Stabilisation Straitjacket: Budget 2016 and the Growth Bottleneck



Backdrop

A nation’s budget and its overall economic policy framework are situated within a certain macroeconomic context.The mix of fiscal and other policies pursued by a government should respond to the challenges inherent in the economic environment. In this perspective, how well does the Federal Budget for 2016-17 deliver?

For the past several years,Pakistan’s economy has been experiencing sluggish and below-par rates of growth. Average economic growth since 2008 has been a tepid 3.4 percent. New investment in plant and machinery, a key driver of growth, has plummeted – with investment by the private sector and by foreign investors leading the way. Exports have been falling since late 2014, while the agri-sector is experiencing declining output and plummeting prices in key crops.

Overall, the macroeconomic context since 2008 has been fairly difficult, shaped partly by exogenous developments but largely by domestic policy choices and self-imposed constraints. The country’s internal security situation has remained disturbed since 9/11, affecting business environment and investor sentiment. However, the two biggest constraints the economy has faced are the inept handling of the power crisis, followed by a failure to introduce meaningful tax reform.

Against this backdrop, the economic policy context of the past three years has been one of fiscal consolidation and macroeconomic stabilisation under the aegis of a three-year IMF program. The fiscal deficit has been brought down from 8.3% of GDP in 2012-13 to 4.3% of GDP (estimated, provisional) for the current fiscal year.[1] A large part of the fiscal consolidation has been driven by a sharp increase of nearly 60% in FBR tax revenue collection since 2013. The tax to GDP ratio has risen to 10.5%, from 8.5% in 2013.

However, the bulk of the increase in tax revenue has come from existing taxpayers via an increase in tax rates; the levy of additional taxes, including a slew of new withholding taxes; an increase in customs tariffs; increased enforcement and auditing by FBR; and the non-payment of tax refunds.

The main specific measures taken since 2013 that have contributed the bulk of the tax revenue increase have included:

·         An increase in the standard rate of sales tax, from 16% to 17%

·         The imposition of the Gas Infrastructure Development Cess (GIDC)

·         An increase in the minimum customs tariff from 0% to 3%

·         New withholding taxes

·         Levy of a “super tax” on large corporates

·         Enhanced rates of petroleum taxation

While some effort has been made to broaden the tax net, these efforts have been modest and are yet to bear fruit (research by RAFTAAR estimates that the cohort of eligible but non-taxpaying Pakistanis is at least 4 million). Hence, the bulk of the unprecedented increase in tax revenue collection in the past three years has come from the large, documented, tax-compliant firms operating in the country’s formal sector – or from average consumers via indirect taxation.0

The combined effect of the government’s tax measures since 2013 has been to add significantly to the cost of doing business as well as to the cost of tax-compliance in the country, as evidenced by the slippage in the country’s global ranking on this score. Pakistan has dropped 10 places in the World Bank’s Cost of Doing Business Index since 2013 (to 138), while on “ease of paying taxes” the country’s rank is now 171st in the world – virtually at rock bottom.

Cumulatively, these measures have hurt the competitiveness of the formal sector – and restricted its ability to invest.

Key budgetary measures and impact

Against a backdrop of stifled economic growth, the federal budget for 2016-17 offers at least two moderately positive policy steps. For exporters, it brings the good news of restoration of zero-rating for sales tax for the five major sectors. For the farm sector, which has been under stress for the past two years, the budget contains several “relief” measures. (Of course, the utility of these budgetary measures is largely contingent on their implementation.)

Notwithstanding these steps, the main thrust of the policy measures is on revenue generation via new taxation measures. All told, the federal budget seeks to impose Rs252 billion via new taxes, the bulk of which are, once again, aimed at existing taxpayers. In terms of the impact on businesses, perhaps the most potent negative effect is likely to emanate from the move to disallow provincial sales tax paid by a business as input tax credit or adjustment. This move – if not rescinded – will add significantly to the overall cost for formal businesses, who are already burdened by new taxation measures of the past three years.

In terms of documenting the economy, the budget takes this government’s strategy of creating a distinction between tax return-filers and non-filers, and setting up a regime of differential taxes,further. However, this approach is fundamentally flawed: it is not “first-best” (which would be the reform of FBR),and it has been tried unsuccessfully since the 1990s in the case of sales tax. At its worst, this approach of trying to collect revenue without fixing FBR is formalising the status quo and is providing the wrong incentive to non-filers: that they can pay a nominal differential and continue to legally stay out of the tax net.

With this context in view, it is clear that the economy needs policies designed to reduce the cost of doing business for formal firms, simplify the tax regime as well as increase its equity and fairness, and widen the pool of tax payers in the country.  Better prioritisation of scarce fiscal resources is needed, away from show-case urban infrastructure projects to targeted interventions supporting new investment and the export sector. Examples would be: funding policy initiatives under the Strategic Trade Policy Framework designed to increase exports (which have been denied funds for the past several years); reducing the customs tariff on import of all new machinery back to 0%; and fully clearing the backlog of tax refunds of the export sector.

A continuation of macroeconomic stabilisation and fiscal consolidation policies in their current form will hurt Pakistan’s growth prospects further.


[1]Numbers are not comparable due to change in definition between the two reporting years.

