THE tax-to-GDP ratio has gone up in FY15, according to revised estimates. The Federal Board of Revenue contributes over 90pc of overall tax revenues, while other sources make up the remaining 10pc.
But there has been a lack of elasticity in the FBR’s taxes during 2005-06 to 2014-15. On average, the tax-to-GDP ratios of income tax and sales tax have been hovering around 3.5pc, while those of excise and customs duties have been either stagnant or fallen.
A marginal increase of 0.3pc and 0.5pc in the tax-to-GDP ratio in 2013-14 and 2014-15 came as a bolt from the blue after the sharp decline of 0.7pc in 2012-13. Hence, there is a need to understand these changes.
Direct taxes: In both 2013-14 and 2014-15, the direct tax-to-GDP ratio marginally increased by 0.2pc and 0.5pc respectively. While the tax base-to-GDP ratio declined in both years, the rise in the effective tax rate was more dominant.
In 2013-14, the income tax rates for both salaried and non-salaried people were revised. In 2014-15, as per the FBR’s estimates, Rs144bn in new tax measures were introduced. For instance, the advance tax was introduced on the purchase of immovable property and high-end domestic electricity bills, and it was raised on the purchase and registration of new private vehicles.
Moreover, new withholding taxes were introduced in both years, like the minimum tax on builders and developers, and the withholding tax on cable operators and other electronic media etc. And withholding tax rates, including those on cash withdrawals, were also revised upwards.
Excise duty: The tax base for excise duties is not very large. The sluggish growth in revenues, particularly in 2012-13, is mainly explained by the declining effective tax rate over 2011-12. In 2013-14 and 2014-15, the effective tax rate marginally increased by 0.1pc.
Given that economic growth is not picking up, increasing tax rates is a wrong strategy. And if this continues, then it would likely further squeeze the tax base
However, the stagnation in the excise duty-to-GDP ratio is essentially a reflection of the incomplete adjustment of the tax rates to inflation, as the duty continues to be levied at specific rates on certain items. Secondly, this is also a result of the gradual replacement of excise duty by the sales tax and the transfer of GST on services to the provinces after the 7th NFC Award.
Sales tax: In recent years, there has been a major broad-basing of the sales tax, which has increasingly been substituted for customs duty, excise duty and the petroleum development surcharge. The size of the GST base has, therefore, been accordingly extended.
But since 2011-12, the sales tax-to-GDP ratio has declined consistently, reaching 27pc in 2014-15. This was mainly caused by the drop in international prices and sluggish growth in large-scale manufacturing. Even in 2014-15, LSM growth at current prices was negative.
On the other hand, the effective tax rate went up from 11.9pc in 2012-13 to 14.6pc in 2014-15. In the ongoing year, the increase in the effective tax rate is due to the hike in the rate on petroleum products from 17pc to gradually 32pc, and the sales tax on electricity bills of retailers.
Explaining the change in the tax-to-GDP ratio: During 2005-06 to 2012-12, the tax-to-GDP ratio increased by over 0.7pc. While there was a negative base effect of 0.28pc, the rate effect shows an improvement of roughly 1pc, which contributed to the rise in the tax-to GDP ratio.
In 2012-13, 2013-14 and 2014-15, the base effect was negative and the rate effect positive (except for 2012-13, when the rate effect was also negative). The positive rate effect is a reflection of the increase in statutory rates in both 2013-14 and 2014-15.
The government’s resource-mobilisation strategy hinges on the increase in statutory rates of sales tax, excise duty and income tax, while that on customs duty has declined. Given that economic growth is not picking up, increasing tax rates is a wrong strategy. And if this continues, then it would likely further squeeze the tax base.
The hike in the sales tax rate has a regressive impact, as it disproportionately affects the poor, besides discouraging domestic production and encouraging smuggling, including that of POL products.
On the other hand, the positive rate effect of direct taxes is an outcome of over-reliance on withholding taxes, along with the cumbersome process of registration and rebate.
The government should shift the focus of its resource-mobilisation strategy towards broadening the tax base, which will have other benefits as well, including job-creation.
The writer is the principal economist at the Social Policy and Development Centre, Karachi
Published in Dawn, Economic & Business, June 29th, 2015