-
zation operation effectively. It may thus bme quite possible for
determined - and moneyed - black money holders t o find
avenues t o enable the conversion of old currency for new. The
experience in Pakistan certainly indicates this t o be so for de-
monetization has not succeeded in making any meaningful dent
in the black money hoard in the country.

Amnesty

The offer of a reprieve from formal interrogation does

appeal t o many flush with black money funds. For this reason
offers of amnesty have usually elicited a fair response. However
t h e black money holders perception of the ability of govern-
ment t o identify them and their black money hoardings goes
a long way in affecting the outcome of ars amnesty. Most third
world governments fiscal agencies are quite hampered in this
respect lacking as they d o the administrative expertise and
technical back-up faeilities t o collect and collate economic
intelligence which together give government the clout that
black money ho!ders fear. In its absence, the offer of an
amnesty may not be taken very seriously as kt may be felt that
it would be cheaper t o "launder" black money without the
hassle of filling " declarations " etc. Nso, most amnesty's
involve the payment of tax - albeit at a much reduced rate.
Conditioned as he is t o avoid the payment of 'any' tax on in-
come, the black money holder would like very much t o avoid
payment of even this reduced rate if it is felt that an alternate
"escape" conduit exists.

Raising Money's through Sale of Redee~nableBearer Bonds by

Government - at an attractive rate of return ofcourse!!
I
1
The huge hoard of black money existing in most third
world economies is a potential reservoir of finance - waiting
t o be tapped.Gover,nmentsin third would countries are finding
it possible t o gain access t o this pool by floating loan issues
The Pamllel economy an Owrview 199

based on redeemable bearer bonds offering good rates of

return vis a vis other investment opportunities. The success ,of
such schemes seems assured given the security of full govern-
ment surety coupled with the fact that no questions are asked
both at the t h e of purchase as well as encashment. Easy con-
vejibility is an additional attraction. It must be recognized here
however that such schemes do after all increase govt. indebted-
ness. Burdened as most third world govt's are with hexvy
debt, such schemes add t o this burden creating potentially
serious problems in the near future when the time of redemp-
tion of the debt issue arrives. If by then government h:as been
able t o effect the structural transformation of the economy that
it aims at, and if such transformation has started yielding a
positive return then ofcourse there would be no p1:oblem.
But these "IF'S" are not to be ttiken lightly. Projecting current
trends into the future, the pictu:e that emerges is not rosy.
Many"futurologists"actual1y envisage a rather grim scenario
with political instability, staggering debt burden, unbearable
population pressures, the daunting challenge of urbanization
etc. etc. all adding up t o an immensely complex 'mix' of prob-
lems defying any easy solution.

The Taatbon of Expenditure

,...-
4he econon~ics of the taxation of expendituxe turns
around the thesis - which is well founded - that despite low
per capita incomes, most third world countries are plagued by
conspicuous consumptior! bythe 'nouveau riche' largely spawned
b y black money operations in the parallel economy. Not only
does sucll consumption affect adversely the savings rate but
it is slso responsible for eroding scarce foreign exchange by
encotlraglng the import of consumer goods - both through
formal and informal channels. It is also responsible for distor-
ting the structural development of the economy by erlcouraging
investment in consumer goods industries and develc!pm~ctof
the service sector - at the expense of the development of pro-
ducers goods. Development of a iital segment of t h economy
~
thus suffers the ignominy of neglect which if al1oww:l t o persist
over any significant length of time can stunt t h e economy's
structural development.

The taxation of expenditure is thought t o not only put

a brake o n the more brazen conspicuous consumption but is
200 Fiscal Impemh'ws in Pukisrun 3 Economic Devflopmen t

also expected t o help identify black money centers thus facili-

tating the design of policy measures t o deal with the parallel
economy. It would also bring in extra revenue for the ex-
chequer and thus improve domestic resource seneration. It
would also aid in the alleviation of the inequitable distribution
of wealth and thus have a salutary impact in easing social
tensions thereby furthering social stability.

While in theory there is much t o commend the taxation

of expenditure, in actual practice the exercise is not at all
anywhere as simple as it appears at first sight. The data defi-
ciencies that plague income tax administration hamper effec-
tive expenditure taxation as well. Administratively, it is much
more demanding than income taxation for keepir~gtrack of
individual expenditures will more than likely prove to be a
herculean exercise. The yield from expenditure taxation is
also not likely t o be sigificant considering the difficulties
in recordkeeping which is a sine -.quo - non for effective ad-
ministration of the tax. Absence of a meaningful data base
and a data matching program is thus likely t o inject a pro-
nounced element of futility in the exercise.

Vigilance t o Prevent Capital Flight

A good deal of black money leaves the country for a

safer haven abroad. Overinvoicing of imports and the under-
invoicing of exports is one way of ensuring a steady outflow -
and this is a ritual in which quite a bit of expertise is display-
ed by third world operators. Smuggling of currency is also
indulged in. Currency ''swapsW are also made with local people
resident abroad. All these avenues are resiponsihle for the
transfer of significant sums of currency abroad each year. If
the government were able to take steps to plug most if not
all of the avenues used to facilitate the flight of capital abroad,
then the frustration of the black money operators can be seen
t o be a blow - albeit not a body blow-against the well being
of the parallel economy. However, here too, there is a yawning
gap between the theoretical conception of the academician
and real world practical imperatives.

A lot can undoubtedly be done to plug the sensitive

areas that are systematically and regularly utilized for capital
The Pomllel economy an &enfew 201

flight abroad. Stringent check on the valuation of goods impor-

ted and exported is one such measure that if succcmfully
implemented could go a long way in curbing capital flight.
However this is easier said than done. Deficiencies in the ad-
ministrative resource base and lack of adequate technical
back-up) together with widespread corruption make it well
nigh impossible to put into play measures that could ef'fective-
ly plug the 1,eakpoints in this context.

Rationalizing the Tax Rate Structure

It is generally believed that a prohibitive rate of income

tax is at the root of much of the non reporting of income.
Well if the rate structure be indeed prohibitive then ofcourse
it could be an important reason for the non reporting - or
underreporting - of income. We ought t o recognize here that
what we are referring to is not "A" particular rate of tax but
a rate structure as it applies to gradations - or "slabs" - of
income. Again, it is usually a high "marginal" rate of tax -
i.e. the incremental increase that results from increasing
"levels" of income - that is pertinent. Thus within the progres-
sive rate structure it is the high marginal rate for the relatively
higher slabs that is normally perceived as a powerful deterrent
to the correct reporting of income.

Popular feeling notwithstanding, the fact of the matter

is that in Pakistan we do not have a prohibitive rate structure.
The highest marginal rate of tax currently is 45% - for personal
taxation. On the face of it this may appear to be prohibitively
high but when we take into account the eroding effect of the
host of deductions, allowances, tax credits, rebates, exemp-
tions - bath partial and total - , the real rate of tax is whittled
down significantly - and in quite a few cases, drastically.

Thus the real problem in Pakistan is not the prohibitive

tax rate :structure but the extreme narrowness of the tax base
that places the bulk of the country's population orltside the
ambit of taxability coupled with the fact that a weak tax admi-
nistration is unable to implement existing law effectively
making it relatively easy for any determined - and not so deter-
mined-tax evader t o get away with systematic and sustained
evasion. Given the poor ability of the fiscal authorities t o take
t n u ovndora tn tscL t h o honnfitc nf t n v nrmcinn hwnmn a11 tnn
202 Fiscal Imperatives in PaMstun 's Economic Deue>I~pnlent

real and a temptation not easy to resist.

An important factor why the common man is antagonistic

to "any" taxation of income is the apparent absence of any
'nexus' between the payment of tax and the receipt of a benefit
from the state. While various facilities - free public education,
good public transportation, medical care, social security,
unemployment benefits, etc. etc. are common in the developed
countries, these are either entirely lacking or elso available
nominally and that too for a minuscule segment of: the total
population. This has led many to accept as true that tlse go-
vernment provides no - or few - public facilities and thus for-
feits the right t o exact a tax levy on income.

What is stated above is ofcourse not wholly correct. While

it is indeed true that most third world governments are unable
to provide the same sort of public facilities that their counter-
parts in the developed world are accustomed t o providing for
their people, the fact remains that third world govts are saddled
with onerous responsibilities which the poor domestic resource
position does not permit them to discharge effect.ively. Ad-
ministration, justice (law and order) and nationid defence
eat up the bulk of the revenues generated domestically. Infact
one head of expenditure alone, defence, can consume ahnost
40% of the budget - in "real" terms - and may be even more!
Under these circumstances it is apparent that not much will
be left for providing the other facilities that are taken for
granted in the developed countries where ofcourse !;he resour-
ces at khe disposal of govt. are much higher. Still the fact
remains that providing a reaso~able defence establishment,
an administrative framework for the day-to-day running of
the country and police forces for law and order - which given
current trends is assuming serious dimensions-is no small
achievement. The fact that the common man is not iadeguately
aware of all that government does for him is actually indicative
of another problem altogether - a lack of "rapport" between
government and the people. This is probably a hangover from
colonial times when it was considered quite inconc~eivablefor
the govt. of the day to have the geneuine interest of the pub-
lic at heart.
'Ihus it is not fair to blame the tax rate structure for
widespread non-reporting of income. Infact even if the tax
The Pamllel economy an Overview 203

rate structure be relatively high, it does not necessaily follow

that non-reporting of income is inevitable. The experience in
the scandinavian countries clearly proves this observation. There
quite high rates of taxation have not led to widespread tax
evasisn. But then this is because tax administration there is
so effective and statutory cover is so comprehensi.we. There is
every reason to expect much reduced evasion in .third world
countries too if the necessary steps are taken t o remedy the
deficiencies in their administration and statutes.

Breaking the Power of Vested Interests

In Pakistan one reason why the parallel economy conti-

nues to grow is that effective legislation t o comprehensively
broaden the scope of the taxation of income is not forthcoming
thereby thwarting efforts t o enforce the reporting; of income.
As pointed out earlier, the reporting of all income is necessary
not only t o levy taxation correctly but also to rnonitor the
income stream flow in the economy. Such monitcring is vital
in the context of the formulation of meaningful po1ir:y measures
and macro projections and analysis of trends and the beha-
viour of key economic indicators.

It would not be easy t o deal with the vested groups in

any head-on clash as they are bound t o score over their anta-
gonists given their present clout through the accumulation of
considerable wealth and political power.

The foremost vested interest is the landed elite that

continues t o exercise a powerful influence on policy formula-
tion due largely t o its political power which is a necessary se-
quel t o the logic of their situation whereby they are strategi-
cally placed in the various political forums in the country
including ofcourse the parliament. It is not in the interest of
this elite t o permit the enactment of laws that viould erode
their pre eminent position. However it is not in the larger
national interest that any elite be invested with disproportion-
ate power as self interest then comes t o dominate and public
interest suffers as a necessary consequence. The initiative t o
break the power of vested interests cannot reasonably be expec-
ted t o emanate from government - for govt. is usually heavily
infested by those who support the vested interest. 'I'his follows
naturallv from the wlitical framework of democr;acv in deve-
204 Fiscal Impem rives In Pakistan's Economk' Dewlo[~?nenr

loping countries wherby power and influence gravitates towards

the privileged in society. This creates something of a dilemma
because if govt. is helpless then an assault on the power of the
privileged becomes that much more difficult. However govt.
always has the wherewithal and the duty t o create conditions
that would encourage enquiry and enlightened debate. The
spread of education and a policy of involving academia in a
consultative capacity t o policy making forums can create the
awareness that could ultimately lead t o the general awareness
that is a condition precedent to the initiation of measlrrea that
would ensure the true democratization of societ3 and break
up of the power of vested interests without which the design
of legislation is bound t o suffer from serious inherent defici-
encies.

Preemption Law

As already pointed out, a good part of the available black

money- is being sunk in red estate. Likewise, this area is also
generating black money. The principal device used t o camou-
flage the actual quantum of investment in real eszate transac-
tions is collusive under reporting of sale value. The deed of
sale executed is invariably for a fraction of the actlaal price
for which the sale has been made. Since both the buyer and
the seller are willing parties to the collusion, it becomes ex-
tremely difficult to establish subsequently, the f , x t of collu-
sive under reporting.

The Deptt. of Income Tax is alive t o this problem and

there are specific provisions in the Income Tax 'Law that are
designed t o take care of such a situation. However, since the
deed of sale when registered is a legal document, any attempt
to rebut the sale value reported therein has got ':o be backed
by hard evidence. Such evidence is extremely dxficult t o
come by. There are a few odd instances when the correct sale
price is reported in the deed of sale but since tkis is a rarity
the few isolated instances cannot become reference points in
the appraisal of collusive sale documents.

The sale price realized in open public auction also gives a

good idea of the actual market worth of land but since such
auction sale is restricted t o particular areas and particular
agencies it is not usually possible to make generalizations by
The Praal!er'economy on Overview 205

taking the auction sale rate as a basis. However notice is being

taken of such sales and attempts are being made t o establish
benchmarks on their basis.

The only practical solution however appears t o be enact-

ment of pre-ernption law which would permit govt.. t o acquire
property when the sale value is reported at a price in sharp
variance t o its true market worth. Such a law would go a long
way in making possible a practical solution in a very difficult
area.

Enhanced Survey and Inspection Powers for Iricome Tax

Authorities.

C:;rrent income tax law in Pakistan does not permit

income tax functionaries t o enter and inspect personal resi-
dential premises of tax defaulters and suspected tax evaders
and their authority is restricted only t o the inspection of
business premises and seizure of accounts and related docu-
mentation. Such obvious limitation of their authority hampers
considtrably any attempt at a meaningful investigation into
the affairs of those who indulge in activities that .result in the
generation of black money. It needs to be pointed out here
that a great deal of ostentatious display of riches, is made in
the personal residential premises of those who have access to
black money. Such luxuriously appointed residental premises
are no longer a rarity in the country. However the "tax perfor-
mance"of such nouveau riche is nothing short ol' a mockery
of the law. They either pay no tax at all or get awLy b y paying
a paltry sum. The system of universal self assessment is ex-
ploited t o the hilt in this context.

Strengthening of existing law with provisions that permit

entry and inspection should -go a long way in reducing the
difficulties that tax functionaries currently face in dealing
adequately with tax evaders. Ofcourse safeguards will have to
be incorporated t o ensure that the provisions are not misused.
However the risk of misuse notwithstanding, the benefits of the
enhanced capabilities that would be bestowed on income
tax functionaries so outweigh the negative aspects that there
can be no doubt of the necessity o f their enactment. Not only
would such laws go a long way in discouraging the brazen
rlicnlav nf r i ~ h t~hca t hac h n o n m o a l m n c t a n n m l in thic cw-
ment of the population but it would facilitate to a consider-
able extent the positive identification of those who have access
to black money o n a significant scale.

The enactment of legislation such has been described

above is hardly a novelty. Countries like India (among the
less developed) and the U.S.A. (among the developed) have
had such pteovisions in their Income Tax Law for a consider-
able period now and the experience has certainly been en-
couraging. lncome tax functionaries there have been known t o
go through residential premises item by item and even go so
far as to inspect, very closely, the personal wordrobe and other
personal effects of the subject of their enquiries. While it
cannot be said that the availability of such provisons on the
statute have completely controlled tax evasion it is certainly
correct that such provisions have had a salutary effect in en-
couraging the reporting of a much greater part of their incomes
than their counterparts in say Pakistan are accustomed to.
This k especially true ofcourse among celebrity people like
filmstars who everone knows enjoy fabulous incomes and
yet who report only a small part of their actual earnings;.

Looking t o the sociology of tax evasion,the deterrrent

effect of exposure would appear to be a threat that is taken
quite seriously by those who seek t o misreport earnings from
whatever activity they are engaged in. However it is only
when such exposure becomes a real possibility borne out by
the practical experience of those engaging in tax evasion, will
the efficacy of such laws becomes established. A persons
perception of the efficacy af a law is formed by the actual
effect that the law has on those whose activities it has been
designed t o control. Thus the theoretical or potential effi-
cacy is of little consequence. What matters is the 'actual effi-
cacy' of the law in practice.

Meaningful Economic Surveillance

Absence of any institutional arrangement to collect and

analyse economic data is a serious shortcoming in most third
world countries - and that includes Pakistan. Understandably,
data analysis is not a fashionable area of activity in developing
7hePomllel economy on Owndew 20 7

countries. It is also considered quite esoteric. The manpower

required in this specialized field is not readily available and
where available would prefer much more t o work for the
private sector where the rewards are considerably higher than
what the government, can offer. These deficiencies notwith-
Standing, it is not beyond the capabilities of the available man-
power to undertake meaningful data analysis-provided there
is a planned effort.

The necessity for economic surveillance arise!: from the

need t o exercise effective control over, and t o design appro-
priate policies for, activities that are considered prejudicial
to the larger national interest. Activities that emanate from the
black economy and further the expansion of the black economy
are the sort of activities that need t o be checked . and t o be
checked in time. However effective action is only possible
if the necessary information is available - and available in time.
F'resent,ly, the absence of a systematized arrangement t o gather
infornnation in this context is a serious stumbling 1:rlock. 'Thus
individuals with imagination - ar,d some connection:; - take full
advantage of the weaknesses inherent in the present anange-
ments. This is amply borne out by the brazen iictivities of
unauthorized finance companies that have successfully looted
thousands of people of vast sums by posing as 1:)onafide in-
vestors capable of paying them huge returns on their invest -
ment - returns as high as 10% per month!! The astonishing
thing is that their activities took .place in full public view.
Infact even public functionaries o n occasion participated in
the opening ceremonies of their "branches" thu:; bestowing
on them the credibility t!ley wanted. When the bi.lbb?e finally
burst in 1979 the "brains" behind this charade vanished leaving
the investigators with precious little t o pursue their investi-
gations. In 1988 again a "corneback'. so t o speak, was staged,
by floating finance companies anew in the full glaze of publi-
city. This time however, there appeared to be f:vidence that
they would not be able t o get away with everythijrlg as, though
again somewhat belatedly, countermeasures have been taken.

The activities of the finance companies referred to above

are black economy activities because the funds appropriated
are put t o use in enterprises whose finances are almost invari-
208 Fiscal Impemtl'ves in Pakistan's Economk: Development

cies like the Deptt. of Income Tax. If the necessary irlformation

about their activities had been gathered and analysed in time,
effective counteraction could have been put into p1a:y well
before real damage was caused.

Thus a number of different measures can be taken to

control the activities of the black economy and to prevent its
encroachment of the domain of the regular economy. The
authorities are not at all as helpless as would appea,r to be at
first sight. Given the will, action against black activities is not
only possible but also necessary if the cause of economic
developrr~entis not to receive setbacks by the revenue that the
exchequer is robbed of and by the necessary structu:ral change
that cannot take place due t o the diversion of funds and the
alternate non developmental use to which they are put..

Of all the measures listed above, the most important

would appear to be those linked to the taxation of income.
Specifically, there should be a comprehensive statutclry defini-
tion of income that would include all income, from whatever
source derived, - and with no except ionslexemp tions. Simul-
taneously, the reporting of such income must be matie nmanda-
tory and a data base must then be structured, computer based
preferably. A data matching program will then have to be deve-
loped to continuously match economic data - regarding cont-
ract income, imports made, interest received, etc etc - with the
data reported on the returns of income filed before the income
tax authorities. This ofcourse is no small undertaking but the
technology is available and the cost, though high, is certainly
not prohibitive and the returns from any investmenl made in
this context are bound t o be even higher. Also, it is imperative
that the cost of tax evasion be made perceptibly high. Penalties
must be made mandatory and must include imprisonment
where concealment is proved and shown t o be deliberate. Simi-
larly, tax defaulters must be dealt with strictly and coercive
methods used to enforce recovery of outstanding dues.

The general strengthening of the income tax base must

be complemented with measures to prevent capital flight
through the underinvoicing of exports and overinvsicing of
imports.

Areas of economic activity like real estate that absorb

The Pamllel economy cn Overview 209

huge funds and where the declared version varies niarkedly

from the actual version must receive special attention and the
enactment of pre emption laws seriously considered.
There is no doubt that once a concerted effort is made
the activities of the black economy can be effectively checked
and kept within permissible limits.
Appraising the size of the Parallel Economy

How big is the parallel economy? This is a question that

has perplexed economists a good deal. Both in Pakistan and
India the dimensions of this hidden sector are now considered
t o be considerable enough t o be a cause for serious wony. Some
estimates indicate that it is already 50%of the G.N.P. The total
quantum of black wealth is postulated at Rs. 180 Billion
in the N.T.R.C. Report 1987. These are staggering statistics
indeed and highlight the tremendous growth in this area in
recent years.

Looking to the constraints imposed by an acute lack of

itemized data it should be quite obvious that any attempt to
pre~iselyquantify the size of the parallel economy is I~oundto
be futile. However generalizations can certainly be n a d e and
depending on the methodology adopted, such generalizations
can be more or less accurate enough t o be of practical use.

One approach in this context is linked t o s quantification

of the total 'volume' of financial transactions in the It!conomy
in a given period and then relating the same t o the official
income. Such comparison made over different time frames
can then indicate a 'changing relationship' between the volurne
of financial transactions and the official income which would,
hopefully, give clues as t o the size of the parallel economy.

The total value of financial transactions is calculated by

taking the total amount of cash in circulation as well as the
amount of "bank liquidities" (payments by cheques, money
transfers from one bank t o another and balances on dernand
deposits) and then multiplying each by its respective "velocity"
(the number of times it changes hands each year). Conipar-
ing the same over two different time spans will indicate the
growth in the volume of financial transactions vis a vis the
official income. The volume of financial transactions vis a vis
210 Fbml Jmpemrlves in Pakistan 's Economic Dtwloy~rnent

the official income will indicate the size of the parallel economy
because studies show that a rather stable relationship exists
between the volume of financial transactions and official in-
come - given the velocity of money. Thus an increase in the
ratio (between the money involved in financial traxksa~t~ions
and the national income) over time, in the absence of any
other plausible causitive factor, would indicate the existence
of the irregular - parallel - economy whose operatiorls would
involve the use of money just as the operations in the regular
economy would.

Edgar L. Feige has used this technique t o appraise the size

of the irregular economy in the USA ("How big is the irregular
economy?" Challenge, NovDec. 1979). His studies indicate
that in 1939 the ratio between the volume of financial tran-
sactions and the national inconie stood at 10:30.As his studies
also indicate that a rather stable relationship exists between the
volume of financial transactions in the economy and, the offi-
cial incon~e(i.e. the G.N.P.) then on the basis of such a11 assump-
tion such a ratio (more or less) should also hold good in subse-
quent years unless ofcourse some other factor is operative in
the subsequent period that was not present in the base year.
This 'other' factor,% the 'irregular' parallel economy.
The comparisons made by Feige using the met,hodology
described above indicate that 19% and 27% of the entire U.S.
economy was accounted for by the unofficial economy in
1976 and 1978 respectively. The economic transactions in the
unofficial economy amounted to nearly 22% and 33% respec-
tively, of the calculated gross national product in 1976 and
1978. Furthermore, the data indicated that the unofficial
economy increased from 1976 to 1978 by as much as 91%
while the official national income increased by 23% in the same
period.

Economics of the Black Market

The basis for a black market is laid when the price ob-
taining in the market place is significantly lower than the
equilibrium priceie.the price dictated by the forces of demand
and supply. Such a price is always arbitrarily determined and
enforced by government. The available supply is tBius quickly
cleared at the artifically low price and a shortage situation
The Pamlkl economy an Overview 21 1

results. The "black market" crops up t o meet this shortage -

and the price demanded in this black market is the equilbrium
price which the government ignored when setting arbitrarily
the original price. Thus there is nothing inherently wrong with
a black market. It is a market which is the outcome of the
play of economic forces. That black marketeers are always
seen as criminals is because the people who operate this mar-
ket are acting in violation of the law which requires that the
product in which the black marketeers are dealing l ~ sold
e at a
given low price. Thus PI.(Fig-1) is the maximum legal price that
is set by order of government. At this price the quantity de-
manded far outstrips the quantity supplied. A shortage thus
results indicated by QB - Q e on the o x axis of the graph.
With such shortage obtaining at price P1 a black market can be
created to cater to the unsatisfied demand that results from the
fact that the legal price has perforce cleared the market of
available supplies leaving a large number of buyers stranded.
On the graph the demand remaining unsatisfied in the official
(legal) market can be plotted by subtracting distance Q1 from
the original demand curve Do-Do at each price (fig-2) D l
D l is then the demand for the producer on tlie black market.

Likewise, the black market supply curve may be plotted

by subtracting from SO-SO at each price, the quantity Q 1
which has already been supplied in the legal market. (fig.3).

