Budget numbers are up in the air. Revenues are not locked yet. There are a few unknown expenditures on subsidies and increments. It is hard to see the next 12-month outlook. It is uncertain when the lockdown ends and when will the business activities normalize.
There are two revenues targets in mind. The IMF is asking for Rs5.1 trillion and FBR is pushing for Rs4.8 trillion. This year Rs3.9 trillion target is elusive and for next year (without any new taxes) even Rs4.8 trillion seems an uphill task. The realistic number could be anywhere between Rs3.9 trillion to Rs4.5 trillion. In current fiscal, a little over three months have been affected and the lockdown norm may continue for next three months. Do not expect much tax growth in the first quarter next year.
The government is not likely to have any new taxes. Authorities are of the view that the impact of imposition of new taxes last year has yet to come. The business community is lobbying for lowering taxes. The argument some present that there is not much room for our economy to absorb new taxes. That is correct as the prime concern should be on reviving economic growth.
The other element is removing the distortions. There are some taxes which are low yielding but have considerable impact on the ease of doing business. These are anti-trade and discourage manufacturing. Government should do away with these taxes. The revenue shortfall may be compensated by unleashing economic growth through easing of such measures.
One such example is WHT on banking transactions. The revenue generation is close to Rs30 billion per annum; but the impact of increase on currency in circulation is probably much higher on formal economic growth and overall tax collection. Ever since the imposition of this tax, the CIC/M2 ratio incremental impact is Rs1.8 trillion. This means additional to normal ratio, Rs1.8 trillion is out of the banking system. This tax should be abolished.
Similarly, there are taxes on imports of raw materials and intermediate goods that are required in domestic industrial production. There are unnecessary custom duties and additional custom duties. In the last regime, such taxes were deployed for revenue consideration without due consideration. Some of these taxes were removed last year. It is highly recommended to end others this year.
Everyone is on the same page to do away with additional custom duties on 1,630 tariff lines and substantial reduction in duties on 350 tariff lines. Tariff rationalization is the need of the hour and is imperative for lowering the cost (and ease) of doing business. The revenue generation is minimal; but economic distortion is big.
There are other proposals such as on lowering the excise duty on cement. Government and cement manufacturers have a soft commitment on it; but FBR is not on board. This proposal is iffy. The rationale was to lower the consumer price of cement to boost construction. But FBR does not look from economic lens; all they see is forgone revenues. There are talks of using technology to bring illicit cigarettes in the tax net. FBR is studying the track and trace system; but there are some complications due to court involvement.
There is push towards harmonization of GST between provinces and federal government. One proposal is to have one agency for filing of both goods and services GST, and subsequently revenues share is to be passed on. But provinces are not liking this idea. The counter proposal was to give GST on goods to the provinces. This demand essentially shuts any meaningful talk on it.
Since revenues have less potential, the focus should be on curtailing current expenditure. But the government is mulling over increasing salary and pension of military and federal government employees. The initial proposal sent to MoF was of 20 percent increase. But that is too much. And let us not forget, provinces have history of following federal government decision in this regard. A one percent increase in salary and pension bill, adds Rs8 billion to expenditure. The government is thinking of increasing this by 10 percent and the impact would Rs80 billion on federal budget.
On debt servicing, the budget is being made based on inflation projection of 8 percent for FY21. The policy rate is assumed at 8 percent (current level) in calculations. If the rates come down further (may be by 100 bps), there will be some savings on this account.
The thorny issue is on the subsidy in the power sector. The infamous capacity payments are growing while the electricity consumption is falling (or not growing at desired pace) due to lockdown and economic slowdown. The government either has to raise power tariffs or to subsidize them in budget. A combination of both could be the case. This year it was budgeted at Rs250 billion; but the actual number may be north of Rs300 billion.
The power sector subsidy can be financed by budgeting higher taxes on petroleum products. At this point, the taxes are at maximum allowed limit. It is recommended to increase Petroleum levy (PL) upper limit on both petrol and diesel. This tax is not part of divisible pool. The power sector subsidies are not shared with provinces either. The win-win situation is to increase PL to finance increase in power sector subsidy.
The federal government wants to enhance PSDP spending. In days of recession, infrastructure spending can boost economy and create much needed employment. But someone has to track the fiscal deficit. FY20 budget deficit is likely to be north of 9 percent and FY21 could not be any different. The IMF will surely not like it.