Several prominent federal ministers publicly stated that the taxation measures approved by parliament on 28 June were prior conditions of the International Monetary Fund’s (IMF’s) “successor” loan to the nine-month-long Stand-By Arrangement (SBA) whose last tranche was released in May.
Two prevailing factors strengthen this perception. One, Finance Minister Aurangzeb has consistently stated that the successor IMF loan is Plan A, there is no Plan B, and he expects programme approval this month, which implies negotiations are at an advanced stage.
And, two, given that the tax measures submitted to parliament by the finance minister on 10 June were less politically challenging than the amendments approved by parliament two and a half weeks later (which do not reflect the recommendations of the Senate Standing Committee on Finance and Revenue as those discussions centred on reducing and not raising the burden on the public) the blame can more easily be placed on the IMF’s prior conditions.
The question is whether the administration is using the Fund as a convenient scapegoat, given that the Fund staff typically refrain from challenging the government’s stance publicly, or is it in fact the case?
Two elements have been prevalent in our interactions with the Fund staff since staff level agreement was reached on 12 May 2019 on the Extended Fund Facility.
Firstly, the Fund displayed considerable rigidity in either revisiting or phasing out harsh up-front conditions (inclusive of periodically raising electricity and gas tariff to achieve full cost recovery in spite of a large per unit tax component, petroleum levy considered the lowest of all hanging fruit, a market based exchange rate and a primary surplus that led to massive increase in borrowing) due to the country’s long history of abandoning a Fund programme when the balance of payments position strengthened in the aftermath of a Fund loan.
And secondly, its corollary is equally applicable: the economic team leaders appointed since late 1990s (including caretakers) either had similar qualifications and work experience as the Fund staff so they failed to bring a domestic perspective to the table or were appointed purely on the basis of nepotism.
And while all donor programmes required engagement with officials in different sectors, yet in Pakistan, ministries are staffed with generalists and not sector experts, which explains the poor state of the power and gas sectors.
Finance ministers have been typically appointed on technocrat seats in the assemblies and their only constituent is the party leader with little understanding of basic economics, though highly sensitive to a rise in the prices of essentials.
This led to major design flaws in the Fund programmes for Pakistan exacerbated in the budget for 2024-25: (i) a zero focus on current expenditure curtailment, which was budgeted to rise by 21 percent this year; (ii) inability to end elite capture of budgetary allocations and revenue generation sources — the budget 2024-25 enhanced elite capture by raising salaries of civilian and military personnel by 20 to 25 percent at the taxpayers’ expense (while the 93 percent of the total labour force employed by the private sector has not received a raise for a number of years due to the ongoing economic impasse), granting exemptions to the officials on sale of property and allocating discretionary funds to parliamentarians; (iii) a high discount rate that has shrivelled growth; and (iv) administrative measures that have steadily eroded the value of the rupee domestically and vis a vis other currencies which accounts for 41 percent poverty levels in Pakistan today.
The incumbent Finance Minister during his 30 June interaction with the media conceded that the tax burden on the salaried class had gone up in the final budget adding inadequately that he could only “empathise and sympathise” and pledged that “the first opportunity we get we will provide relief to them.”
The incremental income tax rate increase for those earning above 600,000 rupees per annum will be as follows: (i) 600,000 to 1.2 million rupees or monthly income of 50,000 rupees to 100,000 rupees per month would witness a doubling of their tax rate – from 2.5 to 5 percent; (ii) 1.2 million to 2.2 million rupees per annum or more than 50,000 rupees per month to 183,000 rupees per month - 12.5 percent to 15 percent of the amount exceeding 1.2 million rupees; and (iii) the highest rate of 35 percent for those earning more than 6 million rupees per annum has not changed.
A comparison with Sri Lanka is relevant as the two countries successfully averted the threat of default by procuring an IMF loan — unlike Sri Lanka which suspended foreign loan repayments on 12 April 2022 Pakistan managed to get rollovers extended from friendly countries (a condition for the then ongoing IMF loan tranche release). Tax rates in Sri Lanka today start at 6 percent and go up to 30 percent, while in Bangladesh the highest rate is 25 percent and in India the highest rate is 25 percent.
A comparison however requires consideration of the prevailing inflation: In India Consumer Price Index last fiscal year was below 6 percent, in Sri Lanka it dropped from a high of 51.7 percent in January 2023 to 1.70 percent in June 2024.
In Pakistan, it registered at 23.41 percent July-June 2024 with a SPI of 27.52 percent. If the Fund insisted on the income tax upgrade on those with a salary of less than 200,000 rupees per month, then one is forced to conclude that it was a poor decision and the government team should have raised the issue of an inflation differential.
The budget 2024-25 continues heavier than ever reliance on consumption and import taxes.
A World Bank 2022 study titled “From Swimming in Sand to High and Sustainable Growth” argues that “distortions in the form of differences in direct tax rates tend to make it more profitable to invest in real estate relative to manufacturing or tradable services.
And because the size of the tradable sector tends to be associated with growth, this reduces growth potential. Within tradables, high import duties make it more profitable for firms to sell domestically rather than exporting. For example, in Pakistan, a 10 percent import duty on a given product increases profits of selling domestically relative to exporting by 40 percent on average.
Firms that decide to embark upon export-oriented manufacturing despite these adverse incentives face a further distortion: if they want to innovate, they miss out on export subsidies. It is 80 percent more likely for a potential exporter that decides to export a traditional product (e.g., apparel) to be eligible for an export subsidy, than for one that decides to innovate andexport a new product.
This is because export subsidy schemes target mostly well established, unsophisticated export products and can provide up to a 30 to 35 percent boost in profits. In agriculture, for example, subsidies and support prices for specific crops coupled with additional subsidies on key inputs (e.g., water) induce farmers to allocate land to sugarcane rather than diversifying into other crops that would fetch better prices internationally, or that embed less water. Talent is also misallocated because of distortions.“
There have been no structural changes in the budget, merely passing the buck onto the hapless electricity/gas and petrol consumers, salaried class and on a target for primary surplus which if past precedence is anything to go by may well lead to higher borrowings with a higher component of debt servicing raising the deficit to more than the budgeted unsustainable 6.9 percent with inflationary implications.
To conclude, the budget follows the pattern of previous budgets – raising current expenditure by 21 percent with major influential recipients refusing to voluntarily sacrifice their raised allocations while sources of revenue imply not only higher taxes on existing taxpayers but also enforcement targets that have never been realized in the past (and Pakistan is not an exception in this regard).
One would assume that failure to achieve revenue targets from the revenue projections (particularly through enforcement and digitization) would imply a detailed contingency plan agreed with the IMF where specific items would have to be taxed as targets are unmet.
Copyright Business Recorder, 2024