Silnplifying assumptions that underlie the construction of

the demand and supply schedules above are that no potential
buyer refuses to make use of the black market for any reason
(say fear of legal action). Similarly, no supplier is m u m e d to
be deterred from supplying the needed quantities om the black
market inspite of the fact that the legal price is given.

Given the above assumptions both the black market

demand and supply curves will lie t o the left of the original
demand and supply curves by the distance Q1. Their inter-
section will take place at a price equal t o the pre-ceiling equili-
bruim Pe and at a quantity QB, equal to the pre ceiling equili-
brium quantity minus Q1. Thus under the assumptions given
above, QB units of the product will be sold in the black mar-
ket at price Pe - i e . the original equilibrium price. (Fig-l).
 FLPcal Im~erallwsin Paklston 'r E c o n o ~ ~ rDevelopment
fc

Fig. 1

Y
Price I

Fig. 3

Fig. 2
 14
The economics of inflation

The phenomena of rising prices in unique for iits ubi-

quitousness on the economic landscape. Economies placed at all
segments of the spectrum of economic development are subject
t o its visitation. And it affects the entire population-in varying
degrees ofcourse. It would not however be correct t o portray
it as the scourge that it is made out t o be. To be true it is not a
circumstance that can make the general public happy. At the
same time, given the realities of economic life, it is inevitable.
And it is controllable-within limits.

Any rise in prices is inflation. Since in the market econo-

my with which we are familiar in the free world-a term used for
purposes of distinction from the regimented command ecano-
mies of the communist bloc of countries-price is determined at
the equilibrium point where demand for goods (and services)
equals supply. It follows that price will change whenever the
parameters that influence demand and/or supply change. When
demand rises and supply remains constant-or increases less than
the increase in demand-then price will increase. It is only when
the increase in demand is matched by a proportionate increase
in supply with no significant time lag will price remain constant.

In the real world demand for goods and services is expres

sed through the monetary outlay that people are wiling t o
make for them. The money supply in circulation now becomes
an important determinant of the level of prices. The equili-
brium level is'not a static phenomena. Because it is dynamic
therefore it is not the static money supply that is of Interest,
 214 Fiscal Irnpemthes in Pakistan :r Eronornlc Development

but rather the way in which money chases available goods and
services that is of interest i.e. the velocity of circulation of
money. The equilib level of price at a given point in time is
consistent with a given velocity of circu1at;ion of the money
i supply in the economy in that time frame.

Besides the notes and coins issued by the Central Bank

money is also created through conscious decision when the
central government decides to print more money for its use and
when the commercial banks issue money after granting credit
facilities to their clients. While all money is backed by some
assets (gold, securities, hard currency reserves etc.) the require-
ment of adequate collateral may not be as rigorous when the
commercial banks "create" money. Even the central bank may
not actually ensure at all times 100%back-up for the money it
issues. However it should be noted that there is no hard and fast
rule for the back-up requirement. It is there simply t o ensure
that there obtains a rational reference point in the context of
money in circulation be enough to match, roughly, the demand
money in circulation be enough t o match roughly the demand
for goods and services which this money is used t o satisfy, given
a velocity of circulation i.e. the rate at which money changes
hands. Should this velocity change the same amount of money
that sustained a given price level may not in the altered velocity
state be able to ensure that prices keep their existing level and
prices could rise or fall depending on whether the velocity had
increased or decreased.

On the basis of all that has been saicl above it would be

apparent that a stable equilibrium level for prices is very rare
and would not be established for any significant length of time.
This is so because it is well nigh impossible for any authority
be it a government agency or an independent authority t o en-
sure a precise balance between money supply and the transac-
.
tions demand in the economy So diverse is the requirement t o
fund transactions in the economy and so many different types
of consumers are there for various goods and services that it is
just not humanly possible t o establish an exact balance. And if
somehow it were possible t o establish such a balance it would
not last for very long. Human nature being fickle as it is there
can be no constancy in demandAstate of flux is thus inevitable.

Given the scenario outlined above, the challenge for the

The economics of !nflatim 215

concerned authorities is t o keep money supply at a level con-

sistent with a stabilized equilibrium level of prices. As has been
made clear however, this is by no means an easy task. Even
taking into account aggregate parameters it is no simple matter
t o postulate what the equilibrium level requirement is and
there are many complicating factors. The existence of a large
parallel economy is one such factor as data regrading the
operation of this sector is scanty-or may not be available at
all-it adds immeasurably t o the problems of authorities to
guess with any degree of exactitude what the requirements of
this sector are. Also, the Government itself, especially in third
world countries with little or no access t o high denland natural
resources, is almost always hard pressed for cash and the temp-
tation to resort t o inflationary financing and deficit financing-
the two are not synonymous- is strong. This by itself is
apowerful source of infationery pressure as vast quantities of
cash printed by decree creates the well known enigma of too
much cash chasing too few goods setting the stage for the
classic situation of inflation.

It is not always easy t o identify precisely which factor, or

set of factors, is responsible for inflation. The so cdlled moneta-
ry factors, ie those related to factors that flow from the official
conduct of monetary policy, are the most obvious and most
easily emphasised.

The transaction demand for liquidity sectorally emanates

from each of the various sectors in the economy ie agriculture,
industry, commerce, service, construction etc. constraints of
data availability make it practically impossible t o make any
accurate assessment of the ieed for cash in each of these sec-
tors. Only educated guesses can be made and that too in very
broad ranges on an aggregate basis and ofcourse there is the
requirement of the parallel economy which may not figure
correctly in the statistics re!evant to the regular economy.

The degree of control exercised by the central bank

should not however be overestimated. The level at which the
bank rate is pitched is ofcourse an important and very real
influence. However apart from that the issue of credit by the
commercial banks cannot be possibly fully controlled and it
is mainly through moral suasion- besides the margin require-
ments- that the central bank can expect t o achieve results.
 Fisml Impemtives in Pakistan s' Economlc Dewlopnlent

It should not be forgotten that the commercial banks are

motivated by a desire to make profits just as any other business
would be. This they do by investing the deposits of customers
i.e. savings accounts and fixed deposit accounts and by earning
interest on 'mounts advanced. Advances are ofcourse required
to be secured by adequate collateral but only too often this
requirement is not fully observed and banks have tfo face the
prospect of declaring a loan to be bad. The important point
here ofcourse is that every time a loan is advanced the bank
is in effect pumping that much liquidity in the money stream
circulating in the economy since it is only fair to assume that
the newly acquired liquidity will be put to use by the debtor
without an appreciable time lag and will not be kept sterile-
as would be the case if the money received were hoarded.
But then it is hardly reasonable to assume that such money
available will be hoarded and not put to actual use since a
charge (interest) arises for the time the loan remains with the
debtor and which charge is extinguished only when the loan
is paid back in full.

Now that we know that inflation is inevitable given the

existing format of the economy we would alm acknowledge
that when it is within acceptable limits, it is also normal. It
would be idealistic and not realistic t o expect that there be no
inflation at all. Clearly however the important aspect here is
the reasonableness of the price rise. This again is a tricky area
and it is not easy to specify what the reasonable limit is and
what appears to be reasonable in one set of circumstances might
not be considered so in another. We will come to that later.

If we ponder over what has been said in the preceding

sections, it should also become evident that inflation is a neces-
sary companion to economic development. Excecution of
development programs entails significant expenditure of funds.
This again means that liquidity is ineffect being pumped into
the economy. Ofcourse the pumping in of liquidity is expected
t o result ultimately in increased physical output in the eco-
nomy, directly or indirectly-so long as the funds expended are
for development activity. Non development expenditure is not
matched with the expectation that there will be a-reverse flow
of output.

While inflationary pressure is present both when expendi-

The economics of infhtlon 21 7

ture is developmental and when it is not so, the mitigating

factor in the case of develop expenditure is that the pressure is
expected t o be offset when additional output becomes
available because the money stream will then be directed
against an increased quantity of goods. Of course there is a wait-
ing period involved and it is the length of this period that will
determine t o a large extent the course of the inflation. The
longer this gestation period the more problematic it will be in
terms of worsening existing inflation.

While the potential is much greater when expenditure is

non developmental it would be overly simple t o assume that all
non development expenditure is neccessarily inflationary t o the
full extent of the expenditure incurred. It must not be forgot-
ten that the total output in a sector cannot possibly be taken
up--purchased-in its entirety by the manpower employed
therein. Thus it is the people placed in the rest of the economy
that must have the purchasing power to absorb the remaining
part. The adequacy of this purchasing power is crucial if effec-
tive demand in the economy is to ensure that full employment
of resources. Thus while non development expenditure so called
may not result in physical output of goods it does not follow
that it has got to be purely inflationary. Infact it will not be in-
flationary at all if the production in the econc)my is present in
adequate quantity so that the money stream is just sufficient
t o lift this output. The problems associated with inflation arise
when the money stream is more than adequate to lift the entire
output and a sizable surplus is evident. It is this surplus that
exerts the most harmful form of inflationary pressure and is
responsible for the worst interference with the adjustment
mechanisms of the market economy with which we are most
familiar.

On a purely monetary plane therefore inflation in the

sense o f a sustained rise in the price level results not from the
injection of liquidity per se in the econoniy but from such
injection of liquidity that is in excess of the requirements that
would lead to full employment of resources,, The monetarists
emphasise this aspect as being of prime signif'icance in explain-
ing the course of inflation in the economy.

In the world view of the monetarist therefore, the quantity

of .money per se is of overiding significance in explaining the
21 8 Flsal Impemllres In Pakistun 'S Economic Development

development of an inflationary situation - and its subsequent

course in the conomy. To be sure the velocity of circulation and
the availability of credit are also releavant factors the inclusion
of which changes quite drastically the complexior, of the classi-
cal pure quantity theory of money but the fact remains that for
the monetarists it is the quantity of money as such that is iden-
tified as the villain of the piece in inflation and it would not be
considered advisable to look t o other factors that could have a
bearing in explaining the nature and course of inflation.

If the monetarists are correct then control of the quantity

of money in circulation (cash and the availability of credit)
should suffice in putting an end to the bogey of inflation and
whenever there exists inflationary pressure in the economy as
manifested through a sustained rise in prices then this is; an
indication that the quantity of money has exceeded by a wide
margin the safe limit visavis the total availability of goods and
services in the economy and the trasactions demand for them.
The obvious solution would be to take steps t o mop up the
excess supply of money through central bank intervention and
t o put a brake to any inflationary financing by Government
that might have already taken place or was being actively
contemplated.

We all know now that exclusive emphasis on the supply of

money is too simplistic an explanation of the nature of infla-
Ition. It would have been all for the better if it were indeed true
that this was infact the case for then the solution to the prob-
lem though not exactly easy would at the same time also not
be s o problematic and difficult as it is in real life situations-
especially in third world countries.

Almost as a reaction t o the glib explanation of the moneta-

rists an alternate school - if one could describle it so-emphasis
with just as much certainty, the significance of so called struc-
tural factors in provoking and maintaining inflationary pressure.

Rather than emphasise money supply the structuralists

emphasis, as the name would appear to indicate, the very nature
of the structure of an economy as having paramount significan-
ce in initiating inflation and in ensuring its continuity. Now the
structure of an economy ;includes its sectoral composition and
the linkages within a sector and between sectors: Aberrations in
The econinnlcr of lnfbtlon 219

the structural arrangement are cited as being primarily responsi-

ble for instigating inflation.

As far as technical sophistication goes, the axgument of the

structuralists appears t o be an improvement - -to some even a
considerable improvement, over the monetarists point of view.

The common view is that inflation is a generalized pheno-

mena and the entire economy is so afflicted when inflation
strikes However if we focus on the structural aspect, inflation
can be seen as taking root in one sector or segment of the
economy, or even in a number of different trouble spots, and
then spreading like a virulent contagion across the full expanse
of the economy. When so localized , as it were, factors peculiar
to a particular area of the economy can be relevant. Thus cost
push factors in a broad range of the manufactoring sector by
forcing price markups can instigate inflation - ignite the fires
of inflation. If the play of forces takes on the garb of a circular
constellation, self sustaining and repititive, (such as can happen
if say a wage rise provokes a price rise and if wages are indexed
to the general price level then this could cause a second round
of wage hikes which in turn can provoke a further price escala-
tion which in time would cause wages to rise and so the cycle
would repeat itself till a sustained price rise became inevitable
given the unique logic of the situation) then we have the basis
for self reinforcing inflation.

Now the reason that inflation instigated in one area of the

economy will spread out t o the other areas is because of the
synchronousness of the intra and inter sectoral linkages. There
is a continous give and take between various ,segments of the
economy and this passes o n the seeds of inflation which then
take root whence they are transplanted.

Abnormal demand pull is just as capable of instigating

inflation as cost push factors. Because supply is unable t o
respond immediately t o escalating demand a price rise becomes
inevitable . An effort t o meet the rising demand provokes
investment in production capability. The increased wages dis-
bursed add t o purchasing power and so further fuel inflation.

While inflation usually occurs concomitanbly with

220 Fiscal Impero Hvcs in Pakistan 's Economic D m l o p m e t ~r

economic development, it is also a fact noticed in the post-

1960's that inflation need not always accompany grc~wth-
infact, and especially in the more developed economies, infla-
tion and long run stagnation (rather than growth) have been
found t o be the enigmatic duality. This has debunked the pop1.1-
larly accepted notion that inflation accompanies growth-whic h
thesis had made it somewhat fashionable almost t o not only
tolerate but t o actually approve of some inflation as a ponter
that growth is infact taking place. Ofcourse this was never t.aken
t o be an approval of obviously serious economic maladies like
galloping and hyperinflation such as afflicted many economies
in the post world war 1period. What we were talking about
here was single digit and initial double digit inflation only.

The phenomena of 'secular stagnation' baffled economists

for a while as it was something new on the economic scent?,
However the presence of inflation with stagnation is sympto-
matic of the fact that new investment -physical investmc?nt in
plant and machinery - is deficient. One indication as t o the
nature of the problem would be the fact that the interest rate
having been pitched a t discouraging levels deters much of the
new investment necessary t o keep t h e growth process going. At
the same time the fires of inflation are fueled by a growing
Government deficit that forces deficit financing and which is
unable t o coax increased output because of stagnation leading
inevitably t o an upward pressure on prices.

In a developing economy structural peculiarities compli-

cate the problems that inflation poses. For one thing, most
third world countries have a fairly large non monetized sector.
The ability of t h e central bank t o take regulatory i~ctioln
through intervention in the market is limited by this anc,maly,
Furthermore, increasing Government deficits coupled with
rigidities in resource mobilization frequently necessitate deficit
and even inflationary financing. As output is not respcsnsive
the upward pressure on prices grows and over time feeds on
itself.

The emergence of a government deficit is symptomatic of

the fact that government revenues fall short of its expenditures.
Now an individual placed in a similar position would endeavour
to meet the situation b y borrowing. That would resolve the
matter for the present. In the long run however, a better solu-
 TABLE 1 2 .
MONEY AND INTEREST RATE IN SELECTED T H I R D WORLD COUNTRIES AND T H E NIC'S

MONETARY HOLDINGS AVFRAGE INTEREST RATE

BROADLY D E F I N L D ANNUAL
INFLATION
-- - -- - -. - - - ---

country A H I ~ C8nnU.l n o n d n d (iUP Nomllul intercat rste ol mnka

g m v l h rate 'h inflator average annual 9. -- I m d h r a t e

PAKISTAN

NIGERIA

BANGLADESH

INDONESIA

INDIA

PHlLLlPlNES

THAII.AN0

TURKEY

EGYPT

s. K O R E A *
SINGAPORE'

b u l r ~ 1 H n r k i Rank. World Urvelopnlrnt R r p l r t 1987. 2 : G o w r n m e n t of P&b%nn.Emnonde S-y. 188667

- In a mixer1 ,.r ~ n o r n vo f the quad rapltllirt format. the h t e r c s t rnte Is s key " r ~ p u l s t o r " o f r c o n o n d e sctlvlty. Whne t h e (central) B m *
R.1. sets the t r m r for the b l r r q s t rate rtyuctrup tn t h e "format" econotny, depomt m d l e n d l w rnter tmudlv w r y . T h e ~ c ~ . t e a ~ U s b l U t y o f

.:!?.it .:iii.~i..: :?IF "

,'lornahlr fctnrls ' i n the e r n n o m y and t h c d r m s n d f o r tc same. determines. b r o s d l y , w h e t~h e I n ? ~ r a rate
r..;h !nan:L!; k n d s 'r ~r.cr?ec* t h e e .
( nmnurr wUI rrtsblish Itself. G o w r n -
t! b dyniflrlm arvf rldw o v n t l m r . It would mean Ln r t l r r t t b t the g o w r n m r n t
will ti? . ' c t > m ~ , ~ u't aql t h t h e other are.$ In t h e rronorny b o m such rlcmand emanatel. This "enmprtctlon* msu h r rpaolvra In t h e governmen1
favnor !I thr rrta. r r I Inter?* offered b y t b c # o v r r n m n t an t h e loan bsues floated b b h m o w h . Thru w h r r r g o w r n m m t d e m a n d f n r loanablc
.,.-a -.i :'r :r~ul.7ri?
s.. r!?c!!ed 11 :--$ thst a r e ahnormallp *h. t h e r a t e o f !nr.erel b bo.3-d t o hr hid up. Because of s "svnchrotmnrss" Ln the
c o m m n c i l l I!ncrr.s( rste R n l c t l a e . the general c a m m m d d h t c r r s t rste rormst b Ukelv t o be d f c c t e d . I l h l m t r l v . rlsirg brtmest rat- w U
damper, r.curll,rrnlr a c t i d t ~b, ~ n a k i n pcredit " c r p m s l w . " The ?rroR !mpn*an! arn t o mffrr would b e u h l a t~a t i o n " "heavy flnmclng"
prolema much m U P t y p i r d l y Lnvulved in r c o m m i e d e w h p m e n t v i r " l n l n rtructurr" components. h a e l n d u t r i a l m t r r p r l z m pLy) become
u n s t t r a n l \ r ~ n w * m c n b ~ C C I U P o f t h e hl#h "cost" o f m a h k m r h m w s t m n l --Inter& c h m s n b e l n l .n ImportmTI p u t o f such cort. O p r r a -
t l o w o f th* ltll,,rrnol "Parlnel eronorny" a h h a w t h e patentlrl t o .'d.stabM?e" the l n t ~ r w nt t c *uehlrc.e.
222 Fiscal Impemhes in Pakistan's Economic Development

tion would be t o increase revenues and/or t o decrease expendi-

tures. Failure t o do so would entail repititive borrowing and
that would ofcourse mean that the burden of debt would keep
on rising.

The position of government is analogous t o that of an

individual whose expenditure exceeds his earnings. The govern-
ment can however do something which the individual 'cannot-
the government can print currency for its use. Ofcourse its
powers in law in this area are strictly speaking, not unlimited
but Government's especially in third world countries, often
find, a way of getting around the legal impediments. When
government's do so then we have an inflationary financing of
the deficit. The effect of such additional currency printed and
injected into the economy is t o bid up prices as a higher abso-
lute amount of cash is chasing the unchanged output. Ob-
viously therefore, this is an undesirable form of financing the
deficit.

When we talk of deficit financing we do not ne~cessarily

mean inflationary financing of the budget through printing
o f currency. However in the public mind that is the image that
is evoked most often when mention is made of deficit financing.
And that has conditioned the public at large t o view the very
idea of deficit financ'ing with extreme disfavor. In actual fact,
deficit financing means a range of policy options most o~fwhich
are valid means of facing up t o a problem that will not vanish
by ignoring it. This is not t o say that a deficit is a desirable
thing o r that once there, it can be ignored.

So long as. government restricts itself t o obtaining loans

from the public by floating debentures, the government is
actually mopping up savings of the public. The government is
thus tapping the existing resource stream in the economy.
However such mopping up has a cost - t h e interest that govern-
ment must guarantee before the public would be willing t o
part with its savings. This has got to be a high enough return
otherwise people would not find the prospect of giving their
money attractive. From this it is apparent that the government
has t o compete with other areas in the economy that are will-
ing t o pay for use of the publics money. This competetion
necessarily exerts an upward pressure on interest rates and if
government. indulges in this exercise often the upward pressure
The economics of !nf7adm 223

will provoke a significant escalation in interest rates as it would

become more and more difficult for government to persuade
the public t o part with its savings and it is only by making it
attractive would such parting be possible - that ofcourse would
mean a high enough rate of return.

This bidding up of interest rates is without doubt an

ominous development. Not only does it increase the cost of
financing the Government deficit, it adds t o the cost of obtain-
ing finance for any kind of activity as it will eventually bid up
inevitably the bank rate of interest and therby set the tone for
interest rates in general in the economy. This means that
projects requiring significant funding, typically public utility
investments and infra structure development, w o ~ ~ lbecome
d
that much costlier now especially where the gestation period is
extended. This would thus become an argument against under-
taking such ventures Considering their pressing need, the cause
of economic development would thus go by default and give a
boost t o anti growth factors thus hindering and slowing down
ing economy can ill afford if it is to be ever able to counter the
anti growth factors and come up with meaningful, effective
growth.

It follows from what is stated above that defivit financing

and inflation do not necessarily and inevitably follow in that
order. Inflation is much more likely when large scale infla-
tionary financing is resorted to. That however is not typical.
More typical is government borrowing from the public. How-
ever when such borrowing assumes a repititive pattern an up-
ward pressure on interest rates is the really worrisome develop:
ment as this can ultimately dampen investment in infra struc-
ture and public utilities.

The art of effective monetary management rs to balance

measures taken t o curb inflation with concomitant action t o
ensure that interest rate escalation does not take place. .This is
not always easy. A reduced money supply will serve t o quench
inflationery pressure but it can also bid up interest rates. The
liquidity preference of the public at the escalated interest
rate would be less and it would be willing t o make its savings
available for deployment in the economy. At the same time
the high interest rate would curb investment in long gestation
heavy financing projects such as are most needed in economi&
224 Fisarl Impemtiws in Pakistan 's Econoniic Developmet~r

development. Increasing money suply would reduce the interest

rate but this would also increase liquidity preference. It would
then become that much more difficult t o secure finance for
implementation of development projects. The trick therefore
is to find that optimum point where both interest rate and
money supply are ideal for economic development.

Serious Inflation is undesirable for a number of reasons:

The most obvious is that the erosion in the value of money

creates an additional burden for all especially for the fixed
income groups who are unable t o raise extra funds t o match
the price increase. The underprivileged in society are the hardest
hit in such inflation and this has implications that bode ill
for social stability.

In the market economy system, prices influence resource

allocation. Resources flow towards those areas where the r e
turns are maximized. In inflationary situations, long gestation,
high finance investment areas lose out t o shorter duration con-
sumer goods investment where the requirements olf finance are
much less. This means that investment in areas connected with
infra structure development and public utilities will lag behind
in the matter of attracting funds. The economic landscape will
instead be dotted with a plethora of consumer g ~ o d sprojects
of dubious value in furthering the future development of the
economy. Failure of reproductive capability t o talie root in the
econoiny is a serious deficiency and inhibits the institutionaliza-
tion of the growth process.

Serious inflation can wipe out household savings especially

for the fixed income groups. The diminution of the savings
pool in the economy hampers investment as more and more
cash is used up t o fund purchases of essential item supplies.

Inflation exacerbates problems posed by the government

deficit. In an inflationary stuation it becomes increasingly
difficult for government t o reduce expenditures. Sirnul-
taneously, government outlays increase as defence establish-
ment outlays and other non development expenditures register
sharp jumps. The indebtedness of Government is thus bound t o
increase and the need t o secure additional funding in an in-
flationary situation will create pressures for escalation of the
The economics of infition 225

rate of interest so as to ensure that a sufficient incentive obtains

for people t o part with funds that could be needed elsewhere in
their day t o day requirement. Pitching the interest rate at too
high a level will create a whole set of different problems that
have been dealt with in the above sections.

Inflation gives a boost t o t h e operations in t,he parallel

economy especially in the black, illegal segment. Prcomotion of
such operations militates against the imperatives of genuine
development of the economy in a long term perspel-tive espec-
cially with regard t o development of infra structure and the
acquisition of reproductive capability.

Inflation thus accelerates the encroachment of the parallel

economy over the sphere of the regular economy. Over time
therefore there develops a possibility that the fiscal jurisdiction
of Government will actually diminish which has sel-ious repur-
cussions for resource mobilization and for regulatory control by
government agencies.

Inflation reduces the competetiveness of a country's goods

in the international market for the simple reason that they now
cost more. Reduced export earnings can dramatically affect the
resources of hand currency.

