Import compression and taxation

The one big challenge faced by the finance ministry is how to keep tax revenues pace intact while reducing the imports. The reliance of taxation has increasingly titled towards import – 43 percent of FBR taxes collected at imported stage in FY18 versus 39 percent in FY13.
Not only the proportion of taxation at imported stage has increased in the last regime, but imports picked up a decent pace too. Now the government has a clear strategy of compressing imports to reduce the current account deficit, and rightly so. Concurrently, it needs to jack up tax revenues to lower the fiscal deficit.

The paradox is how to do away with the twin deficit problem amid the current high import dependent taxation collection. In FY13, the total import bill was $40.1 billion, which at average rupee dollar parity of 96.8 translated into Rs3.9 trillion - at this point imported stage tax was 20 percent of import bill. In FY18, the imports increased to $56.0 billion (Rs6.2 trillion at Rs110.04/USD), while the tax collection at imported stage jumped to 27 percent of import bill.

The economic growth during FY13-18 was based on domestic demand met by imports and domestic production where raw material and intermediate goods were imported. On the flipside, export in dollar value remained flat and declined substantially in terms of GDP. Thus, the good performance of FBR was hinged on hike in imports.

Dar and company used tariffs, sales tax and advance withholding tax at imported stage primarily as a tool for revenue generation, and in the process the trade balance worsened. Now the new economic management - Asad and Razzaq, are eying on using tariff as a trade tool rather than a revenue instrument to improve the trade balance by compressing imports, enhancing exports and having import substitution.

That is the right way to go in the medium to long term, but in the process, FBR revenues might decline in the short to medium term. The policy challenge here is maintaining a delicate balance. In Dar's time, the tariff on an array of intermediate goods and raw material increased in a phased manner to lift FBR revenues at the cost of domestic economic competitiveness.

Now the government in medium term budgetary framework is working on a policy to reduce tariff and duties on raw material and intermediate goods, and lower the incidence of other taxes collected at imported stage. At the same point, the focus is also to cut imports, which is yielding results. In long term, such policies result in industrialisation where the taxation potential is higher than any other sector given the current tax structure.

In the short to medium term, innovation is required to plug the fiscal gap by introducing other taxation measures or by expanding tax base. In the current FBR structure, it's hard to do the latter. The best option for the government is to tax petroleum products in days of lower prices. However, the taxation is already high on petroleum products - incidence of tax on petroleum products increased to 23 percent in FY18 from 13 percent in FY13.

The catch is to move from GST to PL for petroleum and GIDC for gas, as both PL and GIDC are not part of the divisible pool and all the collection can be used by federal government to lower the fiscal deficit. The government is already doing it, and this conversion will probably be an integral part of the upcoming mini budget.