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Impact of fiscal adjustments on income distribution in Pakistan

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Muhammad Ali Baig

A fiscal adjustment is a reduction in the government primary budget deficit,3 Piand it can result from a reduction in government expenditures, an increase in tax revenues, or both simultaneously. Fiscal adjustment is commonly understood as a process, instead of as a status: governments run fiscal deficits, fiscal surpluses or balanced budgets, and the process from a budget deficit to a sustained period of balanced budget is a fiscal adjustment. There are two significant features in any fiscal adjustment: the duration of the process, usually measured in years, that defines the intensity of the effort; and the composition of the adjustment, measured as the proportion of the adjustment obtained from expenditure cuts compared to the proportion gained from tax increases. The income inequality in Pakistan has increased drastically in the last eight years and the trend continues despite all claims of poverty reduction.

However, the single most devastating factor for increased income and wealth inequalities in Pakistan remains the regressive tax system. Incidence of tax on the poor in the last 10 years has increased substantially, while the rich are paying almost no direct tax on their colossal income and wealth.

A more accurate way to determine the income disparities in Pakistan is the calculation of the Gini coefficient. It takes upon values between zero and one; the closer the number is to zero, the greater is the equitable distribution of wealth in the country and vice versa. Reduction in subsidies, a key component in fiscal adjustment, suggests that a contraction in government current spending appears to have a negative impact on the incomes of all urban and rural household groups and a decline in public expenditure on education and health affects the poorest urban and poorest rural more than the relatively better-off urban and rural income groups. Further, the estimates of Gini-coefficients show that reduction in consumption subsidies improves income distribution in both rural and urban areas of Pakistan. Conversely, reduction in subsidies on production worsens income distribution both in urban and rural areas, while reducing overall government current expenditure leads to deterioration of income distribution. Similarly, reduction in government expenditure on education and health adversely affects income distribution in both urban and rural areas of Pakistan. While per capita income in Pakistan has unquestionably increased rapidly over the past decade, that growth hides a disturbing fact: even as household incomes for the urban middle class have continued to rise, the rural poor have continued to see their real incomes decline. Their incomes continued to fall in real terms, even as the rest of their compatriots continued to grow richer. It is not unusual see the rich-poor gap increase during periods of rapid economic growth but also inequitable distribution of income and wealth, monopoly over assets and regressive tax policies. It is suggested that the government should invest in human resource development of the agricultural sector to give the poor a chance. Policies should also be revised to bridge the gap between the rich and the poor. The focus should be on taking appropriate measures to improve income distribution. But if no effort is made to address the growing inequality, then you can have tremendous social strife which hurts all, the rich and the poor.

(The writer is a student of MS Public Administration at Institute of Administrative Sciences, University of the Punjab. His major subject are public finance, budgeting and fiscal policy. He can be reached at: [email protected])

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