Inflation erodes social values and corrodes the fabric

of soceiety.

Inflation influences adversely the security perception

of the populace. . It can thus provoke responses that are exag-
gerated and whimsical and even aberrant. These can, destabilize
financial markets by causing a run on stocks necessitating large
scale intervention by the central bank through support opera-
tions involving funneling large scale funds into credit markets t o
maintain their credibility and for preventing a run of banks. In
the market economy psychological factors are crucial and it is
imperative that no development be permitted t o talie root that
can heighten tension and stress.

Inflation is a symption that the economy is not faring well

and this affects the aid climate adversely.
226 Fiscal Impemttves In PaMstan S Economic dew lop men^

capital. The private investor is bound to be discouraged by the

prospect of continueing inflation which will eat into his profit
margins by escalating costs.

Inflation, by provoking structural disturbances in the

economy is potentially capable of sowing the seeds of unem-
ployment.
 Part I1
THE ECONOMICS OF
GROWTH

Some important lessons drawn from the

historical experiences of nations.

t h e agony of the Past.

 Patterns of economic development followed
by the developed countries of today need
not be valid for all tinies and all countries.

Todate all the developed countries of the so called "free

world" have relied heavily on international trade to promote
the development of their industry by ensuring markets for their
large scale standardized production. Good prices for finished
manufactures made possible the generation of large "st~rpluses"
which by boosting savings have provoked investrr~ent and
thereby made possible the structural diversification of the
economy with growth eventually becoming institutionalized
without the use of extraneous "props" (like foreign asistance).
As a developed country moved higher up in the development
scale it began t o focus more on such manufactures that entailed
the employment of more and more "roundabout niethods"
leaving the relatively rudimentary manufactures t o the newer
entrants.

One of the reasons that the system outlined above yielded

good results was because of the multilateral tradinl; system
that enabled all who displayed a capacity t o participate
meaningfully t o become trading partners o n more or less ~tqual
terms. Such resilience in the system made meaningful partici-
pation a distinct possibility.

Since the end of world war two the multilateral trading

system has been gradually eroded and a crisis of international
liquidity has been instrumental in directing trade more and
more into bilateral channels. For the developing countries this
li ' 230 Fiscal Impemtives in Pakistan 's Economic Dewlopmen t
,I
'I
opted for the (so called) free economy fonnat in structuring
their economy have felt frustrated in being unable t o duplicate
the performance of those among the developed country c a t e
gory that they have sought t o emulate. They have thus been
forced to rely on the export of primary commodities to gene-
rate foreign exchange and where this has not been possible - as
when the developing country is not gifted with high value
mineral wealth (such as oil, copper, bauxite etc)--the only
alternate has been t o attempt t o secure loans from both institu-
tional and non institutional sources-within and without the
country, expecially the latter. This has not always been easy
and even where the attempt has met with success has created
serious problems of its own.

Another factor of significance for the heavily populated

underdeveloped country is that initial levels of literacy are
extremely low. This aspect has ramifications that may not be
immediately obvious. Not only is it difficult to instil basic
technical skills in an illiterate populace but it is also problema-
tic t o motivate therr and t o make them aware of "the national
interest." As most developing countries have had a turbulent
colcnial past it is not at all a simple matter for the largely illi-
terate people t o relate t o government and the administration.
This makes their participation in a broadbased developmental
effort very questionable. Problems like rampant tax evasion,
unbridled growth of the parallel economy, corruption. etc. all
ensue from what may be called a perverse sxiological base. Re-
medial measures can-and are being taken-but complications
arise as most developing countries of the free world have
opted for 'testminister style democracy" and the mixed capi-
talist economy based on a free market. However, illiteracy,
severe resource constraints and gross defnciencies and imper-
fections in the economic infrastructure and the format of the
market make inefficiency inevitable. The huge impoverished,
illiterate population forms a poor market and its members
make poor entrepreneurs. Gross inequities in the distribution
of wealth create cleavages and schisms that have ominous social
and economic implications. In short the antigrowth factors in
the given situation are so awesome that they simply d o not
compare with the problems that confronted the present day
developed countries as they evolved t o their current developed
state. The latest crop of developed countries in asia, south
korea, singapore and taiwan-also did not have t o face problems
 The 'world bank'. d d f l e a t b n o f c o u n t d r b y t n d e o r l e n t a t b n h u l o b w a :

P a d o d : 1063-7 S-

1. !jTRONGLY OUTWARD ORIENTED

2. MODERATELY OUTWARD ORIENTED

Brazil. ~ m e m CRo I w b h . Costa Rlca. C o t c d ' I w h c . Gutemel.. Indon- btrael . MplSyl4 T b i L D d

3. MODERATELY INWARD ORIENTED

BOLIVIA, E l S . h d o r . H o n d u n k Kanya. M . d . p a o n , M e d m . Nl-uu.. Nlgd., Phnlpplncs. S n e g d . TunMa. Yw0.L. da.

4. STRONGLY INWARD O'RIENTED

-ARGENTINA. BANGLADESH. 0URUNDI.ClULE. DOMINICAN REPUBLIC. ETHIOPIA. GHANA. INDIA. PAKISTAN. PERU. S R I LANKA. SUDAN.
TANZANIA. TURKEY. URUGUAY. ZAMBIA.
IN T H E PERIOD 1973-86 T H E FOLLOWING CHANGES ARE CITED

CAMEROON. COLUMBIA. COSTA RICA. COTE D'IVOIRE. GUATEMALA h INDONESIA A R E PI.ACED I N T H E MODERATELY INWARD ORIENTED
CATEGORY.

PAKISTAN.URUGUAYMOVEr0 T H E MODERATELY INWARD ORIENTED CATEGORY.

MADAGASCAR AND NIGERIA A R E NEW ENTRANTS IN THE STRONGLY INWARD ORIENTED CATEGORY.

C o u d r k s t h d move .way t m m ul " l n w u d o r c h t b l o n " t 0 a morc outward o r * n t a t b n haw bccn able t o mmctrue poltdea th.t c r m t e . blu towmrd p o d u c t b n
f o r t h e e x p o d m l d r e t m t h e r th.n t h e d a m s t l c mmket.

.
' E x p o d I d ' w w t h b u bccn t y p l u l lor t h e r r a r n t &Y d m n d c o u n t r l n o f t h e h c c wodd- lncludlry t h e newly !ndlYPlalJ.Ud~c o u n t d o ( t b N.I.CI.).
H o w m r t b c a n d w l .=roalonol t h e m u l t l l a t d t r d i q m t e m h u dkecied m o r e m d morc t n d c Into b h t c r d cbannch. F i a t h e r m o m . '&Lbrth' Sourh'u.de bu not
p o v d t o b e b o o n l o r t h e strwallr\l m m t d m of t h e " S U l h " . Dcterloratbn o f t h d r t e r m o f t r . d c u l d t h e ' p r o ( e c i b n U ' poUcb.of the c o u n t d o 01 t h e 'North'
ha.. mnlrfnutul_ to =ow!= dl.-c!??"l?l!?? ~ ! t h'mdh - %st!! frsde.
The economics of g o w t h S o m e impormnt lessons 233

that compare anywhere in sheer magnitude t o what countries

like say India, Pakistan, Bangladesh, Indonesia, Nigeria etc have
had t o cope with.

As the free market mixed economies 01the developing

countries get bogged down, classical - and . n q classical - re-
cipes for economic development based on such an economic
system, fail t o be effective. It is imperative, therefore, that a
determined and concerted effort be made t o deviate from
traditional patterns of development in this essentialljr capitalist
context and to attempt t o evolve approaches t o economic
development that enable developing countries t o break the
"poverty barrier" in a reasonably short time frame based as
far as possible o n their own resources - material and mental.

Developing countries so far have focussed a good deal

of effort on establishing "North-South" economic and political
ties. The flow of foreign assistance has in part been instrumental
. ..
in forgoing such a relationship. East-West ideological confronta-
tion has resulted in the structuring of alliances based o n politi-
cal expediency. Countries have thus come t o be placed in a
political "bloc" o n the strength of political affiliation that may
have little o r no relationship t o their economic circumstances.
The political dimension has, over time, come t o d o r n i ~ a t eand
developing countries have not been able to s t r u c t ~ u epolicies
based predominantly on their peculiar economics.

By looking t o a "North-South" connection, developing

countries have come t o ignore the "South-South" dim ension.
By their failure'to forge meaningful economic and political
links among themselves they have not able to bargain effectively
with the developed countries with the result that their exports
of primary commodities have had to suffer deteriorating prices
therby impacting adversely o n their aggregate resc.)urce avail-
ability. Prices of finished manufactures from the developed
countries have, o n the other hand, steadily increased. As de-
veloping countries continue t o look t o the developed countries
for much of their demand for finished manufactures, especially
those based on relatively advanced technology, the drain on
their resources has been twofold resulting from lower prices for
their exports and higher prices for finished manufactures.
Nnt nnlv hsc it nnt h-n ~ccihln
f- Anwnlnninu r n i ~ n t i
234 F i s a l Imperatives in Pahistan's Econonric D e w l o p m e t ~ r

to negotiate fair prices for their exports of largely primary

commodities t o the developed countries, they have A 1SO encoun- -
tered strong resistance whenever they have made attempts to
gain access t o the affluent domestic markets of the rleveloped
countries in the post world war two era. This has been especial-
ly true in the area of finished textiles in which many third
world countries have made heavy investment. Protective tariff
waUs and quotas have effectively checked the inflow of third
world exports in this area robbing them of huge revenues. The
advantage that developing countries have in this area due t o
lower relative wages for labour enabling them t o charge a com-
petetive price is thus lost. Although textiles is not the only
area where such a situation obtains, it symbolizes i3 trend that
bodes ill for the future reception that developing countries
might expect for their products that are in direct competetion
with those manufactured by the domestic producers of the
developed countries.

Third world manufacturers have been hindertd consider-

ably in their efforts to duplicate the products of their counter-
parts h the developed countries because they have heen unable
to set up enterprizes large enough to employ the technology
that would enable them to take full advantage of the possibi-
lities resulting from large scale production. Furthermore, re-
search and development is absolutely essential if economic
viability is ever t o be achieved. Both large scale production and
research and development require huge funding. The existing
economic format in most third world countries limits such
mobilization of funds in the private sector. As a result, private
sector enterprizes are typically small affairs limited t o the
production of a small range of output and unablt? t o employ
advanced technology o r t o conduct any meaningful research.
What is stated above should not be taken t o mean that
the many m a l l enterprices in the private sector are of no con-
sequence. In fact they play an extremely important part in the
economic well being of the country through the employment
they make possible and the income that they generate. However
it is a fact that if a way could be found to enable some of the
smaller entrepreneurs t o pool their resources and come together
their collective position would be considerably improved. Ad-
mittedly, this is easier said than done. :Entrepreneurs are wary
of "partnerships" and there is a perception that; "partners"
 TABLE 1 4
CHANGE IN EXPORT PRICESAND IN THE TERMS O F TRADE OF THE COL'NTRIES O F THE THIRD WORLD
---- - - - --

CHANGE IN EXPORT PRICES (AVERAGE ANNUAL PERCENTAGE CHANGE/

TERMS O F TRADE)
Country Group
1966-73 197340 198 1 1982 193 3 1984 198 5

DEVELOPING COUNTRIES
EXPORTS (OVERALL)

HlGHLY DEVELOPED
COUNTRIES (OVERALL)

MANUFACTURED GOODS EXPORTS

O F DEVELOPING COUNTRIES'

NON MANUFACTURED GOODS

EXPORTS O F DEVELOPING
COUNTRIES (EXCLUDING FUELS)

Source: Data derived f m m "World Bank' World development report 1987. (Presentation format mine).

Data in perenthesb shows movement In terms of trade.

1986 Figures are "estimutea"

The real dgnificance of t h e trend In t h e terms of trade for dewloping countries is much greater than what the data suggest¶. For o n e
thins: thler relative dependence o n thelr exports t o generate hard currency is very high. Quantitatively. their o u t p u t of manufactured goods
is M t e d as is their " r q e " of manufactured items. Moreowr, protectionist policies pursued by the dewloped countries discourage expansion
o f t h e pmduction b w . Hlgh external indebtedness adds t o their problems. The "advenity"in t h e terms of trade of t h e primary goods exported
by t h e develophg countries is especially mcvked and since these constitute a significant component of the total exports made, the real impact
of t h e term8 of trade deterioration is qulte high.
-336 Fisml Impem t i w s in Pakistan's Economic Dewloptlrenr

are not to be trusted in the conduct of business. The corporate

form of business organization affords a way out of the impasse
here. However, here too, private corporations are largely family
affairs and the corporate format is used to facilitate t;ax evasion
more than for any other reason. The public corporation does
offer a solution but here the government will have t o take
initial initiatives and "deregulate" as the economic viability
of the project is established. Besides this, the government can
advance the prospects of partnerships by introducing legislation
to oversee the fair and proper management of enterpriies. Cum-
pulsory audit and strict punitive action for violation of fair
practice laws is essential in this context. New statutes would
require t o be enacted in many areas and machinery created t o
oversee their implementation. Thus a fairly radical change in
the institutional format of conducting business in the private
sector would be required to ensure that "large businesses" are
successfully established. It must not be forgotten that an im-
portant reason for Japans position of preeminence in many
areas of business activity is because of the sheer economic po-
wer of major japanese corporations as a result of which they are
able t o deploy huge resources for production, for moderniza-
tion and updating of plant and equipment, for expansion, for
advertising, for research and development and for setting up in-
dependent sales and even production outlets aborad. Of course
this did not happen suddenly and the present position is the
result of an evolution spread out over the last four decades or
so. Infact some o f the corporations have an history even prior
to that but a major restructuring has taken place since the end
of world war two and this is therefore the period of interest t o
US now.

In order to oversee economic development effectively and

t o be able to implement, monitor and evaluate development
programs, it is essential for developing countries to be able to
exercise good control over the major areas of activity. The
position as it exists at present does not permit of such control.
A direct consequence of this is enormous wastage of resources
as a result of inefficiency and corruption. The political format
of most developing countries modeled as it is after that of the
advanced countries of the west, where, needless to say, the
political, social and economic circumstances are totally dif-
ferent, has reslllted in the creation of almost chaotic conditions
in the field of policy implementation. Politics in developing
countries entails a huge social cost by way of work time lost,
destructive politicking, hugely expensive lobbying, corruptiun
on a collosal scale (buying votes "enbloc", buying key persona-
lities, politically motivated handouts of huge sums of money,
"recouping" expenditure incurred on election after attaining
office by virtually ransacking the treasury etc. etc). The best
plans drawn ap by some of the sharpest minds in the country-
many of whom have made their mark in prestigious institutions
abroad - fail to achieve the desired results. Much of this can be
remedied if bold decisions are taken t o ensure that an "apeing"
of the democratic style of the west does not become a blind
obsession.

It is significant t o note that asia's newest entrants t o the

developed country category, south Korea, Taiwan and Singa-
pore, although definitely a part of the free world under a mixed
economy format, have evolved an institutional framework in
which state control of key activities is fairly pronounced. The
pretext for such control may be the emphasised need t o combat
communism effectively for which discipline and orderliness is
percieved as being essential, but the disorder and tumult of un-
adulterated western style democracy in the peculiar environ-
ment of an asiatic people conditioned t o strong central authori-
ty is ,correcl;ly recognized as being detrimental t o politicid stabi-
lity which is a sine-quo-non for long term irnplementa.tion of
development plans.

As it becomes increasingly problematic for the countries

of the South t o manouver t o positions of equality in their
dealings with the developed countries of the North, one-way
out could be a much greater South-South co-operatipn,.A num-
ber of countries of the South have a fair industrial capacity
especially in certain areas-viz Turkey, India, Pakistan - and the
same can be put t o mutually advantageous use in the tievelop-
ment of many third world countries. The industrial output of
third world industry can be absorbed in the markets of the
relatively less developed in the third world and these very
countries that are able t o export their finished industrial goods
can also aid in setting up industrial capability in the importing
third world country thus facilitating the deepening and widen-
ing of capital there. Over time this accelerated cooperation
among the countries of the south is bound t o prove t o be
---
- n ~ t a n s l l x ~ h n n n f i o i r a l s n r l w a l i n x r a d A # th- --..-L...-A-- ...c em-:--
-
TABLE 15
ORIGIN AND DESTINATION OF MANUFACTURED EXPORTS OF SELECTED THIRD WORLD COUNTRIES

MANUFACTURED DESTINATION OF MANUFACTURED EXPORTS

EXPORTS (% O F TOTAL)

NORTH SOUTH

Cc%r~try ( M%= LNmtm High Lnccme Oil Developlag

market economles Exporters Ewnomlw

PAKISTAN
NIGERIA
BANGLADESH
INDONESIA
INDIA
PHILIPPINES
THAILAND
TURKEY
EGYPT

Source: World Bimk. "World Dewlopmeld Report" 1987

- The yearly pementmer for destination of mmrdactcued exports will not add up t o 100 as the data tabulated above doea not lnclude
exports t o Ilon report- "non member" countries of the World Bank.
- The "ipdustrW market economies" caregory lncludea the (structuraUy) U h l y developed economieb of the "North".
- The d a t . s b w s that for t h e rmnufactvred expo- " prhclpal madrets are in the "North". SOUTH-SOUTH
of t h e 6 L S ~ u t hthe
W e in thia context ir not Incredng atbiactorlly. T h b h not an encolaoging development m (see other data appended) the "South"
bas had t o Butfez B progreaive deterioration in the terms of trade and protectionist policies of the 'north" imposes c e w s o n
output therby rentrictiag production and prewnting full utilization of capadty thus impactha d v e m l y o n their development
momentum. A posslhle way o u t of t h e imp- Is greater "southsouth" exchange. Part of the effort made t o win concessions from
the "north"(much of It futile) may b e more profitably expended in promoting "south-south" trade.
The ecu:omics of growth-Some impormnt lessons 239

up to the ennervating competetion of the highly sophisticated

industrial edifice of the advanced countries of the North, the
transition to industrialization would be decidedly smoother and
less traumatic in the South.

The boldest decisions however will have to be taken in

the area of population control. The sustained high i;towth of
population is certainly the single most imporant "anti growth"
factor that threatens to hold back the development of the
South. So far, none of the densely populated countries of the
South have been able to devise successful policies t o curb the
very high addition t o their numbers each year (3%plus). To be
sure some steps have been taken, some quite radical such as the
forced sterilization measures in India, but nothing concrete has
been achieved and proliferation in numbers cont,inues un-
abated. It is now being increasingly realized that effective po-
pulation control is a complex sociological problem in which
education, religion, meaningful leisure, living conditions. oppor-
tunities for socioeconomic advancement-all are inextricably
intertwined and mesh with each other. Education may be the
most important of these with religion a close second. This may
be because the "world view" of the individual is probably
shaped in the most important ways by these two "factors".
However imparting meaningful education to such vast multi-
tudes, given the severe resource constraints, is not the easiest
of tasks Churning out low grade graduates in quantity year
after year has certainly done nothing t o alleviate the situation-
infact the phenomena of the educated unemployed is an omi-
nous development that has dangerous implications of its own.
Thus a great deal of dedicated planning and lots of inspired
imagination is required if education is to be effectively used in
combating the scourge of a threatening rate of growth of po-
pulat ion. I
The developed countries of the west were never con-
fronted with the sort of population redundancy situation that
faces the third world. Infact in its development phase the west
had a different problem - that of a paucity in the numbers of
its people. However it was one of their kind whlo first pro-
phesied the doomsday scenario that must follow in the wake of
unchecked population growth-Robert Malthus. But in the
heyday of capitalism, the gloomy prediction of Rlialthus was
I I. 1 I . . .. 1 .
240 FIsml Imperadves in PaMsran 's Economic Dewlopment

result it was soon forgotten. It is a tribute t o his pres1::ience and

insight that his discourse is now often resurrected and treated
with far more respect than what it ever received o n its concep-
tion. For the third world however, Malthus is still very much a
stranger, their own prophets and sages being so much more
compelling.

Communist China with one billion plus people is today the

most populous country in the world. It is also one ol' most the
densely populated and, very creditably, has been able t o suc-
cessfully control the rate of growth of its populatiora. While it
is correct that the very low growth rates of the highly developed
countries of the west have not even been approached - in some
of these, negative growth rates have been recorded -- the fact
remains that the ominous scenario of an escalating proliferation
in numbers does not obtain and given the resource position and
the development activity in motion, the populatioin remains
under control for the present. This has been made possible by
the energetic steps taken t o educate the populace and by being
able t o devise such policies as definitely encourage a smaller
family. A range of incentive measures from eligibility for
housing facilities to priorities for schooling, childcare facilities
and levy of taxation, have been linked t o the size o f the family.
The "one child family" is considered as the ideal and most
beneficial t o the parents in terms of financial burden and avail-
ability of state provided benefits. Besides this, medical facilities
for the people include free abortion as well as supplly of con-
traceptives and counselling.

Over time, the "package deal" devised by the state appears

t o have succeeded in provoking a change in the attitudes of the
people - and there can be no better test of the efficacy of the
policy measures devised. Planned effort has thus been shown t o
be able t o open up a highly traditional society with mores
deeply entrenched in the psyche of the people. And this has
been achieved without traumatising the populace. The use of
procrustean methods undoubtedly accounts for much of the
success of radical policies put into play by the state but in the
area of population control there is no credible evidence that any
serious attempt has ever been made in china t o control the
growth in numbers by the use of such methods A rather crude
attempt in this context was however made in India when the
government attempted t o force "sterilization" of the (under-
 TABLE 1 6
PAKISTAN IN THE THIRD WORLD - COMPARATIVE DATA FOR SELECTED COUNTRIES - 1 9 8 0 8 5

population Area ( T h o m n d s Population density Per capita Average annual Avemge annual
Country (Millions) o f Square n o of P a m M Income S Growth Rate 4%- of inflation rate %
MID 1 9 8 5 Kilometre3 perm k m 1085 (1965/1985) (1980-86

PAKISTAN
NIGERIA
BANGLADESH
INDONESIA
INDIA
PHILIPPINES
THAILAND
TURKEY
EGYPT
VIETNAM
CHINA

Source: "World h n k " Data

While Pakistan har been mercifully spared the mvngm o f sustained "double diglt"inflatlon, t h e high population growth rate 1.c a w
f o r serious concern It preaem trends continue n aeri"u.5 ef& woii?d be he.it&le .*.ithL". D d e c d e h e t h \u*h regs!! to the vbbllltv
of urban centers and the ablllty of the country's agriculture t o feed the people-

Communist China's dtatlon M a third world country b n o longer valid. It's phcement above & of academic interest only M a re-
ference point.
242 Hscal Impemffvesin Pakistan's Economic Dewlopment

privileged) male population. The step taken was not part of an

integrated policy package and the isolated "dictat" of the state
evoked a negative backlash and forced its being abandoned.

The 'By-Pass' Alternate-

The import of much of the development economics

emanating from the west is t o create a bias in favor of a broad-
based "balanced growth" of the economy. Large scale deploy-
ment of resources is inherent in such a scheme of development
for only then can the momentum required - the "critical
minimum effort - for take off - be generated. A fascination
with the dynamics of flight appears to be more in evidence
here than an insight into the mechanics - and metaphysics
(if one considers the cultural and psycho-social aspects of the
behaviour of peoples)/of ~ i growth.c Myrdal has zeroed
in on these aspects in his epochal study of the dilemma of asian
peoples in their quest for ai-ceterated economic development.

Ideally of course, there can be no better way to promote

economic development than launch a broadbased assault across
the full spectrum of the economy. Developing countries how-
ever cannot do so simply because they are unable to muster the
resources to make such an effort. However the"effort9'has been
made by many looking to the west for (esoteric) advice and the
same has invariably fizzled out for lack of any meaningful pro-
gress made in any important area-because adequate resources
could not be committed to the effort. The only viable alternate
therefore seems t o be to encourage a deliberate - but planned
- "imbalance" through attempting t o develop such segments of
the economy only as is necessary to get the growth process
started and to avoid such areas as are likely t o offer resistance
so strong, or where a development effort is likely t o require
deployment of such massive resources as t o threaten the very
initiation of the growth cycle without which its institutiopali-
zation is not possible. Undoubtedly, this would be a rather
tricky enterprize. Political imperatives alone - given the
existing political format in vogue - might make it difficult to
launch such an attempt. But the limitation might be avoided
if it were possible t o effect a change in the political format first.
The econornla of growttrSome frnportnntlesrons 243

An obvious criticism of the "by-pass" recommendation

would be that it would lead t o a "duality" in the economy and
the creation of "islands of prosperity" - where development
does take place - in a vast "sea of poverty", is only likely t o
provoke socially destabilizing resentment thus introducing
schisms and cleavages that by aggravating existing social ten-
sions would exacerbate rather than improve the given situation
whose improvement is sought by the planners

It goes without saying that the mere creation of a duality

for the sake of having a duality is bound t o be counter produc-
tive and could never advance the cause of economic develop-
ment. But that is obviously not the aim here. Rather, the objec-
tive is t o deal with obstinate areas in the economy "after"
acquiring the capability to make a meaningful effort - and not
before. For this it is essential that the strategic areas be identi-
fied and1effort be focussed on them initially and as results
follow - in terms of improved economic power - such power
be directed in a phased manner t o the segments permitted t o
lag behind in the initial thrust.

