The Tariff Tripod of Pakistan: Protection, Export Promotion, and Revenue Generation (Vol. 59 No.3-2020)

This paper gives an overview of tariff structure of Pakistan. The protection of local industry, export promotion and revenue generation constitute the triangular tripod of Pakistan tariff. The said three objectives are achieved mainly through imposition of high tariffs on output goods (protection of local industry), duty- exemption schemes and SROs for exporters (export promotion), and multiple levies at import stage on tariff-inclusive price (revenue generation). About half of the revenue of FBR is collected from imports. Protection to sectors like auto and textile is high and consumer welfare is totally missing from the entire scheme of tariff. Despite high protection and multiple export promotion schemes, local manufacturing is weak and exports are stagnant. The revenue has, however, increased manifold over the years and interestingly revenue witnessed big upward jump when MFN rates of tariff fell. Revenue generation is the major consideration in tariff setting. Tariffs are set as an exercise in accounting with the assumption that rates and revenue have got a positive linear relationship. Income effect, substitution effect and volume effect hardly enter into the mental calculations of tariff setters. Due to high incidence of taxes at import stage, incentives for smuggling, under- invoicing, misdeclaration, and evasion are high. Smuggling is rampant and hard to control due to peculiar geographic situation of Pakistan. Under-invoicing is clear from the trade gap between China and Pakistan. As regards misdeclaration, evasion and corruption at ports, I calculate a hypothetical value of CD based on TWA and CEF for the period 1997-98 to 2018-19. These calculations provide interesting policy insights. First, evasion through misdeclaration is high when tariff rates are high and evasion goes down in percentage terms with reduction in tariff rates. Second, CEF increases as a result of reforms in Customs like simplification and automation of clearance processes and procedures. After detailed discussion, paper suggests that protection provided to the local industry should be time-bound with clear sunset date and accountability against rent -seeking. Based on cap-cape equation, paper further suggests that exemptions and concessions in import duties should preferably be provided through tariff code and not through SROs and difficult-to-use export-oriented schemes. In order to put the country on the trajectory of long term growth, import tariffs on input goods and machinery should be phased out in the short to medium term and instead of relying on increase in tariff rates and imposition of additional levies on imports, better policy option is to enhance CEF through reforms aimed at risk based automated clearances.

1. INTRODUCTION

ariffs are an important policy tool for economic growth, protection of domestic industry, revenue generation, productivity, and consumer welfare. Tariffs give price advantage to locally produced goods over imported goods of similar nature and create a wedge between domestic and world prices. The rise in domestic prices spurs domestic production of the imported goods but at the same time depresses demand due to price effect. Thus tariffs influence production, consumption and trade. Tariffs are undeniably a reality of international trade and are used for variety of purposes by the countries but if applied excessively, they erode competitiveness of the industry by increasing cost of inputs, cause de-industrialisation by making industrial investment less viable due to eroded competitiveness, impose costs on consumers by making imported products expensive, and create anti-export bias by making domestic market more attractive than exports as local producers find a captive domestic market for their products where they have every possibility to compromise on quality and variety. Tariffs encourage trade deflection to inefficient producers through protection against competition and encourage smuggling to evade import duties.1 The standard economic argument thus runs that tariffs create deadweight loss and distortions, and reduce welfare.

There is, however, huge divergence between theory and practice of tariffs. Almost all countries make use of tariffs for variety of reasons like import substitution, fixing balance of payments issue, revenue generation, or for retaliation. 2 Practically, tariff setting is a complex phenomenon and involves several policy trade-offs. There is trade-off between employment generation through protection to domestic industry and consumer gains through channels of less price, better quality and more variety of products. Trade-off between revenue generation and economic growth is also important at least in case of developing countries wh ich still have heavy reliance on revenue generation through import tariffs. Moreover, the impacts of tariffs are not uniform. The benefits and costs tariffs generate differ between groups in an economy. They create both ‘losers’ and ‘winners’. The redistributions associated with tariffs tend to generate rents which are hard to tax especially in developing countries where tax enforcement is generally weak. As tariffs provide shield to the local producers against foreign competition, so there is lobbying, pull and push and political economy factors are at play in tariff setting. Tariffs impact households as consumers, producers and wage earners etc. depending on the pass-through effect.3 There may be substantial gains from tariff liberalisation but there is huge heterogeneity in the gains both across countries and across households within the countries (Erhan, Porto, & Rijkers, 2019).

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[1]The situation of Pakistan is bit peculiar with regard to smuggling. Pakistan shares long porous border and provides transit trade facility to Afghanistan. The goods imported under Afghanistan under Afghan Transit Trade Agreement (ATTA) are smuggled back to Pakistan. The common perception that goods do not reach Afghan border and enter Pakistani market through pilferage en route to Afghanistan may not necessarily be true as Pakistan Customs took steps like installation of trackers to ensure that goods imported under ATTA cross border but it is also undeniably a fact that goods are smuggled back due to tariff differential and porous border between the two countries. Tariff rates in Pakistan are in a sense linked to the volume of tra nsit trade. If Pakistan sets high import tariff for a commodity, the import volume of that commodity is likely to increase under Afghan transit. So not only weak anti- smuggling paraphernalia but high tariffs are also a big contributory factor to smuggling.

[2]The trade war between US and China is a case in point. There has been tit-for-tat tariff increases from both sides since over one and half year before reaching ‘phase one agreement’ to start de-escalating their trade war. The US wants the Chinese authorities to end currency manipulation, cease intellectual property theft and stop giving subsidies to state-owned enterprises etc. (Why the US-China Trade War could Re-escalate by Anne O.Krueger, Project Syndicate, Dec. 20,2019).

[3]The impact of tariff reduction or elimination on trading prices is called tariff pass-through or simply it means who captures the tariff rents. The full impact of tariff increase or reduction may not pass on from the border to the consumer. Imperfecti ons in the market partially isolate households from the effects of tariff. See for detailed discussion (Hayakawa, & ITO, 2015).