FBR's performance

The Federal Board of Revenue (FBR) put in an exceptional performance in collecting tax revenues from 2012-13 to 2017-18. The average annual growth rate achieved was relatively high at 14 percent, leading to a near doubling of revenues over the five year period. Consequently, there was a jump in the FBR tax-to-GDP ratio from 8.5 percent in 2012-13 to 11.2 percent by 2017-18. This increase was one of the largest ever recorded. Of course, this was partly made possible by the 'windfall gains' due to the exceptionally low oil price and also by some regressive moves.
The current fiscal year has witnessed, however, a big deterioration in the perceptions about FBR's performance. As the year progresses, the shortfall of actual collection in relation to the target continues to increase. During the first three quarters of 2018-19 the growth rate in tax revenues is extremely low at below 3 percent, whereas the growth in the target for the year is above 14 percent. At this rate, the expectation is that by the end of the 2018-19 the shortfall will be over Rs 450 billion. Consequently, there will be a perceptible drop in the FBR tax-to-GDP ratio by almost 1 percent of the GDP.
A number of questions arise about the apparent decline in FBR's performance. Has there suddenly been a quantum change in the quality of tax administration, especially by the field formations, and a greater proclivity towards corruption? Has the top management failed to monitor and guide effectively the tax collection process? Alternatively, is the slackness in performance due to the broader developments in the national economy, especially in terms of the growth of different tax bases and/or because of a more liberal tax policy leading to more exemptions and reductions in tax rates?
There is need first to identify the performance of different taxes to get an assessment initially of the impact of different factors on the revenue performance. Two taxes, viz., import duty and excise duty, have performed relatively well, with growth rates in collection of 19 percent and 12 percent respectively. However, these are the smaller taxes. The two larger taxes, namely income tax and sales tax, have done poorly in the first nine months with negative growth rates of 3 percent and 1 percent respectively.
The buoyancy in import duty can be attributed to the rupee depreciation which has increased the import tax base by 13 percent. The double-digit growth rate in excise duty is primarily due to the enhancement in the tax rate on cigarettes in the Budget. There remains the need to explain the decline in income tax revenues in the presence of the likely increase in the nominal GDP, excluding agriculture, of almost 12 percent in 2018-19. Similarly, the sales tax on imports should have demonstrated high growth similar to that of the import duty. However, in this case revenue may have been affected more by the contraction in the volume of imports. The lack of dynamism in the domestic sales tax can perhaps be attributed more to a decline of almost 2 percent in the Quantum Index of Manufacturing.
A detailed investigation of the performance of income tax revenues reveals the following:
(i) The unprecedented tripling in the income tax exemption limit from Rs 400,000 to Rs 1,200,000 clearly has had a significant negative impact on personal income tax revenues, possibly by as much as Rs 90 billion.
(ii) The corporate income tax rate was brought down by one percentage point. More recently, the Super tax on large companies has been withdrawn. This implies as loss of close to Rs 15 billion.
(iii) The largest source of withholding tax revenue is on contracts. As a step towards containing the fiscal deficit, the Supplementary Budget, presented in September 2018, envisaged a big reduction in the Federal PSDP of almost 28 percent. During the first ten months the releases have actually fallen by 13 percent. Similarly, the Provincial Governments have reduced their ADP allocations by almost 30 percent. Overall, these cutbacks have reduced the tax base and will contribute probably to fall in revenues of over Rs 30 billion in 2018-19.
(iv) Following the Supreme Court judgment, the presumptive income tax on mobile phone cards was withdrawn. However, it has recently been restored. Nevertheless, the loss in revenues in 2018-19 may be as large as Rs 40 billion.
(v) The Minibudget presented in January 2019 removed the tax on cash withdrawals from banks by filers, the tax on undistributed profits above a certain level and the advance tax on capital gains on shares. The loss for the remainder of the year is approximately Rs 10 billion.
The revenue loss in income tax due to the above factors adds up to Rs 185 billion. As opposed to this, additional revenues are likely to have been generated from the withholding taxes on imports, bank deposits, exports and electricity due to faster expansion in the respective tax bases, amounting collectively to Rs 80 billion.
As such, the net loss in income tax revenues in 2018-19 due to changes in tax policy and in the growth of tax bases is Rs 105 billion. Therefore, the absence of these changes income tax revenues could potentially have reached Rs 1590 billion in 2018-19, implying a positive growth rate of 4 percent, still significantly below the target.
There has been some failure also in tax administration. In the Supplementary Budget, a commitment was made by FBR to raise additional revenues of over Rs 90 billion by improvement in mechanisms for detecting tax evasion, especially by the use of information technology. Instead there are growing complaints of harassment of businessmen and traders by the field staff. Also, the number of return filers needs to be further increased.
The next issue to be resolved is the explanation for the negative growth in sales tax collections in the first nine months of 2018-19. It has been argued above that this should not have happened at least at the import stage due to the 13 percent increase in the rupee value of imports.
The major items which contribute 60 percent to revenues from the sales tax on imports are POL products, machinery, iron and steel and vehicles. The process of contraction in import volumes has actually led to a fall in the rupee value of imports of all these products. Imports of POL products have fallen by 5 percent, machinery by 3 percent, iron and steel by 8 percent, and automobiles by 4 percent. Consequently, the contraction of the tax bases has already contributed to a fall in sales tax revenues on imports by over Rs 75 billion.
Turning to the sales tax on domestic production, the major revenue generating industries are POL products, cement, sugar, beverages, iron and steel and cigarettes. With the exception of the last industry, all these industries have experienced negative growth due to the general economic slowdown. The production of POL products has fallen by 6 percent, cement by 4 percent, sugar by 8 percent, beverages by 3 percent and iron and steel by as much as 23 percent. Therefore, the contraction in the tax base is a major factor in the case also. The revenue loss is estimated at Rs 30 billion in the first eight months.
Another important factor contributing to the lower level of revenues from the sales tax is the decline in sales tax rates on POL products, especially of motor spirit and HSD oil. This has happened in an effort to minimize the impact on retail prices of the rise in the international price of oil. Initially, this was the policy followed by the new PTI government. Consequently, sales tax rates were brought down sharply in the first four months of its tenure. There has since been a transition to the levy of the standard sales tax rate of 17 percent in the case of motor spirit and HSD oil. However, a few days ago the rate on motor spirit has been brought down once again to 12 percent.
There has been failure on the part of FBR in releasing promissory notes to exporters in lieu of refunds due to exporters. Also, the tax base of the sales tax has not been broadened adequately to cover retail trade.
Overall, the revenue foregone due to contraction in the sales tax bases and fall in rates is likely to be close to Rs 165 billion in 2018-19. In other words, revenues by June 2019 could have reached Rs 1279 billion in the absence of the contraction of the tax base and falling tax rates. This would have implied a growth rate of 10 percent, still somewhat below the target.
The bottom line is that in the absence of tax policy changes and contraction of tax bases, the overall level of FBR revenues would have approached Rs 4200 billion in 2018-19, yielding thereby a growth rate in revenues of 9 percent. The shortfall in relation to the target would have been less than Rs 200 billion.
Clearly, the above analysis demonstrates that the apparently poor performance of FBR is not due as much to a breakdown in tax administration as to a slowdown in the economy leading to lower growth or even a decline in various tax bases and to the adoption of a tax policy by the PTI Government of reducing tax rates, granting exemptions and reliefs. It is unfortunate that the Chairman of FBR, a seasoned civil servant, has been removed perhaps for the wrong reasons.
(The writer is Professor Emeritus at BNU and former Federal Minister)