In the short run the by pass decision is b u n d t o be pain-

ful and even apppear t o be proof of a callous disregard of the
welfare of the underprivileged. But in the life of a nation, the
short run is not the significant time frame. However callous it
might sound, society will have t o pay for making accelerated
development possible. The peoples of Russia and China have
paid such a price and the results today are there for all t o see.
On the other hand, nations that have shown themselves t o be
unable to take the hard decisions necessary to make accelerated
development possible continue to languish, mired,as it were,in a
morass. Accelerated 4onomic development is thus not some-
thing that the rsqueamish and faint of heart can hope t o
accomplish. More than anything it requires bold, decisive action
- even if that means disturbing the status quo and being con-
Fronted with short term troubles.
I
. An important re-condition for sustained
7
economic deve opment especially where
planned growth IS contemplated is the
- -
presence of a sternly committed executive
I will.

While the adaptability of the average japanese is t o be

credited with facilitating the changeover from a feudal to an
industrial society the fact is that without a determined exe-
cutive will the metamorphoses wrought would have remained
an elusive dream. Not only were specific policies designed t o
ensure the achievement of designated objectives, but authority
was aggressively exercised by the apparatus of the state to en-
sure compliance. Even when this meant doing some violence t o
the personal freedom of the citizen, the executive leadership
remained sternly committed to streering the course that it had
charted for the nation.
The meteoric rise of Soviet Russia as a modern indus-
trial dynamo state parallels the emergence of Japan as an eco-
nomic colossus. Here again, the systematic destruction of a
heavily entrenched feudal arrangement preceded the implemen-
tation of the new economic order ushered in by the communists
based on totalitarian regimentation of the economy, the cold,
procrustean exercise of authority, replacement of the market as
an allocativeldistributive media and its substitution by quanti-
tative assessment of production capacity and fixation of pro-
duction 'quotas' based on such assessments for the manufactu-
ring establishments The collectivisation of the agricultural
sector was another unique feature.
The change indicated above was probably the most tho-
mughgoiqg ever contemplated in modem history. At one stroke
m l + m - d --AL-ll.y a*-- -
both the political as well as the economic arrangements were
h-a-n tn-hfi-v n# - n m t i m a m t s l Akna-
246 Fhml Impem tives In PaMstan I Economlc Doreloprnent

sions. The number of persons affected by the radically altered

arrangements was also highly significant. These two aspects
dramatically enhanced the impact of the change as an ideology
diarnetricallyr opposed t o that espoused by the grea.\ western
democracies was now championed by a large number of people
inhabiting a vast state that had the potential of great power.
Indeed it was the avowed objective of t h e new socialist state t o
spread its ideology t o supplant that of those to which it stood
opposed. The blistering pace at which the transformation of the
economy took place can well be gaugedl from the fact that
within a bare two and a half decades of the revolution, the new
soviet statewasable t o take o n an acknowledged economic and
military giant - nazi germany and inflict o n it ' a crushing de-
feat therby hastening its ultimate collapse. This was made pos-
sible by mobilizing economic potential on a stupendous scale,
by acquiring technological wherewithal and instilling skills in
frianpower t o .attain parity with the advanced western states.
Starting from a war ravaged and impoverished economic base
&d with an-archaic administrative framework, the achievements
of the new soviet state were nothing short of miraculous.

The strong "executive will" referred t o before in the

case of Japan was a prime factor in the implementation of the
new economic order in societ Russia.

The Soviet experience was duplicated by Red China when

the revolution "exported" from soviet Russia in the 1930's
finally defeated Chiang Kaishek's nationalist forces in 1948 and
in doing so changed the exjsting order radically. In China too,
an obsessively singleminded leadership forced changes vigorous-
ly and t o ensure that extraneous influencesdid not distract the
people - o r corrupt the revolution - an insulating "curtain" as
it were, was thrown up. Ensconced behind this shield,, a virtual-
ly manic leadership directed a concentrated effort in promoting
industrialization on a heroic scale.

The success of the effort in china is evident from the

fact that ' a nation of opium eaters' - the chinese were
then derisively described - stood completely transformed - all
in the limited timeframe of a couple of decades. Especially
impressive was the drastic, structural transformation of the
economy. China became self sufficient in steel, manufacturing
its own machinery including heavy industrial plant and defence
The economics of gowth-Some important lessons 24 7

equipment of all kinds much of which it has started to export.

The atom was split early in the 60's and atomic pqwer put t o
use. Mass literacy was achieved and technical skills instilled in a
big way. Autarky in agricultural production has btten a tremen-
dous achievement. Power generation has increased dramatically
with large hydel projects completed.

To be sure, strong executive leadership, especially where

it is concentrated in the person of one man, has not aways
succeeded in bringing about accelerated economic development.
Franco in Spain, Salazar in Portugal, Peron in Argentine, Su-
karno in Indonesia, Marcos in the Philippines-all failed to pro-
voke meaningful structural transformation of the economy.
Instead, debilitating economic stagnation became the lot of
these countries which ultimately was instrumental in causing
much social anguish and unrest and even upheaval. In all these
countries leadership was largely concentrated in the person of
one man. Such inordinate concentration of power combined
with little or no accountability turned out t o be a volatile mix.
It guaranteed inaccessibility of the executive chief and ensured
his aloofness from and non receptivity t o expert opinion.

The great advantage for the, centrally planned socialist

economies is that the system in vogue ensures a forced pooling
of technical expertise which is a safeguard against whimsical
decision making. However this should not be taken t o mean
that the socialist model is an ideal t o be emulated by all d e
veloping countries. For one thing the extreme regimentation o f
the economy makes a mockery of personal choices and in so
doing induces distortions that can inflict much social pain.
An unhealthy - some would say even perverse - bias towards
investment in capital goods has resulted in a gross neglect of
basic consumer necessities that are taken for granted in most of
the economies of the - so called - free world: even those
categorized as underdeveloped. In even the most advanced of
the socialist bloc countries -the Soviet Union - the "poverty"
of the average consumer, in terms of the quantity and variety
of consumer goods available, is even today - liberalism not-
withstanding - quite astonishing. When one considers that an
economic system is expected t o benefit the people, then one
test of economic efficiency. would be the magnitude of such
benefits available in a resonable t h e frame. A system that even
after fortv vears of the end of world war two still does not Pive
the people the things that are considered commonplace in the
£ree worldsome of which in desperate demand by the average
consumer - must definitely be hlnding significant deficiencies
within a facade of superefficiency.
 - - - -

To have accelerated economic

development, a nation must be able to save
meaningfully.

The planned approach to economic development is a

relatively recent phenomena. It is based on the premise that,
through deliberate design, it is possible t o accelerate the-growth
process sufficiently t o compress the growth time frame enough
to facilitate the rapid transformation of a backward economy
to one that is 'relatively developed.' in a period that is much
shorter than that involved "normal evolutionary growth"
- such as is accomplished through the play of market forces
in a competetive environment.
No matter what growth "model" is followed, the engine
of growth will not move sufficiently should there be a defici-
.
ency of "fii.lance" Without it, the growth process c,mnot get
started. Without "adequate" finances, 'growth will be unduly
sluggish and may even be,aborted prematurely. Therefore,
effective resource mobilization has to be the highest priority
item in any scheme of economic development.

Given a purely market economy model, the savings com-

mitted t o investment (in their entirety) by households, by
government and from the surplus of exports over investment,
fund the growth process. Thus the savings generated in one
cycle of the development phase fuel a sixond round of econo-
mic activity and so the process continues. Each phase will be
as vigorous, in terms of the intensity, variety and sheer expanse
of economic activity as the previous cycle if savings are pitched
 250 Fisail1;t~:jecSvesin Pakistan 's Economic Dew10,otnent

only be expected, if the level of savings register an appreciable

increase. In other words, if the Phase2 performace is to be
superior to the phase1 performance, it is imperative that the
savings performace improve. As a logical corollary. it is equally
true then that a fall in the savings rate in phase2 will provoke a
diminution in the growth momentum - other things remaining
t h e same.
I
It should be kept in mind that "savings" and *'hoardingv
, are not synonymous terms. While classical capitali~stdoctrine
assumed that all savings were "invested" , this we know now t o
be a fallacy. In actual fact a part of the amount saved may be
hoarded-kept in sterile, non productive use. This is a "leakage"
in the income generation cycle and can cause equilihrium to be
established at less than full employment of resources. The
'savings' that are of interest to the economist are (.hat of
the disposable income stream that flows t o "productive" use by
providing funds for income generating activity.

Since national savings emerge from the economic"surp1us"

that arises at the end of an economic cycle, the size of the sur-
plus can be critical in determining the level of savings. Thus if
this surplus is minimal and ensures for its recipient economic
power that is adequate only to sustain a subsisterlce level of
existence, then of course savings cannot realisticall v be expec-
ted t o be significant. A reasonably high 'surplus' o n the other
hand can be expected t o yield (though not necessarily so) rela-
tively high savings. At leash that is the potential-given favorable
circumstances-that ought t o emanate from such a situation.

Just as individuals save, so are governments expected t o

save. Infact if individuals do not save enough, as so often hap-
pens in real life in third world countries, then it is the govern-
ment that is expected to mobilize the deficient amount-i.e. the
amount considered necessary by the planners tc3 sustain a
required growth rate. Governments save by restricting expendi-
tures and maximizing revenueejust as individuals do. Govern-
ments have the authority t o 'force' individuals t o save. This
they accomplish through the taxation of income.

However one looks at it, a successful savings effort means

postponement of current consumption. Basic t o the success
of a growth effort therefore, is a sustained high savings rate. In
 TABLE 17
SAVINGS. INVESTMENT 61 THE C U R R E N T ACCOUNT BALANCE - SELECTED COUNTRIES-
(Percent)

GROSS DOMISTIC GROSS NATIONAL CURRENT ACCOUNT

INVESTMENT/GNP SAVINGS/GNP BALANCEfGNP
Country

PAKISTAN 16.0 16.5 16.2 - 10.9 12.5 - -5.6 -3.7

INDIA 18.4 22.6 24.4 17.9 22.3 22.6 4.5 4.3 -1.8

SRI LANKA 15.8 20.6 28.9 14.6 13.5 17.1 -1.2 -7.2 -11.8

INDONESIA 15.8 24.5 29.4 13.7 24.6 26.6 -2.2 0.1 -2.8

MALAYSIA 22.3 28.7 35.1 21.6 29.3 27.5 -0.7 0.6 -7.6

PHILIPPINES 20.6 29.1 25.8 20.6 24.3 20.0 0.0. -4.8 -6.9

THAILAND 2 3.8 26.6 24.4 22.6 21.5 18.5 -1.1 -5.1 -6.9

EGYPT 14.0 2b.8 31.4 10.9 19.6 20.0 -3.1 -10.3 -11.4

TURKEY 18.5 29.9 20.9 19.1 18.1 17.2 0.6 -2:i -3.7

S . KOREA 25.1 31.8 30.7 21.5 26.4 26.9 -3.6 -5 3 -3.8

Source:'World Bank' World Development report. 1987.

252 Fiscal Irnpentfves In Pakistan's Economlc Development

the era of unadulterated pure capitalism-ie the era following

the onset of the industrial revolution - economic surpluses
were contrived largely through an exploit ive arrangement
wherein labour was not allowed t o receive a fair wage consistent
with its competetive position. Trade unions and fair wage
legislation gradually brought an end to the rampant exploita-
tion that had become the norm.

Without exception, all countries that we find placed in

the developed countrv categpry today, managed sustained
high savings either\voluntorily~orcontrived through the levy
of taxation that forced peopleto save - in order to be able to
pay the taxes which then became the investment fund in the
hands of government. The western democracies, wedded as they
were to capitalist dogma, thrived in an environment in which
international trade became for them a dramatic "engine of
growth." Uniquely placed, because of colonial authority, t o
procure raw materials at especially favorable rates, the genera-
tion of significant economic surpluses was almost inevitable in
the given situation. Burgeoning demand, both domestic and
foreign, for the finished products of the many industrial enter-
prizes sprouting up on their economic landscape, sustained the
investment made in them - and ensured the re-investment that
was vital to their expansion.

Present day developing countries are not so favorably

placed. On being freed from colonial bondage they inherited
an infrastructure that lacked both depth and range. In the
great majority of cases, third world earnings emanated princi-
pally,from raw material exports. Grinding poverty was evident
everywhere. Obsessed with moving onto a new higher thre-
shold of life, the seemingly 'leisurely' momentum of the mar-
ketplace was found t o be grossly wanting. Committed to
"accelerated economic development", planned effort therefore.
appeared to be the only way out of the impasse.

The most important constraint, that third world coun-

tries have come up against in their quest for accelerated econo-
mic development is that of marshalling sufficient resources t o
launch a sustained program of economic development. It is
of course not the domestic finance only that is in short supply.
There .is an acute shortage of "industrial capital" and in the
initial stages this has got to be imported from sources that have
The ecmornles o f gowthSome impormnr lessons 253

enough of such resource. If the developing country does not

have the export capability t o muster sufficient foreign ex-
change t o ensure the acquisition of the required industrial
inputs, then the only alternate is t o secure "assistance" (aid)
from international financial institutions o r the countries from
which such imports are sought t o b e made. Considering the
pressing nature of the need for "industrial capital", develop
ing countries often have t o go t o great lengths t o secure the
wherewithal that would enable them to acquire such capital.
However in making the effort, they are often required t o accept
terms that are not favorable. These so-called 'conditionality
clauses' not only place restrictions on the utilization of the
foreign funds secured but also requile the formulation of
specific policies t o qualify for the funds in the first place. Such
conditions are seen by many as actually limiting the sovereignty
of the recipient country. However the real cause for immediate
worry for the recipient of such finance is the cost of acquiring
the funds i.e. the interest charges. Over time, these can 'snow-
ball" and amount t o a huge burden especially as the structural
changes that the utilization of such funds seek t o induce often
entail an extended t ime-frame.

The debt burden eats into the foreign exchange earnings

and when these are relatively sparse vis a vis the actual require-
ments for imports, can create serious problems and hold up the
development effort as the required imports cannot be made-
the foreign earnings having been diverted t o debt repayment.
Such diversion of resources can force the government to float
new loan issues thus adding to its indebtedness. As the govern-
ment would in effect be competing for;available loanable funds
with others who seek t o obtain finance, the cost of such finance
is bound t o increase which would mean bidding u:p interest
rates. This will impact adversely o n the cost side of projects
thus discouraging investment in long gestation, high cost pro-
jectssuch as are typically involved in infra structure develop-
ment.

In contemporary times, Japan is often cited as a classic

exampie of accelerated economic growth. The Meiji Restoration
of 1867-i-plunged Japan, as it were, into the modern era. By
1917 Japan had already shaken off the deadweight of' its feudal
past- and. had---launched a determined, 'broadbased' effort
. -
to
 TABLE 18
EXTERNAL PUBLIC BEBT AND DEBT SERVICE RATIO O F SELECTED T H I R D WORLD COUNTRIES & T H E NIC's *

EXTERNAL PUBLIC DEBT DUTSTANDING DEBT SERVICING AS % O F :-

A N D DISBURSED:
Interest-Payments
(Millions o f A s % o f GNP onexternalpublic GNP Exports of Goods
Countn U.S. Dollars) -
Debt Millions o f and Senrlces
% U.S. Doll-
1970 1985 Change 1970 1985 1970 1985 1970 1985 1970 1985

PAKISTAN
NIGERIA
BANGLADESH
INDONESIA
INDIA
PHILLIPINES
THAILAND
TURKEY
EGYPT
S. KOREA
SINGAPORE *

Source:- World Bank World Development Report 1987.

I n the decade and a half b e t w e e n 1970 and 1985. third world external indebtedness has increased dramatically. Thls is worrisome
because t h e increase in indebtedcess is not matched b y a concomitant improvement in t h e s t ~ c t u r a transformation
l of t h e economy which
would confer o n it t h e potential t o increase exports a n d t h u s b e c o m e able t o generate the1.hdcurrency"earnings which form thewherewithal
f o r t h e liquidation of the d e b t liability.
7he economics ofgrowfh-Some impormn t lessons 255

cation were the keynote and theme of this truly heroic effort
by a people steeped in an insular, inbred, factional, warring,
highly ritualized lifestyle.

The willingness to postpone present consumption was an

important, indeed crucial, component of the development
effort. Heavy taxation of agriculture, the predominant econo-
mic sector, with all economic activity conducted there pri-
vately, released a good part of the funds required t o get the
development effort going . To be sure, a legacy of the procrus-
tean exercise of authority was also a very important part of this
effort. Willingness to accept the official "dictat" thus may not
have been spontaneous at all times and in all matters.

By nature, the japanese have shown themselves to be

a thrifty people. Inflationary pressures notwithstanding, the
japanese have usually saved a good part of their c u m n t income.
Thus "conspicuous consumption", which is the bane of all third
world countrieq-hasnever posed a dilemma for Japan. The dis-
sipation of scarce resources has therefore been avoided and this
aspect is of much greater import than it might appear at first.
Infact, in the context of Japan, this has crucial significance for
the country is particularly disadvantaged in its deficiency of
natural resources.
h the Pakistan context, savings have been poor at the best
of times-like in the early '50s when the boom provoked by the
korean war yielded a bonanza of hard currency earnings for
the country through its golden fibre (jute) exports. wbich were
dissipated with such despatch on the import of automobiles and
assorted consumer goods as to be a 'flash in the pan' as far as
resouces go.

An extremely narrow direct tax base has forced depen-

dence on a variety of indirect taxes, many of them regessive,
for making available the bulk of the revenue required by govern-
ment for meeting its current expenditure needs .As no worth-
while surplus remains to meet the capital expenditure require
ments, these have t o be met perforce by raising moneys through
loan issues, borrowing locally from the banks and also borrow-
ing abroad. A chronic lack of self sufficiency in domestic
resource availability is thus very much in evidence.
256 Fiscal fmpemrlws In Pakistan's Economic Development

The inability t o mobilize adequate finance domestically

has been at the root of many of the problems Pakistan has faced
from the beginning. However the failure is also due to a lack of
national will, of improper priorities and an ill
keeping the agriculture sector out of the fold of direct taxation.

The "easy way out" has always had a fatal fasci.nation for many
species of the humankind. For the pakistani nation this appears
to be a complusive obsession. A serious program of economic
development usually means a lot of belt tightening Paradoxi-
cally, in Pakistan no regimen has ever been devised that would
require any belt tightening at all. Part of the reason for this is
the availability of aid from abroad. Pakistan having decided very
early to be in the western sphere of influence 'became linked to
the western neo capitalist scheme of things. Over time the aid
largesse has assumed addictive propertions and has impacted
adversely on domestic resource mobilization.
zation.
 IV
Both capitalism and socialism and variants
-
thereof have their good points. The "success"of
an economic system however, would appear to be
related not merely to its intrinsic technical merit
but also the "ethos","ecology" and "worldview"of
- --
the people "adopting" or adapting it. The closest
that the system is to the socio cultural setting,
the greater the chances of its success.
Alternatively, the people must adapt to the alien - -
system. They must consciously change their
outlook and their "worlduiew."

In our times the emergence of a host of cc~untrieso n the

world scene following decolonization has witnessed a struggle
between the champions of capitalism and socialism t o force
their political and economic systems o n t h e e developing
countries. Their logic is that since their politico-economic
format has yielded such good results in terms of economic
achievement and in improving the quality of life of their peo-
ples, therefore the same results should follow if a developing
country were t o adopt the system that has taken root and
thrived in the "home" country. However as many developing
countries have learned t o their chagrin, the adopted system has
often failed miserably when "planted" in the virgin soil of a
"backward" third world country. Such failure of "a tested
system" is often attributed by a developed country t o a lack of
commitment o n the part of the host country. It is usually
pointed out that the host peoples have not bothered t o create
the set of conditions that are necessary t o ensure the success
of the system. Much is made of the "institutional deficiencies*
present and a failure t o remedy such deficiencies is cited as a
key factor in the apparent failure of the system.
There is no denying that every economic system requires
that the institutional framework peculiar t o the system be
faithfully structured if it is t o be optimally effective. However
it is also true that most developing countries 'have socio - cul-
tural "roots" that may harbour elements and ingredients that
are inimical and antagonistic t o the "foreign" system and work
t o reject the alien implant.
 258 Fiscal Impemtlves in Pakistan 's Economic Dewlopmenr

The advent of the ideological state on the world political

scene has added a new dimension to the problem of adaptation
t o a foreign politico - economic system. The problem appears
t o be ~articularlyacute for the Islamic state for the values
htrinsic to the Islamic faith d o not allow for compromises that
could jeopardise the very basis of the faith. Howevt?r in actual
practice compromises have been made primarily because alter-
natives t o the western capitalistic economic syste:m and the
political democratic framework originating in Britain, are not
readily available. The reasons for this lie in a paucity of mean-
ingful research into various facets of the Islamic faith..

The Islamic state is the first true welfare state in history.

It is intolerant of elites and it makes the well being of its
peoples a primary responsibility of the political and spiritual
executive. The faith enjoins its adherents to strive to attain
the ideal state both in spiritual and worldly matters. The weak,
disadvantaged and underprivileged are the special responsibility
of those who are better off. Islamic society does not glorify
t h e )'survival of the fittest." "Cutthroat" competetion is ana-
thema to Islam.

It does not require much insight to see that the values

and motivation inherent in the western democratic state and
its attendant capitalistic economic system are diametrically
opposed to the Islamic norms. It would not be fair therefore to
expect the two to ever have a "symbiotic" relationship. Infact
the inherent contradiction between the two is so marked as to
make ceexistence impossible. Thus the failure of the western
politicoeconomic system in an Islamic society is not a fault of
the system as such, but signifies an incompatibility between the
two.
The situation outlined summarily above holds true for
many third world countries in africa, latin america and asia
In many different ways the societies in these countries have
I unique features the roots of which go back to antiquity and
I
which distinguish them sharply from their more modern coun-
terparts. Because of these fundamental differences, it becomes
difficult if not impossible for their peoples to identify them-
selves with and relate to the values and norms peculiar to
western society whose politico economic system they now seek
to emulate.
The economics of growth-Some important lessons 259

There is no denying that t h e human capacity for adapta

tion is considerable and as society has evolved from the primi-
tive to the modern form its inherent capability t o adjust t o
changing circumstance has increased significantly. That would
appear t o be the reason why even s o called highly traditional
societies like that of the japanese and the chinese - and the
korean - have been able t o cope exceedingly well with the
western form of politico economic system. However this ability
t o "cope" is not a matter of simple evolutionary change. The
"direction" that evolutionary change takes is important. Thus
we see that the real reason for the success of the japanese is
relatable to a peculiarly "pragmatic" direction given in its
transition from the traditional t o the modem form. Such
pragmatism included a sharp .l, distinction drawn between
church -and state so that t h e political format of the state is
divested of any religious tinge. More'importantly, it also in-
cludes an ability t o identify those elements from amongst its
own traditions that need t o be retained, developed and refined
t o enable the people t o have a sense of identity. Thus japan
discarded its traditional ways and opted for the .western politi-
c* economic system but it retained its peculiar language. This
does appear odd as the ornate and complicated ideographic
form of the alphabet - and 'its peculiar grammer is indeed
cumbersome and has nothing a t all in common wi,th the western
form. But it was percieved as central t o the japanese "ethos"
and necessary for japanese individuality and uniqueness. That
the perception has been correct is evident from the huge success
japan has had in developing a system of education based
on it own cultural resources that has absorbed thle knowledge of
the west and made its own unique contribution t o it. It should
be noted however that the Japanese have not hestitated to
"tamper" with their language t o make it easier t o comprehend.
Thus the very large number of "characters" required to be
learned in classical japanese stand drastically curtailed - but the
basic ideographic form remains intact.

