Fiscal Measures

The fundamental question is how can the wide-ranging negative impact of the huge additional tax burden be managed, to reduce the adverse impacts on the economy?

Dr. Hafiz A. Pasha

The Federal budget of 2024-25 has targeted for the biggest increase ever in the incidence of taxes. FBR revenues are expected to rise from Rs 9252 billion in 2023-24 to Rs 12,970 billion in 2024-25, with a growth rate of over 40%. The other tax, petroleum levy, has been classified as a non-tax revenue by the Ministry of Finance. However, some years ago it was treated as a tax. IMF still classifies it as a tax. Revenue from this source is expected to also show a big increase of over 33% in 2024-25.

Overall, total tax revenues of the Federal government have been budgeted to increase from Rs 10,212 billion to 14,251 billion in 2024-25, with a very high growth rate of 39%.

The economy is expected to increase in nominal terms by 17%. Consequently, the tax-to-GDP ratio is targeted to rise from 9.6% of the GDP to 11.4% of the GDP in one year. Such a big increase in the tax-to-GDP ratio has never been achieved before.

In fact, the tax-to-GDP ratio of Pakistan has been falling the last five years. Therefore, in the absence of any new taxation measures in the Federal budget, the tax-to-GDP ratio would have fallen further to 9.3% of the GDP. This implies that the plethora of taxation measures in the 2024-25 budget are expected to raise additional revenues of 2.3% of the GDP, equivalent to a very large amount of Rs 2,855 billion.

The fastest growth among Federal taxes of 48% is expected from the income tax. It is anticipated that the large number of taxation proposals in the income tax will fetch an additional Rs 1200 billion. The incidence is likely to fall across-the-board and, in particular, hit more the exporters, salaried income tax- payers, property owners, and number of withholding tax agents in different sectors.

The additional tax revenues to be generated from indirect taxes through the taxation proposals are Rs 1655 billion. Estimates are that sales tax proposals will generate additional revenues of over Rs 960 billion. Corresponding estimates are Rs 280 billion from the petroleum levy, Rs 300 billion from the excise duty and Rs 115 billion from the customs duty. These additional revenues should have been quantified by the FBR for each taxation proposal in the budget which it has not done.

The objective of the quantification here is to highlight the size of the increased tax burden on different sectors of the economy. This will negatively impact generally on the level of production and sales. Further, it will add significantly to the rate of inflation, especially along with the announcement of a big hike in power tariffs.

The fundamental question is how can the wide-ranging negative impact of the huge additional tax burden be managed, to reduce the adverse impacts on the economy?

We focus first on exporters, who are very much the lifeline today of the economy. If the extreme level of external financial vulnerability of Pakistan is to be reduced then exports will need to rise from the current level of just above   $30 billion to at almost $50 billion by 2026-27, with a cumulative growth of 66% over the next three years.

Unfortunately, exports have not been given the necessary level of support. There was a time when exporters were beneficiaries of various forms of incentives to facilitate and increase competitiveness. First, a subsidy was given on the power tariff. Second, domestic sales by exporters were zero-rated. Third, a concessionary interest rate was charged on export financing by the banks. Fourth, and to top it all, a fixed tax of 1% of the value of export sales was levied as the fixed and final presumptive income tax. Now all these incentives stand withdrawn.

Pakistan now will not be able promote exports through special incentives. However, Bangladesh, for example, continues to offer big incentives to exporters. These include provision of export subsidies, exemptions/ reduction in corporate income tax, reduced import taxes on machinery and raw materials, reduced VAT and various banking facilities. There is a special export subsidy up to a maximum of 10% of the value of sales.

Bangladesh is currently operating under an IMF program. The IMF has accepted all the above-mentioned measures to support exports in Bangladesh. Why is it engaging in discriminatory behaviour in Pakistan and compelling it to withdraw the export incentives?

Clearly, in the impending process of finalization of the next IMF Program, efforts should be made to convince the Fund that there is need to revert back from full income taxation to the scheme of fixed and final 1% of export sales as the presumptive income tax. Otherwise, there is also the risk that exporters may be compelled to under declare their sales.

The other less strong option is to provide a tax incentive for achieving higher growth in exports, so as also to prevent declaration of lower sales. This could be in the form of a 0.1% of export sales as the reduction in income tax liability for every 1% growth in sales. This will motivate exporters to increase their sales while simultaneously reducing the tax liabilities. The overall tax base will also expand as a result.

The other category of income tax payers who have been hit significantly are salaried income individuals. It is strange that as the consequence of changes in tax slabs and marginal tax rates there has been a regressive increase in the incidence of the personal income tax.

Calculations reveal that there is as much as a doubling of the tax payment for a salaried person earning Rs 100,000 per month. The increase for a person earning Rs 300,000 per month is 26%, while for a person earning Rs 500,000 per month it is 24%. Therefore, there is need to raise the exemption limit from Rs 600,000 to Rs 1,000,000.

Further, there is a strong case for restoring the investment allowance scheme for salaried tax payers. A tax credit of up to 20% of the tax liability may be given for investment in Government securities and bonds of up to 20% of income.

This will be an extremely useful measure as it will help in promoting savings, which have fallen to historically low rates of 4% to 7% only and thereby greatly restricted investment financing. Also, this will greatly facilitate the inflow into non-bank borrowing for financing the budget deficit and reduce the level of debt servicing. There has been no resort to non-bank borrowing by the Government in recent years.

Further, the Government is rightly focusing on increasing the number of income tax filers. An incentive could be in the form of a no tax audit of a new filer for the first three years. Also, if an existing tax filer increases the income tax payment by more than 20% then he/she should be exempted from tax audit in the particular year.

There are some other steps which need to be taken to alleviate the burden on lower income groups. This includes the withdrawal of the recently imposed sales tax on a number of basic consumer goods, including food items and medicines. Similarly, there is need also to reconsider the imposition of regulatory customs duties on a number of essential imports.

A substantially better strategy is to take concrete steps for integration and harmonization of the Provincial sales tax on services and the Federal sales tax on services. India implemented the reforms to achieve these objectives, Today, the sales tax on goods and services in India yields 5% of the GDP, whereas the corresponding magnitude in Pakistan is 3.5% of the GDP.

Turning to the petroleum levy, Pakistan is one of the few countries which has a higher retail price of HSD oil than of motor spirit. The former is used more for the transportation of food items and other basic goods. The motor spirit is consumed more by the middle- and upper-income groups. The government plans to increase the petroleum levy by Rs 10 per litre. It would be appropriate if it is raised by Rs 15 in the case of motor spirit and Rs 5 on HSD oil.

There is need to highlight in conclusion once again that Pakistan has seen in   the Federal Budget of 2024-25 the highest ever incremental taxation in the form of a vast and diverse set of taxation proposals. The increased burden will make it even more difficult to achieve a higher GDP growth and to lower substantially the rate of inflation as targeted for by the Government.

Therefore, a set of proposals have been presented above to reduce the negative impact on the economy. In particular, these proposals focus on facilitating export-led growth and on the reduction in the regressivity of the increased tax burden of both direct and indirect taxes.