The writer is Senior Adviser for RAFTAAR – an advocacy platform for economic reforms

 Please note that the views in this publication do not reflect those of the Jinnah Institute, its Board of Directors, Board of Advisors or management. Unless noted otherwise, all material is property of the Institute. Copyright © Jinnah Institute 2016

By Sakib Sherani

Backdrop

A nation’s budget and its overall economic policy framework are situated within a certain macroeconomic context.The mix of fiscal and other policies pursued by a government should respond to the challenges inherent in the economic environment. In this perspective, how well does the Federal Budget for 2016-17 deliver?

For the past several years,Pakistan’s economy has been experiencing sluggish and below-par rates of growth. Average economic growth since 2008 has been a tepid 3.4 percent. New investment in plant and machinery, a key driver of growth, has plummeted – with investment by the private sector and by foreign investors leading the way. Exports have been falling since late 2014, while the agri-sector is experiencing declining output and plummeting prices in key crops.

Overall, the macroeconomic context since 2008 has been fairly difficult, shaped partly by exogenous developments but largely by domestic policy choices and self-imposed constraints. The country’s internal security situation has remained disturbed since 9/11, affecting business environment and investor sentiment. However, the two biggest constraints the economy has faced are the inept handling of the power crisis, followed by a failure to introduce meaningful tax reform.

Against this backdrop, the economic policy context of the past three years has been one of fiscal consolidation and macroeconomic stabilisation under the aegis of a three-year IMF program. The fiscal deficit has been brought down from 8.3% of GDP in 2012-13 to 4.3% of GDP (estimated, provisional) for the current fiscal year.[1] A large part of the fiscal consolidation has been driven by a sharp increase of nearly 60% in FBR tax revenue collection since 2013. The tax to GDP ratio has risen to 10.5%, from 8.5% in 2013.

However, the bulk of the increase in tax revenue has come from existing taxpayers via an increase in tax rates; the levy of additional taxes, including a slew of new withholding taxes; an increase in customs tariffs; increased enforcement and auditing by FBR; and the non-payment of tax refunds.

The main specific measures taken since 2013 that have contributed the bulk of the tax revenue increase have included:

·         An increase in the standard rate of sales tax, from 16% to 17%

·         The imposition of the Gas Infrastructure Development Cess (GIDC)

·         An increase in the minimum customs tariff from 0% to 3%

·         New withholding taxes

·         Levy of a “super tax” on large corporates

·         Enhanced rates of petroleum taxation

While some effort has been made to broaden the tax net, these efforts have been modest and are yet to bear fruit (research by RAFTAAR estimates that the cohort of eligible but non-taxpaying Pakistanis is at least 4 million). Hence, the bulk of the unprecedented increase in tax revenue collection in the past three years has come from the large, documented, tax-compliant firms operating in the country’s formal sector – or from average consumers via indirect taxation.0

The combined effect of the government’s tax measures since 2013 has been to add significantly to the cost of doing business as well as to the cost of tax-compliance in the country, as evidenced by the slippage in the country’s global ranking on this score. Pakistan has dropped 10 places in the World Bank’s Cost of Doing Business Index since 2013 (to 138), while on “ease of paying taxes” the country’s rank is now 171st in the world – virtually at rock bottom.

Cumulatively, these measures have hurt the competitiveness of the formal sector – and restricted its ability to invest.

Key budgetary measures and impact

Against a backdrop of stifled economic growth, the federal budget for 2016-17 offers at least two moderately positive policy steps. For exporters, it brings the good news of restoration of zero-rating for sales tax for the five major sectors. For the farm sector, which has been under stress for the past two years, the budget contains several “relief” measures. (Of course, the utility of these budgetary measures is largely contingent on their implementation.)

Notwithstanding these steps, the main thrust of the policy measures is on revenue generation via new taxation measures. All told, the federal budget seeks to impose Rs252 billion via new taxes, the bulk of which are, once again, aimed at existing taxpayers. In terms of the impact on businesses, perhaps the most potent negative effect is likely to emanate from the move to disallow provincial sales tax paid by a business as input tax credit or adjustment. This move – if not rescinded – will add significantly to the overall cost for formal businesses, who are already burdened by new taxation measures of the past three years.

In terms of documenting the economy, the budget takes this government’s strategy of creating a distinction between tax return-filers and non-filers, and setting up a regime of differential taxes,further. However, this approach is fundamentally flawed: it is not “first-best” (which would be the reform of FBR),and it has been tried unsuccessfully since the 1990s in the case of sales tax. At its worst, this approach of trying to collect revenue without fixing FBR is formalising the status quo and is providing the wrong incentive to non-filers: that they can pay a nominal differential and continue to legally stay out of the tax net.

With this context in view, it is clear that the economy needs policies designed to reduce the cost of doing business for formal firms, simplify the tax regime as well as increase its equity and fairness, and widen the pool of tax payers in the country.  Better prioritisation of scarce fiscal resources is needed, away from show-case urban infrastructure projects to targeted interventions supporting new investment and the export sector. Examples would be: funding policy initiatives under the Strategic Trade Policy Framework designed to increase exports (which have been denied funds for the past several years); reducing the customs tariff on import of all new machinery back to 0%; and fully clearing the backlog of tax refunds of the export sector.

A continuation of macroeconomic stabilisation and fiscal consolidation policies in their current form will hurt Pakistan’s growth prospects further.


[1]Numbers are not comparable due to change in definition between the two reporting years.

The writer is Senior Adviser for RAFTAAR – an advocacy platform for economic reforms

 Please note that the views in this publication do not reflect those of the Jinnah Institute, its Board of Directors, Board of Advisors or management. Unless noted otherwise, all material is property of the Institute. Copyright © Jinnah Institute 2016

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