What is stated above would also appear t o be true of

the chinese. Indeed chinese civilization is the older of the two-
and one of the oldest in the world. However chinese society was
"thrust" into the modern age much more rudely than the
japanese. Despite this "trauma" it has been able to cope with
the pressures of change and has a d a ~ t e dwell t o a politico-
26 0 Fisml Impemrlws in Pakisran 's tconotnic Development

capitalist west but nurtured and developed in neighbouring

Russia. It might be significant in this context t o note that the
political format based on strict regimentation andl control and
the necessity for the,procrustean exercise of authority which
is central to a socialist system (as distinguished from a truly
eommunist system which appears to be a theoretical ideal at
present) is quite compatible with the political traditions of both
Russia and China. This could be one reason why the people
have not had much problem in coping with the'xigors' of the
system.

One should be careful t o note however thlat not every

secular state has done we!l in adapting t o a foreign ideology.
Turkey is one example of a traditional Islamic society attempt-
ing t o discard the Islamic politico economic format (Islam one
must not forget lays down a comprehensive prescription for all
aspects of life - the social, cultural, political and economic-)
and adopting the western system. The experience has, so far,
not been encouraging - despite the fact that Turkey went far
to put on the western garb-literally. Turkey lztinized its al-
phabet, adopted western dress and western political and eco-
nomic institutions. That the change, which was thorughgoing
by any standard has not had salutary results is borne out by the
protracted political ferment in recent times - that is whenever
the procrustean exercise of authority has been relaxed - and an
economic development that has not brought the country in the
ranks of the developed despite the significant time frame in
which the new system has been put into play.

The example of India too is a pointer in this regard.

Here again we have an ostensibly secular state adopting the
politico economic format of its erstwhile colonial masters and
after more than four decades of independence still grappling
with serious economic problems. By third world standards the
economic edifice built up in India is impressive but if one con-
siders the example of modern China one can see how great a
gap there is between the two in terms of sheer economic
achievement. China has done wonders in the eradication of
mass poverty, malnutrition and illiteracy providing employment
and shelter for a huge - the worlds largest -- population, con-
trolling the growth of its population and building an impressive
industrial infrastructure without the massive infusions of
foreign assistance t o which third world countries - including
:he economics of growthSome Imporhmt l e s a s 26 1

India - have become conditioned, as it were. India on the other

hand, is still plagued by grinding mass poverty, illiteracy, un-
employment, indebtedness (including external indebtedness)
a population growth rate that is threatening and an industrial
edifice that is chaotically structured. It is apparent therefore
that whereas China has adopted well to doctrinaire socialisn
and its regimented and controlled economic system with no
market t o aid economic decision making and distribute the
national product, indias tryst with westminister style demo-
cracy and mixed capitalism tinged with elements of non mar-
xian socialism have kept the country underdeveloped and with-
in the ranks of the third world - four decades of "develop-
ment" notwithstanding. This is not to belittle the achievement
India has made in certain areas, especially the development of
its agriculture and specific segments of industry - including
fairly advanced areas like metallurgy, heavy chemicals and
the like. But the fact remains that in a world setting the.Indian
achievement pales before that of China - and even south
korea One is forced t o conclude therefore that there must be
elements within the Indian ethos that do not mesh with the
alien format of its politico-economic system. It is also evident
that not every society can make a smooth transition to the
sort of pragmatism that would enable it t o adapt effectively
to a foreign system. This would appear to be espscially true for
a traditional soceity that has not been "opened up'bnd fully
exposed in a manner as to make it compatible with the foreign
system sought t o be implanted.

The "mistake" that many third world countries appear

to be making therefore - as evidenced by their continued third
world status - k a failure to have an integrated and compre-
hensive approach t o economic development. It is not enough
to "import" a politico economic system. One must also create
the essential conditions that would make the implant fully
workable. Decisions ( to modernize) taken in kolation, create
imbalances that stifle and thwart the growth process
 v
Inequities in the distribution of income and wealth
lead to the creation of urban and rural elites that
compartmentalize the economy and create
powerful vested interests whose foremost
objective appears to be a preservation of their
privileged position. Because of the political and
economic power of these elite classes the fruits of
economic development gravitate towards them.
This state of affairs, if allowed to continue, has the
potential of becoming the single most important
threat to orderly development.

The Iran experience is a pointer to what the compart-

mentalization of society and the economy resuliting from per-
petuation of inequities in the distribution of wealth and income
can lead to. In the Shah's Iran there appeared t o be a situation
tailor-made for rapid economic development. There were no
forbidding pressures of population. The oil wealth of the
country guaranteed a bonanza of petro dollars. A leading super-
power, the U.S., was eager and willing to extend help and co-
operation in every field. Political stability seemed assured,
thanks to "savak" and a huge military establishment - its
arsenals bristling with top of the line, state of the art equipment
- devoted t o the monarchy and the existing order. Literacy was
increasing yearly and the administration rightly boasted of its
"white revolution". Industrial development seemed to be
making good progress with brand new plant dotting the land-
scape. Agriculture too was vibrant. lnfact everything seemed
perfect. And then in a traumatic, rapid, sequence of events,
cataclysmic destablization occured which the iipparently well
entrenched forces of the existing order could do little to con-
trol

There can be no simple explanation for the sudden down-

all of the Shah's regime and the "system" that, had been pain-
itakingly structured over the years. There is little doubt now
'lowever that a build up of forces diametrically opposed to
?ach other based on an affluent "praetorian" dite obsessively
leuoted to the person of the shah, the monarchy and the ark-
264 Fisml Impemtiws In Pakistan 'J ~FconomicDevelopment

class conservatively linked to deep seated fundamentalist forces

and a vast body of students aware of the powttr of ideas and the
masses, on the other hand, eventually so polarized iranian 'so
ciety as to create an unbridgeable schism. Over time, privileges
continued to gravitate towards the elite and the rich kept o n
getting richer. The middle class however found that its bargain-
ing power vis a vis the elite steadily deteriorated and the fruits
of economic development did not percolate clown the ladder as
evenly as they ought to. Infact the middle class had t o be con-
tent with only a trickle.

All elites are minority forces that maintain their authority

by virtue of their economic and political clout. When the
power of the military is added a decisive tilt in the balance of
power occurs. It still however remains a minority force juxta-
posed to the rest of the population. The logic of numbers
ensures that an aroused majority must prevail over a powerful
but decadent minority. It had happened in France in 1789, in
Russia in 1917 and in China in 1948. In each case, to be sure,
change did not take place in an orderly, evolutionary manner.
Rather, a tumultous upheaval turned the existing order upside
down-and inside out. And change was not sparked off spon-
taneously but required a catalyst-usually a well articulated and
propagated idea that is able to catch the imagination of the
majority of the people.

When economic development is perce~rled as benefiting a

select few, the groundwork is laid for an exploitive scenario
which the "victims" continously embellish with facts and
figures to prove that a perverse motivation exists on the part
of the privileged to not only deprive the underprivileged of
what is rightfully theirs but also to deliberately exploit them
by putting into play schemes that exact from the underprivile-
ged a price that is unfair. It is not necessary that actual, deli-
berate exploitation be a fact. It is enough that it be percieved
as such. Vague generalizations based on isolated cases can thus
be manipulated in a manner as to substantiate an exploitive
scenario. The psychological aspect is critical and looking t o the
limitation of illiterate - or at best semi literate - minds little
able to collate information and draw valid inferences, it is
apparent that this is fertile ground for the propagation of false-
'loods or half truths that can inflame the uninitiated but do not
The economics of growth-Some impormnr lessons

TABLE 19

THE DISTRIBUTION OF INCOME IN PAKISTAN

1980 1987
f
1. 70 Share of GNP going to poorest 20% 7.0 6.1

2. % Share of GNP going to richest 20% 45.4 49.8

3. % Shareof GNP going to poorest 40% 19.1 16.1

i

4. % Share of GNP received by top 5% 31.7 35.7

5. % Share of GNP of Rural Rich 40.8 42.2

Ir
6. % Share of GNP of Urban rich 48.1 45.3 ii
!i 1I
7. % Share of GNP of rural poor 8.5 7.8 !I Ii
II
I :

8. % Share of GNP of Urban poor 6.8 7.8 II

- I '

Source: Economic growth in the 1980's-

Profesjor Sajjad Haider "The Nation" 26th May 1988.

The pronounced "skew" in the distribution of income

is readily apparent from the above data. Not only does this
bode ill for ameliorating the lot of the common man but in a
developmental context is inmical to economic growth because
of its destabilizing potential. Concentration of income provokes
conspicuous consumption and gives a boost to the operations of
the "parallel economy". M i l e the rich get richer, the poor
remain mired in poverty with grave social portents. Absence of
a "middle class. of any depth, does not permit aggregate
national saving to be pitched at levels necessary for self sus-
tained economics development. The super rich habitually in-
in moving "ca~ital"t o "safe havens" abroad.
 266 Fiscal I?-pcmtlves in Poldston's Economic .Development

inform or educate anyone.

The bengali revolt in former East Pakistan is typical of

this trend. The alienation of the peoples of East Palcistan was
certainly not deliberately provoked by the west Pakistanis and
no diabolical scheme of exploitation was put into play in this
context. This is amply proved by the fact that even after in-
dependence no credible "evidence" has been unearthed by
those who then read much "deliberate" exploitation in the
"system". While it is correct that the foreign exchange earned
from the sele of east Pakistans golden fibre, jute, provided the
bulk of the nations foreign exchange resources after indepen-
dence and also that project implementation was much more
vigorous in west Pakistan especially after the mas.ive indus
basin replacement works that had a "snowball effect" across the
full spectrum of the economy in the west, the fact remains
that east Pakistan disparity visavis the west was relatable more
to the yawning gap between the two wings on independence
due t o years of deliberate colonial neglect than t o any callous-
ness of the west Pakistanis. Even the pattern of recruitment t o
the armed forces that became the focus of much vitroilic debate
- and had besides an economic dimension t o it in the lopsided
flow of income -- was attributable t o the british policy of
keeping the bengali people away from the armed forces alleged-
ly due t o their "non-martial" characteristics but probably more
due t o an anarchic streak that has been much in evidence even
after independece from the west. Whatever be the reasons - and
there were many - east Pakistans plight was not directly the
result of perverse west Pakistani design. But the perception of
the common man was otherwise. This was actively encouraged
by the pro india lobby and the economics of the situation was
lost in the tumult of the unrelenting psychological warfare
waged by those who stood t o benefit from secession. There is
no denying however that with an alternate politico-economic
'

format, things could have been different and the lot of the east
Pakistanis, qualitatively better. The "system" inherited on in-
dependence was that designed by the british. It was adopted
by Pakistan with marginal adjustments only. Such a system was
ill suited t o the exigencies of a free country committed to the
promotion of accelerated economic development. The logic of
the political set up created a pronounced bias towards elitism
and the urban and rural elites spawned by the system divided
the economy into spheres of interest effectively compartmenta-
1
 The economics ofgmwth-Some fmpmtant lessons 26 7

lizing and insulating these spheres from the rest of the economy
The fluid flow of wealth and income was thus checked and set
the stage for the subsequent distributional inequities that were
to create the plethora of problems that defied resolution and
culminated in an explosive ventilation of grievance that turned
into a revolt of the bengali population of the country.

The exploitation scenario is complicated further if ethnic

diversity be a factor of significance. The perception of unfair
treatment and economic exploitation is heightened significantly
if sharp ethnic divisions be present. This aspect was an impor-
tant factor in the East Pakistan case and was also dominant in
the 'Ibo' revolt in Nigeria in the late '60's Ofcourse the " r e
bellion" was crushed there and secession thwarted but at the
cost of much human suffering. The economic cost of the war
was also considerable.

That political and economic dimensions intertwine, with

the political aspect often dominating, (good econonlics usually
losing out to bad politics) the significance of the political for-
mat adopted by a country can hardly to overemphasised. Thus
if a political arrangement fails, then the economic infrastructure
can often go into shambles and that too quite rapidly. This has
occured often enough in third world countries t o warrant
serious concern and should therefore be accorded a high
priority when "adoption" of a "system" is under consideration.

A skewed pattern of wealth and income distribution is

also objectionable in that it does little to facilitate the sort of
capital widening that is necessary to build up the economic
edifice of a country. As wealth remains largely localized and
concentrated in a few hands the gene@ population is prevented
from participating meaningfully in the economic development
of the country. The advent of the large corporate form of busi-
ness organization which is n&essary under mixed capitalism
both for significant capital mobilization and in order to ensure
large scale production and the use of roundabout methods in
produc tion--and also to make possible research and develop-
-
ment is unnecessarily delayed. The experience of Japan in
this context is significant as is also the experience of south
- korea and taiwan.
 Just as the successful prosecution of a war
necessitates the formulation of a "winning
strategy", so it is that the planned structural
transformation of the economy require that
a "design for accelerated development"be
drawn up and implemented.

The deliberate acceleration of the development process

was first attempted by Japan when with the meiji restoration in
1867 policies were devised t o lead t o industrialization. Japan
sought to make up the backlog in industrial achievement
vis a vis the west in the shortest possible timeframe. It is per-
tinent t o note that Japan did not simply seek to import indus-
trial plant and machinery but rather launched a broadbased
effort in which a change in the personal attitudes of the japa-
nese people was sought to be made just as eagerly as a change in
technological capability. Japan may thus be said t o he the first
country to realize that sociology was just as important as tech-
nology in the development process. This required a good deal
of soul searching as at that point in time there was no develop-
ment economics to refer to-nor was sociology an acknowledged
separate discipline. With remarkable insight the japanese focus-
sed on three key variables: education, sociology and technolo-
gy. As for the political dimension, here too Japan sought to
emulate western democracy and aggressively brought about the
unification of the country structuring a strong central authority
which demolished the centuries old bastions of power presided
over by local warlords. But here old Japan proved too strong
and the democratic set up proved to be a facade behind which
procrustean authority was ruthlessly exercised by the power
elite headed by the military. The mythical and mystical person
of the emperor buttressed the new order and was skilfully
exploited by the power elite to ensure obedience to official
dirtat whirh hnd theurn1 nf mval snnrnvrrl
2 70 F l s a l Impem tives In PaMstan 's Econon~fcDewlopmen t

Japan planned for its accelerated economic development

in a carefully calculated effort that sought t o inculcate in its
people the "knowledge" of western man which quite correctly
was seen as the motive force behind the extraordinary achieve-
ments of the west. Education was therefore assigned very high
priority and "batches" of the brightest students were sent
abroadrLy the government t o study in the best institutions in
America, France, Britain and Germany. The accent was o n
science but the humanities were not ignored. Nor did the ja-
panese ignore their own cultural heritage. Rather they con-
sciously sought to enrich it by a constant reaffirmation of
their unique individuality. Mass literacy was acliively promoted
and a vast pool of skilled labor created.

The transplantation of western technology in the virgin

soil of Japan was another bold experiment. Japan was content
in many cases with the importation of second hand "used"
plant. Even obsolete plant was eagerly sought. The advantages
in this were twofold: the equipment was relatively inexpensive
and "copying" such equipment was very instructive and was
actually an aid in learning. As labor was cheap in Japan, the out-
put manufactured o n such equipment could be priced low
thereby making it highly competetive in the international
market which the japanese began t o make inroads into with a
vengeance. True, quality initially was poor and the label " ~ a d e
in ~ a ~ a n ' l w athe
s object of much derision but the Japanese
managed t o make good sales nevertheless finding the colonial
territories of the western democracieg good markets for their
low priced copies of expensive, high quality r~roductsof the
western industrial giants. And the ~ a ~ h n e gradually
se improved
product quality making their own innovations in the design of
technology.

In the crucial formative phase of Japans economic develop-

ment the state took the initiative in the acquisition of industrial
plant from abroad. It was only after the technology so acquired
had been set up and made operational that it was put up for sale
to japanese entrepreneurs. Thus while the western capitalist
economic system was adopted the state became the first capi-
talist in Japan. This was a momentous step indeed because
otherwise the fledgeling . entrepreneurs might have found it
extremely difficult to muster o n their own the large amount
of capital required t o finance the purchases of western indus-
The economics of growthSome imporrant lessons 2 71

trial units. Furthermore, an individual, especially in an under-

developed country - such as Japan was then - is much more
disadvantageously placed than a government in negotiating
purchases from a developed country. However the policy of
selling t o private enterprize industrial units already in profit-
able operation by the state paid off hand.some dividends in the
rapid s1;ructural transformation of the Japanese economy.

The Japanese were quick also t o discern tlie potential

o f the corporate form of business enterprize in a capitalist
environment. Policies were deliberately designed t o encourage
the formation of large public c o r p o r a t i ~ n swhose access t o large
amounts of finance was invaluable in large scale prc~ductionand
has been of considerable significance in making possible re-
search and development. Infact it is this research and develop-
ment that has been at the back of Japans emergence as a world
leader in several important areas including electronics, optics,
automotive engineering, textiles and shipbuilding. Needless t o
say it is extremely difficult for the smaller entrepreneur operat-
ing individually or in partnership t o lay aside signiricant capital
t o fund a research and development programme that is truly
meaningful. Corporate power therefore has played a pivotal
role in fueling Japans engine of growth.

The "behind the scenes" role of Japans government in

promoting economic development without resorting t o regi-
mentation and control that deliberate planning often entails is
a phenomena of the utmost significance. After the large scale
devastation of the Japanese economy when many western
"experts" were firmly o f the opinion that Japans days as an
industrial power were over and henceforth Japans salvation lay
in the development of its agriculture and primary manufactures
at best, t h e . Japanese government began a "covert guidance"
programme for the private sector that skilfully made available
vital economic intelligence t o private entreprise and by es-
tablishing a close rapport with it continously devised policies
that strongly promoted the efforts of private industry. Govern-
ment and private enterprise thus merged, so to say, and became
two facets of one face. Over time this became a truly~'symbiotic
relationship. "M.I.T.1"' thus stands o u t as the kingpin in t h e
elaborate indirect planning scheme ingeniously put into practice
' - ~ i n i c + rnvF T - C l n n l n n x r P7 TN'T'T Trda
2 72 Fiscal lrnpmrtiws in Pakistan's Econornfc Dewlor~rnent

since the end of world war two. It was M.I.T.I. that was instru-
mental in "provoking" the hugely successful japanese drive in
automobile manufacture, shipbuilding, home video equipment,
steel etc. Currently M.I.T.I. is behind a sustained Japanese
effort in computers as in its assessment successful computer
development and application will be the key to success in
diverse areas in the 21st century.

Obviously the Japanese economic miracle ~ r o u l dnever

have been possible had not specialized intelligence been avail-
able. Although Japan has eschewed formal planning there is
no denying that a good deal of behind the scenes planning has
been present on a continuous basis ever since the Meiji resto-
ration when the momentous decisions were taken to come at
par with the western democracies. A pool of highly trained
manpower has been created over time that although employed
deliberately in a low profile has been behind the design and
implementation of policies that ensured the structural trans-
formation of the Japanese economy. Strategy and tactics have
been developed and refined over time by a trained manpower
skilfully deployed t o enable Japanese industry t o w e s t markets
from entrenched weste!n competetitors. In many ways thus the
problems posed by economic development have been tackled -
and resolved - o n a war footing.

While Japans economic development is a study in the

capitalist context in which free enterprize leads the way in a
highly competetive environment dominated by a free market, at
the other end of the spectrum is the planning that takes place in
a highly regimented command economy. Obviously, the plan-
ned effort here is highly visible and is infact the dominant
feature of the economy. While the mechanics of the growth
process are ofcourse quite different vis a vis the capitalist
economy, it might also be said that actually the difference is
not really that significant for here the state becomes "the"
only entrepreneur and at the same time strives t o perform all
those functions that the free market performs in a capitalist
system. In a way the same objective - of promoting economic
development - is being promoted in a different manner. How-
ever an important difference lies in the ability of the state to
virtually "commandeer" resources. Every thing in the state,--its
land, its population, its mineral and water rewurces - is at its
disposal t o d o as it will. This immense power confers on the
The economics ofgrowth-Some Important lessons 2 73

state a leverage that makes it an extremely potent force in every

area of human endeavour. Properly applied, such power is
bound to lead t o highly significant results. So far we have be-
fore us the examples of Russia and China - and their satellite
states - only as examples of unbridled state power. And the
results have been, todate, highly encouraging. Both Russia and
China have wrought a revolution in the structural transfor-
mation of their economies. h o k i n g t o the limited timeframe
within which this has been achieved the significance of the
effort is enhanced manifold. It would b e no exaggeration t o
say that never before in human history has so much been
achieved in so short a time. Here again, as in the case of Japan,
the deliberateness of the effort stands o u t prominently. Con-
scious human endeavour has been responsible for this meta-
morphoses. Here again, the sustained effort of trained man-
power has been behind the astonishing speed with which
structural transformation has taken place. Very little has been
left t o chance. Everything has been planned. Many mistakes
have been made but much has been learnt from these mistakes
and in t h e end remedial measures have been designed imd put
into play. Specialized expertise having been allowed a relatively
free hand - within limits ofcourse, political constraints being
significant in an ideological state - and the results are there for
all t o see.

If planning is t o be truly successful, continuity is abso-

lutely essential. It is only a sustained effort that rr~aintains
growth momentum. It follows from this logic that a break in
the continuity of t h e planning effort will reduce, stop and even
reverse the forward growth momentum dread y achieved. What
happened in China in the tumult of the "cultural revolution"
of t h e sixties is especially instructive in this context. \When the
revolution was launched, a drastic soul searching replaced the
normal evolution of policy in all areas of activity. In c.conomic
planning t h e prevalent schemes were dubbed as deficient
having been allegedly inspired by 'bourgeois' thinking. Many
ongoing projects were scrapped and radical new measures taken
instead. One such measure was the decision t o set up literally
thousands of small "backyard" steel furnances which were
expected t o yield an output qualitatively and quantitatively
superior to the traditional large steel mill. As the revolution
rlnucanor=td intn a n a r ~ h vi t c fa111tvInoio Wac cnnn o u n n u d and
2 74 Fiscnl Imperatives in Pakistan's Economic Dewlopnienr

But the time lost as a result of the disruption of the cultural

revolution actually put china back almost ten years and it was
no easy task t o put t h e economy back on the road t o progress.

T h e cultural revolution in china is of'course an extreme

example. In developing countries so many things happen that
cause- breaks in the sustained implementati.on of development
plans. As a result "adhocism" has becomc a regular feature.
Most plans devised are short term. There i~stalk of long term
perspective planning but that is usually rhetoric. The lack o f
continuity is o n e of the important reasons t,hat growth momen-
tum is not maintained and cannot be accelerated enough t o
provoke a "take - off" of the economy.
 Throughout history it is the
country's manpower that has distinguished
- -
or disgraced it in the comity of nations.
Whether it be warfare or cultural or
economic achievement, the "worth" of a
people stand out in stark relief.

It is indeed ironic that abstract ions like "st ates","empires"

"nations", "ltingdoms", "republics", receive credit for achieve-
ments that are essentially achievements of the people. Li!:e-
wise, when such entities demean themselves (as the "Third
Reich" did in world was two) the individuals that collectively
symbolize the entity often retreat into the background.
1
p
L
Throughout history, - both ancient and modern - it is the
intellectual and physical vigour of the people that has left
lasting impressions t o be recorded for posterity. P;eedless t o
say, therefore, the most valuable asset of a "state" is its popula-
tion - provided it has qualities that can be put t o use: o n the
battlefield, in the factory, in its agriculture, in leadinsit t o new
frontiers of achievement. Bereft of such qualities, !.he popula-
tion can just as easily become a liability, consuming the national
product but contributing little.

Looking at the developed countries of today, we find that

there was a time in their history when there was little in terms
of tangible physical achievement that they could claim credit
to. In many cases we d o not really have to g o far back in time.
The U.S.A - which is the leading economic power in the
world today -- was "virgin territory" in the 17th century with
a few intrepid adventurers perilously placed in safe havens on
the coast. However it was not long before the immigrant popu-
lation of this new world overtook many an ancient superpower.
Before the close of the 19th century, America was already fast
nn t h e WRV t n h ~ ~ n r n i nauwnrlrl nnwor T . i l r ~ w i c n .Tanan -- nn
2 76 FLrml Imperatiws in Pakistan 's Econon~icDoelopment

economic colossus of today - was a war ravaged feudal society

noted for its pathalogical hatred of all things foreign. This was
so as late as the mid 19th century. However these very people
overcome their distrust and hatred of things foreign and within
just over half a century hungrily devoured what the developed
democracies of the west could teach them with an application
that put them o n the way t o becoming asia's leading military
and economic power.

