Tax reforms: Aurangzeb has a difficult road ahead

Reportedly, the IMF expects FBR tax revenues to grow by over 30 percent in the upcoming fiscal year (FY25).

However, achieving such growth is simply impossible without broadening the tax base and further taxing the existing base, especially when inflation is falling, and GDP growth is expected to remain low.

It is nearly impossible to achieve tax growth twice that of nominal GDP growth, which is anticipated to be around 15-16 percent (comprising 12-13 percent inflation and 2-3 percent GDP growth). The government needs to increase taxes on the existing base and introduce new taxes as well.

This presents the first major challenge for the new finance minister. What will be his strategy for generating tax revenues? What are his plans to achieve such ambitious growth?

The FM is embarking on a risky path. He might intensify efforts to bring retailers and traders into the tax net, potentially alienating the core base of PML-N (Pakistan Muslim League-Nawaz) voters. Already, the middle-income rural farming community is in discontent due to the self-created wheat crisis. The budget may further upset the urban middle class in Punjab.

Leadership in Lahore may not approve of the steps taken by their federal colleagues. Some leaders are already distancing themselves from federal decision-making, and the budget may exacerbate this trend. It is no secret that deputy prime minister Ishaq Dar was unhappy with the appointment of ex-banker to the position, and he may seize the opportunity to undermine the FM and mark his territory, just as he did with the then finance minister Miftah Ismail during PDM’s (Pakistan Democratic Movement’s) government.

Sources, however, suggest that the prime minister is deeply involved in decision-making at the finance ministry, with the finance secretary working closely with him. Similar dynamics are observed in the power ministry. The PM has a reputation for centralizing control, dating back to his days as Punjab CM when he directly operated with the bureaucracy, sometimes sidelining ministers.

In his bid to assert control and preserve political capital, Aurangzeb may need to navigate a slew of challenges carefully. It looks like his honeymoon period is already over.

These political tensions within the ruling party add to the broader political uncertainty highlighted by the IMF (International Monetary Fund). The IMF’s latest report warns of a resurgence in social tensions, reflecting the complex political landscape and high cost of living, which could hinder policy and reform implementation. Policy slippages, coupled with reduced external financing, could threaten debt sustainability, and exert pressure on the exchange rate.

The challenges ahead are daunting. Unless there is significant pressure on the currency, inflation is expected to decrease faster than anticipated. However, the government may struggle to regain lost political capital due to taxation measures.

There are two major challenges: achieving higher tax revenue growth and securing external financing. The IMF anticipates $13.9 billion in disbursements from private creditors, with nearly half arranged by the struggling private sector, which has faced difficulties repatriating profits and payments in recent years.

The finance minister faces twin pressures: achieving high tax revenues and securing an optimistic among external financing from private creditors. If the latter falls short, the gap must be filled by reducing the current account deficit. Maintaining a balanced current account may prove challenging and could hinder efforts to achieve 2-3 percent GDP growth, further complicating revenue growth targets.

The question arises: where will higher taxes be collected, especially when many sectors, such as automobiles, steel, and white goods, are operating at only half capacity? Further taxation could dampen sales and encourage informality. In sectors where taxation has increased, market share has shifted to informal players offering inferior products, as seen in petroleum, tobacco, and juices.

If taxes on salaried individuals and formal businesses increase further, marginal individuals may be pushed toward informality, shrinking formal sector employment.

Presenting such a budget is not easy, and achieving its targets is economically challenging. Tough luck!

Copyright Business Recorder, 2024