The slow poisoning of economy?

Some of the budget proposals circulating in the media — especially those recommended by the reforms and revenue mobilization commission (RRMC) –have been termed anti-documentation and anti-corporatization by analysts and businessmen. One businessman described this as nationalization. The government must think through before implementing some of the measures such as tax on company reserves and minimum asset tax (MAT) on domestically held movable and immovable assets.

The government is desperate to enhance tax revenues at a time when debt servicing expense is higher than net federal fiscal revenues by a good margin. However, the government is attempting to tax those who are already in the tax net while not much effort is being put to those who are (or part of their balance sheet is) simply out of the documented system. In the previous PTI regime (or even under Miftah Ismail last year), there was at least a resolve to tax the untaxed. However, now under Ishaq Dar, the concepts are clear – to squeeze the existing taxpayer further.

In terms of direct taxes collection, 15 percent (or less) of the manufacturing sector is paying half of the tax. And Dar is determined to further grind that axe. In addition, recommendations have been made to tax the accumulated reserves. The proposal is to impose an advance tax of 5 percent on listed firms and 7.5 percent on unlisted firms. The tax is adjustable on actual dividend distribution by the company in the future.

The architect of this proposal perhaps think that this tax is levied to lure the companies to pay dividends and it is in the interest of minority shareholders. One may wonder if that is the case why there is a tax (and the rate is higher) for unlisted companies. The objective seems simply to collect as much of taxes today from a pool that is in the tax net. And such measures may shrink pool that further.

The question is if the government is collecting advance tax on future income what would the government collect in the future? The tax shall be adjusted against future dividends to the shareholders; but ownership may change hands at the time the actual dividend is paid. Is it a tax on the shareholders or the company?

One financial market expert termed this as slow poisoning of the economy. “I am not saying give capitalists any tax advantage, but when you tax the same guy, the other untaxed guys become stronger and stronger and your ability to tax them reduces further i.e., slow poisoning of the nation. Not the state, state is a club of men who govern, they get their due share from every Tom and Harry; but the nation that gets even poorer.”

Others have complained how can the government differentiate between those reserves which are to be used for dividends and those that are to be used for working capital and capital expenditure. Such taxes hinder firms’ ability to expand, and they must borrow at prevailing high interest rates to finance working capital. However, the public sector perhaps believes that if the government borrows at 20 percent+ why cannot the private sector? This reflects a complete lack of understanding that the government is passing on the burden to the public and keeps on borrowing without bringing any efficiency in its spending. The private sector is a different animal.

The tax has triggered a panic among big companies. One of the owners of a big textile firm (who is operating from Dubai these days) decided to call a meeting of shareholders to increase the authorized capital of the firm to lower the undistributed reserves through offering bonus shares. Many others may also follow suit. There is a hefty fee of Rs130 million for doing so. Seths are ready to spend this money to avoid the tax.

Then there is another tax- MAT. This is to be an extension of existing capital value tax (CVT) which is currently levied on foreign assets. In this case, any domestic individual would pay a minimum tax on movable and immovable assets where the asset value exceeds Rs100 million. This shall be adjustable against domestic income. This is akin to wealth tax and regressive in nature. And if companies avoid tax on undistributed income, they will come under the ambit of this tax.

The message for the organized tax-paying sector is that they are – for the lack of a better term - suckers for being formal and organized. Message is to move further towards informality. And that has been happening since 2015-16 when the then finance minister Dar (who is at the helm today as well) imposed tax on banking transactions and expanded the withholding tax regime where the formal sector becomes responsible for collecting taxes for suppliers and other informal players in the value chain.

One indicator of informality is cash in circulation. This used to be 30 percent of bank deposits in 2015 and now it is close to 45 percent of bank deposits. This is going to increase further. And now foreign currency cash circulation is increasing as well. There are other measures in parallel which are increasing informality – for example, the imports restrictions from official payment channels while opening a route to pay for imports through informal (hundi/hawala) channel. This has pushed the formal businesses to the back-foot while smaller and informal players are exploiting the opportunity.

In the end these measures intentionally or unintentionally kill the formal documented sector. So much for reform!

Copyright Business Recorder, 2023