Strikes and deficits

October 31, 2019

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The writer is a member of staff.
The writer is a member of staff.

THE government’s plan to increase revenues by expanding the tax base has already run into an impasse. Major markets around the country had been shut in response to a strike call given by the leadership of the trader community, and were only just beginning to reopen. What a fortuitous time for the State Bank to release its annual report for the fiscal year 2019. It might sound like it is a dated document seeing as it is coming a full four months after that year ended, but it is actually just in time with some important reminders to bear in mind.

The report gives important context to understand the historic high fiscal deficit that was seen in that year, but more importantly, it sheds light on the fiscal challenges shaping up for the government in this crucial year of economic adjustment. For FY2019, the deficit was recorded at 8.9 per cent of GDP, arguably among the highest ever recorded, but this “could be partly attributed to factors beyond the control of the fiscal authorities” the report says.

It lays part of the blame on the targets contained in the budget of April 2018, announced by the outgoing government, and another part on the interest rate increases that were the single largest contributor to expenditure overruns. When drawing up the revenue targets for the next fiscal year, a government that was in the final days of its term “envisaged a sharp increase in tax revenues without specifying any fresh measures to boost collections”, leaving behind a tax revenue target of Rs5.336 trillion where actual collection came in at Rs4.473tr instead.

Perhaps the snake has shed its skin, or maybe the government has realised who it is really supposed to serve.

A simple narrative could be built here saying that the new government inherited an unrealistic budget and its performance looked bad because it was unable to meet these targets. But this would be misleading. Two facts are important: first the new government had two occasions to revise the fiscal framework in two separate ‘mini-budgets’, and second because a substantial chunk of the failure on the revenue front was due to a policy choice made by the government at the time, which was to keep taxes on petroleum products low.

“[T]he entire decline in the single-largest revenue source for the government, ie, sales tax, during FY19 was attributed to lower collections from petroleum” says the report, adding that between lower recoveries from petroleum and the wiping out of State Bank profits, a revenue loss equal to 1.1pc of GDP was incurred, which is over Rs400 billion. The State Bank says that the tax reduction was due to “court orders” but the fact is that then finance minister Asad Umar took full credit for it in a press conference on November 30, 2018, in which he also announced a reduction in the prices of petroleum products despite an increase in international prices and a recommendation of a price increase from Ogra.

For comparison, he said that diesel was taxed at the rate of 27.5pc in the month of May 2018, when the PML-N was in power, but by end November 2018, after four months of the PTI government, “this had been reduced to 12pc, meaning less than half, and the 15pc GST on petrol was reduced by us to 4.5pc, meaning one quarter”. He explained that the purpose of the step was to “protect the people from the impact of rising petroleum prices in international markets”.

Those were different days, and there is no doubt they are now gone. Today’s PTI government does not tout its credentials in protecting the poor from the vagaries of market forces, whether global or domestic. Today’s PTI government is building its narrative on grounds far from the people, such as reductions in the current account deficit and “import compression”. Perhaps the snake has shed its skin, or maybe the government has realised who it is really supposed to serve.

But it would be petty to let the discussion get mired in this battle of narratives between the ruling party and the opposition, the turbo-charged nature of this exchange notwithstanding. There is far more at stake here than the image of one or another political party, because we’re only at the start of the adjustment process; there is still a long way to go.

This is where the State Bank’s look at the fiscal reality of the previous year gets interesting. In April 2018 the government had indeed envisaged a sharp increase in revenues without specifying where these will come from. But in June 2019, the PTI government envisaged an even sharper increase in revenues, and specified that the bulk of these will come from broadening of the tax base and documentation of those sectors of the economy that are currently operating outside the tax net.

That effort has led them to today’s impasse. Drawing on the lessons from last year, the State Bank says “[t]he key takeaway from the revenue performance is to expedite documentation and taxation efforts”. To build this point, the report points out that there is excessive reliance on indirect taxes that are regressive and rise and fall with the pace of economic activity. On top of that, more than 30pc of the indirect taxes come from petroleum products.

Direct taxes, such as they are, are largely collected either through withholding agents or as advance tax. Close to 64pc of all income tax is collected in withholding mode, and less than 10pc through return filing.

These are astonishing numbers, though not surprising. In its last budget, the government sees revenues jumping by Rs1.4tr, with 40pc of this to come from new revenue measures. The rest of the increase has to come from higher collections from existing taxes, which includes some amount due to growth rate, inflation and yes, base broadening, by getting more people to participate in the revenue exercise than before. Failing this, they have little option but to turn to the rest of us to help meet their target, since a repeat of last year’s performance is now out of the question given the IMF programme.

The writer is a member of staff.

khurram.husain@gmail.com

Twitter: @khurramhusain

Published in Dawn, October 31st, 2019