The Budget of 2019-20 contains over a hundred proposals spread over 30 pages related to the granting of tax reliefs, measures to generate additional tax revenues and improvements in the tax system, especially to reduce tax evasion. Seldom has one year's budget attempted so much. This is probably the consequence of a commitment to raise FBR revenues by almost 38 percent and reach the target of Rs 5.55 trillion as a prior condition for the IMF Programme. This requires an increase in revenues of over Rs 1.5 trillion. The formidable and extremely ambitious nature of this increase in one year can be judged by the fact that only eight years ago this was the actual level of total revenues collected by FBR.
The objectives of this article are to assess, first, the likelihood that the proposals included in the Budget are adequate to achieve the revenue target. Second, in the process of collecting more revenues there is need to assess the impact in 2019-20 on key macroeconomic metrics like GDP growth, investment, exports, imports, rate of inflation, etc. Third, it is also important to determine the burden of this mountain of taxation. Has FBR skilfully targeted the rich or in a somewhat oblivious manner the incremental burden has been spread all over the population?
Feasibility of revenue target The growth targeted for of 38 percent in FBR revenues has not been achieved or surpassed in any year since 2000-01, the turn of the century. The highest growth rate during the last eighteen years is in 2015-16, when it approached 21 percent. This was due primarily to the extraordinary dip in the international price of oil. This conferred 'windfall gains' to revenues with almost trebling of the sales tax rate on HSD oil while preserving retail price stability.
Projection of the growth of tax revenues has to be undertaken in two steps. The first step is to quantify the absolute increase in revenues that is likely to take place next year due to growth in the national economy in the presence of an unchanged tax system. This is referred to as 'normal' growth. The next step is the estimation of the additional revenues that are likely to be forthcoming due to enhancements in tax rates and broadening of the tax bases in the Budget. The two estimates combined together yield the projection of tax revenues for the next financial year.
The normal growth in tax revenues hinges on the projected growth in the nominal GDP and its sectoral composition. Historically, on average, a 1 percentage point increase in the GDP has led to a, more or less, 1 percentage point rise in FBR tax revenues. However, this relationship can break down in particular years.
The ongoing year, 2018-19, is likely to see growth in FBR revenues which is much less at about 3 percent as compared to the almost 11 percent increase in the GDP. There are two reasons for this low growth in revenues. First, the two key tax bases are the volume of imports and the output of the large-scale manufacturing sector. The volume of imports has fallen by 6 percent while the Quantum Index of Manufacturing is down by 3 percent up to March in 2018-19. Second, various reliefs and concessions were granted at different points in 2018-19, adding up to a revenue loss of over Rs 250 billion.
The year 2019-20 promises also to be a very difficult year. The GDP growth rate is projected at only 2.4 percent. Import volume will need to be brought down even further, given the target of reduction in the current deficit by more than half, from almost $14 billion in 2018-19 to $6.5 billion in 2019-20. Simultaneously, the concomitant increase in interest rates, depreciation of the rupee and a big increase in the indirect tax burden will have a negative impact on the growth of the large-scale manufacturing sector.
Therefore, the normal growth in tax revenues linked to the growth in tax bases may not be very large. Fortunately, the restoration of the presumptive income tax on the telecom sector will add almost Rs 60 billion to tax revenues in 2019-20. Overall, the normal increase in FBR revenues could be about 10 percent, as compared to a nominal GDP increase of 13 to 15 percent. This will add Rs 400 billion to revenues in 2019-20.
Turning to the revenue impact of the large number of taxation proposals in the 2019-20 budget, the basic problem is that, unlike past practice, FBR has not released information on the estimated revenue from each proposal. Only the aggregate figure of Rs 516 billion as the impact of all proposals combined has been indicated.
Combined together, the overall normal revenue increase of Rs 400 billion and the FBR estimate of the total revenue yield from the budgetary proposals of Rs 516 billion, a positive outcome will be if FBR revenues approach Rs 5000 billion. This indicates that the shortfall could be as large as Rs 550 billion. However, the growth rate could reach 25 percent. This will represent the best performance by FBR since 2000-01
Economic impact An assessment is made first of the impact on production in different sectors of the economy. Tax rates have been enhanced on domestic sales/ production or on inputs of a large number of large-scale industries like textiles, leather manufactures, aerated water, vegetable ghee, cooking oil, cigarettes, sugar, cement, iron and steel, engineering goods, CNG and fertilizer. Never have so many industries been subject to additional taxation in one annual budget. Almost 55 percent of large-scale manufacturing now faces a higher tax burden. On top of this, the small-scale manufacturing sector also has been brought more into the tax net. This includes the domestic sale of sports goods, surgical instruments and carpets.
There is, however, one positive aspect of the taxation policy adopted in the budget. The import tariff structure has been cascaded more. At the lower end of tariffs, 1600 tariff lines on raw materials and intermediate goods have been exempted from import duty. Simultaneously, at the upper end the 16 percent tariff slab has been raised to 20 percent and the 20 percent slab to 27 percent. The measures will jointly provide more effective protection to domestic industry and hopefully lead to more import substitution.