History teaches us that the mind of man harl+urs ~ o t e n -

tial enough to work wonders in this world - but,;in order to
harness its tremendous potential it has got t o be educated. It
must be taught t o draw on the experience and lessons of the
past in order t o be able to build for the future. Witllout such an
effort the mind must remain a blank slate. Since economic
development is an effort at improving the qu,ality of life
through concrete economic achievement, the mind must play a
pivotal role. It is this mental resource that in the final analysis
will determine whether the effort is going to succeed or n o t
Unfortunately this is an area that has not received attention
enough in most of the third world countries struggling to attain
developed country status. They have succeeded in acquiring
the physical "hardware" of development but since their people
remain largely illiterate - o r because the literacy given their
people is not consistent with the requirements of the situation-
such (countries;are unable t o sustain economic development for
any significant length of time and thus fail to imititu tionalize
the growth process. Also, because their collective mental capa-
bilities lack the necessary range and depth, such countries are
devoid of the "residual capability" that could enable them to
recover from serious "traumaw- a devastating war, a natural
calamity etc.

The overriding significance of "residual capability" is

borne out vividly by the experience of Japan and Germany
after world war two. Both countries had been thoroughly devas-
tated in the conflict and had emerged as losers deprived of al-
most all their industrial base. The little that remained was not
enough to lead t o economic recovery. Even with foreign assis-
tance neither country could hope to regain its former position
in the foreseeable position. Yet in just over a decade both were
placed on the road to economic recovery and in another decade
were overtaking some of the victors of the great war --Britain
278
TABLE 21
EDVCATION IN T l t E T H I R D W O R m - SELECTED COUNTRIES-COMPARISON WlTH T H E N.I.C'Sg
-
NUMBER ENROLLED IN SCHOOL AS PERCENTAGE O F AGE GROUP

PAKISTAN 40 42 69 64 20 29 12 16 18 - 6 - 2 2
NlGERIA 31 92 39 103 24 81 6 29 1 - 9 - - 3
BANGLADESH 49 62 61 61 31 66 13 19 23 26 3 11 1 b
UiDONESIA 12 118 79 121 66 116 12 39 18 46 7 34 1 1
INDIA 74 90 89 106 67 73 21 34 41 44 13 23 6 9
PHILIPPINES 113 101 116 106 111 101 41 68 42 66 43 71 19 29
THAILAND 78 97 82 - 74 - 14 30 16 - 11 - 2 25
TURKEY 101 113 118 116 83 109 16 38 22 47 9 28 4 9
EGYPT 16 84 90 94 60 72 26 68 31 70 1b 48 7 21
VlPTNAM - 11s - 1 - 106 - 4 8 - - - - - -
S. KOREA* 101 98 10s 99 99 Ob 36 91 44 94 S 88 6 26
SINGAPORE. 106 11b 110 118 100 113 46 71 49 10 41 73 10 12
Tbe newly Lndutdalhed counlrles (N .l.C1s). S o w e : World EU&. World D e v ~ b p m m Repon.
l 1987.
I h c prcusd .bysndly p m r lttsncy n t r In P.Uusn L, the re.ult both of n d r n a n d r u o u r c e m P r t h & Soodobfied Lmvaatlrrr
blnder Irmak s e h m U a d rtbnlc d l v c d t y ob.huets r e d y acerpuner of .'I" ~ t l o lanauase.
d Tbc m r u b o o d r u of ektc " e W b modlum"
aducatlolul I n d l t u t l o n caterins to the wbmn and md rleh h s lntroduecd a potentdaUy d v l g c m u " d d t y " ln tbc e d u c a t l o d V k m . All
h a w coldrtbukd to the e m r n t e h o . In a l u u t l o n whlcb buomlnouspodints for the future. DxsAlc actIan h c a l l e d f u r 15 INS ale. ~ W C ~ Y
u the aeeeloatlon of e c o n o d e dcveiopment I. now recogdrrd u b c h g d k c U y LLnlred to in\+strnent In education.
 The economics of gowth-Some important lessons 2 79

and France. This was indeed a metamorphoses but behind it

lay the residual mental capability acquired by the patient
efforts made in the past that could not be destroyed even in
military defeat and became the basis for a magnificent recovery.
Ofcourse even such capability wpuld not have been enough
had the current education of the( japanese peoples been neglec-
ted by the government of the day. But the fact remains that
such residual capability was crucial to full recovery.

The advent of the technological society has injected a

new urgency for the acquisition of specific skills. Needless to
say such skills can only be acquired if a basis for such acquisi-
tion obtains. Without a good basic education it is not really
possible t o acquire fully comprehensive technical proficiency
to derive optimal benefit from the complex artifacts of the
technological society. Besides, research and development, which
is a crucial ingredient of this society, cannot be undertaken
in any meaningful manner if the necessary skills are not avail-
able in the people.

The relevance of education to survival in our intensely

competetive age is relatable not merely t o technologid needs
but has another, not readily discernible dimension. This is the
sociological aspect and it has t o do with the way people think -
with their attitudes, their responses; indeed their "worldview:'
In the opinion of many, without proper education it is not
really possible to give the worldview a positive stance People
deprived of meaningful education thus remain mired ina morass
bred by ancient superstitions and negative attitudes and d o not
have the wherewithal t c grasp what is significant :In a given
situation. To expect ~ocjpleso disadvantaged t o perticipate
meaningfully in a developmental process is asking t,oo much.
What one must expect here however is for such people t o hold
up the development process.

One of the most serious problems facing third world

countries is a very high rate of growth of popula1;ion. Such
unchecked proliferation nullifies much of the concrete achieve-
ments made in economic development. What is exasperating
however, is that despite the obvious problems that rapid popu-
lation growth poses in an environment of severe resource con-
straints people seem to be oblivious t o the dangers that are
-
is store for them. Even official "propaganda" goes unheeded.
280 Fiscal Impemtiws in PaMstan 's Economic Development

Why so? Are people so stupid as t o wilfully ignore the dangers

inherent in the situation? the answer appears t o be that the
people lack the "knowledge" that could make then aware of the
real significance of the situation. It is their "ignorance" that is
at fault. This need not necessarily mean that they are illiterate.
Infact when the literacy imparted is deficient, a "distorted
worldview" can easily result.

If third world countries are t o be able t o overcome the

plethora of "anti grbwth" factors that dot the road t o economic
development, the crucial significance of education as 'The'
leading factor will have40 be grasped. The exa~nplesof China,
south Korea, Taiwan and Singapore are vivid testimony t o what
miracles proper education can wrought. Likewise, the dis-
turbing experience of India, Pakistan, Banglandesh, Nigeria
and many others highlights in no uncertain manner, what
serious prolems beset those who dare to neglect education.
 VIII

Many once rich & powerful nations missed

the ~ndustrial revolution and entered the
20th centu as relatively backward
countries. 1
hile the reasons for their
predicament are varied and complex -
perverse attitudes appear to be highly
significant.

Economic growth is the end result of a complex play of

diverse forces that create an environment in which initiatives
are launched that are instrumental in the structural transforma-
tion of an economy. Modern technology has played a vital role
in facilitating such a change. Historically, the impetus t o the
setting up of "new industry" has followed in the wake of
developments that are not easily and certainly not rigorously
marshalled. In "virgin territory" the machine syinbolizes mans
challenge t o nature. The Tdea" that ushers technical change
will emanate and take root only if the right set of conditions
obtain. Many of these requirements are "mental". Attitudes
therefore &e highly significant.

The ability of a people t o carve out a chos,en destiny for

themselves is relatable t o their "world view." Their perception
of the control that can reasonably be exercised by man vis a vis
his environment will mould their attitudes andl fashion their
responses. This in turn will eventually be responsible for giving
such responses a "positive" or "negative" stance.

As the "response" we speak of is essentially a mental

phenomena, the human mind has a lot t o d o here. And since
the mind is an amalgam of a baffling diversjty of mental inputs,
the dominant mental input will determine the attitude of a
people at a given time. In a backward society where the people
are largely illiterate, the predominant mental input is usually
that of religion. The 'content' of their religion o r what is per-
1
282 in Pakistan 5 Economic Development
Fiscal ini~pe~~r;';c.s
I
I ceived t o be the content will be the key factor then, in deter-
mining their worldview.

It is generally accepted that "nonwest.ern man" has by

and large, a fatalistic outlook. Many of the woes of "eastern
man" are also attributed to this negative attitude in which
'destiny' is seen as wholly pre-ordined. Since it is unfortunate
ly the lot of our eastern man t o be placed among the poorest on
k; our planet, a relationship is often perceived between his world-
F
si
r

,
view and his poverty.
$
Much of the negativity in (he third world worldview
follows from obscurantist obfuscation of the real nature of their
religions.

There are many instances in history when the forward

march of a powerful nation is seen t o lose momentum, even-
tually to 'stop dead its tracks', as it were. In some cases a rever-
sal is even evident when instead of any progress there is re-
gressio n.

In economic development the phenomena described above

is of interest because it serves t o identify factors and relation-
ships that are of relevance in the growth process.

Spain is an important case in this context. Here we have

a leading "old world" superpower that with the 1479 union
of Aragon and Castile became united under a central authority
and prepared-the way for her to become the richest and most
powerful state in europe - and the world. Spain had established
a vast empire in the South Americas - the New World - and
her intrepid, plundering, adventurers - the conquistadores -
looted the fabled riches of the New World with abandon. Spains
fleet of 'galleons' transported the treasure across the atlantic
back to the motherland. Eventually, Spain was t o amass a vast
hoard of gold, silver and assorted precious gems. Spains euro-
p a n teritories included the netherlands and in the east, the
Philippines.

Looking to the rich heritage, one would expect Spain t o

continue its onward march and be a m o k the front ranking
nations when the momentous trauma of the industrial revolu-
The economics of growrhSome importanK lessons 283

tion hit europe. However t h t w q not to be so. The rot had

already set in and Spain became a second rate power. did not

It would be misleading t o oversimplify and cite "a"

particular cause for spains decline. Nations d o not collapse
"overnight", as it were -- least of -all "great nations." However
there are always causes that have overriding significance in this
context.

The renaissance was instrumental in "provoking change"

in europe by eroding the basis o f the feudal, monastic, agrarian
culture of the middle ages and replacing it - gratlually - with
a secular culture rooted in a rebirth of classical forms and ideas
in the arts and the rise of urban, mercantile civilization and a
new ruling class. Wherever the renaissance ideas took root, a
change in mental at tit udes followed. Spain h o w e ~ ~ became
er by
circumstance and design, an insulated, isolated bastion of
medievalism, far removed from the ferment and zross currents
of the renaissance. While the light of the renaissance lit up
europe, Spain remained engulfed in darkness. A cruel inquisi-
tion tormented and crushed all dissent, stopped debate and
ushered in "a new dark age"-as far as ideas go. With religion
degenerating into obscurantism complemented by an essentially
despotic, narrow power base, creativity of expression became
impossible. The implicications of this ominous development for
the future of Spain were disastrous. With the mental faculties of
an entire nation put to disuse, atrophy was inevitable.

The industrial revolution made its momentous advent on

the island of Great Britain. The choice was n : ~ tmerely for-
tuitous. The island people had revolutionized their outlook
by broadening the powerbase and &vesting paliament with real
authority in matters of governing the state. The unbilical cord
that linked Britain t o the papacy had been severc?d. The trauma
of this separation itself provoked and promoted independent
mental expression. A new "protestant ethic" revealed itself and
aided capitalism in establishing itself firmly as an economic
system. The ferment in the life of the peolples of Britain
brought about by the many changes that took place over two
centuries, changed mental attitudes perceptibly and culminated
in the series of achievements that put the b r i t i h people more
and more in control of their environment enabling them t o
284 Fiscal I r n p e m t k s in Pakistan's Economic Development

Bereft of any impetus for meaningful change, saddled

with a medieval political arrangement and insulated by its
isolation from the ferment on the continent, Spain stagnated.

What is stated above is undoubtedly an oversirrlplification.

It is just'' not possibly t o dissect history so neatly. But the
point made - that attitudes shape mental responses -. would
certainly appear to be valid, for it is not only what happened in
Spain that proves this point but the demise of many a great
power in history is relatable t o perverse attitudes resulting
from a deficient and impoverished mentality. Infact, through-
out history, the dynamic development of a people is relatable t o
the motivation induced by ideas shaping their worldview.
 For a developin country the quest for an
#
"appropriate tec nology" is likely to prove
elusive. Simply because a country is
over opulated does not mean that it "must"
labor intensity in all areas
application.

Technology as a factor in economic development has

crucial significance and from t h e experience of a1 the present
day developed countries of the world it is easily cited as a pivo-
tal factor. The use of technology has made posslble standardi-
zed 1-e scale production. Ipcreased output has brought in its
w&e a fall in unit prices. Countries able t o deploy modern
technology effectively have been able t o capture large markets
for their products and looked at in this context, international
trade, at least till recent times, has rightly become an "engine of
growth" for them.

The use of highly capital intensive "round-about" methods

of production has added a new dimension t o the role of tech-
nology in the economic development of a country. Much of
the accelerated increase in productivity in the present day
developed countries is relatable t o the s u c c ~ ~ f u usel of
'round-about' production techniques. However, for t h e develop-
ing countries of the world there appear' t o be no easy answers
t o the problem of technological choice. U'hile use of technology
is admittedly essential t o accelerate economic development, the
use o f particular types of technologies has proved t o be a much
more complicated problem t o resolve than it appeared early on.
The problem has been particularly difficult for developing
countries plagued with problems of populatioi~redundancy.
In such countries the use of "generalized" capital intensive
techniques has apparently, appeared t o exacerbate the popu-
lation redundancy problem. At the same time, given their
286 Fisca! Impemtives In PaMstan 'S Economlc Development

under-developed state, such countries have been alnnost totally

dependent, at least in the initial stages of their economic
development, on the developed countries for making available
to them the infusion of modern technology necessary t o form a
basis for the industrial Mra-structure that is required to get the
development process under-way.

Two approaches have been generally adopted in the

matter of selecting technology for use in developing, countries.
The first approach was based on the deliberate induction of
"used" technology from the developed countries. This w& the
approach adopted by Japan in the initial stages of its drive
towards industrialization. Japan imported used plant, from
Britain and other european countries especially in the area
of textile manufacture and also in steel making. After farni-
liarisation with the old, and in many cases, obsolete technology,
Japan endeavoured to improve it on its own and thus laid the
basis for the indigenous manufacture of plant and machinery
which in the initial stages amounted t o little more than "copy-
ing" the technology of the West. Over time however, as it gain-
ed experience and built up its level of technical expertise,
Japan was able to significantly enhance its ability to manufac-
ture plant and equipment on its own. By the time Japan bad got
involved in the Second World War it had acquired the technical
wherewithal t o design and fabricate modern technology in-
dependent of out-side assistance. It was the acquisition of this
capability that gave Japari the "residual" potential to recover
from the trauma and massive dislocation of the huge material
losses suffered in the ;second world war. especially the satura-
tion bombardment of its industrial centers. In the post war,
period Japan displayed a remarkable recovery and mured for
itself a place of eminance in the comity of developed nations.

h contradistinction to the approach adopted by Japan,

the newly industrialising countries (N.I.C'S), South Korea and
Singapore, both resorted to the use of highly capital intensive
round-about techniques based on ultra modern, state of the art,
technology. They imported the latest, most mwiern technology
and started their industrialisatior~ effort .Prom there. Their
success is evident from the fact that in merely two and a half
decades of sustained effort, they ha,+? clearly broken away
from the shackless of backwardness and are today placed
among the front runners. These countries have been able to
 TABLE 22
ECCINOMIC STRUCTURE O F SELECTED THIRD
W O R L D COUNTRIES COMPARED WITH THE N.1.c.'~

GROSS DISTRIBUTION O F GROSS DOMESTIC PRODUCT (PERCENT)

DOMESTIC
PRODUCT

( w o n 5) .4griculture Industry Manufacturing Services

1965 1985 1965 1985 1965 1986 1965 1985 1965 1985

PAKISTAN
NIGERIA
BANGLADESH
INDONESIA
MDIA ,
PHILIPPINE
THAILAND
TURKEY
EGYPT
S. KOREA*
SINGAPORE*

Soume: World Bank, Wor!d Development Report :1987

The changing complexion of t h e 'developing' economy over t w o decades of development is e n d e n t f ~ o m

t h e data tabulated above.
The "drift" away from Agriculture and towards industry h clearly dlscerntble.
288 Fiscal I m p e r a r t ~ sIn PoMstan's Economlc Development

institutionalize the growth process and have been able t o

sustain the same on a recurring basis on their ow1.1.

As against the approach favoured by South Korea and

Singapore, India,, after attaining independence, opted- t o
"mimic" the approach favoured by Japan arnd thus sought
build up on used plant and equipment imported from the de-
veloped countries. Its effort in this context was motivated
primarily by a desire t o make use of the labour intensive tech-
niques relevant to such technology, the use of which was
thought to be necessary in order to alleviate its population
redundancy problem. In actual practice however, it was found
that such technology proved to be inefficient inso-far as it was
not able to yield the increases in productivity that the more
modem and capital intensive technology was able to do. The
net result of the use of obsolete technology was t o make the
end product non-competetive in the market both because of its
relatively high price and deficient quality. Furthermore, the
"investible surplus" that emerged as a result of the use of
such obsolete technology in the initial stages was also found
to have been adversely affected. This investible surplus, on a
national scale, is a crucial determinant of the resources that
can be deployed in successive rounds of ecoi~omic activity.
Should the investable surplus be eroded the resource position
suffers as a necessary consequence thus limiting further the
already limited ability of the developing economy t o invest
in developmental activity.

In the opinion of many, the quantum of the investable

fund available t o a developing economy is-of crucial signifi-
cance. The -french economist, Charles Bettelhei~m,("Choice of
Technology and Economic Development") has elaborated on
this aspect and has illustrated its dramatic impact in ensuring
the success of a development drive. Since modern technology
assures not only standardized large scale produ~ctionbut also
lower cost per unit, the investible fund that emerges from its
deployment is bound to be significantly higher than what
would result from the use of obsolete technology. The "catch"
here of course is the impact of capital intensive technology
on population redundancy. Apparently, .widespread use of
highly capital intensive technology is bound to create serious
problems in the matter of absorbing the huge :;upplies of un-
employed labour ubiquitous to most developing countries.
The economics of growthSome imporant lessons 289

For such countries continued inability t o provide employment

to this large pool of labour amounts not only t o a wastwe of
human resources available in plenty but also has omlnous
political implications.

There is no denying that labour available in plenty con-

stitutes an important economic resource. No developing coun-
try can afford t o ignore the availability of this resource for
long. The example of communist China in successfully putting
to use this resource illustrates the positive results that follow
if the right approach is followed. The popular view in this
context, that large supplies of labour can only be successfully
absorbed if labour intensive technology. is used, i a fallacy.
That this line of reasoning is not consistent with the objective
parameters in a developmental context is evident from that
fact that there can be no single, "standard" choice of technolo-
gy for the entire range of activities that are t o take place in an
economy. The modem economy is a highly comp1,ex structure
and embraces features that necessitate varying capital --labour
combinations in different areas. There may thus be spheres of
economic activity in which the use of labour intensive techno-
logy may be fully warranted. At the same time in certain other
areas, the use of capital intensive technology may be indicated.
In still other areas, a middle position may be warranted. The
point to note here is that technology must be "matched" t o
the activity. Thus activities inherently complex in nature may
be best served with complex capital intensive technology
employing highly "round-about" methods necessary to ensure
sustained high productivity and to maintain "competetiveness"
in the market while at the same time an investible surplus is
adequately generated.

The whole question of technological choice thus boils

down t o one of "appropriateness" of the technology sought t o
be employed. The experience of different countries todate
would appear t o clearly indicate that there are no ready-made
solutions in this regard. The technology developed in an advan-
ced country may or may not be appropriate t o the peculiar
needs of a developing country. However, it does not always
follow that the technology of a developed country is consis-
tent with the needs and resource position of a developing
countrv. As mentioned a h n v ~it si the "a~t,ivitv"to which the
 TABLE 23

STRUCTURE O F MANUCACTURING IN SELECTED THIRD WORLD COUNTRlES A N D THE N I C S

DISTRIBUTION O F MANUFACTURING V A L U E ADDED- 'i-1900 PRICES-

VALUE ADDED IN I A A N V ~ ~ A ~ U R I N G -
Coualry (MILLIONS O F ID80 U.S. Donus)
Food and Textikm .nd hbchhuv m r d
~aricunrne dot- 'Ihmpori Qulpment Cbcml&m 0th.~

PAKLSTAN

NIGERIA

BANGLADESH

INDONESIA

INDIA

PHILUPINES

THAILAND

TURKEY

EGYPT

SINGAPORE 1114 6 4 228 8 3 0 4 20 52 3 6 61 36

-
Souma: World Burt. World Development Repor(. 1981.

An iadlmtlon o f the masnnude o f the M l r t r W b e I l n In the datm lor n l u e d d e d h r n m u i m d ~

(ml2) 11 U M N c U r to note that =hn d d d to Mid*
1970 raa almost iom t h n n higher than 1h.t tn r Lor- BY 1904 1. L o r u h.d mmc n r y
In the bdlan m.(nltudes indlcntlq d r m a t i d y the npbi p-
d l In the stnutun1 hamterrnatbn o i the emnomy.
n e economics of growrhSome Important lessons 291

context. The examples of Communist China and India both

show that the assumption that the only way to alleviate prob-
lems forced by population redundancy is deploy labour inten-
sive technology on a large scale is fraught with grave risk. Com-
munist China during the course of its tragically misguided
"cultural revolution" great leap forward' 'embarked on a pro-
gramme of building "backyardsteel furnaces" o n a very large
sclae throughout the countryso as t o both meaningfully employ
its large population and t o ensure the large output of a vital pro-
d u c t s t e e l . The attempt, we all know how, was an economic
disasaster and caused such dislocation as t o not only stop the
forward momentum of the economy but also to reverse it dra-
matically. In the opinion of many experts, the mistakes (includ-
ing the one cited above)made China loose more than a decade in
terms of development time. Similarly, in India, the Amber
Charkha programme, t o produce cotton cloth by the use of
thousands of small spinning and weaving units set up In homes
and small establishments all over the country was a complete
failure as not only was the end product substandard, but also
it was limited in quantity and uncompetetive in price when
compared with the production possible through the use of
modern technology.

It is thus imperative that "simplistic" solutions t o com-

plex problems - such as that of technological choice 'be
religiously avoided for decisions based on "Naivete" rather
than experitse and imagination are bound t o be counter pro-
duc tive.

Structuring an industrial base.

For most Third World countries extrapolation of present

day trends does not take us t o a future that is radically different
from the world we live in today. The reason is that anti growth
factors led by the scourge of population growth are more than
adequate to ensure that on balance the threshold of economic
achievement in 2000 A.D. remains roughly where it is in 1987.

Does this mean that there is really no hope? ofcourse not.

However we have got t o realize that in the find analysis people
eventually get what they deserve. A people who fail to red the
writinn n n +hn .wall rnrrc+ +ha
C I I ~ ~ P V PAIIPP~~~IC??W!S W e rn~~st
292 Mrcnl Impemtlves In Paklstan 's Economic Development

Aq the advanced countries of the world more into high

tech areas of economic activity residual areas are now available
for countries willing and able to make forays into previously
forbidden teritory. We have examples before us' already. South
korea is ofcourse a scintillating, and very relevant instance.

In S. Korea we have an example of a country that has

moved into areas of economic activity that were not long ago
the exclusive preserve of asias economic collosus - Japan.
Consumer electronics, textiles, automobiles etl::. were success-
fully usurped. This new territory was not easy to secure for
Japan was not inclined t o surrender meekly. However in the
face of decisive advantages on the cost side due 00 lower relative
wage rates and technological capability based on patient struc-
turing of an effective industrial base, the challenge could not be
countered.

It would appear that the crucial factor here is the struc-

turing of the industrial base. What is required is the develop-
ment of interocking segments in the technological infrastructure
that lend support t o each other and together ensure that there
exists a broad based capability t o participate collectively
in a developmental effort.

An industrial base is not a mere conglomeration of indus-

tries. Its vitalcomponents include a pool of skilled manpower, a
plan to link the development of this pool with the requirements
of a growing base, an effective logistical system, a fiscal system
that provides the wherewithal t o fund the building of the base
and a planned industrial layout that provides for the setting up
of variegated units that each focus on different areas viz steel,
machine tools, heavy chemicals, mechanical fabrication etc.

In Pakistan we have not been able t o structure an "effec-

tive base". T o sure we now have a steel mill, a heavy mechanical
complex and machine tool capability. These however have not
helped the country make any significant inroads into inter-
national markets through the e x ~ o r tof 'manufactured goods.
Nor has the base been put t o use effectively irr opening up the
The economics of growth-Some important lessons 293

backward and underdeveloped areas of the domestic economy.

