Budget 2012: IMF agrees to drop RGST demand

Budget deficit target set at 4 per cent, tight fiscal space unlikely to leave room for subsidies.

ISLAMABAD:

Pakistan has managed to convince the International Monetary Fund (IMF) to drop its demand for Islamabad to levy the value added tax – also referred to as the reformed general sales tax (RGST) – during the upcoming fiscal year, effectively burying the politically unpopular measure.

Finance ministry officials, in Dubai for talks with the IMF, confirmed that the RGST would not be levied during the fiscal year ending June 30, 2012. As a substitute, the government would continue to withdraw general sales tax (GST) exemptions, a process that began in March this year.

The government expects to raise at least Rs90 billion through the removal of exemptions from sales tax on domestic oil sales, poultry and cattle feed, according to officials at the Federal Board of Revenue (FBR), in addition to retaining the withdrawals of exemptions initiated in March.

Officials familiar with the negotiation said that both sides agreed to a budget deficit of Rs802 billion, or 4% of the total size of the economy. The government has set a tax revenue target of Rs1,952 billion for the upcoming fiscal year.

Pakistan had asked for permission to run deficits between 4.5% and 5% of gross domestic product. The narrower deficit target means that the government is likely to withdraw or reduce several subsidies and not introduce any new ones.

As a result of the agreement between Pakistan and the IMF, the Washington-based lender is expected to disburse $1.7 billion to Islamabad by September in what is expected to be the final tranche of the current IMF bailout programme, which ends later that month. The next meeting between finance ministry and IMF officials will take place in July, after the federal budget has passed Parliament, to review progress made on the promises made this week.

At the height of the global financial crisis in late 2008, Pakistan had asked for a bailout from the IMF, which agreed to an $11.3 billion only after attaching several conditions, including levying the value added tax (as the RGST is internationally known).

The RGST was meant to increase the tax-to-GDP ratio in Pakistan from the current, abysmal 9.1% of GDP to 14% of GDP within five years of levying the tax. Doing so would have reduced the budget deficit by more than four-fifths of its current level.

However, the plan faced stiff resistance from within  Parliament, dominated by agricultural and business interests, as well as within the FBR. Sources familiar with the negotiations say the reason the tax was so bitterly opposed is that it would allow the government to better document the economy, forcing many of the wealthiest citizens in the country to finally begin paying taxes on hitherto hidden income.

The value added tax levies a tax across the entire value chain, as opposed to just at the end user stage, thus making it an inherently fairer tax. And it requires a greater degree of documentation of business revenues and expenses, since VAT is levied on the full revenues of a company, which must then apply for a refund for the taxes it paid on expenses. This higher level of documentation makes tax evasion more difficult.

The IMF, in its press release, also warned Islamabad to end its “quasi-fiscal operations”, a reference to the government’s commodity procurement programme, which often results in significant outstanding liabilities on the government’s ledger. The agricultural lobby, however, has beaten back any efforts to end the programme.

The international lender also asked the government to continue to broaden its tax base by going after tax evaders and continue to remove exemptions from the sales tax regime. The government has agreed to audit tax withholding agents, an estimated 53% of whom do not file their taxes.

The IMF also continued to insist that the government phase out subsidies in the energy sector and focus fiscal resources instead on improving the quality of the country’s infrastructure, including health, education and transportation.

The IMF also raised concerns over Pakistan’s debt management. It said “government debt has increased and debt management needs to be improved”. This puts a big question mark on the efficiency of Directorate of Debt Management, currently being run by a private sector professional. The IMF has also asked Pakistan to carefully monitor the financial sector to assure continuing financial stability.

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