Obsession With Pakistan’s Tax System

Just the latest in a long string of articles and other public comments in this vein, the New York Times today made a front page story of Pakistan’s low tax rate, with author Sabrina Tavernise going so far as to directly blame it for the nation’s rising insurgency. Quote:

In Pakistan, the lack of a workable tax system feeds something more menacing: a festering inequality in Pakistani society, where the wealth of its most powerful members is never redistributed or put to use for public good. That is creating conditions that have helped spread an insurgency that is tormenting the country and complicating American policy in the region.

Ms. Tavernise’s claims come as Secretary of State Hillary Clinton is making a high profile visit to Pakistan, and serves as a reminder that calls to dramatically raise taxes in Pakistan have been official Obama Administration policy for quite some time.

In early February, US Deputy Treasury Secretary Neal Wolin demanded that Pakistan impose a Value Added Tax and raise Capital Gains Taxes. Pakistan promptly complied, even though this meant the resignation of their Finance Minister, who had disagreed with the policy.

Days after the announcement Secretary Clinton was demanding that Pakistan again raise taxes precipitously and use it to “increase spending on health care and education.” This will likely again be a topic of Clinton’s visit, in between demands to launch ever more aggressive military offensives against the tribal areas to their north.

Yet while Ms. Tavernise correctly identifies Pakistan ratio of tax to GDP as “among the lowest in the world,” it is actually not out of keeping with other developing economies. Taxes are roughly the same percentage of GDP as Panama, slightly lower than Taiwan but slightly higher than Mexico.

The conclusion that this is helping to “spread an insurgency” is never defended but just presented as an obvious fact. Yet Pakistan’s rate of taxation did not suddenly drop drastically, and its insurgency has only really cropped up since the 2001 NATO invasion of Afghanistan.

Moreover this insurgency was born predominantly in the Federally Administrated Tribal Areas, and not in the low-income neighborhoods of richer cities like Karachi and Islamabad.

It is not, then, a lack of confiscatory taxation or a lack of massive social spending that is fueling this insurgency, but rather the presence of some 150,000 US-led occupation forces in their neighbor to the north, fighting an ever-worsening war with no end in sight.

Pakistan’s tribal areas have not, traditionally, come under more than nominal control of the central government, and when the American-led invasion of Afghanistan drove massive numbers of refugees, both Taliban and civilian, into those tribal areas, it was inevitable that it would serve as a bone of contention.

The tribesmen welcomed the refugees, who share a common culture and language, and American officials have been pushing for Pakistan to clamp down on the regions ever since.

It is true, of course, that Pakistan cannot afford to commit hundreds of thousands of troops to fighting these endless tribal wars without massive US aid, but these wars are being done almost wholly on the basis of US demands. Pakistan’s government has demonstrated, from the Swat Valley to North Waziristan, that its preferred way of dealing with tribal unrest is through diplomacy, and through ceasefire agreements predicated on the tribes agreeing not to become involved in the insurgency.

Pakistan’s current status as a financial basket case dependent on international largesse is not a function of mean-spirited politicians but rather of unreasonable demands placed on them by the international community. Attempts to dictate a higher tax rate on them will not solve this problem but will only put them at a competitive disadvantage economically, ensuring that the economic development that stalled when the US War of Terror broke out never fully restarts.