In order to ensure the vialbility of the economic base in

the initital stages when the developmental effort is taking root
the functional capability of the base needs t o be estabilished.
The examples of both Japan and S. Korea show that such capa-
bility is best established by focussing the application of the
economic base to opening up the backward domestic economy
by aggressive and sustained effort directed towards moderni-
zation.

It is only when the economic base has achieved criticality

in its structuring that the first experiments can be made for
making inroads into international markets.

An important question. here is when does the economic

base achieve criticiality?

Based on the examples of Japan and S. Korea it would

appear that in the so called free world group of countries the
break away point of criticality is when the new aspirant to
membership of the club of developed countries starts to take
on one - or more - of the developed countries it seeks t o
emulate in a given area of economic activity and in direct
'competetion seeks to replace it. Japan did this in textiles and
then .in assorted, uncomplicated consumer goods--, including
(but not restricted to) toys!!

S. Korea has followed suit in like manner taking on its

giant neighbour that ironically supplied much of the technolo-
gical components of its economic base. The potential capability
of the economic base was then patiently translated into actual
achievement as one area of economic activity after another was
taken over and successfully retained through consolidation of
the break in effort. This consolidation, it appears is the
second crucial determinant of the test of criticality. This is so
because the initial break - in may well be a fluke - a chance
happening not justified by objective parameters. The newcomer
must prove that he has staying power and that he can retain the
(ground that he has captured.
2 9 Fiscal Impera dves in Pakistan 's Economic Development

ket for its increasing output of textiles produced on machines,

not handlooms, provided the opprtunity for take over and
consolidation. T o be sure the market was s o large that it was 'nt
necessary for Japan t o attempt t o take it over in its entirety.
However in the segment of mass demand for simple cotton
textiles the Japanese were able t o outprice the competetion.
The first dent in the stronghold of the established industrial
powers of -the west .-Britain, the USA-was thus made. Sub-
sequent consolidation was not easy. The derisic~n and sheer
contempt that greeted the first consignments of nianufactured
output from Japan was hardly any encouragement. But patience
coupled with continueing effort resulted in a gradual but
perceptible improvement in quality and eventually not only
consumers but the countries that Japan sought t o emulate
accorded acceptance- albeit grudgingly.

After the trauma of the 2nd world war Japan had t o

start all over again. However because of its residual capability
the reconomic base was restructured in a relatively short time.
By the 50's the recovery drive was in full swing. However
this time Japan felt capable enough t o attempt forays in areas
other than textiles. The world demand for motorcars appeared
t o be an ideal test area. Motorbikes were there too and cameras.
And then there was the great opportunity ushered by the
explosive revolution in electronics. Japan in classic predatory
manner made cunning and aggressive forays in all these areas
and was able t o win thanks to its residual capability based on
the concrete achievements of the post meiji modernization
drive.

For S. Korea the task was more difficult. The western

democracies realizing that in a truly free market world they
would lose out t o Japan in a number of important areas of
economic activity thus placing in jeopardy'large segments of
their economic edifice, had decided t o arbitrarily restrict
imports from the new competitors. Thus low price alone could
not now secure entry in the markets of the west where the real-
ly large profits lay. The flock of newly independent third world
countries however was a fortuitous event. An alternate market
was now available. No doubt a smaller market and a cheaper
market but a market nonetheless. The profits ofcourse were
lower but they were enough t o justify the ddspening and widen-
ing of the economic base at home.
The econornicssof growth-Some important lessons

Machines make possible mass production and mass

production means lower prices. Modern machines mean not
only mass production capability but also the capability t o
improve on quality and t o optimise reduction in cost per unit
therby ensuring maximum mark up i.e. profits folr the given
price that gives a control of the market. This is precisely why it
is not possible in the present post world .war 2 era t o structure
an effective economic base the technological component of
which is obsolete and outdated. S. Korea percieved this impor-
tant insight early on in its development drive and sought t o
structure a modern tekhnological edifice by installing the latest
-which is not necessarily the biggest - in steel making capabi-
lity, in machine tools, plastics etc In vivid contrast t o this
and as pointed out above-India in the early stages sought t o
acquire steel making capability by buying antiquated plant from
Britain. Similarly in textiles it sought through the much touted
arnbar charkha program, t o m a s produce textiles o n hand-
looms. Both the attempts backfired. In another context, Red
China in the traumatic years of the cultural revolution attemp-
ted-in all seriousness ofcourse-to mass produce steel through
a plethora of backyard fumances. Again the attempt was a
hugely expensive failure.

That its modem economic base has paid off handsome

dividends is amply borne out from the successful inroads S.
Korea has made in a host of different areas of economic activity.
Its success can be judged from the fact it has actually replaced
Japan in all the areas in which it challenged it. This is no small
achievement for a country that did not have a residual capabi- I
lity like Japans, that was ravaged by war in the early years of its
independence, that had t o bear a heavy defence burden and that I
was placed in an international economic environment which if 1
not actually hostile to aspiring new entrants did not otter much
encouragement either.

However, as pointed out elsewhere also, the recipe for

sustained economic growth that worked in the 60's and 70's
for S. Korea and taiwan need not work for 3rd world countries
in the 80's.

After all Japan did buy second hand plant for its textiles.
296 Fisml Imperatlws In Paklstan 's Econc7mlc Development

and taiwan did not do thisjIndia tried t o ape the Japanese but
the attempt did not meet with the kind of success Japan had.
The S. Koreans on the other hand bought the best that money
could buy and built from there using regimented stability t o
ensure relatively low internal prices- and that included wages
for labour.

In the 80's increasing protectionism has reduced growth in

world trade and this means that third world countries will have
that much more difficulty in making inroads into international
markets. An export led development drive therefore. does
not seem to assure the guaranteed generation of hard curren-
cy o n a scale adequate to fund the acquisition of economic
material to deepen and widen the economic base and usher
in the elusive stage of self sustained growth leading to high
mass consumption.
It is clear therefore that there is no universal formula
applicable t o all countries for all times. However there is no
denying that with a deficient economic base there cannot be
a n y self sustained growth.
 they help resolve.

Governments and bureaucracies go together. Govern-

ments must have "legal cover" for their actions. Everything
that they do must be backed by an "authorization"- a law or
a rule that can be quoted. This necessitates a veritable maze of
statutory enactments in diverse areas of activity.bThus we have
civil, criminal, municipal, revenue laws - t o mentSiqnbut a few.
To implement the legislation requires a virtual army of "civil
servants". In theory this "army" should greatly facilitate
achievement of the objectives for which the statute h a s been
designed. But that is in theory only. In practice bureaucracies
have provoked great resentment against their members by the
public. The third world scenario in this context presents a
chaotic picture of public functionaries constantly at logger-
heads with the people they are expected t o serve. 'Fhe end
result of this strife is to lead t o great inefficiency in adminis-
tration. Things therefore do not happen the way they are
supposed to. The implications in the context of a developing
country are especially serious since economic development
suffers. Considering that a huge bureaucracy is specifically
earmarked for the execution of development plans, this is
indeed a great waste.

Most third world countries today have a colon.ia1 past.

On gaining independence they have usually copied the politico
economic format of their erstwhile colonial masters. This has
ofcourse included the selection and training procedl.lres and
heirarchical organization of civil servants. Considering that
t h n v a w r a t i n n a l e nf a d r n i n i c t v ~ l t i n nn f a r n l n n i a l n i i t l i n r i t v is
298 Fiscal lmpavrtiws in Paldstan :F Economtc Dewlopment

first and foremost, the exercise of authorrty --- usually pro-

crustean - to ensure continuation of the occupying power, it
is evident that for a free country t o continue with the same set
of laws and regulations - in general -that were conceived in a
colonial mould, is t o antagonise the public which in the changed
circumstances resulting from independence jilstifiably expects a
more compassionate, receptive, considerate and responsive ad-
ministration. The "accountability" of public functionaries t o
the people is also a matter of considerable significance and pub-
lic representafiives feel (wherever there are bona-fide represen-
tatives) that it is their ri&t to haul up errant public functiona-
1

ries before a proper forum and interrogate - and if necessary

chastise - them. This change in perspective thus alters radically
the complexion of administration. However we see that in
actual practice, public functionaries continue to behave in much
the same manner that they used to before the departure of the
colonial authority. The body of laws, rules and regulations
enacted during colonial rule continue t o be followed. What is
highly significant is that administrators are relkctant to reorient
theif behaviour vis a vis the public and revel in the exercise of
procrustean authority which they feel makes them command
great respect in the public. The capability to induce fear in the
public is perceived as a mark of distinction.

This persistence of "elitism" is at the root of many of

the problems that third world public functionaries face.

Modern day bureaucracies are saddled with an enormous

worlkload made inevitable in an environment of threatening
population pressures and the increasing complexity of life in
all spheres Most statutes, thanks t o continueing "amendments"
made with a monotonous regularity, have assumed a highly
distorted and complicated form quite different from that con-
templated in the original "parent" legislation,. This by itself has
been instrumental in increasing the size of the bureaucracy.
However mere increase in size has not had salutary results as the
bureaucracy continues t o be beseiged with a workload that
threatens t o overwhelm it. Thus the size though large in abso-
lute terms is still not large enough. As the existing size-perceived
as highly bloated -eats up a large part of the available revenues
governments are unwilling t o approve any further increase.
Inefficiency thus soon becomes ingrained and institutionalized.
The ecmomia of growthSom important lessons 299

Technology available today, properly deployed, does have

the capability t o facilitate greatly the task of bureaucra.ts as-
pecially those dealing with routineptandardized, repititive tasks
involving data. Unfortunately, bureaucracies traditionally tend
to be highly conservative - more so in third world environ-
ments - and the induction of modem technology is thus de-
layed - or even thwarted. However it is being realized that
technology assisted rationalization of procedures - mostly
computer based systems - appears the only way out of the
impasse in many areas of bureaucratic activity viz revenue -
tax - assessment, collection, collation, storage and retrieval
of statistical data having a bearing on fiscal policy formulation
and implementation, economic planning and the like.

Third world buneaucrats are usually invested with too

much authority at a relatively early stage in their careers. How-
ever due to revenue constraints and higher priorities assigned
t o other sectors, the bureaucracy is generally ill paid especially
the lower and middle level functionaries. This is responsi.ble in
no small manner for opening the floodgates of corruption by
the deliberate misuse and akbitary exercise of power. Wide-
spread corruption however has implications far more serious
than what the generation of ill gotten gains would suggest. It
has spawned a huge class of functionaries so conditioned to
receive extra legal earnings that situations are deliberately
created to provoke the generation of such moneys. In other
words nothing - or very little - gets done unless the "price"
is paid. For the ordinary man in the street the sheer burden of
this price and the manouvering that is involved in its payment
can be literally crushing. Furthermore, the huge scale on which
extra - legal earnings are generated has contributed signifi-
cantly to a vast "parallel economy" that is outside the ambit of
official control and which distorts and subverts the functioning
of the regular economy. Also, the "exploitive" menta1it.y that
the situation breeds in public functionaries is inimical t o the
public interest.. As an end result, the public and the adminis-
trator ,are being increasingly isolated and insulated from each
other. This compartmentalization and polarization has grave
sociological implications of its own and bodes ill for social
stability and cohesiveness so essential t o ensure unity of pur-
pose and action in a nation.
ganization is vital if optimal performance - or near optimal
psrfnrmance is t o he euyectd :!T thic pro3
 The present day "convergence"of economic
systems indicates that the limitations on
both sides of the spectru'm are being
-
recognized as are the strong points.

Pure capitalism advocates and extols the accumulation

of "private capital" t o fund the acquisition and'operation of the
costly equipment necessary t o ensure large scale systematized
production. The key t o the successful operation 01the capitalist
economic system is the 'marketplace' wherein all exchange
takes place and which allocates economic resources to diverse
activities by fixing factor prices in accordance with the per-
tinent supply - demand equation obtaining. The "market"
also distributes the national product to the participants in the
production process, again in. accordance with their relative
supply-- demand position.

The "market" will perform its role "optimally" if corn-

petetive conditions prevail throughout the marketplace -- which
en?ompasses the entire economy. Any obstructions o r hind-
rances to the free play of market forces will "corrupt" the
system and thus make it that much inefficient. Thus a "free
market" becomes the linchpin of the capitalist system, automa-
tkally, and always 'correctly,' making the adjustments neces-
sary t o fine tune the economy t o remain on an even keel with
resources flowing freely across the expanse of the economy t o
be utilized in areas where their utilization is likely t o be most
beneficial and self interest of the entrepreneur and consumer
becoming "enlightened self interest" by force of the logic of the
system.

In the free market economy the consumer is "sovereign"

heed t o his decisions and enters into the production of such
goods as are in demand. In order t o minimise costs and ensure
large scale production so as t o be able to cater t o the demand
effectively) specialization and division of labour becomes
necessary and is another important feature of the capitalist
system. Full employment of resources is made possible as all
savings are invested and there is no hoarding. To be sure there
maybe transient 'frictional unemployment' but no long term
redundancy..

At the opposite end of the spectrum is the highly regi-

mented, fully controlled economy of the socialist (mamian)
system. The means of production are controlled by the state
and all production operations are centrally planned by an
agency of the state (the central planning board or commis-
sion). Priorities and physical production targets for all com-
modities are set by the central planning board which also de-
termines the physical quantities of all resources, including
labour t o be used as inputs in the production of each commo-
dity.

Consumers have no direct voice in prodiuction decisions.

They may have a choice in what they consume, however, sub-
ject t o the limits imposed by the central planners decisions
regarding the production of consumers goods. If consumption
goods are not distributed by command, then consumers are free
t o buy consumption goods in markets at government set prices.
Laborers may be assigned to their jobs or the central planners
may set w3ge rates in such a way as t o try t o achieve the allo-
cation of labor among industries called for by their plan.

When economic resources are allocated according t o the

commands of a central planning authority, we can also speak of
a command economy. All means of production are owned and
operated by the state and directed by the central planners who
determine how much final output of each good is to be pro-
duced, how much of each input, including labor, is t o be alloca-
ted t o the production of each commodity, and the quantity
and composition of ouput t o be received by a1.I workers, includ-
ing managers in charge of state enterprizes.

In the command economy, the marketplace does not exist.

Consumer sovereignty is absent o r at best only nominal. All
The economics of growthSome Importon? lessons 303

production and distribution is the sole prerogative of a state

apparatus whose preferences become the criteria for the alloca-
tion of economic factors for utilization in production and for
determining what compensation (price) is to be paid for the use
of these factors. Relative scarcities emerging from supply-
demand relationships thus become redundant in the context
described.

Capitalism in its pure form has probably never existed

for any significant length-of time - not even in its birthplace:
post industrial revolution Great Britain. The perfect compe-
tetion based on perfect mobility and perfect awareness of
market conditions and absolute consumer sovereignty have
never been presentl ie their totality; Likewise, the absolute
command economy has never been present in its pure from-not
even in the Soviet Union.

Under a (less than pure) capitalist system Britain emerged

as a major industrial power. However early on in its evolution
it was apparent that the sort of capitalism that had taken root
was prone t o deficiencies and gave rise to ills that could cause
great social anguish by its skewed distribution of wealth and
blatant exploitation of labor by the owners of capital who
because of their superior bargaining position were able to in-
flict a wage rate that made a. mockery of the market price of
labor arising from its relative scarcity position. Furthermore,
the so called consumer sovereignty turned out t o be very
limited in its scope with the consumer often duped into accept-
ing something which he was "told" was best for him - at a
price that was higher than that warranted by its relative scarcity
position in the market. More ominous was the tendency of the
system t o be subject to highly destabilizing gyrations sympto-
mized by marked fluctuations in prices and levelsof economic
activity.

The emergence of the command economy was largely a

reaction t o the deficiencies of the so-called free capitalist eco-
nomy. However the theoretical basis of the command economy
rooted as it was in marxian dogma prophesied the ultimate I
collapse of the capitalist system and its replacement by tho- I

roughgoing communism. Economic forces were decreed as being I

within the control of man. Lndeed it was considered necessarv 1
304 FLrarl I m p m t l w s In Pakistan 'J Ei:onoml~Developmenr

aberrations of perverse market forces corrupted by the machi-

nations of grasping, self seeking capitalists.

The evolution of the capitalistic system in Britain -as in

other countries of europe and the USA - witmm-xl a marked
increase in the structural complexity of t h e economy and the
increasing use of roundabout methods of ~roduction.With the
development of standardized machine tools, technical change
became rapid and the advent of heavy industr~isaw the emer-
gence of a technolclgy that necessitated massive infusion of
capital and futhennore required a "waiting period" (gestation
period)which at times was significant. In certain =ear, especially
public utilities, it became increasingly risky for private enter-
prize t o operate, as returns were not quick e n o ~ hand the
requirements of capital investment were much too high. An-
other feature of significance was the emergence of "trade
unions". At first resisted by the capitalist ownt?rs of industry,
the unions finally prevailed and became a recognized - and
powerful - arrangement t o bargain for rights and privileges -
including the right to a fair wage. It was n o longer possible for
the owners of capital t o exploit labour at will -- though some
exploitation is inherent in the capitalist system considering the
heavy bias in favor of capital. However it is true that the
sort of blatant exploitation of labour that characterized the
formative phase of capitalism is just not ~ o s s i b l today.
e

Thus even before the advent of the command economy in

soviet Russia in 1917, changes had already taken place in the
capitalist system in vogue in the western democrac:ies of Britain,
America and France. State ownership and control of key areas
of economic activity was already becomir-g a regular feature and
organized labor was becoming increasingly and aggressively
assertive. However the free market continued t o be the key
institutional arrangement for resource and distri-
bution of the national product with supply -
demand equili-
brium determining relative scarcities and pitching prices at given
levels. As yet academia in the west found nothing fundamentally
wrong with the existing economic order and indeed considered
it resilient enough to "self adjust" rapidly t o normal full em-
ployment equilibrium should any destabilizing variation from
the norm occur. Infact such variation was yiewed as an h e m -
tion resulting from an unlikely set of circumstances.
 The economla of growth-Some Important lessons 305

The myth of "self adjustment" fostered by the advocates

of capitalism received a devastating rebuff from the apocalyptic
events1that followed the stock market crash of 1929. -4s eco-
nomic activity in the United States ground to a halt, bringing
in its wake massive unemployment, the shock waves of Ameri-
ca's deep depression were felt worldwide. A radical doctrinal
change in capitalism took place with the revelation by John
Maynard Keynes that "unaided" it was perfectly possible for
the capitalist economy t o remain in less than full employment
equilibrium for a protracted period and arbitrary government
intervention was, necessary in such situations to st,abilize the
economy by the sustained infusion of purchasing power. Em-
ployment thus had to be "given" t o the people even if this
meant putting them t o work in areas where there was no cur-
rent need for the work they were being asked t o do. The resul-
ting accretion to "effective demand" would result in a higher
level equilibrium escalating the national product by bolstering
economic activity.

The need t o monitor economic activity paralelled the

Keynesian revelation that a complex capitalist economy - or a
mixed economy-did not possess any magical property of con-
tinuallself adjustment and needed to be "tampered" with quite
frequently if it was to be kept on an even keel. A sequel to such
monitoring was the advent of economic planning - in limited
degrees of course but present nonetheless. T o be sure no formal
five year plans have ever been drawn up in the western demo-
cracies but an army of "analysts" maintain a watchful vigil over
t h e torrent of data that computer aided statistics spew forth
with monotonous regularity covering all facets of the economy.
A number of important formal planning techniques like Input-
Output analysis have also been developed though their use is
not pervasive.

Capitalism today thus presents a much modified scenario

from what its creators visualized. The "drift" in its evolution
has clearly been towards greater state ownership of the means
o f production especially public utilities, increasing govern-
mental intervention t o remedy destabilizing aberrations, close
monitoring of economic activity and even a degree of economic
planning. Also, fair wage legislation is ubiquitous8 and in-
equities in this context d o not remain unnoticed for long. No
,.vndnwn nr\.rnmmamt nnn a22nJ tn nntnr-n:-- lnL-- Cr.r 1-mn hrr
306 Fiscal ImpemHws In PaMstan 'r Economlc Development

siding blatantly with the owners of indust~y.The prodigous

industrial potential and the high standard of living of the wes-
tern democracies is living proof of the highly successful co-
existence of democracy and "mixed" capitalkm.

The highly regimented command economy such as obtains

in the Soviet Union is of much recent origin m,~kingits advent
with the creation of the worlds first socialist st,\te in Russia.
The free market of the capitalist system was done away with
and replaced by centralized planning directing resource allo-
cation on the basis of specific criteria. Returns to economic
factors came t o be determined not by supply-demand equili-
brium but were assigned on the basis of "need" and on the
value assigned to the individuals contribution in a productive
activity. The rationalized regimentation was expected to bestow
a significant degree of predictability to economic phenomena
and to remove the whimsical aberrations of the free market thus
protecting citizens from the destabilizing gyrations of the
capitalist economy.

The great advantage of the command economy, besides

facilitating removal of inequities through exploitation of labor
by capital, was to ensure accelerated econonnic development
enabling the socialist economy to 'catch up' with the developed
western economy in the span of a few decades rather than go
through the agony of development over a pr~tr~acted time frame
and subject to the cycles of depression that characterize the
swings in the capitalist system taking their heavy toll in terms
of social and economic cost.

While the command economy succeeded splendidly in

structuring, in a relatively short time - frame, an ecommic
edifice that gave huge productive potential and more signifi-
cantly, reproductive potential, it soon became evident after
the end of the cold war period following the cessation of
hostilities in 1945, that in terms of economi,~efficiency and
consumer satisfaction the economic system born in the Soviet
Union and transplanted in communist europe, China, N. Korea
and Vietnam, left much t o be desred. Its fidings in agricul-
ture were especially galling as collectivisation failed miserably
in bringing the autarky desperately sought by the planners
forcing these countries t o import huge quahtities of foodgrains
from the highly productive private capitalist farmers of the
The econornlcs of growth-Some lmportan t lessons 30 7

west whose surpluses fed not only the communists but also the
teeming millions of the third world when they experienced
crop failures and deficiencies in production.

Fundamental changes in the command economy format

did not come about easily. The doctrinaire basis did not permit
of ready compromise. But the deficiencies in the system could
not be ignored for long especially when it came t o be recogni-
zed that in areas of research in key areas like computer develop-
ment and applications, computer software Jevelopment, super-
conductivity research and applications, genetic engineering,
cybernetics, robotics etc etc. and especially in its ability to
innovate and t o harness the creative potential of its manpower,
the soviets had begun t o lag behind significantly vis a vis not
only the americans but even the japanese.

Rigidity was characteristic of the soviet command eco-

nom; in both the leninist and stalinist eras. A heavy bias to-
wards capital goods investment was evident in these phases and
the evolution of soviet economic doctrine placed heavy em-
phasis o n the development of planning models over given time
frames (the five year plans) that strove t o encompass all facets
of economic activity within the plan framework. There was no
"market" in the "free, capitalist - or mixed - econonly" sense.
This immediately imposed a severe burden in termsof irforma-
tion -data-collection and collation. A daunting number of
'sub-plans ' had t o be conceived and developed for each factory,
each - collective - farm, each state institution whatever its
complexion and scope - and there were only "state in-
stitutions" now: the private sphere had completely vanished.
Considering the hugely ambitious targets fixed by the planners
t o achieve "parity" with their western antagonists in the shor-
test possible time, the enormity of the planning assigrunent can
scarcely be overemphasised. The consolidation of the many
sub-plans into a "national plan" and the mobilization and
matching of resources with priorities assigned t o different areas
of economic activity was a truly herculean task. The vast
expanse of the Soviet Union and the imperatives of national
defence further complicated an already complex scenario.

As political and economic dimensions were so closely

intertwined
- - . -
it was
.
just
.
not possible for economic thought t o
i'i 308 Flsccll Imperadues in Pakistan's Ecr--,c

figured prominently in the planning activity. As the defence of

. .- ,

the new socialist state was the number one priority, the f!c:;. cf
resources t o defence relaced projects was obvious. Consumer
goods had low priority and the people were told t o make the
sacriices necessary and to forego consumer items even at the
risk of some - or even much - inconvenience, The straight
forward bias simplified matters a great deal and made the
planning task easier. With the end of the secortd world war, the
soviet people were not to get much respite as the country had
been devastated and the sheer cost of the war both in terms of
men and material was staggering. No sooner had the great war
ended that the 'cold war' begun in right earnest. The nucleur
imperative injected an ominous - and hugely costly as well as
mentally demanding - dimension and ensured that the state of
crisis continue . The use of procrustean methods was inevi-
table and even necessary in such a difficult situation and it was
only the ruthless and even at times brutal execution of direc-
tives that maintained the forward momentum of the economy.

