Regressive taxes, neglected reforms

Pakistan’s reliance on bilateral, trilateral, and friendly countries to fulfill its financial requirements not only undermines its sovereignty, but also intensifies the hardships of its citizens.

Despite engaging in numerous International Monetary Fund (IMF) programmes, Pakistan has consistently failed to adhere to its agreed agenda with the lender of last resort across all initiatives.

Among the twenty-three IMF programmes we have pursued, a significant portion consists of Extended Fund Facility (EFF) programmes intended to aid nations facing severe challenges to meet balance-of-payment needs.

In addition, Pakistan has entered thirteen Standby Arrangements (SBAs) to receive short-term financial backing for policy adjustments.

Moreover, Pakistan has sought IMF assistance through the Extended Credit Facility (ECF) twice to address the prolonged balance of payment issues and implement economic strategies aimed at achieving sustainable macroeconomic stability, poverty reduction, and growth.

Criticism mounts over Pakistan’s ongoing political instability, where the roles of military establishment and the judiciary in executive affairs have led to further complications and challenges for good governance and long-term sustainable economic development.

Apart from the establishment’s role, the executive branch has also persistently failed to reform its governance and fiscal management systems, struggling to maintain fiscal discipline and establish adequate controls for transparency and accountability across all institutions, including the judiciary and military.

Similarly, the parliament has not significantly contributed to comprehensive legislation, instead often serving to endorse preferences of dictators by passing favorable laws. Recently, Defense Minister Khawaja Muhammad Asif disclosed how former military dictators manipulated the legislative process for their benefit.

The failure of our elected representatives to adhere and uphold constitution and their inability to initiate structural reforms brought us to the position that even in 2024, the country is still dependent on IMF to present its annual federal budget.

Over the last five years, our successive governments have struggled with IMF, starting with September 2018 mini-budget and imposition of around Rs. 730 billion in new taxes to write a letter of intent for the IMF’s EFF Program, approved on July 3, 2019, by the coalition government of Pakistan Tahreek-e-Insaf (PTI).

This pattern continued with additional taxes and raised duties on petroleum products, culminating in the sixth review of the IMF program. The final review by PTI government added Rs. 350 billion in taxes, amended the State Bank of Pakistan law to IMF’s specifications, and imposed a petroleum levy of Rs. 60.

Throughout this period, no agreed-upon conditions with IMF were met, and the government focused on extracting the maximum from public. The subsequent violations of the IMF agreement for political gains further exacerbated the hardships of common people.

Subsequently, the coalition government of Pakistan Democratic Alliance (PDM) continued the same path, implementing heavy taxation, import bans, higher policy rates, and currency devaluation. These measures contracted economic growth, spiked inflation, and weakened the small and medium enterprises (SMEs).

During the Ninth IMF Review, Pakistan’s economic team, led by four-time federal finance minster, Muhammad Ishaq Dar, devalued the currency to a historic low, raised the policy rate to 22 percent, and imposed additional taxes.

Despite adhering to IMF terms and completing the staff review, the international lender did not issue a staff-level agreement. The IMF repeatedly demanded further actions from Pakistan until the program lapsed prematurely without releasing the remaining funds.

Following the lapse of IMF’s EFF programme, Pakistan opted for US$3 billion 9-month Standby Arrangement, in July 2023, which was successfully completed. The final IMF Report No. 24/105, released in May 2024, revealed overestimation on its part regarding current account deficit and external borrowing requirements.

During the IMF US$ 6-billion 36-month EFF, approved in July 2019, the inability of our rulers to enforce financial discipline at domestic level became evident. They focused on securing more and more loans at high borrowing costs, which stifled growth, augmented fiscal deficit, ultimately reducing the purchasing power of the common man, and restricting the space for small and medium enterprises, which are considered as the backbone of our economy.

Instead of implementing structural reforms to maximize revenue from available resources, the government relied heavily on IMF bailouts and local borrowings. The recent budget for FY 2024-25 testifies to inability of our political leaders, those running Special Investment Facilitation Council (SIFC), and so-called technocratic (sic) economic managers to think out-of-box solutions and address fundamental issues.

