Fall in revenues

The unprecedented has happened. National revenues, tax plus non-tax, of the Federal and provincial governments combined have actually fallen. They stand at Rs 2335 billion in the first six months of the current financial year. This is a fall of Rs 56 billion in relation to revenues in the corresponding period of last year. During the last eighteen years this has never happened before. Every year, since 2001-02, there has been some absolute increase in revenues in the first six months of a year even if the growth rate was small.
The fundamental questions are why have national revenues actually fallen in absolute terms in the first half of 2018-19? Is this decline limited to a few sources of revenue or is there a, more or less, across the board tapering off of revenues? Is this due to underlying structural factors or the consequence of widespread tax breaks or lower user charges? And, what is the outlook for the remaining six months of 2018-19?
The big decline is in overall non-tax revenues of 31 percent. These revenues contributed 15 percent to national revenues in 2017-18. Their fall is so large that the modest growth of 3 percent in tax revenues has not been able to cover the fall in non-tax revenues. There is a need, therefore, to analyze first the extremely poor performance of non-tax revenues. They have fallen both at the Federal and Provincial levels by 25 and 55 percent respectively. These revenues have, in fact, been witnessing a downward trend in recent years as a percentage of the GDP. This is attributable, first, to the end of inflows from the Coalition Support Fund and by the absence of receipts from any major privatization.
The largest source of federal non-tax revenues is the profit of the SBP, which is owned by the Federal Government as it is the Central Bank. Last year, in the first six months, this source contributed over 40 percent to Federal non-tax revenues. However, revenues from this source have now plummeted by almost 50 percent. This probably comes as a surprise as there has been a record level of borrowing by the Federal Government from the SBP. This had risen to almost Rs 1257 billion by the end of December 2018. Consequently, the interest income of SBP should have gone up substantially and reverted subsequently to the Federal Government as profit. Apparently, there have been large losses to the Central Bank due to the large rupee devaluation which has raised the rupee value of the external liabilities in the form of deposits, swap funds, etc. This has reduced the net profit of SBP resulting in a lower transfer to the Federal Government. Further, the assets of SBP have been depleted by the fall in reserves.
The other revenue sources in non-tax revenues which have shown big declines are mark-up on loans extended by the federal government to provincial governments and PSEs and revenues from other sources. The huge losses of the latter have rendered them in capable of honoring their debt servicing obligations. Others sources consist of receipts from sale of government assets, UN peace keeping income, etc. The decline of 61 percent in revenues from this head is unexpected since in its economy drive the new Government had auctioned off a large number of surplus vehicles and other items.
Provincial non-tax revenues consist mainly of revenues from user charges, tolls on highways, the canal water rate (abiana) and so on. They have not been levied at the required rates for full cost recovery and in recent months there has probably been some breakdown in the collection process.
Turning to the pre-dominant source of revenue, that is, tax revenues, the major source of concern is the only 2 percent growth in Federal tax revenues as compared to 7 percent in Provincial tax revenues. Federal taxes account for 91 percent of national tax revenues. The low 2 percent growth in federal tax revenues is due to very low rate of increase or even a decline in revenues from four out of the seven taxes. Therefore, this is likely to be a reflection of a general slowdown in the economy, especially in the two major tax bases of large-scale manufacturing sector and the quantum of imports, although the rupee value of imports has gone up significantly due to the devaluation.
The real concern is with the performance of the income tax which has shown no growth in revenue. There has been, first, a sizeable revenue loss due to the tripling of the personal income tax exemption limit. Second, a major source of revenue is the withholding tax on contracts. The large decline in development spending by both the federal and provincial governments has probably reduced the flow of revenue from this source. Third, the presumptive income tax on mobile phone cards has run into serious legal problems. These negative developments have taken away the growth momentum from the income tax.
The surprise is the near zero growth in sales tax, the largest source of FBR revenues. The sales tax, levied on the duty paid value of imports, should have shown handsome growth given the over 19 percent growth in the rupee value of imports. This is the case with import duty which has demonstrated an almost equivalent increase in revenues.
The problem is probably with the domestic component of the sales tax. First, the value added component in prices of many locally manufactured goods may have been reduced by a disproportionate increase in the cost of imported inputs and the hike in utility tariffs. Second, the decline in industrial production has implied that the tax base has shrunk.
Excise duty, now the smallest FBR tax, has shown double-digit growth. This is a reflection of the increase in tax rate on cigarettes. Revenues from the Petroleum Levy have fallen by almost 13 percent. This is in the nature of a fixed tax per liter on petroleum products, especially HSD and motor spirit. The consumption of these products has also shown a decline in the face of the general economic slowdown.
Gas-related taxes have begun to yield much loss revenues than in previous years. There was a time when the Gas Infrastructure Development Cess used to yield annually revenues of up to Rs 80 billion. It has been limited greatly by legal problems due to the lack of earmarking of revenues for construction of pipelines as per the GIDC Ordinance of 2014. The government has offered a settlement of outstanding dues in the mini-budget. It remains to be seen if the major tax payers will respond or not.
Provincial tax revenues have also seen single-digit growth. This is in contrast to the over 20 percent growth annually during the last five years. This was greatly facilitated by the phenomenal increase in revenue from the sales tax on services. But even this revenue source has slowed down with zero growth in the first half of 2018-19. Here again, there may have been some transitional problems with the change in Government, especially in Punjab. Alternatively, even the service sectors have probably also slowed down.
Overall, the decline in national revenues combined from both taxes and non-taxes of the Federal and Provincial Governments is a major new structural problem that the PTI Government is now confronted with. There is a real risk that the year 2018-19 will close with a decline in the revenue-to-GDP ratio from 15.2 percent in 2017-18 to below 14 percent of the GDP in 2018-19. This will be the dominant factor in the quantum jump in the size of the fiscal deficit. Perhaps the biggest challenge to the MOF is identification and legislative enactment of wide-ranging reforms for restoring the buoyancy of revenues.
(The writer is Professor Emeritus at BNU and former Federal Minister)