In the soviet system, relative scarcities reflected in prices

derived from supply - demand equilibriurr~ are not of any
significance as the command system fixes prices deliberately
on the basis of given criteria. As prices d o not provoke resource
flows between and within economic sectors in the command
ecommy. their derivation is not of any importance in this
particular context. This is however not t o fay that prices are
n o t of any significance at all in the soviet type economic sys-
tem. Prices define value in the sovi& system just as they define
value in the capitalist system. And by defining value they
facilitate exchange just as they d o so in a free market economy.
However in the soviet economic system a deliberate attempt
is made t o ensure that the price fixed relates to the set of fac-
tors identified as relevant. Thus production cost may be -and
often ~s- one such factor. The aggregate production cost, i.
the sum total of the cost arising at different phases of the
production process. Enterprises sell products to intermediate
distribution outlets at "wholesale prices'' derived from an
already calculated "average production cast" for the various
firms engaged in the production of the given article. T o this
average production cost is added a very modest profit mark-up.
This is the standard practice. However it is to be noted that the
profit mark up is practically a formality and in actual practice
if a state enterprise has, for any reason, a production cost
7he economics of growthSome important leaons 309

that varies sharply from the "norm" derived from the produc-
tion performance of other enterprizes producing the same
item, then the production cost cannot be covered by sales
revenues and such a state enterprise would be forced t o incur I

a loss to be made good by a state subsidy. Hence the normal

and widespread phenomena of planned lossej. I
I

Soviet pricing policy accords differential treatment to

intermediate industrial goods and to consumer goods sold t o the
public. As long as tlie former are traded between enterprises
and govt. organs, price levels are kept disproportionately low
as taxation is not a component of the formal price structure. In
the case of consumer goods however, a hefty !'turnover tax"
enters into the price format. Because of such differential
treatment accorded, the soviet price structure is sometimes
spoken of as a two tier price system.

If we are to focus o n the mechanics of agricultural pricing

in the soviet system, we would be entering a different realm,
so t o speak. Now a "third tier" of prices wouId be evident.
Just as consumer prices in the soviet system have been high, so
have prices of agricultural commodities been traditionally low-
relative t o the wholesale price level of intermediate inputs of
industry. Agricultural prices have also been low relative to pro-
duction costs for agricultural .commodities. It is significant t o
note in this context that wage rates for farm labor are not what
they ought t o be and it has been possible to keep them low
because direct taxes on agriculture have been 1igh.t and the
incidence of the turnover tax passes the rural population by as
the clientele in retail stores normally does not ir~volveany
significant number of 'rurals.' It has thus been possible to arti-
fically contrive a relatively low production cost for i~gricultural
produce.

The arbitrariness inherent in soviet pricing policy is all

too evident even from the summary account given above. Such
arbitrariness has been at the root of many of the problems that
have plagued the soviet economic system. For one thing, the SG
called "planned losses" have usually been a camouflage for
mismanagement and inefficiency with prices varying widely
from the optimal. For another, the overall soviet pr:icing struc-
ture has lacked rationality in that relative pricrq are :not usually
310 Fiscal Imperatives in Pakistan 'r' Economic Dewropment

been possible t o structure coherent prices for finished pro-

ducts and intermediate inputs - derived from a coherent
scaffolding.

The "peaceful" ouster o f Kruschev from the political

scene appears t o be a turning point in soviet policy formulation
and the blind rigidity that had become characteristic of the
soviet system now began to show signs of relenting. However
the first important signs of a change in this context appeared in
the mid sixties. The thrust of the "reforms" was t o yield a
coherent set of industrial prices. This ofcour:;e necessitated that
the objective basis on'which these prices were structured be
first established o n a firm footing. In a sense this reglization by
itself was a crucial development for it signified an awareness
that the system in vogue was deficient and w&.in need of
reform - something which would have constituted anathema a
short time ago.

The basic aim of the reform measures of the pricing

structure was t o rationalize relative prices by bringing them
closer in line with relative costs of produc:tion. This did not
mean then - just as it cannot mean now even in the wake of
"perestroika" and "glasnost" - that prices would be permitted
to vary in line with changing supply and demand, conditions.
This would be asking too much from the soviet system for it
would amount t o a negation of the basic premise o n which it
has been established - that the very essence of the capitalist
system is inimical t o fair and orderly economic relations bet-
ween and within economic sectors. Since the free play of mar-
ket forces is t he very essence of the capitalist system and crucial
to supply - demand equilibrium and thus price determination,
therefore it cannot ever be realistically expected that any r e
:arm measures would actually envisage "in toto" adoption of
such a basis for the pricing structure in the soviet system.

Notwithstanding what is stated above, it is a fact that

a small sub set of prices has been taken out of the category of
"fixed" o r "ceiling" prices and put into the free price category
by actually permitting supply and demand t o yield something
like an equilibrium price. This has been true usually - though
not always - for over fulfilled production quotas of consumer
goods and agricul t u r d produce. These hare been essentially
"incentive" measures that aimed at injecthg some stimulus in
the soviet sq stem for int rebed production - a stimulus other
than that bdsed on the procrustean exercise of authority: if that
can be called a "stimulus." This cannot therefore he really seen
as a fundamental reform measure for it is clearly not that.

There are indications that soviet planners may have been

using "reference prices" approximating in some measure t o
"presumed" scarcity prices to see how credible the plan format
is in a supply - demand context. This should not be taken t o
mean that where there is a marked variation from the presumed
supply - demand context there has been any attempt to modi-
fy or alter in any way the basic parameters of the plan. However
if true (precise information about the exact objective basis of
economic planning remains largely classified and only lately
have broad generalizations in the context of plan formulation
begun t o be made public) then this could atleast indicate that
an attempt is underway t o rationalize prices with reference t o a
given parameter - scarcity prices - as it obtains in a relatively
free market context. Insofar as even an "exercise" is being made
in the context described above, -this can be spoken of as a move
towards reform because it could ultimately lead to the develop-
ment of "market type institutions". One has t o say this with
"tongue in cheek" because the inherent rigidity of the soviet
system must not be underestimated. The soviet system has done
a good job of bodily lifting the economic edifice to a new mar-
kedly higher threshold. Its present deficiencies are not such as
t o render it redundant. However in a highly competetive world
environment, especially in the context of "North - North"
competetion, it is imperative that "improvements'" be made to
ensure that the challenge from the competetion in the 21st
century can be reasonably met. It is in this context that " r e
form" acquires significance.

Every small step taken toward a greater degree of c o

herence in the structure of prices can be considered "progress"
As such "coherence" must inevitably lead t o a lessening of the
extreme regimentation that has been characteristic of the soviet
economy for many years therefore in the context of the
phenomena of "convergence of economic systems" this would
mean a move towards a freer, more "plastic", more "respon-
sive" (responsive t o genuine constructive criticism, both do-
mestic and foreign) and more "rational" system.
312 Fisml Impemtives In Pakistan's Economic oewlopment

The fundamental "flaw" in the doctrinaire soviet system

would appear t o be the belief that it is at all possible t o plan
comprehensively and effectively every facet of activity in a
highly industrialized structurally very complex, economy.
Looking t o the intricate interrelationships between economic
segments and considering the sheer magnitude of such func-
tional segments no system in which human interference "at
every stage" is necessary can possibly cope with the prodigous
workload involved. Not even with the aid of super computers
has it been possible t o develop programmes that would en-
compass the full spectrum of economic activity within its
ambit. In other words the work done by the "marketplace" as
a "clearing house" of information has not been possible t o
duplicate in a workable manner for an advanced, structurally
intricate economy. For this reason it has become imperative -
if the soviet system is to remain viable in the future - that
adjustments be made to make the soviet system more "pragma-
.
tic" This would necessitate certainly, a loosening of the rigid
framework characteristic of the "classical" soviet system.

The basic format of the cor~mandeconomy devised in the

soviet union has been emulated in other communist countries t o
which the revolution has been "exported". However, attempts
have been made t o "tamper" with the system to improve its
operational performance whichhas generally been found want-
ing in several important respects. This has been especially
evidant in comunist china. The "drift" towards "pragmatic
rationalization" noted in the soviet system and about which we
have spoken above, is much more marked in China and there are
indications that china might be getting ready t o break away
from the soviet format in a fairly radical reposturing of ideolo-
gy in which the deliberate structuring of "market type" insti-
tutions might be much in evidence. If this does come about
then the'schism between the two communist giants could take
the shape of a permanent perhaps unbridgable cleavage.

To conclude we may say with confidence that the logic

o f the current world situation makes inevitable great economic
control to limit aberrations, to accelerate the pace of economic
development, t o reduce distributive inequities and to stabilize
cyclic variations in the so called, free economies. Concomitant-
ly, for the regimented command economies a loosening of the
oppressively harsh control characteristic of the system has be-
T k econornlcs of gruwth-Some irnportunt lessons 313

come necessary so as to breathe new dynamism into the system

and to ensure. that chronic stagnation is aviod.ed. In short,
survival of the two systems requires that they "converge" and
"borrow" from the other what they lack themselves.
Sources 315

Sources: Chapters 1 t o 8.

The protracted tax reform debate in the United States -

an integral part of "REAGANOMICS" - provides an especially
I
useful backdrop to isues involved in ths highly specialized area
of fiscal policy. The author had an intensive one year academic
exposure to important aspects of this debate at the Harvard
University School of Law (1985-86 Session) when he partici-
pated in the H.L.S. International Tax Program as a nominee of
the Goverment of Pakistan.

The sheer weight of erudite - even esoteric -- comment

flooding the media in the U.S. in the course of this debate, was
enough t o tease anyones imagination, but for those with a
professional, academic interest, it was also highly instructive.

While the Pakistan income taxation system is hardly

"on all fours" with its U.Scounterpart, much of the technical
framework of the two systems has common features, For this
reason, the author was able to bring' to bear lessons learnt at
the H.L.S. in this context in his technical evaluation of the
Pakistan tax system.

The following materials deserve special mention here:

- The Presidents Tax Proposals to Congress - IJ. S. Govern-

ment Printing Office, WASH. ,D.C.
- Bartlett and Roth - " The supply side solution" Chatham
House publishing Inc N.J. 1983.

The Wall Stareet Journal. May 31, 1985 "Winners and

Losers in the tax revolution".

- The Wall Street Journal, May 28,1985 " Reagans new tax
overhaul plan."
316 Fisml ImpmafIws In Pakistan's Economlc Development

formalized through the Income Tax Act of 1922 was adopted

Pakistan in 1947 virtually unchanged. Although subjected to
repeated yearly "amendments" mainly to provide so called
fiscal incentives, its basic format was the same as that devised
by the British. The statutory exemption for income from agri-
culture has continued and the narrow tax base ktxps revenues a
an abysmally how level. The 1979 Income Tax Ordinance re-
placed the Act of 1922 but the change was "cos~netic"and not
substantive and represented more a desire t o rationalize the ar-
rangement of the statutory provisions that successive "amend-
ments" had rendered quite chaotic than t o alter dramtically
the legal format.

The following additional sources are cited.

- HINRICHS

A General Theory of Tax Structure Change During Eco-

nomic Development. (HARVARD LAW S'CHOOL Inter-
national Tax Program-).

- SULLIVAN

The Search for tax principles in the European economic

community. (HARVARD LAW SCHOOL -- International
Tax Program-)

- LEON YUDKIN

A legal structure for effective income tax administration.

(HARVARD LAW SCHOOL - International Tax Program
- 1.
- STEPHEN R. 3,WWIS Jr.

Taxation for development - principles and applications.

- DAVID N. HYMAN
- PUBLIC FINANCE-
A contemporary application of theory to policy.
 Sources

- RICHARD GOODE

Government finance in developing countries.

- C.P. KWDLEBERGER & B. HERRICK

Economic development.
1

- GUNNAR MYRDAL

Asain Drama.
- HEILEBRONER

The economic problem.

- VIQAR AHMAD & RASHID AMJAD

The management of Pakistan's economy 1947.82

-PAKISTAN ECONOMIC SURVEY- (Various issues).
I
- INCOME TAX ACT 1922 (ACT XY O F 1947)- RE-
PEALED -
1
-INCOME TAX ORDINANCE 1979 (Amended). 1I

- RAZA NAQVI

THE LAW & PRACTICE O F INCOME TAX IN PAKIS-

TAN.
- KANGA & PALKIVALLA

THE LAW & PRACTICE O F INCOME TAX (India).

- "TAXATIONw- RAZA NAQVI Ed. various issues-

-NATIONAL TAXATION R E F 0 RM COMMISSION (PA-

KISTAN)- THE FINAL REPORT .- 1987.

- -TAXATION ENQUIRY COMMISSION REPORT. - 1971.

 Fisml Impemffwsin Pakistan's Economic Development

- M.A. ABBASI
BURDEN OF INCOME TAX - " TAX OBSERVER"
i KARACHI MAY 1984.
I
- M.A. MAJEED
COMPUTERIZATION OF THE PROCESS OF SELEC-
TION OF CASES FOR DETAILED SECURITINY - TAX
!
i OBSERVER' KARACHI JULY 1984.
I
i :
1 - S.A. SALAM
r 1

i1 f
.
INCOME TAX LAW.
i
'i
I.

8
4
,
7 -L. WHITE
INDUSTRIAL CONCENTRATION & ECONOMIC PO-
WER IN PAKISTAN.
-B.A. AZHAR
TAX HOLIDAY FOR INDUSTRIAL DEVEILOPMENT-
An Evaluation -- PAKISTAN ECONOMIC: JOURNAL
1973-74pp. 7285.
- N. KALDOR
STRATEGIC FACTORS IN ECONOMIC DEVEWP-
MENT.
- J. P. COLE
THE DEVELOPMENT GAP
- BARLOW & WENDER
FOREIGN INVEWMENT & TAXATION
- DERNBERG & MCDOUGAU

MACROECONOMICS.
Sources 319

-RICHARD GOODE "Reconstruction of foreign tax

systems'" (RICHARD M. BIRD AND OLIVER OLD-
MAN (eds) READINGS ON TAXATION IN DEVELOP-
ING COUNTRIES-
-RICHARD A. MUSGRAVE
"The Theory of public Finance - A study in public
Economy. (Mcgraw Hill, 1959).
320 Ffscol ImpemD'ves In Pahistan's Economic Development

Sources: Chapter 9

-The Income Tax Act (Repealed) 1922 PJo. 11 of 1947-

(as amended )

-The Income Tax Ordinance 1979 - XXXI of 1979.

(as amended).
-ANTH@INE r. (ed) "TAX INCENTIVES FOR PRIVATE
INVESTMENT IN DEVELOPING COIJNTRIES". DE-
VENTER: KLUWER, 1979.

-DOMINIC, M. "Income Taxation and foreign. investment

in Developing countries. AMSTERDAM: lN"IERN.4-
TIONAL BUREAU OF FISCAL DOCUMENTATION.
1980.

-S.A. Salarn
Complete Income Tax Law.
Sources 321

-A.G, Merchant- "Income Tax Law" - Tax observer

1982-
-M.A. Abbasi- "Burden of Income tax" - Tax Observer
Karachi - May 1984.

-MA. Majeed - "Computerization of the process of

selection of cases for detailed scrutiny. "-Tax Observer,
Karachi - July 1984.

-[ (1986)53 Tax 109 (HC Lah)] Mohd Asghar vs. CBR-

Lahore Hlgh Court.

-[ (1985)51 Tax 114 (HC Kar)] -Cannon Products Ltd.

vs. ITO-Sind HIgh Court, Karachi.
-Ria2 Bottlers Ltd. vs FO-Lahore HIgh Court-Writ Peti-
tion No. 3590 of 1982.

-Messrs Escorts Ltd. vs IT0 Lahore, 1975 PTD--50-

-N.T.R.C. REPORT, 1987.

 1

322 Flrcal Imoem tlves in Pakfstan 3 Economtc Dew lovment

Sources : Chapter 10
-Income Tax Act (Replealed) 1922- No. XI of 1947-
-Income Tax Ordinance 1979- No. XXXI of 1979-
-Finance Ordinance (1980 through 1986j

-Self Assessment Scheme-Central Board of Revenue -

197980 to 1986-87.

- SRO 8 4 (R)/64 dated 28th August 1964.

-SRO 794(1)/77 dated 22nd Aug. 1977.
-Circular instructions CBR Islamabad.

- Taxation-Journal (1964) Vol - 1 0 Page 4).

-Taxation Journal (1966) Vol-14, page 1 4 .
- Taxation Journal (1979) Vol39, page 9.
- Taxation Journal (1 969) Vo119, page 35.

-Taxation Comrnision Questionaire 19 71

- Taxation Journal (19 74) V o l 3 0 , page 45.

-Taxation Journal (1979) Val- 39, page 69.

-Central Board of Revenue, Brochure 976lCBR dated

24th June 1981.

- Taxation Journal (1981) VoI43.

-Burget Speeches 1964 thru 1987.
Sources 323

Sources: Chapter 14
-GERAID M. MEIER
" LEADING ISSUES IN DEVELOPMENT ECONOMICS-

SELECTED MATERIALS AND COMMENTARY "

C H A F I V N. Y., OXFORD UNIVERSITY PRESS' 1964.

" Public Finance in Under developed countries", WILEY,

N.Y. 1972.
-RICHARD M. BIRD AND OLIVER OLDMAN (eds).
" READINGS ON TAXATION IN DEVELOE'ING COUN-
TRIES", JOHN HOPKINS, BALTIMORE, 1975.
-MCKINNON, ROUND, I.

" MONEY AND CAPITAL IN ECONOMIC DEVEWP-

MENT" BROOKINGS, WASH, 1973.

" GOVERNMENT FINANCE IN DEVELOPING COUN-

TRIES."
324 Fiscal Impemtiws In Pakistan's Economic Dewlopmenr

Sources : Chapter' 1 5

"RELIGION & THE RISE OF CAPITALIAM".

-Max Weber.

"The protestant Etbic and the spirit of capitalismw--

Scribner N.Y. 1956.

-DAVID C. MECLELLAND

" The Achieving Societyv- Priceton NJ 1961.

-BERT HOSELITZ
" Noneconomic factors in economic development '- A.
E.R. May 1957.

--Adam Smith.

"An inquiry into the nature and causes of the wealth of

Nations. "

A Study of History".

-WILL & E. DURANT

" The lessons of history."

" h i a n Drama."
Sources 325

"Economic Theory and the under - development coun-

tries" O.U.P.1971.

-GERALD M. MEIER

"Leading issues in development economics"' - selected

materials and economentary.

"Japan as No. 1".

-D.B.KEESING
"Economic Lessons from China". (Journal of Develop
ment Economics March 1975).
-1.L. HOROWITZ
"Three worlds of Development - the theory and prac-
tice of international stratification9'- 0 .U.P. 1972.
-IRMA ADELMAN AND C. T.MORRIS

" Society, Politics and economics development - a quanti-

tative approach".
-SEN AMARTYA (ed)
"Growth Economics - (Penguin 1970)
-ALBERT 0.HIRSCHMAN
" The strategy of Economic Development."
-HARBISON, F.H.
"' Human Resources as the wealth of Nations" - O W ,
NY 1973.

-KERR, HARBISON, DUNLOP & MYERS

 326 Flrcal Impe;utiws in Pakistan's EconomL Dewlopment

-G. BECKER
I

"Human capital." col., N.Y. 1975.

- M. BLAUG (ed)

"Economics of Education."
-F.H. HARBISON AND C. A. MYERS
"Education, Manpower and economic Growth."
MCGRAW-HILL N.Y. 1964.
-F. RIGGS
"Administration in developing countries."
-N.T. UPHOFF & W. F . ILCHMAN (eds)
"The political economy of change"

-N.T, UPHOFF & W. F. ILCHMAN (eds). .

'The political economy of development."

! j i
i i
i!
;! 'The theory of economic development."
il
I;
'1 i -R.M. SOLOW
" Technological progress and productirty changew- in
A. Sen (edited) "Growth Economics"

-CHARLES BETTELHEIM..
"Choice of Technology & economic development."
,
-RAGNAR NURKSE
" Problems of capital formation in underdeveloped coun-
tries,. "
sources 32 7

-DAVLDS' LANDES
"The unbound prometheus: Technological change and
industrial development in western euroe from 1950 t o
the present" - CUP 1969.

-R.B. SUTCLIFFE

"Industry and underdevelopment."

-A. K. SEN

"Choice of techniques: An aspect of the theory of planned

economic development."

-N. ROSENBERG
"Economic development and the transfer of Tec:hnology:
Some historical perspectives" ("Technology an'd culture
Oct. 1970 pp. 570-575)

-H. J. HABAKUK

"American and British Technalogy in the 19th century"

CUP - 1962.
- J. C.H.FEI and G.RANIS.
" Development of the labor surplus economy -.- Theory
& policy."

" Economic Growth of Nations : Total output an,d produc.

tion structure, Harvard, 1971.

-H.B. CHENERY & MOISES SYRQUIN

"Patterns of development, 1950 - 70 --"
- OUP 1975.
-B.F. JOHNSTON
328 Ftscul Imperatives in Paklsmn 's Economic Development

A survey of Research-" Journal of economic literature,

June, 1970..

-HARRY G. JOHNSON

" Planning and the market in economic development" in

his "Money, Trade and economic growth".

- PAUL N. ROSENSTEIN RODAN

"The flaw in the nechanism of market forces" in MEIERS

"Lading issues in economic development O W - 1976.

-GRIFFIN, KEITH & J. E NOS

"Planning Development".

-HARVEY LEIBENSTEN

"Economic backwardness and economic growthv'.

-AJ. COALE AND E. M. HOOVER

" Population growth and economic development in low

income countries".

-DONALD J. BOGUE

"Principles of D~emography."

-HARRY G.JOHNSON (ed)

'Trade strategy for rich and poor nations".

--RAGNAR NURKSE

"Patterns of trade & development".

-BARBARA WARD (eds)

"The widening gap."

--MUCKS
 "Comparative economic systems. "
-HANEY
"History of economic thought ."

- HEI1,BRONER
"The economic problem."

-WORLD BANK, WORLD DEVELOPMENT REPORT,

1987.
About the Author.

Mr. Muhammad Munir Qureshi, Director General, Directorate

General of Income Tax (Training & Research), Lahore, is the senior
most officer of the Income Tax Group in Grade-21. He was
appointed as Director General, DOT, in April 2006 after competing in
a selection process under the Internal Job Posting [IJP] policy of the
CBR. He has completed 37 years in Government Service in Nov
2006.; has served for 6 years at the Income Tax Appellate Tribunal,
Lahore, [2000 – 2006] as Member; was promoted to Grade-21 in
Oct 1998 and appointed Member [HRD] in the CBR and he served
in that post till March 2000; has worked as Commissioner, Income
Tax from Oct 1990 to Oct 1998; as Addl Commissioner from 1979
to 1998 and as Income Tax Officer from 1969 to 1979. Before
joining Govt Service in 1969 he worked as a Research Associate at
the Harvard Advisory Group to Pakistan [1968 – 1969].

Mr Munir Qureshi holds a Masters Degree in Economics

[HONOURS SCHOOL] from the Government College, Lahore
[1967] and was placed in the Academic Roll of Honour of the
Institution for his outstanding merit. He has previously studied at
Aitchison College, Lahore. In 1985 he went to the Harvard
School of Law, Harvard University, USA, and successfully
participated in the International Tax Program [Aug 1985 to june
1986], a specialized course in Tax Administration that attracts tax
specialists from all over the world. Earlier, in 1977 he went to Japan
to participate in a seminar on Fiscal Management under the
auspices of JICA [the Japan Int’l Cooperation Agency], in Tokyo.
He has also attended Training courses at the National Institute of
Public Administration, Lahore [1987 – 52nd Advanced Course in
Administration & Development] and in 1995, at the Pakistan
Administrative Staff College, Lahore, [-the 62nd National
Management Course]. He is widely traveled and has been to the UK,
France, Italy, Switzerland, USA, Canada, Spain, Portugal,
Holland, Indonesia, Australia, Singapore and Saudi Arabia. He
is the author of a book on Fiscal Management, “Fiscal
Imperatives in Pakistan’s Economic Development,” published
in 1989 and has also written numerous papers / articles published
in various newspapers / magazines.

He is married and has two sons, Omar, age 25 [BA., LLB, Punjab
University(2005)] and Hassan, age 24 [MBA., IT (2006)]. His wife,
Leena, is a graduate of the Home Economics College, Lahore
(1980). Their only daughter, Kiran, [‘A’ Levels, Grammar School,
Lahore, [2003]& an Hon’s student at the Punjab University,
[Management Science] died in 2004, at age 19.