countries including Pakistan have continued to accumulate the burden of public
debt due to inadequacy of tax revenue to finance government expenditure.
Pakistan is persistently depending on the heavy public debt to finance the
budget deficit. In the long run scenario, the persistent budget deficit and
debt accumulation are unsustainable, and may create several problems to Pakistan
economy including inflation, low economic growth, and consequently fiscal
crisis. Therefore, it is crucial to understand the relationship between public
debt, and tax revenue so that we can come up with the policies to ensure
economic growth and development. This study attempts to analyse the
relationship between public debt and Federal taxes in the context of Pakistan.
The reason for choosing the Federal taxes is that the contribution of Federal
taxes in total tax revenue of Pakistan is largest and therefore highly
significant. This article briefly describes the general background of the
public debt and taxation, and then attempts to analyse the relationship between
them. For this study, time series data relating to public debt and Federal
taxes was obtained from secondary sources. In order to find the relationship
between these two variables, data was taken from 1971 to 2017. With the help of
coefficient of correlation, a strongly positive relationship was found between
public debt and Federal Taxes.
The problems of public debt and taxation are important financial problems
currently affecting developing countries, including Pakistan. Pakistan’s total
public debt for the Year 2016-17 was found to be Rs. 21,407 Billion rupees. It
means each citizen of the country is bearing the burden of almost Rs.
100,000/-. On the other hand general public is not willing to pay taxes and
many individuals and businesses have adopted certain ways to avoid the tax
through legal as well as illegal means. The result is low Tax to GDP ratio and
thus inadequate amount of government tax revenue. Keeping in view the current
scenario of the country, an attempt has been made to analyse the relationship
between public debt and FBR taxes. This study describes the general background
of Pakistan’s total Public Debt and Taxation and then analyses the impact of
public debt on FBR taxes in Pakistan.
According to Classical Debt Theory
(1742-1859), debt imposed a burden on future generations and very high levels
of public debt created national bankruptcy. Later on, this view was made clear
by Buchanan (1958) who stated that bondholders acted voluntarily choosing from
a number of investment opportunities and in future would be better off the
moment they are paid the principal together with interest. Hence they did not
bear the real burden of debt. In this case burden of debt was a utility loss,
not a financial loss. Furthermore, public debt was accompanied by interest
payment on debt that affected net income negatively and hence reduced future
standard of living of a borrower.
In Buchanan’s point of view, public debt
was immoral as it made future generations pay the principal and interest
towards government decisions in which they did not participate themselves.
Classical economists supported the idea
of Balanced Budget. It meant all government expenditure financed by tax
receipts. The only justification for running budget deficits and resort to
borrowing was during national emergencies such as natural disaster.
Contrary to the classical viewpoint, Keynes
(1936) argued that there was no need to force the budget to balance. He further
argued that there are various mechanisms which bring disequilibrium in the
economy and market forces (supply and demand) left alone were unable to bring equilibrium.
In particular, the economy was cyclically unstable and thus under the threat of
fluctuations due to insufficient investment and high saving. The only solution
to insufficient investment was to include public investment in its place in the
form of borrowing to finance the budget deficit (Yergin and Stanislaw, 1998).
In 1943, Lerner introduced the concept
of Functional Finance which means judging fiscal policies based on their
effects on the economy, irrespective of their soundness. According to him,
government should borrow only if it was in interest for the government to hold
more money, and the public to hold more government bonds.
According to Barro (1989), taxation and
public debt to finance government expenditure had the same result. If public
debt was financing government expenditure through a decrease in taxes, future
taxes would be high with the same present value equal to the tax reduction.
Gerson P. Lima, Doctor in economic
theory by the University of Paris (1992) says that Public debt has been a
widespread problem because majority of the economists have no effective
procedure to deal with it and prevent its financial, economic and social
negative consequences. He argues that the public debt is a macroeconomic
phenomenon and not the simple company’s accounting situation. To better
understand the effects of Public debt, a great deal of research work has been
done. The study conducted by Kiminyei
Felix Kimtai (2014), to understand the relationship
between public debt, tax revenue and government expenditure over 1960-2011
concluded that public debt responded to both tax revenue as well as government
expenditure. Moreover, Umaru, Hamidu and Musa (2013) found out the positive
impact of internal debt on the economic growth but negative impact of external
debt on economic growth in study however he found no causal relationship
between internal and external debt.
