Slow growth in FBR revenues

FBR put in a stellar performance in 2015-16. The target for the year was more than achieved. The growth rate was over 20%, the highest since 2011-12. In one year, the tax-to-GDP ratio was raised by one percentage point. The only disappointment, if any, was somewhat slower growth in direct tax revenues. Consequently, the share of income tax in FBR revenues fell from 40% to 38%.
Based on this performance, a moderately ambitious target has been set for 2016-17 of 16% growth. In particular, direct tax revenue is projected to grow by a handsome 31%. This will raise the share of income tax to 43% and contribute to making the tax system significantly more progressive.
A number of taxation proposals have been included in the Budget of 2016-17, to facilitate achievement of the revenue target. The potentially biggest move is the levy of a capital gains tax at the rate of 10% on properties sold within five years of acquisition, based on substantially enhanced valuations.
Other steps include continuation of the super tax, broadening of the coverage of the 1% minimum income tax and imposition of a final tax on rents and builders and developers. In indirect taxes, the excise duty on cement, cigarettes and aerated waters has been enhanced while the flat sales tax on mobile phones has been increased. Customs duties have been rationalised by reduction in number of slabs to four, with the highest rate down to 20%.
Unfortunately, the outcome up to now in 2016-17 has been completely contrary to expectations. In the first quarter, the overall growth rate in FBR revenues is only 4%. Two of the largest taxes, viz., income tax and sales tax, have actually shown negative growth. Initial estimates for the first five months indicate a growth rate of 3%.
What explains the loss of momentum by FBR? There are numerous reasons for this apparent debacle. First, it appears that one of the fundamental reasons for the spectacular growth in sales tax revenues in 2015-16 was the large scale escalation of tax rates on POL products, especially motor spirit and HSD oil. For example, in the case of the latter product the tax rate was raised to a peak of 51%, three rimes the standard rate. However, since April 2016, the price of petroleum products has been left unchanged, despite some increase in import prices. By November, the sales tax rate per liter of HSD oil and motor spirit was down by almost 40% in comparison to the peak rate, implying a loss in revenue of almost Rs 45 billion in the first five months. The Government has clearly opted to insulate the consumer from a further hike in POL prices, although there has been a modest 3 to 4% increase from the 1st of December.
Today, the price of motor spirit in Pakistan is lowest among the eight South Asian countries. For example, it is 30% lower than the corresponding price in India. The sales tax rate for motor spirit has now been set at 14.5%, compared to peak rate of 20% in September 2016. There is a case for raising this rate to back the standard GST rate of 17%.
Second, there is evidence that a significant quantum of advance tax was taken in the last quarter of 2015-16, to enable achievement of the annual target. The growth rate of income tax revenue in the fourth quarter was over 21%, as compared to 13% in the previous three quarters. Consequently, this has implied a reduction in the growth rate in the first quarter. In fact, FBR has tried to justify its poor performance on the basis of a lower growth rate generally in the first quarter. This is not factually correct. In the three previous years, 2012-13 to 2014-15, the growth rate of FBR revenues in the first quarter was higher than for the year as a whole.
The third reason for the slow growth of revenues up to November 2016 is that FBR has undertaken finally to at least partially clear the backlog of due refunds, thereby implying somewhat lower net revenues. This process is likely to continue for the rest of the year if the liquidity position, in particular, of exporters is to be improved substantially, thereby facilitating exports. In addition, the zero rating of imported inputs into six export sectors has also implied some revenue loss.
Beyond the above reasons for slow revenue growth, there is the reality of slow growth currently in various tax bases. According to PBS, net of the impact of SROs, the growth in the rupee value of imports is only 4% up to October 2016. In fact, POL imports have shown no growth. Last year, iron and steel imports yielded substantial additional revenue from the customs duty plus regulatory duty. Currently, there is negative 2% growth in import of iron and steel products.
Turning to domestic taxes, the large-scale manufacturing sector has lost buoyancy, with growth in value added at current prices of less than 6%. In fact, cigarettes production, the largest source of revenue in excise duties, is down by as much as 43%. Similarly, last year the production of cars increased by 46%, but the output this year, up to October, has fallen by 3%.
There is similar story with regard to withholding taxes in income tax. Revenues are not growing fast because of low rates of return on financial assets, decline in exports, slow implementation of construction activities in the federal PSDP and lack of growth from the presumptive income tax on imports. Overall, the slowing down of the growth process in key areas of various tax bases is restricting the increase in FBR revenues.
Based on the above analyses, what is the projection of FBR revenues for 2016-17? The 'mega' taxation proposal of capital gains tax on property has effectively been abandoned and instead an amnesty scheme has been offered. Overall, a relatively low single digit growth rate is likely in FBR revenues in 2016-17.
The overall shortfall in relation to the target could exceed Rs 250 billion. This will mean that the tax-to-GDP ratio will fall by over 0.3 percentage point from the peak attained last year. Along with the short fall in non-tax revenues, the fiscal deficit in 2016-17 could be higher by almost Rs 450 billion and reach 5% of the GDP, somewhat higher than last year and substantially above the target deficit of 3.8% of the GDP.
The basic question is what the government may wish to do given the prospects of an adverse outcome of fiscal operations in 2016-17. There would have been a strong pressure for a mini-budget if the IMF programme had been operative. The government may be unwilling at this time, given the political environment, to raise taxes.
However, at the minimum, it should consider some action on the direct tax front, including broad-basing of the super tax to large individual tax payers, higher taxation of perquisites, better coverage of companies and AOPs and 1% shares transaction tax on the stock market.
Otherwise, given that the increase in fiscal deficit is also being disproportionately financed currently by higher borrowing from SBP, there is likelihood that the inflation could reach a high single-digit rate by June 2017, especially given the recent jump in oil prices.
(The writer is Professor Emeritus and a former Federal Minister)