Taxes and then some

10 Jan 2020

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The writer is a senior research fellow at the Institute of Development and Economic Alternatives, and an associate professor of economics at Lums.
The writer is a senior research fellow at the Institute of Development and Economic Alternatives, and an associate professor of economics at Lums.

THE Federal Bureau of Revenue (FBR) is behind on its collection targets in first quarter. This, despite the fact that tax targets have also been revised downwards. Given our commitments to the IMF, this is not going to make the rest of the year and next year’s budget easy for the people of Pakistan.

The FBR has been saying that though they are behind target, tax revenues have been showing significant growth over last year, and if one allows for the slowing of the economy and import compression, the slippage in target achievement can be better understood. In accounting terms, it is indeed as the FBR says. The slowing economy and import compression has indeed led to lower tax revenues.

But the FBR has known for a while now that the government has been doing both purposefully: it has explicitly tried to reduce imports in order to shrink the trade deficit, and they have been cutting expenditure and raising taxes to reduce overall deficits as well. Why, then, has the FBR not been able to anticipate this? Why has this come as a surprise? And if this is being done by policy design, how can it be an excuse for not meeting targets?

The increase in taxation that the FBR has been celebrating is, for the most part, also not good news for Pakistanis. Most of the increase has been coming from indirect taxation. Most of it has been coming from increases in energy prices and changes in federal excise duties and so on. Indirect taxation is regressive.

The FBR tax shortfall is not good news; it means that further adjustments might be made.

The latest State Bank of Pakistan quarter-one report gives details on the taxation changes and how they have been contributing to the overall inflation pressure in the economy. When the economy has slowed down, many sectors within large-scale manufacturing are posting negative growth, income and job growth are virtually nonexistent, and inflation is in the double digits. To keep hitting people with regressive taxes does not seem to be a sustainable means of raising revenue.

A lot of the increase in taxation has been derived from increased levies on gas and electricity. If you look at your electricity bill, you will see a substantial (roughly 20-30pc) difference between the ‘energy’ cost and the bill that you are asked to pay. The differential is usually under the headers of ‘arrears’ and sales tax. ‘Arrears’ exist even though you have been paying the full amount of your bills on time. This is retrospective adjustment.

Another aspect of this is the fact that most of the burden of indirect taxation is falling on people who are already in the tax net. When a vendor refuses to pay tax, the buyer of the particular good and/or service has to cough up the money. So the burden of indirect taxation shifts to another rung of the ladder, one of the rungs that happen to be documented. Given the lack of overall progressiveness of the Pakistani tax system and the fact that entire sectors have been left out of the tax net, this just adds up to further unfairness in the system, and rubs it in the faces of those who are in the tax net.

The government has not been able to widen the tax net by much or get any substantial revenue out of the net-widening exercise. The number of people who are filing their income taxes has gone up by a certain percentage, but the change in tax yield has been quite small. In addition, the government has backtracked from its commitment to bring traders into the tax net and has given them breaks, yet again, to benefit from going rogue.

Liberalisation, globalisation and market-based structural adjustment tend to increase inequality of income and wealth in a society. This has happened in most countries, developing and developed, in the world over the last two to three decades. There is a minority that tends to get very rich. This minority exists in Pakistan as well. Over the last few decades, the government has been singularly unable and/or unwilling to tax this minority.

Income tax rate adjustment, when most of the rich are able to hide incomes and are not fully documented, is not the only and/or even optimal instrument that should be used for getting taxes out of this minority. Other forms of taxation are also needed. Taxes on landholdings, wealth tax, inheritance tax, gift tax, taxes on moving savings out of the country, small taxation on money movements, capital gains tax and so on are options which have been effectively used in many jurisdictions. The FBR’s inability to design and implement effective direct taxation systems has been internalised to the point that we now only think of indirect taxation as the main tool to raise revenue.

The FBR tax shortfall is not good news for the people. It means that further adjustments might be made, in various tariffs, even before the next budget. And the next budget will have taxation proposals as well. Given the inability of the FBR to do much about direct taxation, the likelihood is that indirect taxation rates will be adjusted, prices will increase and, as usual, the burden will fall disproportionately on the poor. Direct tax changes will hurt those who are unfortunate enough to already be in the tax net. The inequities in the tax system will increase. Inflationary pressure too, though maybe a little less, will continue as indirect taxes are further adjusted.

What is the growth plan that is meant to follow this stabilisation effort, given that it is still not clear where growth is going to come from? Exports are not responding fast enough, despite massive devaluation and a number of breaks that have been targeted at exporters. Foreign Direct Investment is not expected to do much here either. There are not going to be major changes in remittance flows. Nor are we expecting any breakthroughs in the agriculture and/or services sectors. Will construction do it? Can it? Looks unlikely. Given the above, the 2020 budget is not going to be an easy one for people, and 2020 does not look like the year for the economy’s ‘takeoff’.

The writer is a senior research fellow at the Institute of Development and Economic Alternatives, and an associate professor of economics at Lums.

Published in Dawn, January 10th, 2020