Tax Increment Financing for Pakistan

TAX INCREMENT FINANCING FOR

PAKISTANSalman Ahmed Shaikh

salmanashaikh@iba.edu.pk PhD Scholar & Economics Faculty

IBA Karachi

Presentation Outline Introduction Mathematical Model Possible Hindrances in TIF Application in

Pakistan Pre-Requisites for TIF in Pakistan Welfare Benefits of TIF in Pakistan

Introduction Housing Needs: 8 Million (Source: World Bank).

Urban Population Growth > Total Population Growth

Reason: Urban Centric Development

Result: Increased Cost of Living

House Rent Inflation

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

House Rent Inflation

House Rent Inflation Linear (House Rent Inflation)

Source: Economic Survey of Pakistan 2012-13

Introduction Need: Develop New Cities

Reason: Developing Cities Have Positive Externalities

Who Must Initiate? Cities Are Public Goods

Problem: Funding Development Expenditure

Solution: One of the Many, TIF.

Basic Idea of TIF When a public project such as a road, school, or hazardous waste

cleanup is carried out, there is often an increase in the value of surrounding real estate and new investment.

This increased site value and investment sometimes generates increased tax revenues.

The increased tax revenues are the "tax increment".

TIF dedicates tax increments within a certain defined district to finance debt issued to pay for the project.

TIF is a tool to use future gains in taxes to finance current improvements which will create the conditions for those future gains. This tool is widely used in U.S and in Europe.

Basic Idea of TIF

Mathematical Model

Tax on property (𝑇) function is based on two components, i.e. tax rate on property (𝑡𝑝) and taxable base value of property (𝐵𝑉𝑝). 𝑇= 𝑡𝑝 𝑥 𝐵𝑉𝑝 --- (1) The taxable base value (𝐵𝑉𝑝) can be decomposed into its own components, i.e. number of properties in a locality (𝑁𝑝) times market value of each property (𝑀𝑉𝑝): 𝑇= 𝑡𝑝 𝑥 [𝑁𝑝 𝑥 𝑀𝑉𝑝] --- (2)

Mathematical Model

In our model, the number of properties (𝑁𝑝) is a function of three variables:

1. Urban population growth rate (𝑁𝑢) which is a sum of natural rate of increase in population plus the net migration rate.

2. Level of public capital including physical infrastructure for sustaining basic urban lifestyle (𝐾𝑝).

3. Net capital inflows (𝑁𝐶𝐼) into the country which includes remittances and foreign direct investment in production sector. It may include foreign aid as well but it excludes foreign portfolio investment for our model.

𝑁𝑝 = 𝑓(𝑁𝑢,𝐾𝑝,𝑁𝐶𝐼) --- (3)

Mathematical Model

Assuming a simple Cobb-Douglas functional form for 𝑁𝑝, we have: 𝑁𝑝 = 𝑁𝑢𝛼𝐾𝑝𝛽𝑁𝐶𝐼𝛾 --- (4) We can represent (𝑀𝑉𝑝) as a function of (𝐾𝑝) and governance (𝐺): 𝑀𝑉𝑝 = 𝐾𝑝 𝑥 𝐺 --- (5)

Mathematical Model

If we put (4) and (5) in (2), we get: 𝑇= 𝑡𝑝 𝑥 [𝑁𝑝 𝑥 𝑀𝑉𝑝] 𝑇= 𝑡𝑝 𝑥 𝑁𝑢𝛼𝐾𝑝𝛽𝑁𝐶𝐼𝛾 𝑥 𝐾𝑝 𝑥 𝐺 𝑇= 𝑡𝑝 𝑥 𝑁𝑢𝛼𝐾𝑝1+𝛽𝑁𝐶𝐼𝛾 𝑥 𝐺

Finally, assuming a Laffer curve relation between 𝑡𝑝 and 𝑇, we put 𝑡𝑝𝛿 in place of 𝑡𝑝 where 𝛿 <1 for diminishing marginal contribution in taxes of increase in 𝑡𝑝. 𝑇= 𝑡𝑝𝛿 𝑥 𝑁𝑢𝛼𝐾𝑝1+𝛽𝑁𝐶𝐼𝛾 𝑥 𝐺 --- (6)

