The revenue challenge

The first set of estimates of FBR revenue collections during the period, July to February, 2014-15, published last Saturday in the Business Recorder, reveals the makings of a revenue crisis. The growth rate of FBR revenues in the first six months of 2014-15 was already low at less than 14 percent, compared to the target growth rate of 24 percent in the Budget for 2014-15. But the matter of great concern is that in the months of January and February, the growth has plummeted further to below 6 percent. Consequently, the growth rate of FBR revenues for the first eight months of 2014-15 is down to below 12 percent. This is even lower than the nominal growth of 14.5 percent projected of the GDP in 2014-15 by the Government.
Why has FBR revenue growth fallen to a low single digit in recent months? Part of the explanation may lie in the fall in oil prices. But this has been compensated for by the rise in the GST rate from 17 percent to 22 percent in January and then to 27 percent in February.
The fact is that the growth rate of all taxes has fallen in January and February 2015, in relation to the growth rate in the first six months. In the case of income tax, the decline in growth rate is from 20 percent to less than 13 percent; in customs duties from over 22 percent to less than 14 percent; in GST from about 7 percent to a negative 3 percent and in excise duties from close to 11 percent to 10 percent.
The poor performance of revenues is magnified by the fact that heavy additional taxation was built into the Budget of 2014-15, with taxation proposals adding up to a potential revenue yield of Rs 231 billion. Within direct taxes, the withholding tax regime was expanded, rates were enhanced and higher rates proposed on transactions by non-filers of tax returns. An alternate corporate tax was introduced; accelerated depreciation allowance was reduced and bonus shares were brought into the tax net.
Within indirect taxes, a number of SROs in sales tax and import duty were withdrawn; retailers were taxed on the basis of their electricity bills; restriction was placed on the extent of input tax invoicing, the excise duty on cigarettes and air travel was enhanced, 1 percent duty levied on hitherto exempted imports and so on.
Beyond the original taxation proposals in the budget, the Government has effectively introduced a mini-budget recently. The first measure was the imposition of a regulatory duty of 20 percent on the import of wheat and sugar. This was followed by an enhancement in the general sales tax on petroleum products initially from 17 percent to 22 percent and then to 27 percent. More recently, a regulatory duty has been levied on non- essential imports, furnace oil and scrap metal. The withholding tax on non-compliant importers and service providers has also been enhanced. The total annualised yield from these measures is Rs 160 billion.
The problem is that if the additional revenue from the taxation proposals is taken out of actual revenues from July to November of Rs 1519 billion, then the underlying revenue is Rs 1363 billion, which indicates that the normal growth rate of revenues is near zero. The inevitable conclusion is that the lack of buoyancy in FBR revenues is due primarily to a slowdown of the growth process in the economy.
The lack of dynamism of the economy is highlighted by the sharp decline in the growth rate of the large-scale manufacturing sector in the first six months to only 2.6 percent as compared to over 6.5 percent in the corresponding period of last year. Major revenue spinners have shown little or even negative growth in production like petroleum refining (1 percent), sugar (-17 percent), cigarettes (-7 percent), fertilizer (-2 percent), cement (3 percent) and vegetable ghee (zero percent).
Within direct taxes, the growth of revenues from withholding taxes has also been restricted by the performance of the economy. Dutiable imports have shown little growth and exports have declined by over 4 percent. The revenue from contractors has been restricted by the cutback in PSDP. Also, telecom revenues have flattened out.
There is an important lesson from the emerging revenue crisis. Enhancements in rates of taxation should be avoided at a time when the economy is floundering and showing little dynamism. As such, increases in the GST rate and in withholding/advance tax rates should have been avoided. Classic examples of the impact of high tax rates being counterproductive is in the case of telecommunications and cigarettes.
The Tax Reforms Commission must first independently diagnose the causes of the current malaise in FBR revenues. It should then identify not only changes required in tax policy but also suggest fundamental changes in tax administration.
Finally, FBR will need to show a growth in revenues of over 30 percent in the next four months, if even the reduced target of Rs 2691 billion, agreed with the IMF, is to be met. This is next to impossible. It would be some consolation indeed if revenues reach Rs 2600 billion.
(The writer is Managing Director of the Institute for Policy Reforms (IPR) and a former federal minister)