Accountability through taxation

We only pay lip service to the problem of corruption in Pakistan. When it comes to actual practice, our hypocrisy stands badly exposed. While voting in elections or finding marriage suitors for our children, corruption hardly enters into our mental calculations as a negative variable. Narrow identities of biradari, ethnicity, and geography take precedence over merit and character.
The possible reasons for this hypocrisy are many, including prevalence of norms of tribal culture in society, dysfunctional public service institutions compelling people to fall back on extended family for support, sense of insecurity and low levels of trust in state institutions, powerlessness of the man on the street, extreme social and income inequalities, and politics of exclusion based on ethnicity and parochialism etc promoted by our so-called politicians since the very inception of Pakistan.
All these factors are responsible for poor state building but one other major reason for ineffective governments and tolerance for corruption which is not much emphasised in our public discourse is the civic disengagement of citizens especially in developing and poor countries like ours. Generally low social capital is cited as the main candidate for low civic engagement. But Lucy Martin of Yale University in her recent paper ‘Taxation, loss aversion, and accountability’ has attempted to answer this question in a novel way by conducting two experiments in the neighbourhoods of Kampala, Uganda.
In an ‘aid game’ (first experiment) two players, a leader and a citizen, divided 1,500 Ugandan shillings. The leader received 1000 shillings as aid and the citizen 500 shillings of wages. In the ‘tax game’ (second experiment) the citizen was given 1000 shillings out of which 500 shillings were taxed. The tax was supplemented with 500 shillings out of state money and given to the leader. Now the leader had to decide how much of the 1000 shillings was to be allocated to the citizen and the citizen whether to accept that division. The disgruntled citizens could punish the leader with a fine of 400 shillings if they considered the division unfair. However, exacting the punishment was not free and citizens had to pay 100 shillings to exact the punishment on the leader.
The results vindicated the predictions of the loss-aversion theory. Embezzlement of tax money provoked greater wrath from the citizens than the money stolen from aid. Citizens in the tax game punished leaders when they received, on average, less than 460 shillings. This figure was 13 percent higher than the threshold for the ‘aid group’ and in case of wage-earners this threshold was 30 percent higher. The results imply that high taxes induce high civic engagement of the people and more accountability of the governments. Thus there is a strong link between taxation and accountability.
The taxed citizens thus have lower tolerance for corruption, and for poor performance. Professor Lucy suggests that low level of taxation in the developing countries is partly responsible for the disengagement of the citizens and ineffective governments. Her argument is that ‘ loss aversion’ – an economic proposition that the pain of a loss is greater than the pleasure afforded by an equal gain, meaning that most of the people care more about losing what they have than about getting something extra.
The tax-to-GDP ratios in developing countries are very low compared to developed countries. In European countries tax-to-GDP ratio, on average, is 40 percent whereas in developing countries it ranges between 9 and 17 percent. In case of Pakistan it is perhaps the lowest among countries of the same level of per capita income and development. Developing countries fill this fiscal gap through foreign aid. Most of the African countries are pertinent examples.
Pakistan is also no exception. What happens is that if aid money is siphoned off through corruption, the level of anger among the people is not that high compared to if they discover that their tax money has been embezzled through corruption. In such a case their level of fury will be far higher. The concept of loss aversion explains this difference in the level of anger in these two situations.
Leakage of tax money makes people feel the loss of money more as this money was their income before tax payment whereas the aid money was never with them. It could have benefitted them if invested in public projects. A high-tax country has thus more probability of having more politically engaged citizens and better functioning institutions than a poor and aid-receiving country.
The findings of this paper are also pertinent in our case. The point can be raised that since the people of Pakistan are already heavily taxed and pay taxes on each and every consumer item, then what explains their civic disengagement? That brings us to an interesting point. Indirect taxes may not be as helpful to citizen engagement as direct taxes are.
Direct taxes help with civic engagement as people perceive that if direct taxes are squandered through corruption and bad management that is a direct theft from their pockets which may not necessarily be the case in case of indirect taxes. It means that there is a need to increase the share of direct taxes by bringing more people into the tax net and making the tax structure more progressive. It is mainly through progressive direct taxes that the objective of shared prosperity can be achieved in society. Who should be taxed more and who should become the main focus of redistribution of income in the society?
The findings of Professor Palma of Cambridge University with regard to dispersion of income and inequality in society can be helpful in answering this question. Professor Palma found that 50 percent of the total income of a country is held by the middle-income groups (50 percent) irrespective of country’s level of development, income level political regime, location, and other related variables. Inequality of income is concentrated in the tails – top 10 percent and bottom 40 percent. Thus diverging tails need to be taken care of through taxation of the top 10 percent and via redistribution to the bottom 40 percent.
The ratio of the incomes of the top 10 percent and bottom 40 percent is called ‘Palma ratio’ though researchers are now arguing that the concept of the Palma ratio needs to be further refined through Palma ratio 1 (ratio of income of the top five percent and bottom 40 percent) and Palma ratio 2 (ratio of income of the top one percent and bottom 40 percent) to determine where the extreme concentrations of wealth and poverty lie. Such analysis will also help set the optimum tax rates to make the tax structure really progressive.
Pakistan’s tax structure is riddled with serious pitfalls. The tax-to-GDP ratio is extremely low. Most of the direct taxes are collected in the indirect mode like withholding taxes and deductions at source. Resultantly, Pakistan’s fiscal policy is not playing its redistributive role. Despite all rhetoric about the manna of democracy, people are powerless and cannot hold the rulers accountable. So it should not come as a surprise that a candidate who might be known as a corrupt person wins in elections.
Tilting the taxation structure towards direct taxes may be instrumental in strengthening democracy in Pakistan via channels of civic engagement and governance. The question here is whether the rulers have the will to make the taxation structure really progressive by bringing people into the tax net and making them pay their due taxes. Perhaps the existing power structures will not let this happen. Civil society organisations, journalists, academia, and intelligentsia, and researchers should play their role for altering such power structures that are failing us.
The writer is a graduate of Columbia University.
Email: jamilnasir1969@gmail.com Twitter: @Jamilnasir1