A high-powered World Bank team, which recently visited Pakistan, has advised the government to substantially increase the tax on CNG and LPG and discard its policy of cross-subsidising one kind of fuel at the cost of others.
The rationale of the advice dispensed by the World Bank team, according to a Recorder Report, is that incentives provided to CNG and LPG are likely to result in a steep decline in the government's revenue receipts, which can generate serious problems for it in the future. Being a commonly used fuel for private vehicles, gasoline in Pakistan is being heavily taxed. However, in recent years CNG, which costs only 40 percent of the price of gasoline, has understandably captured a substantial market share, and over one million out of about five million light vehicles are now using this cheaper fuel.
The World Bank views this as a major source of distortion in petroleum products' prices. The Bank team has also voiced concern over marginally less taxation on LPG, the price of which is 80 percent of that of gasoline. Such pricing distortions would not only hit the government's fiscal receipts, but also the income and profit margin of the refining industry.
A Bank study acknowledges that the levy of 5-10 percent import duty on refineries is forcing the consumers to pay correspondingly higher rates for the petroleum products. The government is doing this apparently to protect the old and depreciated refineries, which already enjoy hefty tax concessions and other incentives. The prices of most of the petroleum products have meanwhile been equalised all over the country through freight equalisation margin, applicable to 29 main depots. The fund is administered by the industry on behalf of the government, while the cartage rates are fixed by the government in a policy that is questionable from an economic perspective.
The distortions which the World Bank delegation has pointed out are a direct result of the flawed system of cross-subsidies the government has adopted to achieve some social or other objectives. Independent experts believe that the policy of providing cross-subsidies is defective on many counts, because these make an adverse impact on the fiscal performance of the government in its expenditure and taxation functions. Viewed in the larger economic perspective, if the expenditure on a subsidy is financed through increased borrowing, there will be upward pressure on inflation, real interest and exchange rates in the economy, with negative implications for investment, trade and capital flows. Further, the borrowed funds will have to be eventually repaid through higher taxes in the longer-term perspective.
However, if taxes are raised to finance the subsidy (for instance, income tax, consumption tax and import duties) the production, employment and competitiveness of the economy will be adversely impacted. According to economists, a subsidy is created when, as a result of public policy, the price paid by the consumer is lower than what it would otherwise have been in the absence of policy. In fact, a subsidy is a negative tax in that there is payment from the government to the citizen, rather than the other way around. When prices depart from the domestic cost of production as a result of subsidies, economic distortions occur.
The World Bank's call to the government to tax CNG and LPG more heavily is primarily meant to bring the rates of these fuels reasonably close to the gasoline prices on thermal value basis. This will relieve market pressure on both CNG and LPG. The best way out of the dilemma lies in fixing the price per btu price for all types of fuels. This will not only bring about greater uniformity in the pricing mechanism, but it will also ease out the distortions that have crept into the petroleum products' prices.