The upcoming 'mini-budget'

The Fin-ance Minister has announced that he will be presenting a 'Mini-Budget' on the 23rd of January, a few days away. In effect, this will be the third Budget presentation in a financial year and has probably never happened before. The process started in May 2018, when in its last days the PML (N) government presented the Budget for 2018-19 loaded with concessions as a pre-election ploy. This was followed in September 2018 by a (Revised) Budget for 2018-19. The salient feature of this version of Budget was a big cut of 28 percent in the size of the Federal PSDP. However, many of the tax concessions announced in the original Budget were retained.
What is the compulsion now for presenting a mini Budget in the seventh month of the financial year? Historically, the justification for presenting a mini Budget may be an exogenous shock. For example, a major natural disaster like an earthquake or flood necessitating emergency provisions for rehabilitation expenditure has to be financed by additional taxation measures. Alternatively, during a particular year an IMF Program may be negotiated based on a set of prior actions on the fiscal front through an additional Finance Bill.
The justification this time for presenting a mini-budget appears to be an adverse fiscal outcome in the first half of 2018-19 in relation to the targets in the (Revised) Budget. FBR revenue growth has been disappointing with low single-digit percentage increase as compared to the Budget estimate of growth in 2018-19 of over 14 percent. Further, current expenditure, especially on debt servicing and defense services, has shown high growth of close to 18 percent.
Consequently, the preliminary estimate of the consolidated fiscal deficit in the first six months is above Rs 1000 billion, equivalent to 2.6 percent of the GDP. The annual target is 5.1 percent of the GDP and in the first six months on average 38 percent of the annual deficit is incurred. This indicates that if the trends continue unabated then the annual deficit could approach 6.8 percent of the GDP in 2018-19. This would be even higher than the large deficit of 6.6 percent of the GDP in 2017-18 and much higher than the targeted deficit.
The impact of the substantially larger deficit would not only reflect poorly on the quality of economic management by the PTI in its first year but also lead to the intensification of inflationary pressures on the economy with concomitant large borrowings from the SBP. The devaluation by 32 percent of the rupee has already led to an upsurge in the rate of inflation.
Following the tide of protests by the business community on the adverse impact of measures taken by the new government to date and the prevailing overriding sense of uncertainty about short-run prospects for the economy, the Finance Minister has opted to change the stance on the need for a mini Budget. The justification is now being given that there was need for a new Finance Bill to incorporate tax incentives and other measures for promoting investment and exports.
Therefore, the big question is what will be the features of the 'Mini-Budget'? Here there is a big unknown. This relates to the status of negotiations with the IMF. Have the talks stalled because of unacceptably tough conditions specified by the Fund? This has been indicated by the Finance Minister in one of his most recent statements.
However, there is the finite probability that talks are proceeding and the 'Mini-Budget' is an effort to take steps in the nature of prior actions to bring the fiscal deficit down to the level agreed with the IMF. In this is indeed the case then the mini budget will focus more on taxation proposals to generate higher revenues. These steps will, of course, be cloaked as 'homegrown' in character.
The shortfall in FBR revenues is already Rs 170 billion or so in the first six months. If there are no efforts to mobilize more revenues then the actual revenues could be almost Rs 350 billion less than the target level by the end of June 2019. Fortunately, the precipitate fall in oil prices has enabled the announcement of the enhancement in the sales tax rates to the standard rate of 17 percent along with a big increase in the Petroleum Levy on motor spirit and HSD oil. If the low oil prices persist than additional revenues of Rs 130 billion could be generated in the next six months due to this move. The gap then would be down to Rs 220 billion or so.
What will be the strategy for mobilizing additional revenues? There is considerable on-going speculation on the likely moves. It has been suggested, for example, that the standard sales tax rate may be enhanced from 17 percent to 18 percent. The maximum import tariff, barring a few peaks, could also be raised to 25 percent or 30 percent from the present level of 20 percent in order to provide more protection to domestic industry and reduce imports. This will also create the fiscal space for reducing duties on intermediate goods and raw materials which are inputs into exports and thereby enhance competitiveness.
However, the biggest shortfall in the first six months is in the income tax. A rational response would be to focus on generating more revenues from this source. This will allay concerns that the PTI has relied too much on raising utility prices and jacking up indirect tax rates, as in the case of POL products.
There are a number of options with regard to development of direct taxes. First, there is a case for reducing the exemption limit on personal income tax. It was enhanced phenomenally from Rs 400,000 to Rs 1,200,000 in the original Budget and retained in the (Revised) Budget. At least temporarily it could be reduced to, say, Rs 800,000 and thereby minimize the substantial revenue loss. Second, the super-tax on companies could be replaced by an excess profits tax whereby if the return on equity exceeds 20 percent then the additional profit may be subject to 10 percentage points higher tax rate.
A major reform would be the use of the full fiscal powers available in Federal Legislative List-Part 1 of levy of a tax on the capital value of assets, not including immoveable property. Initially, this tax may be levied at the rate of 1 percent. Alternatively, in line with the high priority being attached to the construction of the Diamer-Bhasha and Mohmand Dams a special Water Resource Levy may be introduced on income tax payments at the rate of, say, 3 percent. The revenues collected could then be earmarked for financing the construction of the dams.
There is also a case for examining the Second and Third Schedules of the Income Tax Ordinance from the viewpoint of eliminating some of the exemptions and concessions. Also, the Finance Minister has indicated that promulgation henceforth of SROs would require Parliamentary approval. This is an appropriate step and is welcomed. A select Committee of the National Assembly may also be asked to 'clean up' the existing SROs, many of which involve significant revenue losses.
Overall, there exists a significant scope for broadening the tax bases. The 'Mini Budget' is an opportunity for developing, in particular, the income tax and enhancement in indirect taxes must be avoided to the extent possible. Apparently, the Planning Commission is engaged in an exercise of pruning the portfolio of projects in the Federal PSDP. This could lead to some rationalization of the size of the development program in the remaining months of 2018-19. Also, economy in operating costs should yield some savings.
There is indeed a strong case for promoting investment, both domestic and foreign. The initial depreciation allowance was reduced earlier from 50 percent to 25 percent. It should be brought back to 50 percent. Similarly, the tax credit for balancing, moderation and replacement may also be doubled. A special tax credit could be offered to banks for the increase annually in credit to agriculture, SMEs and housing.
There is a degree of anticipation, especially in the business community about the 'Mini-Budget'. Hopefully, it will end the prevailing uncertainty and stabilise the markets.
(The author is Professor Emeritus at BNU and former Federal Minister for Commerce, Planning and Finance)