Other study conducted by Krogstrup,
Signe in 2002, found a relationship between the public debt and taxation.
Through statistical analysis, he found that proportional debt and increased
debt lead to the large amount of taxes as compared to other states having fewer
The study by
Gomez-Puig, Marta and Sosvilla-Rivero, Simon (2015) tested the performance of
public debt in the economy through data from the European Union during the
period 1960 onwards. The statistical analysis showed a long-term negative
effect of public debt but a positive short-term impact on the economy of the
European Union. This study attempts to analyse the impact of public debt on
Federal Taxes in Pakistan Context.
Public Debt Profile of Pakistan
Public Debt refers to the government’s
total domestic borrowing and borrowing from foreign countries. Public debt is total borrowing
by the government to finance its expenditure. Public debt is needed by
developing countries so that they can finance their development expenditure as
well as current expenditure. Effective management of the public debt results
the growth in the economic activity. With efficient utilization of debt, the
government can achieve its social and developmental goals. With the help of
debt, the government can generate its revenue by establishing new business
enterprises and developing the existing ones.
On the contrary, inefficient utilization
of debt not only increases unnecessary burden of debt servicing but also
negatively affects the economic activity. The countries should not borrow funds
higher than their capacity of efficiently managing those funds. Currently
Pakistan’s Public debt servicing consumes nearly 45 percent of its total
Components of Public Debt
There are two components of public debt:
Domestic borrowing and external borrowing. In Pakistan, domestic borrowing is
incurred so that the country can finance its fiscal deficit. On the other hand,
the external borrowing is used for developmental purpose and for support the
balance of payment.
Pakistan heavily relies on domestic debt
which constitutes almost 70 per cent of its total public debt. The domestic
debt of Pakistan consists of Permanent debt which is a medium and Long-Term
debt, Floating Debt which is a short Term debt and unfunded debt which is
result of various National Saving Schemes.
includes PIBs, Prize Bonds and Government Ijara Sukuk (GIS). PIBs are the non-callable
instruments which are offered for 3, 5, 10 and 20 years maturity, with the
fixed as well as semi-annual coupon payment. PIBs are most liquid instruments.
Government Ijara Sukuk are bonds which
are issued for 3 years tenor, keeping in view the Islamic principles. These
bonds are Shariah compliant ones which are offered to generate the funds for
Floating debt comprises short term domestic borrowing instruments in the form of Market
Treasury Bills and State Bank borrowing through purchasing MRTBs. The tenor of Treasury Bills is three months.
These treasury bills are borrowed from domestic banks and are auctioned twice a
month, by State Bank of Pakistan with the objective of raising short term
The third component of the domestic debt
of Pakistan is referred to as the unfunded debt which is profit payable to the
accounts holders on savings accounts such as Mahana Amdani Account and on various
other saving schemes such as National Savings Schemes, Bahbood Savings
Certificates, and Special Savings Certificates.
External Public Debt
External Public Debt of the government
is defined as the debt serviced out of consolidated fund and debt owed to the
International Monetary Fund. External public debt is borrowed to increase the
pace of economic developmental and to finance the infrastructure of the
country. Other use of external debt includes the support of balance of payment.
The external funds received by Pakistan increase the foreign exchange reserves
of the country and stable the exchange rate. Pakistan’s external debt accounts
for almost 30 per cent of its total public debt.
The largest component of the external
debt is multilateral debt and bilateral debt which accounts for 87 percent of
the external debt. These bilateral and multilateral concessional loans are
aimed at increasing the economic activity in the country by implementing
structural reforms in the areas of taxation, trade facilitation, and the
promotion of small and medium enterprises (SMEs). It is important to highlight
here that Pakistan has used these concessional loans to retire relatively more
expensive domestic debt.