Strategy for resource mobilisation

The technical discussions in Islamabad on the ninth review of the IMF programme between the IMF staff and the officials of the Ministry of Finance are on-going. They have tended to focus more on the targeted level of FBR revenues and the taxation measures required to achieve this target by end-June 2023.

The original target set in the federal budget of 2022-23 for FBR revenues was Rs 7,470 billion. This requires a growth rate of almost 22% in these revenues during the year. Apparently, the growth rate achieved in the first seven months is close to 17%, which implies that if it remains unchanged then the shortfall at the end of the year will be close to Rs 300 billion.

However, the recent fall in the value of the rupee should now lead to a faster rate of expansion in the rupee value of the import tax base. This has earlier increased by only 1% from July to January, 2022-23 due to the overvalued exchange rate and the physical restrictions imposed on imports.

The import tax base should now grow in rupee terms by almost 20%. The growth rate of import-based tax revenues has been negative until now. They should show faster growth from February 2023 onwards. This will enable FBR revenues from taxes linked to imports to rise faster, along with the extraordinary dynamism demonstrated by direct tax revenues. As such, if total revenues growth increases from 17% to near 25% in the last five months of 2022-23 then the revenue target for the year is likely to be achieved.

However, a case is being made for raising the target for FBR revenues in 2022-23. First, in the presence of a higher rate of inflation than anticipated at the start of the year the projected GDP in current prices is likely to be larger. As such, attainment of the FBR revenue target for the year will still lead to a fall in the tax-to-GDP ratio of almost 0.5% of the GDP.

Second, there is the likelihood that based on the present trends the fiscal target of 4.9% of the GDP is unlikely to be achieved. The rise in emergency expenditures due to the floods, higher power sector subsidies, smaller provincial cash surplus and lower non-tax revenues, especially from the petrol levy, could lead to a deficit of over 6% of the GDP, even after a big cutback in development spending. This will imply that instead of a small primary surplus there will be a significant primary deficit.

Therefore, the IMF may ask for significant additional resource mobilisation from FBR revenues and higher rate of petroleum levy to generate a primary surplus. A feasible target is of Rs 400 billion in the five months, February to June, 2023. This implies the presentation of proposals with a yield of Rs 960 billion on an annualised basis. They will have to be carefully designed and implemented, given the current poor state of the economy.

Apparently, the proposals under discussion are as follows:

(i) Raising the general sales tax rate from 17% to 18%.

(ii) Introduction of the sales tax on petroleum products.

(iii) Jacking up the petroleum levy by Rs 20 to Rs 30 per liter.

The emphasis appears to be entirely on raising indirect levies. This will be a very flawed policy because it will add further to the rate of inflation and place a bigger burden on the lower income groups.

This is the appropriate time to highlight the findings of the BNU Centre of Policy Research on who bears the burden of taxes in Pakistan? Results are presented below on the incidence of the sales tax in Pakistan by quintile in Pakistan in 2020-21.

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     Tax Incidence as % of Household Income
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               Bottom Quintile    Top Quintile
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Sales Tax           6.74                  3.83
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The regressivity is due to the 16% share in collection of revenues from food items like sugar, edible oil, tea, beverages, etc. Also, 18% of the sales tax revenue was generated from petroleum products in 2020-21. The sales tax has now been largely substituted by the petroleum levy.

The incidence of taxes on petroleum products has been examined by looking at the sectoral Input-Output table of Pakistan and the statistics released by OCAC. Almost 95% of the two main petroleum products, motor spirit and HSD oil, are used for transport purposes.

The shares of sub-sectors receiving transport inputs according to the I-0 table, are as follows:

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Input into Sub-Sectors                           Share (%)
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Agricultural Food Items                               20.2
Manufactured Food Items                               11.1
Manufactured Export Items                             12.4
Supplies to Domestic Wholesale and Retail Trade        5.4
Machinery Sector                                       4.2
Public Administration and Defense                     10.8
Others (Private Transport, Services, etc.)            33.9
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TOTAL                                                100.0
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Therefore, over 31% of the transport input is for the agricultural and manufacturing of food sub-sectors. This increases the regressivity of taxes on petroleum products. Further, the transport input is significant for exports and for defense purposes. As such, there is little case for enhancement of taxes on petroleum products.

There is the need also to highlight that after the recent hike on prices of HSD oil and Motor Spirit of Rs 35 per liter, the price of HSD oil in Purchasing Power Parity (PPP) terms is higher than in India and Bangladesh. Following the build-up in the impact of the recent devaluation of the rupee, the price of Motor Spirit will also be higher.

Overall, the enhancement in rates of sales tax and petroleum levy will be regressive in nature. It will hit badly the lower income groups at a time when they are already suffering the ravages of high and increasing inflation.

The resource mobilization strategy should focus on highly progressive taxation. According to the UNDP National Human Development Report of 2020, the direct tax exemptions, lower tax rates, rebates, credits, reliefs, etc., to effectively the top income quintile of Pakistan add up to over 3% of the GDP. This explains why the direct tax to GDP is low in Pakistan at under 3.5% of the GDP as compared to over 6% of the GDP, for example, in India.

Based on the comprehensive analysis of the income tax regime in Pakistan, the following menu of progressive taxation proposals is presented:

(i) Introduction of a progressive corporate income tax with a 30% tax rate on pre-tax return on equity of up to 18%, rising to 35% on pre-tax rate of return on equity of above 24%.

(ii) Tax credits to individual taxpayers for various admissible expenditures be restricted to a flat rate of 15% and not linked to the average tax rate of the taxpayer, with the condition of a minimum of zero tax liability and carry-forward provision.

(iii) Conversion of fixed and final withholding taxation of different types of income into advance taxation, with the requirement of filing of total income and taxation accordingly.

(iv) The personal income taxation system of Pakistan is not very progressive. The maximum marginal tax rate is attained at an income which is 38 times the per capita income, as compared to 10 to 12 times in India and Bangladesh.

(v) There was a time when the corporate income tax rate on commercial banks was 60%. It should be raised back to at least 45%.

(vi) There should be no concept of ‘holding period’, beyond which capital gains are exempt on real estate. The initial tax rate should be 15% and the tax rate should be 5%, if trading after 5 years.

(vii) A 0.5% withholding tax should be levied on the trading value of shares.

(viii) Provincial governments must be urged to develop the agricultural income tax and the urban immoveable property tax, with substantial untapped revenue potential.

(ix) The sales tax on food products like sugar and vegetable ghee should be reduced, and the sales tax be levied on notified retail prices on other products, especially luxury goods.

(x) The petroleum levy on Motor Spirit be raised to 60 Rs per liter and on HSD oil reduced to Rs 40 per liter.

(xi) Harmonization of the sales tax goods and services with the same standard rate throughout the country.

Implementation of an appropriate subset of the above reforms should yield the additional revenues of Rs 400 billion and make the tax system significantly more progressive.

Apparently, the IMF Staff Mission is in the process of finalizing the Macroeconomic and Budgetary Framework. We look forward especially to the balance of payments projections and the estimated gross financing requirement with sources for 2022-23 and beyond. Hopefully, an agreement will be reached on completion of the ninth review of the IMF programme and the threat of an imminent financial crisis be at least temporarily averted.

Copyright Business Recorder, 2023