Achieving enhanced revenue targets

Revenue mobilisation system needs paradigm shift to real-time data integration

ISLAMABAD:

Finally, some good news on the economic front; Pakistan’s staff-level agreement with the IMF concluded and the matter referred to the IMF board for formal approval.

This development was preceded by the levy of new taxes of Rs215 billion in the winding up speech of the finance minister. These taxes were in addition to the Rs220 billion rate changes introduced in the original Finance Bill.

The final changes also included backtracking on increase of limit on unexplained foreign remittances, increase in the monetary turnover limit of SMEs to avail of the fixed tax regime, some rate increase and withdrawal of few other exemptions and concessions provided in the Finance Bill 2023.

As a result, the FBR’s revenue target has been increased to Rs9,415 billion, requiring a 31% increase over collection of Rs7,180 billion in the recently concluded financial year.

The task seems to be onerous and mammoth, as in the last eight years, the FBR’s revenue has, on average, grown at a pace of around 14% per year. Although the current growth targets are very close to those achieved in 2021-22 (29%), yet the underlying assumptions about GDP growth, inflation, LSM and import growth are quite adverse as compared to that year.

The targets assigned to each head of tax collection will be difficult to achieve given the import compression and resultant LSM growth retardation. It is also evident that revenue growth under all four heads (income tax, sales tax, FED and customs duty) behaves quite erratically when compared to GDP growth, inflation or other macroeconomic indicators.

For example, one could have expected the revenues to at least grow by a factor of 25% (GDP deflator) to 29% (CPI) even in the case of zero GDP growth but the revenue growth remained a little less than 17% despite increase in the general rate of sales tax in January 2023.

The traditional method of forecasting revenues (as used by the FBR) in which buoyancy of each tax is determined and is multiplied with the relevant macro indicator, ie nominal GDP for income tax, nominal LSM for domestic sales tax and FED and expected imports for customs and import sales tax to work out the autonomous tax growth, is very crude in its form and almost always fails to predict revenue growth.

The impact of new rate and base changes is added to this autonomous growth to estimate the total expected tax collection.

This impact calculation is also traditionally based on a static model by using the new rates to the base of immediately preceding year. The expected quantity changes consequent to price impact (tax plus inflation) is largely ignored.

Simply put, it is assumed that the tax collection for the current financial year should be equal to the GDP growth rate (3.5%) plus inflation (21%) plus new measures of Rs435 billion. This formula gives a revenue forecast of Rs9,375 billion, which is almost equal to the targeted collection of Rs9,415 billion.

But if we apply the same formula to the last financial year, the possible collection should have been Rs8,400 billion instead of the actual collection of Rs7,180 billion.

This huge difference indicates that tax forecasting calculations on the basis of a few macroeconomic indicators and simple assumptions are not appropriate for a complex economy like Pakistan because of the following reasons: (i) The taxes are not evenly distributed across the economy (the formal manufacturing and imports are the only real contributors to taxation). (ii) Inflation and tax increases create a quantity dampening effect on goods and services. (iii) Policy and method of tax collection in Pakistan, though aligned to the rest of the world in nomenclature, is actually quite basic and primitive.

For example, most of the income tax is contributed by withholding taxes on formal sector contracts, imports, dividends, salaries, interests and advance minimum tax paid by corporate and large-scale manufacturing.

Similarly, sales tax and customs duty at import stage are largely dependent on the import of petroleum products (sales tax and duties have been reduced to zero in lieu of PDL increase), vegetable oil, steel scrap, plastics, electronics, vehicle parts, chemicals, tea and ceramics.

A major amount of local sales tax and FED is again collected only from electricity, sugar, cotton yarn, natural gas, cement, cigarettes, tea, beverages, coal, LPG, auto parts and food processing.

The simplistic method of tax collection at various gates (governments, corporates, banks and imports), instead of documenting and collecting due taxes at each stage of income earning/ value addition, has now become a roadblock in the real growth of revenues.

Most of these methods and policies, introduced in Pakistan in the early 1990s, contributed sizeable amounts to the national exchequer in the last 30 years but now they have reached their maximum limit. That is primarily the reason the FBR’s revenue collection has been hovering around 10% of GDP in the last two decades (maximum 10.8% in 2017-18, minimum 8.8% in 2009).

If we look at the international best practices, only those countries have graduated to a tax-GDP ratio of 15% plus which have moved on to documentation and real income assessment of each individual, firm and corporate and integrity (price and quantity) of retail sales and import data.

Unless we start a real re-thinking and reconstructing the revenue machinery, capable of delivering a tax-GDP contribution of 15% and above, the current revenue constraints and horizontal inequity in taxation will not allow us to grow in a positive and sustainable matter.

The current revenue mobilisation system (policies and procedures) has hit its ceiling and needs a paradigm shift to a real-time data integration at the national level at a single identifier (including banking data of 67 million accounts – only 10 million declared in tax records, data on foreign travel, utilities, properties, etc), import scanning, remote manufacturing, transport and retail monitoring and a far less physically intrusive and least visible FBR officers and officials.

The earlier we shift to the policies and methods of our more developed peers, the better it will be.

The writer is a public policy practitioner and can be reached at [e-mail]

 

Published in The Express Tribune, July 10^th, 2023.

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