The biggest concern is with the withdrawal of zero rating facility to exports, especially on textiles, accounting for almost 70 percent of exports. The search for additional revenues has led the Government to levy a full-fledged sales tax at 17 percent on the domestic sales of these industries. This comes at a time when the exporters have very serious problems of liquidity due to the big delays in payment of refunds as part of the zero rating system on exports. Perhaps this move could have been staggered by at least one year during which all the backlog of refunds could be taken care of. Another somewhat insidious move is the withdrawal of input invoicing facility on utility payments. This implies that in future over Rs 50 billion of refunds will not have to be paid annually to exporters. Needless to say, this will have a significant impact on their profitability and on their competitiveness.
Another inexplicable move is the levy of a 10 percent sales tax on ginned cotton. This will have to be reverted to yarn exporters. In the case of domestic sales it will be input invoiced and not lead to any increase in revenues with the introduction of the 17 percent sales tax on yarn. However, it could disturb the cotton market and create serious problems in the liquidity in the cotton value chain. There was no case for levy of a sales tax on ginned cotton at a time when the cotton crop is going through a period of great crisis.
The inflationary impact of the taxation proposals will be significant. The price of sugar will go up by 8 percent, clothing and footwear effectively by almost 17 percent, CNG by 4 percent, LNG by 5 percent leading to higher electricity and gas tariffs, consumer durables by almost 4 percent, aerated waters by 5 percent; vegetable ghee by 1 percent, small cars by almost 3 percent; cement by 3 percent and lower quality cigarettes by over 33 percent. In the face of these wide ranging increases, the projected inflation rate 11 percent to 13 percent appears to be understated. It could be even 2 to 3 percentage points higher.
Turning to impact on investment, we have already seen this year that both private and public investment have fallen sharply. The former has been negatively impacted by the prevailing uncertainty, steep increase in interest rates and the rise in the cost of imported machinery due to the depreciation in the value of the rupee. Public investment has been reduced by the big cut back in development spending after the Supplementary Budget of 2018-19, presented by the newly inducted government of PTI.
The forthcoming year is likely to witness a continued shyness of private investors due to the continuing increase in interest rates and fall in the rupee. Two proposals will magnify the negative impact. The first is the withdrawal of the tax credit on balancing, modernization and replacement and the partial termination of the initial depreciation allowance. These measures are very ill-advised and should not have been proposed at a time when modernization and technological innovation is absolutely essential for enhancing the competitiveness of our export industries.
The Budget does propose a big enhancement in the size of the National PSDP even if the lower figure of Rs 1612 billion is operative, rather than the Rs 1863 billion set by the Planning Commission. However, reaching even the level of Rs 1500 billion may not be possible if during 2019-20 the gap between the target and actual revenues of FBR begins to widen then a corresponding cut back in the outlay on the PSDP may become essential.
Burden of higher taxes The fundamental question relates to the burden of the taxation proposed in the Budget. According to the Budget Documents, only 30 percent of the incremental revenue will come from the income tax. The bulk, 70 percent, is expected from indirect taxes, especially the sales tax and excise duty.
As highlighted earlier, the price of a number of basic consumer gods will increase due to the higher taxation. This includes sugar, vegetable ghee, cooking oil, clothing and garments, leather goods, electricity, gas, CNG etc. Collectively, these items have a disproportionately higher share of the income of the lower and middle income groups. Therefore, the burden of the increase in indirect taxes will tend to fall on them.
Fortunately, there are some progressive moves in the Budget in the domain of direct taxes. This includes reduction in the exemption limit of the personal income tax, broad-basing to tax more effectively incomes of traders, providers of services, property developers, etc. A welcome move is the increase in the holding period for capital gains taxation of property. In addition, major steps have been included towards greater documentation of transactions and use of collateral evidence for detection of tax evasion. A major factor determining the success of these reforms will be the implementation capacity of FBR.
Alternative proposals With the objective of withdrawal of indirect taxes imposed in the budget a number of alternative proposals are presented to ensure there is no revenue loss.
First, levy of an extra profits tax on companies which have a return above 25 percent on equity. The tax rate is proposed at 15 percent on the higher profit.
Second, a limit placed on tax deductibility on financial charges on debt up to a debt to equity ratio of 70:30.Higher financial charges may be allowed tax credit at 15 percent.
Third, higher tax rate of 35 percent on commercial banks if the share in private sector credit to preferred sectors like SMEs, agriculture, infrastructure, housing and microfinance is below 40 percent.
Fourth, the rental income from property may face a minimum income tax of 2.5 percent of the capital value, based on the assessed value of the locality by the FBR.
Fifth, levy of a 2 percent Water Resources Surcharge on income tax paid.
Sixth, in the domain of indirect taxes there is a case only for raising the sales tax rate on Motor Spirit from 13 percent currently to the standard rate of 17 percent. Today, Pakistan has the lowest price of petrol in the region. It is currently 72 cents per liter in the country as compared to 93 cents in Sri Lanka, 104 cents in India and 105 cents in Bangladesh.
Overall, the budget of 2019-20 is based on an unrealistic target of over Rs 5.5 trillion in FBR revenues. The Government has itself admitted that the potential revenue from the taxation proposals is likely to be inadequate in meeting this ambitious target. On top this, many of the taxation measures will impact negatively on exports, private investment and level of production in key industries. This will tend to reduce the GDP growth rate in 2019-20. Also, the burden of the enhancement in indirect tax rates on basic consumer goods will fall disproportionately on the lower income groups. Some proposals are put forward for more progressive mobilization of revenues. There is a need for a series of cut motions in the National Assembly to enable a review of many of the taxation proposals.
(The writer is Professor Emeritus and former Federal Minister)
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