Pakistan’s plea for billions of dollars to recover from this summer’s floods has sparked pressure on the country to reform a tax system that collects very little money, even from the rich.
The country’s biggest donor, the United States, has issued one of the strongest warnings, saying the world will only be able to fund a quarter of the tens of billions of dollars it will take to rebuild – and it will be difficult to get American taxpayers to help if Pakistanis aren’t footing their share of the bill.
“Pakistan can say, ‘If you don’t help us, the economy crumbles, the Taliban takes over and there goes your war on terror,”‘ said Akbar Zaidi, an economist who recently published a report on Pakistan’s tax system for the Carnegie Endowment for International Peace.
“They don’t want to alienate the government, so they will let them off the hook.”
Despite years of international pressure, Pakistan has one of the lowest effective tax rates in the world, equal to about 9 percent of the value of the country’s economy, according to the Carnegie report.
In contrast, the US equivalent is more than three times as high at about 28 percent.
One of the reasons Pakistan’s rate is so low is because many people avoid paying taxes. Fewer than 2 percent of the country’s 175 million citizens pay any income tax, according to the report.
Also, some sectors of the economy like agriculture – a major money maker for the elite – are totally exempt from tax, and the rich have pushed to keep it that way.
“A small elite comprised of the military, land owners, and the rising urban upper and middle classes, is loath to give up any of its wealth (some of which is illegally accumulated),” said the report.
Ishrat Hussain, former head of the Pakistan central bank, estimated that better enforcement of current tax policies and the elimination of key exemptions should produce an effective tax rate of 15 percent – generating nearly $10 billion in additional revenue per year.
That money would go a long way toward repairing devastation from the floods, which affected more than 18 million people and damaged and destroyed over 1.8 million homes.
It would also provide the money necessary to begin fixing Pakistan’s crumbling school system and health infrastructure.
“This is a time we have to tell people that we have to all pitch in and mobilize our own resources,” said Hussain. “Why should the international community come to your rescue if you are not doing your part of the bargain?”
He said donors should keep up the pressure on Pakistan, but advised against directly linking reconstruction money to tax reform, predicting the move could backfire in a country where animosity toward the West, and the US in particular, is extremely high.
“It wouldn’t be a very smart move because people here would consider this as an intrusion on their sovereignty, and the debate would then be muddied,” said Hussain.
The US and other countries have donated around $1 billion for emergency relief, and international financial institutions have provided about $2.5 billion in emergency loans.
Donors are scheduled to meet in New York this weekend to discuss raising additional aid.
Washington has promised more money for reconstruction, but the US special envoy to Pakistan, Richard Holbrooke, warned during a visit to the country this week that the international community could only fund about 25 percent of the bill.
He said the US would not condition reconstruction money on tax reform, but cautioned that American generosity has its limits.
“I don’t want to withhold money they need, but I think we have to be clear that the Congress is going to be reluctant to give money if the money is filling in a gap because people are not paying taxes,” he said.