The difference between an accountant and an economist is that while an accountant obsesses over balancing numbers, an economist analyses them to understand the drivers behind trends and seeks to address them. Unfortunately, the country's Finance Ministry consumes all of its time in trying to juggle numbers on a quarterly basis, instead of strategizing policies that achieve sustainable results.
The most recently announced mini budget is another example of this flawed focus. The purpose of the new revenue boosting measures is to plug a gap of Rs40 billion which is the shortfall in FBRs collection target for the first quarter of FY16. Any missing motivation was compensated by pressure from the International Monetary Fund (IMF).
In a recent development, the government had shaken up the FBR team with a view to improve its performance. Apparently, the shake-up yielded some results - tax collection in the first three months grew nine percent which increased to 12 percent in four months and to 15 percent in five months.
In last five years, the CAGR of FBR revenue is 15 percent while the nominal GDP growth is similar. However, now that inflation is down and nominal GDP growth has slowed down, it is very hard for FBR to achieve 20 percent growth in revenues in FY16. BR Research would once again, implore the authorities including the Finance Minister, to focus on the tax to GDP ratio instead of nominal growth in tax collection.
While we are on the subject, we would also request that focus should be on broadening the tax net rather than increasing the incidence of taxes on the existing payers. The prevalent policy chokes genuine tax payers and entices them to enter the informal segment. Then higher rate of taxation on certain segments also hurts real growth.
The Laffer curve explains that tax elasticity changes in response to changes in the rate of taxation. In economic terms, as the rate of tax rises, tax revenue increases up to certain level. Beyond this, further increases in tax rate begin to drive down tax revenue. Finance Minister Dar increased the GST by one percent to 17 percent as part of this governments first budget and slowly and gradually has been increasing various forms of indirect and direct taxes since then.
At the same time, the narrative from his office is that the fiscal policies are growth oriented. How can the Super Tax, higher GST, ever increasing WHT and regulatory duties generate more growth as the tax incidence was already too high when the government took office?
The recently announced mini budget is a continuation of the same counterintuitive tax policies. The minimum slab of Customs Duty rose to 21 percent from 20 percent to yield additional Rs21 billion in the remaining fiscal year. That doesn make sense on simple arithmetic as given the budgeted 20 percent growth in Customs Duty; an additional one percentage point increases Rs11 billion in seven months. Does the Finance Minister expect traders to import more as import duties rise?
What the measure can do, is make smuggling more economically viable. Smuggling is already very high as according to UN Comtrade data, Chinas exports to Pakistan were $13.2 billion in 2014 while imports from China recorded by SBP were just $6.32 billion. Thus, the illegal imports of $6.84 billion were higher than documented imports. Smuggling from China is a norm and any increase in Customs Duty will reduce the opportunity cost of smuggling and this may further lower the documented imports share. A better policy would have been to lower import duties and enhance the threat of being caught by penalizing a few of the smugglers as well as those importers who play the system through under invoicing or other under-handed tricks.
Similar is the case for cigarettes where Federal Excise Duty has been further enhanced to generate Rs6.5 billion. The tobacco manufacturing companies have already launched a wide campaign that the illicit manufacturing (local) and trade (imported) of tobacco is hampering the formal sector. The Finance Ministry didn't give it much heed though.
The duty on imported cars has been increased further. The economic literature is there for two decades that protectionist policies are making local assemblers too lazy to localize the industry. The auto assemblers are happy and stock brokers have already revised up their valuations of their stocks.Then there is five percent additional Regulatory Duty on 289 items and a fresh 5-10 percent Regulatory Duty on 61 items that have been deemed to be luxury items. Is formula milk (not manufactured in Pakistan) a luxury good or a necessity?
The higher duties on imports will give domestic manufacturers some room to grow and may ease the import pressure which is good for the Balance of Payments. Inflation may not be affected much by these measures as taxation on most of the products in the basket of the common man remains unchanged. The measures may reduce imports growth but may not bring the expected increase in tax collection. It is also unlikely to help the crumbling exports.
The federal fiscal deficit could have been more effectively reduced by increasing the Petroleum Levy at a time when international oil prices are consistently low. And this would have gone all to the Federal Government as PL is not part of the divisible pool. On the other hand, the minimum budget revenue increase will be shared with the provinces with the hope that they will subsequently post surpluses to give back to the Center so it may achieve its consolidated fiscal deficit target.
But for the PL, Dar would have had to take the parliamentary route through legislative process. Instead he seems to be more comfortable keeping things under his own nose. Thus, SROs routed through the ECC which he himself heads the preferred route. Will the move fetch Rs40 billion in addition revenues? Probably not.
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