Can the IMF make Pakistan collect taxes?

A delegation of senior Pakistani finance officials was in town last week for talks with U.S. officials and with the International Monetary Fund and  World Bank. From the IMF’s perspective, the key issue was whether Pakistan has complied adequately with the conditions the Fund placed on Pakistan’s existing loan package. At the very top of the agenda is tax revenue–specifically, whether the Pakistani government collects enough of it.

Pakistan has a poor record on that front: it collects less in taxes as a percentage of its overall economy than almost any other country its size. Tax revenue comprises less than 10 percent of GDP, on par with Haiti.  Whole swathes of the economy are not covered by the tax system, and the government doles out enormous subsidies for electricity consumption and to public enterprises.

All of this is the IMF’s business because Pakistan sought and received support from the Fund during its 2008 financial meltdown, when high oil prices wiped out reserves and inflation hit 25 percent. The IMF initiated a multi-billion dollar assistance package, which was to be disbursed in several tranches and was conditioned on fiscal and economic reforms. The Pakistanis made some initial progress, but by 2010 reforms had faltered. The IMF stopped disbursing funds last summer.  

In an agreement designed to revitalize the loan program, Pakistan pledged to institute a new value-added tax system and to crack down on those individuals and companies that do not file tax returns. Since then, there’s been progress in a few areas, but nothing like the IMF had hoped. An attempt at the end of last year to push through a package of key reforms mostly foundered.  Recent media reports suggest that Pakistan will miss  even its modestly increased target for tax revenue this year.

An IMF official confirmed to me yesterday that a senior Fund mission will visit Pakistan in May to discuss the 2011-2012 budget and review developments. "This budget is a cornerstone of putting Pakistan’s economy on a more solid and safe basis going forward," the official said.  For the moment, Pakistan has a bit of fiscal breathing space. The prices of key textile exports have been high.  Remittances from abroad have also reached record levels, perhaps because many Pakistanis in the turbulent Arab world are sending home savings for safekeeping. But the rise in world fuel prices could quickly erode that buffer, making further IMF funds essential.

For the moment, the IMF staff has significant leeway in managing these negotiations.  The Fund’s executive board–comprised of national representatives–has not tried to micromanage the negotiations as it has occasionally done in the past. While some board members are skeptical of the program, there appears to be consensus among major IMF shareholders that Pakistan’s finances are not yet a lost cause.

If Pakistan veers toward financial collapse, key board members–and the United States above all–could insert themselves more directly into the negotiations. Pakistani officials would no doubt insist that financial collapse wouldn’t serve U.S. strategic interests and could create an opening for extremists. Trying to play the Americans against the Fund’s staff is not a terrible strategy. In the 1990s, Washington intervened repeatedly with the IMF on Russia’s behalf to loosen conditions the Fund had imposed. But for all its importance, Pakistan is not Russia, and Washington’s reserves of good will are already quite low.