Mathematical Model

In our model, 𝛽 > 0 and hence 1+ 𝛽 > 1 and hence we have increasing returns in taxes with additional investment in public infrastructure 𝐾𝑝. In our model, 𝛾 > 0 and has no upper bound as it is possible to have a value greater than 1 for 𝛾 especially in developing countries with high rates of growth. Lastly, we assume that 𝐺 will also be positively related to 𝑀𝑉𝑝 and hence also with amount of 𝑇 that can be collected in the economy. Hence greater the value of 𝛼,𝛽 and 𝛾 and base values of 𝐾𝑝 and 𝑁𝐶𝐼, greater will be the value of 𝑁𝑝 and hence a circular complimentary process will lead to increase in both 𝑁𝑝 and 𝑇 leading to more accumulation of 𝐾𝑝 and subsequent increase in 𝑀𝑉𝑝 in an iterative process.

Possible Hindrances in TIF Application

Low Rate of Savings

Source: Handbook of Statistics on Pakistan EconomyIt is hard to attract investment funds in a country with very low rate of savings.

Possible Hindrances in TIF Application

Tax Haven for Elite Class Lowest Tax to GDP Ratio among IMF

Classification of Middle Income Countries. Only 2% population are registered taxpayers.

India

Pakist

an

Sri La

nka

Sub Sa

haran

Africa

World

High Inc

ome

Middle I

ncome

0

10

20

30

Tax to GDP (%)

Tax to GDP (%)

Source: Ministry of Finance Source: IMF

Possible Hindrances in TIF Application

Fiscal Deficit Eats Up Development Funds

Source: Ministry of Finance

Possible Hindrances in TIF Application

Lack of Documentation

Large Informal Economy. ‘Benaam Zameen’. Flawed Documentation with False Valuation. Capitalistic Democracy Provides Status Quo

Incentives

Possible Hindrances in TIF Application

Lack of Investor Confidence in Public Policies.

Policy Reversals Case in Point: Engro Case in Point: Uncertainty in Energy

Distribution

Possible Hindrances in TIF Application

Inefficiency in Public Sector

Lack of Trust Poor Delivery & Service Record Corruption & Governance Failures DFIs Prefer NGOs Over Government

Possible Hindrances in TIF Application

Lack of Political Will

Capitalistic Democracy Provides Status Quo Incentives

Pre-requisites for TIF in Pakistan Engage Remitters & Big Investors for

Seed Capital Remittances Increased After 9/11

Went in Stock Market & Real Estate Mostly Potential: People Prefer Real Estate Investments After

Market Crash

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Growth in HS Growth in Construction Remittances Growth

Source: Economic Survey of Pakistan 2012-13

Pre-requisites for TIF in Pakistan Engage Banking Liquidity for Initial Funding.

Banks Prefer T-Bill Investments Over Private Lending Islamic Banks Have ADR of 35% Only.

0.000.100.200.300.400.500.600.700.800.90

ADR

ADR

Source: Islamic Banking Bulletin, SBP, Various Issues

Pre-requisites for TIF in Pakistan Connect TIF with Tax Amnesty. Connect TIF with REITs. Compliment TIF with Energy Financing.

Welfare benefits of TIF in Pakistan Reduce urban congestion Reduce urban crimes Reduce prices of real estate Widen the urban centers Generate employment in new urban centers Facilitate closer migration to wide choice of urban

centers Create new growth nodes and production zones. Reduce ethnical conflicts that arise from ethnical

diversity in congested urban centers.

Thank You

For Feedback & Queries

Salman Ahmed ShaikhIBA City Campus, Garden Kiyani Road,

Karachi, PakistanPh# 0334 – 3193395

Email: salmanashaikh@iba.edu.pkWeb: www.islamiceconomicsproject.wordpress.com