Govt set to cut import taxes

The government has decided to substantially lower import taxes worth Rs120 billion in the upcoming budget aimed at opening the economy to foreign competition amid concerns over the impact of a steep tariff reduction on external financial imbalances.

Prime Minister Shehbaz Sharif has this week endorsed the plan of reducing import duties while turning down the objections raised by the Ministry of Industries and the Ministry of Commerce. These ministries expressed concerns over the negative impact of steep but gradual changes on the manufacturing sector and the balance of payments, two members of the cabinet told The Express Tribune.

Interestingly, the finance ministry and the Federal Board of Revenue (FBR), which were behind increasing the tariffs in the past to raise revenues, have supported the plan. The first phase of the plan will be implemented in the new budget and will be fully completed in five years, said the sources.

While rejecting the commerce ministry's proposal to increase the number of tariff slabs to six from five, the PM decided to reduce the slabs to four under the five-year plan, said the sources. The maximum slab rate will be set at 15% by reducing it from the current 20% over five years.

The free trade plan approved by the government is even steeper than the one agreed with the International Monetary Fund (IMF), according to a member of the committee that finalised the plan.

Total revenue impact of the plan is Rs512 billion, excluding any changes in tariff rates for oil and gas exploration and production companies, according to the sources. In the first year, the negative revenue implications will be roughly Rs120 billion, including around Rs100 billion due to changes in slab rates.

According to the decision, which will be given legal cover in the budget, customs duty slabs will be reduced to four - 0%, 5%, 10% and 20%. Currently, there are five slabs. Some 2,201 goods are imported at zero duty but there is 2% additional customs duty and up to 20% regulatory duty. The government will not change import duties for the automobile sector in the budget.

There is a 3% duty slab having 972 items. This slab also carries 2% additional customs duty and up to 35% regulatory duty. It has been decided to abolish the 3% slab and move tariff lines either to zero or 5%.

Sources said that there were chances that the majority of those tariff lines would be moved to 5%, which would generate a revenue of about Rs70 billion to offset losses.

It has been approved to introduce a new 5% duty slab. The 11% slab will be lowered to 10%. There are 1,121 tariff lines under this slab, which also attracts 2% additional customs duty and up to 50% regulatory duty. There is a possibility the 11% slab will be lowered to 10%.

The current fourth slab rate is 16% under which 545 items are traded. This slab also attracts 4% additional customs duty and up to 50% regulatory duty. The slab rate will be reduced to 15% in the budget.

The fifth slab has a 20% rate, which will be abolished gradually, said the sources. There are 2,227 goods that can be imported under this slab, which attracts 6% additional customs duty and up to 60% regulatory duty.

However, there are concerns that the sudden opening of the economy may put an additional import burden, which can trigger a balance of payments crisis. The finance ministry has estimated that a 1% reduction in duties can increase trade deficit by 1.7%.

The commerce ministry had proposed the introduction of six slabs - 0%, 3%, 6%, 9%, 12% and 20% but the PM did not agree.

According to the decision, additional customs duties will be abolished in four years, starting from this budget. Regulatory duties will be eliminated in five years. The Fifth Schedule of the Customs Act that deals with imports of capital goods and industrial raw material will be abolished in five years.

A senior tax official said that the losses due to reduction in import taxes would be offset through increased tax collection from domestic economic activities. In the first year, the customs duty loss is estimated at Rs15 billion, additional customs duty loss at Rs50 billion, regulatory duty loss at Rs35 billion and the Fifth Schedule-related losses are estimated at about Rs20 billion.

As per the decision, the trade-weighted average tariff will come down from 10.62% to 9.57% in the next fiscal year while the trade-weighted average customs duty will come down from 5.68% to 5.54%.

Sources said that the PM Office was of the view that high tariffs were pulling down productivity and local companies were not inclined to export. But the Ministry of Commerce officials said that the approved plan was contrary to the cascading principles related to raw material and finished goods.

They were of the view that the cost of production may not drastically decrease despite tariff reduction due to the high input cost (energy, labour and productivity).

Out of the Rs512 billion revenue losses, nearly Rs300 billion will occur during the IMF's ongoing three-year programme.

Some of the government functionaries also urged caution, stressing the need to proceed carefully. But the government decided that in order to boost exports it was important to reduce tariffs on intermediate inputs and capital goods crucial for the export sector.