Property Taxes and State Incapacity in Pakistan
by Dr M Mujtaba Piracha
Oxford University Press 2021, 246pp

Reviewed by: Dr Ali Cheema, LUMS
24 June 2022
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In 1789, Benjamin Franklin famously said that in this world there is nothing certain except death and taxes. However, Mujtaba Piracha’s incisive book Property Taxes and State Incapacity in Pakistan argues that in the country nothing is certain about taxes! The book’s starting point is a rich description of the weak fiscal compact between the state and the citizenry in the country. Pakistan’s fiscal compact provides one certainty that wealth holders will not be asked to make an adequate contribution to support the service delivery needs of a growing population.

The author starts by showing that Pakistan’s tax-to-GDP ratio is lower than the average for countries at similar levels of income. Importantly, the weak fiscal compact on the tax side is not mirrored by a weak compact on the expenditure side. Unlike the tax side, Pakistan’s government spending-to-GDP ratio is around the average for countries at similar income levels. This suggests that a commitment to state supported services and safety nets are essential elements of Pakistan’s political settlement. The puzzle is why hasn’t the political commitment to a larger state resulted in a stronger fiscal compact on the tax side between the state, economic elites, and the broader citizenry? An implication of this incongruity is that Pakistan’s economy finds itself perpetually incarcerated in a state of debt.

The book discusses this broader concern in the context of the urban property tax, which is globally recognised as a tax with tremendous potential (Ahmad and Brosio forthcoming). The property tax is paid annually by citizens to finance the provision of critical municipal and social services by urban local governments. The book’s focus on the province of Punjab makes sense as it is Pakistan’s most populous and urbanised province, which is home to five cities with a one million plus population and nearly fifty cities with a population of over one hundred thousand.

The author shows that the fiscal compact around property taxes is much weaker than the compact around other taxes. Punjab’s property tax-to-GDP ratio at 0.05 percent is exceptionally low and insufficient to finance the service delivery needs of its urban citizens. The scale of the underutilisation of property taxes can be understood from the fact that the province’s property tax-to-GDP ratio is ten-fold lower than the average for developing countries and four times lower than the equivalent ratio in neighbouring India, which is not considered an exemplary model of urban taxation. More importantly, the author shows that the puzzle around property taxes is more complex as, unlike the other main taxes, the property tax-to-GDP ratio has steadily declined in Punjab over this century.

This is important because a recurrent property tax is an important source of finance for critical urban public investments like water and sanitation. It is also a critical source of income that urban local governments use to raise capital on bond markets to finance local infrastructural investments in public transport, education, water, and sanitation. Several studies attribute the huge mortality drop witnessed in 19th century US and UK to the ‘municipal revolution’ in these countries which consisted of empowered urban local governments introducing modern water and sanitation systems (Alsan and Goldin 2019, Chapman 2019, Cutler and Miller 2006, Hunt 2004, Szeter 2002, Fraser 1979). The research finds that this provision would not have been possible without the emergence of a strong fiscal compact between local governments, city elites and the broader citizenry, which enabled city governments to finance this infrastructural investment. Consequently, local taxes came to constitute an important share of overall taxes in the US and UK during this period. Local revenues contributed over 60% of total revenues in US and around 40% of UK’s revenues in the early 20th century (Gadenne and Singhal 2014). Interestingly, the US and UK, at the time, were low tax societies with overall tax-to-GDP ratios that were the same as Pakistan’s today.

Contrary to this, the author shows that Pakistan has evolved an extremely centralised model of taxation with exceptionally weak local fiscal capacity that makes local governments highly dependent on transfers from federally collected taxes. Unlike 19th century US and UK where local governments were built on the foundation of strong fiscal accountability, Pakistan’s local government system is riddled with weak fiscal foundations. This has two consequences: weak local tax bases constrain city governments from servicing a growing demand for municipal and social services; and it makes governments reliant on lenders to finance these investments. The lack of financing for local municipal and social services is a critical development challenge; recent evidence shows that around forty percent of households in urban Punjab still don’t have water availability for more than six hours a day and lack access to modern forms of sanitation (World Bank 2018).

The book’s overarching question is, why is property tax collection in Punjab exceptionally low? It situates this question in the period 2000-2010 when a major decentralisation reform in 2001 substantially increased the service delivery responsibilities of local governments. This was also the decade when donors provided extensive policy and technical assistance for property tax reform to fiscally empower local governments. The book uses this event to ask why did property tax collections continue to decline during this period despite local governments, local government reformers in the federal government and donors having tremendous skin in the game?

The book acknowledges that a set of poor tax policy choices have eroded the potential of property taxes as a catalyst for development. Important among these are the high level of exemptions that erode the base. Recent evidence from Lahore shows that nearly two-thirds of properties in the city enjoy some form of property tax exemption (Abbas et. al. forthcoming). Importantly, the most widespread exemption for small plots is regressive as it is tied to a property’s area and not to its value or location. The current policy also freezes the valuation applied to calculate the taxable value of a property for a period of five years. This makes the tax inert for this period and makes it politically costly for governments to undertake steep revaluations every five years. It is no surprise that only one revaluation has been undertaken in the last twenty-two years. In addition, existing policy gives a twenty percent discount on the average tax rate for land areas in excess of 500 square yards and built areas in excess of 3000 square feet. Finally, the existing tax framework applies an extremely low tax rate on vacant plots and does a poor job of registering these properties. These features of the tax code make property tax regressive and erode its potential.