The National Assembly approved the heavy-tax-laden budget for fiscal year (FY) 2024-25 on June 29, 2024, totaling Rs. 18.877 trillion. Despite amendments to the original proposal presented by Federal Minister for Finance & Revenue, Senator Muhammad Aurangzeb, on June 12, 2024, the budget reveals a deficit of Rs. 8.5 trillion, undoubtedly detrimental to economic expansion and detrimental to low-income groups.

The key changes include in the Finance Act 2024 is an increase in petrol and diesel levy from Rs. 60 to Rs. 70 per litre, alongside new levies on light diesel oil, kerosene, and high-octane fuel. These adjustments are expected to escalate transport expenses, thus raising prices for goods and services, further straining disadvantaged communities.

Tax incentives for hybrid vehicles remain in place until June 30, 2026. Cars with engine capacities up to 1800cc will face an 8.5% tax, while those between 1801-2500cc will be taxed at 12.75%. This policy favors affluent vehicle owners, contrasting starkly with the challenges faced by the underprivileged reliant on insufficient public transport.

Federal Excise Duty (FED) on cement has risen from Rs. 3 to Rs. 4 per kg, likely elevating construction costs and exacerbating housing affordability issues among low-income groups, thereby impacting a pivotal economic sector.

Extension of sales tax benefits for the erstwhile federally and provincially administered areas (FATA/PATA), while beneficial locally, perpetuates an uneven tax reform, adding strain to other regions without effectively addressing broader economic disparities.

Exporters must now pay the standard corporate tax rate of 29%, plus any applicable super tax, replacing the previous 1% tax based on export turnover. This change may diminish the competitiveness of Pakistani exports, possibly resulting in job losses and economic downturns.

A 10% surcharge on individuals or associations earning over Rs. 10 million annually aims to target the wealthy, but could also deter high earners from further investing in the economy, potentially reducing economic activity.

The Finance Act 2024 introduces significant additional changes, including a 15% capital gains tax on securities redemptions, likely deterring stock market investments and thus reducing capital flow and economic growth.

A 15-20% tax on contractors and developers might curb profitability and slow development projects in the construction industry. Moreover, clarifications regarding non-resident business income based on significant economic presence in Pakistan could discourage foreign investments, further impeding economic growth.

IMF’s latest diagnostic of Pakistan’s tax system in their Technical Assistance Report, ‘Pakistan Tax Policy Diagnostic and Reforms Options’, published in February 2024, revealed significant deficiencies in revenue generation, efficiency, equity, fairness, and sustainability. These challenges are exacerbated by a sizeable informal economy and a prominent agricultural sector.

Despite earlier efforts such as rationalizing expenditures and adjusting tax rates, Pakistan’s revenue remained stagnant at 10-11% of GDP between FY 2019 and FY 2023. Looking ahead, reforms are designed to achieve a 2% GDP revenue increase by the FY 2026 through streamlined expenditures and targeted incentives aligned with economic benefits.

The key policy reforms include introduction of a unified tax administration law incorporating anti-avoidance measures, reduction of most income tax incentives to only those legally required or with clear policy benefits, and simplifying tax brackets.

Recommendations also emphasize rationalization of sales tax rates, elimination of exemptions, and implementation of a single turnover-based registration threshold. Excise reforms aim to standardize rates across products like cigarettes and e-cigarettes while enhancing control measures against smuggling.

Establishing a dedicated Tax Policy Unit within the Ministry of Finance promises improved policy analysis and decision-making capabilities crucial for advancing Pakistan’s fiscal reform agenda.

These reforms are expected to streamline tax administration, broaden the tax base, and ensure fairer and more efficient taxation across Pakistan’s economy.

These scribes in these columns, various articles, and books have suggested similar reforms. However, instead of reforming the tax system, the government remained focused on piling up debts and imposing regressive taxes.

The positive impacts of these reforms, if implemented in true essence are multifaceted involving anticipated enhancement in revenue generation, thereby reducing fiscal deficits and national debt levels. By simplifying the tax system and eliminating loopholes, these reforms aim to lower compliance costs for taxpayers and tax administration, potentially reducing inflationary pressures.

Moreover, a more efficient and equitable tax regime could foster sustainable economic growth by attracting investments, creating jobs, and supporting long-term development initiatives.

Copyright Business Recorder, 2024