A belated budgetary action

In the emerging economic scene of slowing, but still high, inflation, rapidly rising exports, massive inflows of remittances and respectable reserves, a high fiscal deficit seemed like an outlier. Most reports and comments suggested that the leadership of the ruling party had said no to all proposals to increase revenue and reduce expenditure, at a time when the country was heading for elections. An IMF mission kept postponing its departure at the urging of the economic team, which was stated to be making last ditch efforts to persuade a dithering leadership.

A belated budgetary action was taken on March 15. The measures announced could have easily been implemented soon after the country was hit by the floods of 2010. At the time of such a grave emergency, nobody would have objected to a surcharge on income tax and duties on luxury items to generate funds for relief, rehabilitation and reconstruction. Instead the zeal to reform, as scripted by the IMF, overcame the ill-prepared economic team. It had to face stiff resistance not only from the opposition parties, but also from the parties allied with the government. As a matter of fact, the government had to retreat from the oil price raise announced in line with the higher world prices. Far from reforming the tax structure to increase the share of taxes in GDP, the country is back to the good old game of introducing marginal changes through SROs (statutory regulatory orders) and ordinances. The irony is that the near-consensus among political parties on not to tax any more, forced the government to issue ordinances rather than move a bill in parliament. This is not exactly the beauty of democracy one hears so much about. Ordinances are legal, but so is the acquittal of Raymond Davis!

In terms of the impact, the 15 per cent surcharge on the assessed income tax will leave less money to spend on consumption as well as investment, both not very good in times of depressed growth. Also, the same percentage of tax for all brackets means that the lower brackets will suffer relatively more than the higher brackets. The charge that those who already pay are being made to pay, sticks. Only Rs2 billion is expected from the estimated 700,000 tax evaders. However, the lifting of exemption of domestic sales of agricultural inputs, textiles, leather, sports goods, carpets and plant machinery from the GST broadens the tax base. As the levy is at the final sales point for effective collection, prices of all of these items will go up by 17 per cent. Most of these are not common items of consumption. Bringing agricultural inputs under the GST will put pressure on output prices, particularly food, which has the largest weight in the CPI, as well as the SPI. The benefit of higher support prices and booming world commodity prices, will now be shared with the government, an indirect way of taxing agriculture. In no way is this, however, a substitute for an agricultural income tax.

These are the unintended consequences. The measures are intended to achieve the fiscal deficit target announced in the federal budget and reduce government borrowing, which can be inflationary. A Rs20 billion reduction in the notoriously rigid current expenditure, reliance on FBR’s ‘efficiency’ to add twice that amount in about a quarter, and the provinces going their own way, does not inspire much confidence. The inflationary downturn of the last two months may see an about-turn, signalling the next monetary policy to be a continuation of the past.

Published in The Express Tribune, March 18^th, 2011.