FBR revenue shortfall

The shortfall in FBR revenues is likely to reach a record level this year. The magnitude of this shortfall will be the prime determinant of the extent to which the primary deficit in the budget diverges from the target level agreed with the IMF for 2019-20 as part of the Extended Fund Facility. Therefore, it is not surprising that this has been the major source of concern and discussion during the two IMF staff missions that have taken place.

A number of questions arise with regard to the size of the shortfall in FBR revenues. Was the target unrealistic and far too ambitious? Have there been some unforeseen events which have impacted on revenues? What is the outlook for revenues in the second half of 2019-20? What is the likely magnitude of the shortfall for the year?

The Budget presented for 2019-20 indicated that FBR revenues were expected to reach Rs 5,555 billion. The revised estimate of FBR revenues for 2018-19 was taken as Rs 4,150 billion. The Finance Bill contained a large number of taxation proposals either in the form of withdrawal of exemptions or enhancement in tax rates. According to estimates by the IMF staff these were expected to yield 1.7 percent of the GDP, equivalent to Rs 756 billion. This quantum of additional taxation had never been introduced before.

The IMF staff report of July 2019 estimated FBR revenues in 2019-20 at a somewhat lower level of Rs 5,503 billion. The basis for arriving at this magnitude was presumably as follows:

(i) The GDP was projected to increase in real terms in 2019-20 by 2.4 percent. The rate of inflation was also projected at 13 percent. This implied that the increase in the nominal GDP will be 15.7 percent. On the assumption that the normal growth in FBR revenues, in the absence of any change in the tax system, has a one-to-one relationship with GDP growth, FBR revenues were expected to rise to Rs 4,800 billion.

(ii) Additional revenues of Rs 756 billion were anticipated from the implementation of taxation proposals.

Therefore, combining the normal increase with revenues from taxation proposals, FBR revenues were expected to reach Rs 5,556 billion in 2019-20. This explains the approach probably adopted by the Ministry of Finance for fixing the FBR revenue target for 2019-20. This was, no doubt, ambitious with growth rate of almost 34 percent on the base year revenues in 2018-19 of Rs 4,150 billion.

Unfortunately, this approach to setting the target was seriously flawed for a number of reasons. First, the base year figure of Rs 4,150 billion was exaggerated. It turned out to be Rs 3828 billion, lower by Rs 322 billion. Further, there was a once-for-all increase in revenues of Rs 65 billion due to the Tax Amnesty Scheme. As such, the true base figure for projection to 2019-20 was actually Rs 3,763 billion.

Second, FBR revenues not only depend on the overall GDP but also on the level of imports. In fact, almost 46 percent of the tax revenues are linked to imports. This includes the customs duty, sales tax on imports and the presumptive income tax on imports. The year 2019-20 was likely to witness a very strong attempt at stabilization through currency depreciation and other policy instruments. As such, the level of imports in dollar terms was likely to be lower by over 10 percent in relation to the level in 2018-19. With currency depreciation, the rupee value of imports was expected to show some positive growth but only at a low single digit rate.

Therefore, combining the growth of tax bases of the nominal GDP and rupee value of imports, the normal growth of FBR revenues was unlikely to exceed 10 percent in 2019-20. As such, in the absence of taxation proposals, FBR revenues could reach Rs 4139 billion in 2019-20.

Third, the estimate of Rs 756 billion as the quantum of additional revenues generated from taxation proposals was based on the flawed assumption that the respective tax bases would not be reduced by the imposition of higher taxes on them. As such, the more likely yield from the many taxation proposals was in the range of Rs 550 billion.

Therefore, a more realistic target for FBR revenues in 2019-20 was Rs 4,189 billion plus Rs 550 billion, equivalent to Rs 4,689 billion or approximately 4700 billion. This implies a still high growth rate over the actual revenues in 2018-19 of 23 percent. This is even higher than the highest growth rate ever achieved by FBR of 21 percent. However, it is achievable given improvements in the quality of tax administration by FBR and faithful implementation of the envisaged tax reforms.

The FBR revenues as of the end of December 2019 were Rs 2,093 billion, demonstrating a growth rate of 16.6 percent. Meanwhile, the IMF revised downwards the target from Rs 5,503 billion to Rs 5,238 billion, probably in light of the overstatement of the base year revenues. Accordingly, the six-monthly target was brought down to Rs 2198 billion. As such, the actual shortfall in first six months is Rs 105 billion.

FBR has argued that the shortfall is due, first, to the economic slowdown. But a big decline in the GDP growth rate was already anticipated at the time of framing the budget for 2019-20. Also, FBR has focused on the unprecedented decline in the dollar value of imports of 17 percent. But the rupee value has still increased due to the currency depreciation, albeit by only 1 percent. This is lower than the growth originally anticipated and implies lower revenues by almost Rs 75 billion.

Moreover, there have also been a number of favourable factors. First, even though the level of consumption of POL products has declined this has been more than compensated for by the big increases of 16 percent in the price of HSD oil and 18 percent in motor spirit. Second, the withholding tax on telecommunications has been restored. Third, auto sales have declined in volume terms but prices have risen sharply leading only to a small decline in the rupee value of sales. Fourth, the big hike in interest rates has led to higher revenues from the presumptive tax on interest income. Also, the deduction at source of payment of interest to commercial banks has increased because of the substantially higher borrowing by the Government from the banking system. Fifth, the income tax on contracts should have yielded higher revenues due to the 39 percent increased PSDP expenditure on projects. Sixth, the PIT on exports is yielding somewhat more revenue because of the higher rupee value of exports.

Overall, the unfavourable factors highlighted by the FBR ought to have been, more or less, compensated by the favourable factors. As such, efforts must be made to achieve higher growth in FBR revenues in the second half of 2019-20. Of course, achieving the IMF figure of 5,238 billion is not possible as it will require a growth rate of over 54 percent from January to June 2020.

However, efforts must be made to achieve the more realistic target of Rs 4,700 billion, derived above. This will require a still somewhat ambitious but achievable growth rate of 23 percent. Also, with the big fall in petroleum prices part of the benefit could be passed on to consumers and part captured in the form of a higher sales tax rate yielding thereby significant additional revenues.

The bottom line is that if the revised target of Rs 4,700 billion is reached, there will still be a shortfall of Rs 538 billion in relation to the revised target set by the IMF. This will lead to an additional primary deficit of up to 1.2 percent of the GDP depending on the magnitude of expenditure cuts. Given the low growth in the tax bases, especially of imports, this should be considered as an acceptable deviation from the original target. Any effort at mobilizing additional revenues through a mini budget would impose an additional unbearable burden at a time when the people are already facing the ravages of high inflation and rising unemployment.

(The writer is Professor Emeritus at BNU and former Federal Minister)