Growth in federal tax revenues

Federal tax revenues consist primarily of FBR revenues. In addition, they include other taxes like the gas infrastructure development cess, natural gas development surcharge and the petroleum levy. The share of FBR revenues in total federal tax revenues in 2019-20 was 92 percent.

There has been an unannounced and inexplicable change recently in the classification of the federal sources of revenue. From March 2021 onwards in the fiscal operations and in the federal budget documents for 2021-22, federal taxes now consist only of FBR taxes, viz, income tax, sales tax, customs duty, and excise duty. The other taxes, including the petroleum levy, have been transferred to the category of non-taxes.

This is no explanation offered for this change. The International Monetary Fund (IMF) in its programme review staff reports has followed the earlier system of classification of federal revenue sources into taxes and non-taxes. An alternative name has been given to the petroleum levy of 'carbon tax' by the IMF. Therefore, there is clearly a need to revert to the earlier classification of revenues as the petroleum levy is a tax.

Inclusive of all the taxes, the total federal revenues reached Rs 5,243 billion, according to the revised estimates, in 2020-21. The level of Rs 5 trillion was crossed for the first time. This is a significant step forward.

The share of FBR revenues has shown a growth rate of over 17 percent in 2020-21. FBR has claimed that the revenues by the end of the fiscal year were somewhat higher, and the growth rate exceeded 18 percent. This is a relatively high growth rate compared to the previous two years. Inclusive of other taxes, the growth rate of federal tax revenues was as high as 22 percent. Given this high growth it is surprising that the Federal Ministry of Finance has preferred not to highlight this exceptional performance.

Overall, the eight federal taxes combined have yielded revenues equivalent to 10.9 percent of the GDP. This is, of course, significantly better than last year when revenues plummeted after the first Covid-19 attack. The rise in the Federal tax-to-GDP ratio in 2020-21 is 0.6 percent of the GDP. However, despite the jump in revenues this year, there has been a fall in the federal tax-to-GDP ratio of 0.7 percent of the GDP, compared to the level attained in 2017-18. Therefore, more efforts are required for raising the federal tax-to-GDP ratio.

Within federal taxes, there has been a substantial variation in the growth rates of revenues in 2020-21. The slowest growth is observed in the income tax of 13 percent and the highest of 70 percent in petroleum levy. The other three major taxes, namely, sales tax, customs duty, and excise duty, have shown growth rates of 24 percent, 18 percent, and 13 percent, respectively.

The relatively slow growth of income tax has implied that the share of direct taxes in federal tax revenues has fallen in 2020-21. It was 36 percent in 2019-20 and has declined to 33 percent in 2020-21. Inclusion of withholding taxes of an indirect nature in the income tax in indirect taxes, the effective share of indirect taxes in total federal tax revenues is almost 80 percent. This has made the federal tax system very regressive in nature.

The year, 2020-21, has witnessed a big difference in the quarterly growth rates of FBR revenues. The growth rate was low at below 6 percent in the first two quarters. Suddenly, it jumped up to 23 percent in the third quarter and even further to 42 percent in the fourth quarter.

The extraordinary jump in the fourth quarter is largely attributable to the 'low base effect'. From March to June 2020, tax revenues contracted severely in the immediate aftermath of Covid-19. The tax base of imports contracted by as much as 23 percent in the fourth quarter of 2019-20.

The big jump in FBR revenues of 42 percent in the fourth quarter of 2020-21 is due largely to the 63 percent jump in imports in this quarter, which facilitated a big upsurge in revenues from the import sales tax and customs duty. As such, much of the growth is due to the 'base effect' and not higher effort at collection.

What are the prospects for federal tax revenues in 2021-22? The target is Rs 6,605 billion, while that for FBR is Rs 5,829 billion. The respective required growth rates are 26 percent and 23 percent. These are extraordinarily high and have seldom been achieved before.

A new approach has been adopted to projecting FBR revenues. This is called 'Evidence Based Revenue Forecasting'. Unfortunately, the methodology used is fundamentally flawed. The historical series of tax revenues should have netted out the additional revenue each year from taxation proposals implemented during the year. This has not been done. Therefore, the projected revenue in FY 2020-22 of Rs 5336 billion includes the revenue impact of additional policy and administrative measures.

There are three somewhat unusual features of taxation proposals presented in the Federal budget of 2021-22. First, sales tax rates have been raised on inputs like crude oil, LNG, and ginned cotton. These will be mostly input invoiced away in the next stage of value added. Second, there is greater reliance on administrative measures for generating more revenues from the income tax and the domestic sales tax. Third, an unusually high number of taxation proposals has been withdrawn following the budget debate in the Parliament.

Overall, an optimistic projection of FBR revenues in 2021-22 is Rs 5,425 billion, with a likely growth rate of 15 percent. This will imply shortfall of revenue of over Rs 400 billion. In addition, the government has already revealed a strong reluctance to raise the rate of petroleum levy. If this continues in subsequent fortnightly price adjustments, then the shortfall in this tax could also approach Rs 400 billion.

Therefore, the prospect is for a large shortfall in federal revenues in 2021-22 of Rs 800 billion, equivalent to almost 1.5 percent of the GDP. This will make it extremely difficult to achieve the budgetary targets of 2020-21.

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

Copyright Business Recorder, 2021