The World Bank has asked the Federal Board of Revenue to abolish existing customs tariff exemptions (especially at the 6-8 digit headings of Pakistan Customs Tariff). In its proposals on policy reforms for customs duty, the WB 'Pakistan Tax Policy Report' observed that the exemptions at the 6-8 digit headings level of the Pakistan Customs Tariff are unusual and cumbersome from the perspective of administration and compliance.
The WB proposed the FBR to combine tariff reductions with a sequence of separate measures to avoid overall revenue losses, including elimination of existing tariff exemptions (especially at the 6-8 digit level), increases in excisable imports; and expansion of the yield from general sales tax. There should be uniformity of rates, reduction in tariff dispersion, especially at disaggregated level. Moreover, there is also need of compliance, co-operation with trading partners to ensure accurate trade flow records.
In the short term, proceeding prudently with any further reduction of customs tariffs is desirable. Tariff reduction leads to revenue losses as long as the government is no able to compensate these revenues from domestic tax sources. While continuing with carefully paced tariff reductions, Pakistan could consider a sequence of separate measures to avoid overall revenue losses. It could initially eliminate existing tariff exemptions in the system; then increase excise rates on excisable imports to balance out tariff reductions; and finally adjust the scope and rate of the general sales tax to meet remaining revenue needs, the WB said.
In the long term, FBR is set to focus on trade facilitation rather than revenue generation, with the expectation that lower tariffs will spur economic growth and revenue gains elsewhere in the economy. This policy will help reduce the differences in the effective rates of protections of different sectors of the economy, reduce distortions in the allocation of economic resources, and lead to increases in economic welfare.
A progressive substitution of customs tariff collection with revenues from domestic taxes could also make the tax system more progressive. One reform priorities lies in further reducing tariff dispersion, by reducing the number of rates outside the regular tariff bands and eliminating special exemptions. For example, in 2007/08, some 471 tariff lines out of the overall 6,774 tariff lines were above 25 percent.
In addition, Pakistan might want to consider altering its tariff schedule in the direction of more uniform rates. Right now, lower rates apply in general to raw materials and higher rates on finished goods. Such escalated tariff structure leads to effective rates of tariff protection that are much higher for final goods than the nominal tariff rates indicate. A uniform tariff applied to all imports would remove differences in effective protection rates within the import substituting sector and provide broad based protection to the entire manufacturing sector.
Infant industry protection would be replaced by infant economy protection providing equal treatment for all activities engaged in import substitution. More uniform tariffs also reduce the pressure of special interests lobbying for preferential tariff treatment. This reduction in rent seeking opportunities would not only save resources directly due to the lower reward for lobbying activity but also result in less opportunities for corruption in the customs offices and elsewhere.
Misclassification of imports at the border entry would no longer be an issue and customs clearance procedures would be simplified and less costly due to the need for fewer inspections. What might a uniform tariff for Pakistan look like? Presumably, it should be revenue neutral as it would be difficult to make up any lost tariff revenue from other revenue sources. The current tariff regime generates revenues of 1.4 percent of GDP.
Dutiable imports as a share of GDP are around 10 percent, so a revenue neutral uniform tariff would be around 14 percent (1.4/0.10). Switching from the current to a uniform tariff schedule is obviously a large policy change. An interim goal would be to reduce fine distinctions between commodities at the 8-digit level, as duty rate differentials of this magnitude create incentives for firms to misclassify imports to avoid paying duty, the WB added.
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