Growth in tax revenues

Tax revenues have shown buoyancy in the first half of 2017-18. The overall growth rate in these revenues of the federal and provincial governments combined is 16 percent. During the corresponding period of 2016-17, the growth rate was substantially lower at only 6 percent. If this buoyancy continues then there will be a significant increase in the tax-to-GDP ratio this year.
The basic question is what explains this buoyancy in tax revenues? Is it due to heavy taxation proposals in the budget of 2017-18 or the result more of rapid expansion in tax bases? Has tax administration visibly improved, especially of the Federal Board of Revenue (FBR)?
There are some special features of the high growth in tax revenues. First, Provincial taxes have demonstrated more buoyancy with a growth rate of 21 percent, as compared to the increase in Federal tax revenues of 16 percent. In particular, the provincial sales tax on services continues to show rapid growth since its levy over five years ago. The efforts of the Sindh Revenue Board and the Punjab Revenue Authority must be recognized.
Second, the performance in the first quarter of 2017-18 was exceptional. National tax revenues showed a very high growth rate of over 21 percent. This growth rate has fallen sharply in the second quarter to below 13 percent. This does not auger well for the rest of the year.
Third, despite the high growth there is still a shortfall with respect to the budget estimates for 2017-18. Federal tax revenues were targeted to show growth of 19 percent. With the actual increase of 16 percent, there is potentially a shortfall of almost 84 billion. This could rise if there is no improvement over the performance in the second quarter.
Fourth, of particular concern is the fact that direct taxes of the federal and provincial governments combined have demonstrated a substantially lower growth rate of 15 percent as compared to 20 percent in the case of indirect taxes. This continues to have negative implications on the regressivity of the tax burden in Pakistan.
Fifth, FBR is by far the major contributor to tax revenues in the country with a share of 84 percent. As such, the dynamism in revenues is largely due to enhanced collection by FBR. The performance is very close to target. FBR was expected to show an increase of 19 percent in 2017-18. In the first eight months of the year, it has managed to raise revenues by almost 18 percent. Here again, the efforts of the management team in FBR should be appreciated.
However, there is a need to analyze the sources of growth in tax revenues. Among the four taxes of FBR, the fastest growth from July to December 2017 has been shown by customs duty of almost 30 percent. Sales tax revenues have also exhibited buoyancy with a growth rate approaching 20 percent. Income tax revenues have increased by 15 percent. There has actually been a decline in revenues from excise duty of 3 percent.
Why has customs duty, which has historically been a declining source of revenue, shown such fast growth? The answer lies in the, more or less, unprecedented growth in the relevant tax base combined with some enhancement in the tax rates. Imports have increased in rupee terms by as much as 21 percent. The largest source of revenue in customs duty and the sales tax on imports is from crude oil and petroleum products. These imports have increased by as much as 38 percent.
Therefore, while the burgeoning of imports has led to a record level of current account deficit in the balance of payments, thereby implying a fall in reserves with SBP, they have contributed to higher revenues and a lower fiscal deficit. It is interesting to note that they have also implied more income tax revenues. The presumptive income tax on importers is one of the largest contributors to direct tax revenues.
Coupled with the rapid expansion in the tax base is the enhancement in the tax rates. Regulatory duties, ranging from 2 percent to 80 percent, were levied on 731 import items in October 2017. On top of this, the rupee was devalued by 5 percent in December 2017, leading to a further increase in the tax base.
Therefore, the explanation for the buoyancy in tax revenues lies more in rapid growth of tax bases and higher tax rates. An indicator of improved tax administration would have been somewhat faster growth in direct tax revenues on the back of more filing or returns and stronger detection of tax evasion. Apparently, the number of persons filing income tax returns has actually declined by 9 percent in 2017. This stands in sharp contrast to India which has an economy eight times the size of Pakistan but almost 28 times as many tax return filers.
What is the outlook for tax revenues for the remainder of 2017-18? 46 percent of the target level of FBR still remains to be collected. There is a risk that the growth rate could decline due to a number of reasons. First, the continued imposition of regulatory duties has been brought into question by the recent judgment of the Sindh High Court.
Second, the growth rate of the large-scale manufacturing sector has fallen sharply from 10 percent in the first quarter to below 6 percent by December. If this continues then it is bound to affect the rate of increase in revenues from the domestic sales tax and excise duty.
Third, import duties showed a remarkable upsurge in revenues of 47 percent in the last quarter of 2016-17. Consequently, there may be a 'high base effect' and revenues from imports may not show the same growth as in the first three quarters.
Fourth, there is a major change taking place in the fuel mix of electricity generation. Furnace oil is being replaced increasingly by LNG. The tax rates of import duty and sales tax are substantially lower on LNG. Consequently, this may result in a significant revenue loss.
Further, in an effort to control the trade deficit the coming weeks may witness more measures to curb imports like an expansion in the coverage of case margins on imports and more non-tariff barriers.
Overall, the first half of 2017-18 has witnessed an upsurge of tax revenues, on the back especially of rising imports. However, the tax agencies will have to make a more intensive effort to sustain this growth in the second half of the year.
(The writer is Professor Emeritus at BNU and former Federal Minister)