The book’s contribution is that it goes beyond these proximate causes and instead focuses on deep structural factors as explanations for the underutilisation of property taxes in Punjab. It does this in a multifaceted way. It provides a rich description of the institutional architecture of Pakistan’s fiscal federal system; analyses the perverse incentives it creates for local tax effort and presents original ethnographic evidence on the perverse incentives for tax collection created by the formal and informal arrangements that govern property taxation.

Chapters 2 and 3 argue that complex intergovernmental fiscal arrangements create disincentives for provincial and local governments to cooperate on actions that would increase the utilisation of property taxes through better policy choices. Under the current framework urban local governments are the biggest beneficiaries of property tax revenues but have few revenue-raising powers with respect to it. The current fiscal framework doesn’t require them to set the tax rate and assigns them no oversight role in the valuation of properties. As opposed to this, the provincial government is assigned all the major tax policy functions – setting the rate and the valuations – even though it gets a small share of this revenue. The book argues that this dissonance weakens the incentives for tax effort at both levels of government.

Chapter 4 proffers an interesting hypothesis that the local fiscal system creates a low tax-low spend political equilibrium that mutes incentives for tax effort at the local government level. There is some recent evidence in support of this hypothesis which shows that urban local governments tend to accumulate cash reserves instead of using them to provide services (Bryan et. al. 2019). The author attributes this to the prevalence of patronage politics that prefers targeted spending to clients over universal provision and to the reduced reliance of the wealthy on public services. While speculative, this is a thought-provoking and original hypothesis that would have benefited from more systematic analysis and evidence. The author would have done well to probe the tendency of the state to increasingly outsource the provision of housing and municipal services to private developers. Consequently, many of these new developments remain outside the property tax system and remain unconnected to the public infrastructure in cities. This has resulted in the under-provision of critical municipal services within urban areas and has created differential access to these services for citizens residing in different parts of the city. The lack of planned investment in citywide infrastructure is recognised as a major factor behind environmental hazards such as flooding and poor sanitation (Hasan 2020).

Finally, chapters 5 and 6 provide an insight into the ‘real working’ of the tax administration. In my view, this is the most original and novel part of the book. These chapters use primary field work and rich ethnographic research to show that the existing system gives front-line tax collectors a monopoly over information about properties and taxpayers. This worsens the principal-agent problem by granting tremendous discretion to front-line staff, thus making it hard for higher-level administration to change the low tax equilibrium. This part of the book also provides rich insights into how the court system reinforces the current equilibrium and fails to check government and taxpayer actions that perpetuate the low tax outcome.

This book makes a significant contribution to our understanding of the real workings of the local fiscal state and how systemic incentives can weaken the fiscal system by exacerbating principal-agent and common pool problems. It does this in a readable manner that makes it accessible to a broad readership interested in questions about the political economy of taxation and state-building in Pakistan.

References
Abbas, A., M. Best, M. Callen, A. Cheema, S. Khan Mohmand and A. Q. Khan (forthcomingProperty Taxation in Punjab: Policy, Tax Equity and Utilisation. IGC policy report.
Ahmad, E and G. Brosio (forthcoming) Beneficial Property Taxation for Emerging Market Countries. Palgrave-Macmillan.
Alsan, M. and C. Goldin (2019) Watersheds in Child Mortality: The Role of Effective Water and Sewerage Infrastructure, 1880-1920. Quarterly Journal of Economics, 127(2).
Bryan, G., A. Cheema, A. Jamal, A. Khan, A. Liaqat and G. Padro i Miquel (2019) State Capacity in Punjab’s Local Governments: Benchmarking Existing Deficits. IGC policy report.
Chapman, J. (2019) The Contribution of Infrastructure Investment to Britain’s Urban Mortality Decline, 1861-1900. Economic History Review, 72(2).
Cutler, D. and G. Miller (2006) Water, Water Everywhere: Municipal Finance and Water Supply in American Cities. in E. Glaeser and C. Goldin (eds.) Corruption and Reforms: Lessons from America’s Economic History. University of Chicago Press.
Fraser, D. (1979) Power and Authority in the Victorian City. Oxford: Basil Blackwell.
Gadenne, L. and M. Singhal (2014) Decentralisation on Developing Economies. Annual Review of Economics, Vol. 6.
Hasan, A. (2020) Why Karachi Floods. Dawn: September 6th, 2020.
Hunt, T (2004) Building Jerusalem: The Rise and Fall of the Victorian City. Metropolitan Books: Henry Holt and Co.
Szreter, S (2002) A Central Role for Local Government? The example of late Victorian Britain. History and Policy
World Bank (2018) When Water Becomes a Hazard: A diagnostic report on the state of water supply, sanitation and poverty in Pakistan and its impact on child stunting. Washington.

© Bloomsbury Pakistan 2022

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