Out of box solutions or IMF agenda?
Huzaima Bukhari & Dr. Ikramul Haq
The fourth Finance Minister Shaukat Fayaz Ahmed Tarin of the coalition government of Pakistan Tehreek-i-Insaf (PTI) immediately after taking oath of his office is faced with the daunting challenge of preparing budget for fiscal year 2020-21 amidst very difficult times when the country is faced with economic meltdown due to Covid-19 endemic, especially after the third and deadly wave. There are complete and partial lockdowns in many cities. Protection of human lives and mitigating extreme financial hardships faced by weaker segments of society, need to be given the top most priority in the coming budget. The traditional approach adopted for decades in Pakistan for balancing the books, levying more taxes, containing fiscal deficit and other number games also must be reconsidered.
Bold initiatives and innovative measures are required to rethink our growth strategy in totality under the prevalent exceptional circumstances, while remaining in the programme of International Monetary Fund (IMF). The gloomy predictions of rate of growth by the State Bank, IMF, World Bank and others can be proved wrong through fundamental structural reforms and by taking concrete steps for higher and sustainable growth.
In his op-ed of April 25, 2021, Ali Khizer mentioned: “Prime minister Imran Khan has started the second innings of his 5-year term with a new zest. A clear message has been sent to the new economic team in the first meeting of Economic Advisory Council (EAC). Only out of the box solutions are warranted. PM’s message is clear and loud–he has had enough of the stabilization measures, now is the time to focus not only on growth but sustainable growth”.
The Prime Minister and new Finance Minister may be aware of the fact that “out of the box solutions” and the way forward is provided by the Pakistan Institute of Development studies (PIDE) in PIDE Reform Agenda for Accelerated and Sustained Growth, (April 2021), launched on April 22, 2021. The launching ceremony was chaired by Mr. Asad Umar, Federal Minister for Planning, Development, Reforms and Special Initiatives. He was the first Finance Minister of the coalition government of PTI from August 20, 2018 to April 18, 2019, announced even before victory in elections by Imran Khan. Later, he was replaced with Dr. Abdul Hafeez Shaikh, first appointed as Adviser to Prime Minister and then Finance & Revenue Minister but failed to win the seat of Senate from Islamabad against former Prime Minister, Yousaf Raza Gilani, who was disqualified by the Supreme Court of Pakistan on June 19, 2012. After Hafeez Shaikh, Hammad Azhar, Minister of Industries, was given the portfolio of Finance & Revenue for 18 days [March 29 to April 16 2021] and then made Minister for Energy.
The fourth appointment by Premier Imran Khan made on April 16, 2021 of Shaukat Tarin, whoearlierheld the same portfolio from 2008 to 2010 in the Cabinet of Yousaf Raza Gillani. Mr. Shaukat took oath of his office on April 17, 2021, subject to becoming member of National Assembly or Senate within 60 days!
Challenges faced by the new Finance Minister are grim and daunting, but he looks determined to follow the agenda of growth as desired by the Prime Minister. The issue of stabilisation versus growth will continue vis-à-vis IMF and World Bank presenting their prescriptions. It is pertinent to mention that before taking the oath of office, Shaukat Tarin openly criticised the economic policies of the PTI Government and his main target was high interest rate by Governor of State Bank of Pakistan and his two predecessors, who according to him, entered and revived the IMF programme “unprepared” and “without any plan”. Shaukat Tarin is further quoted as: “If the Federal Board of Revenue (FBR) does not increase its revenue to 15%, then the country will run out of money to spend. The FBR will have to bring revenue to 20% in 5-7 years […] otherwise the country will not be able to achieve an economic growth rate of 7-8%“.
Shaukat Tarin is fully cognizant of the fact that the coalition government of PTI before the release of tranche of US$ 500 million by the IMF on March 24, 2021 agreed to make amendments in the Income Tax Ordinance, 2001 to withdraw tax exemptions or curtail them through tax credit involving complicated procedure and unreasonable conditions. Resultantly, the President of Pakistan in exercise of the powers conferred by Article 89(1) of the Constitution promulgated Ordinance VII of 2021 on March 22, 2021, with immediate effect. The notification says that this Ordinance “shall be called the Tax Laws (Second Amendment) Ordinance, 2021”.
The Tax Laws (Second Amendment) Ordinance, 2021 is termed unconstitutional by opposition parties and many experts. According to them, it is a mini-budget and Money Bill cannot be presented in the form of a Presidential Ordinance. The PTI Government claims that it is justifiable under Article 89 of the Constitution that says it shall deemed to be a Bill laid down before the national Assembly. The main issue is faulty economic policies of the Government of PTI giving leverage to IMF to dilute beneficial tax exemptions granted to CPEC projects but maintaining the same for IFC-funded projects of Independent Power Plants (IPPs) destroying our growth due to high cost of energy. Mr. Shaukat Tarin has spoken about it and showed determination to deal with it but not necessarily as suggested by IMF through price hikes in electricity and imposition of heavy petroleum levy as both are going to create negative impact for businesses and purchasing power of the citizens. The Finance Minister has yet to make public, the alternate plan and its implementation strategy.
According to a news report, FBR’s target for next fiscal year 2021-22 “is projected by IMF to be Rs. 5.9 trillion which the government “will try to achieve by increasing rates of income and sales tax and withdrawing exemptions, as per new report of IMF”. This is strongly opposed by Shaukat Tarin saying we will increase revenues but with our own strategy and plans and not as per dictates of the IMF. The official blueprint of enhancing taxes is not made public till today. This was highlighted in Restructuring of tax system: a blueprint, Business Recorder, May 7, 2021.
According to a report, the PTI Government for the revival of programme, “finally conceded to slap Rs. 140 billion in taxes” that “was a prior condition by the IMF”. It says: “The government also increased electricity prices by 16% in February and a commitment to further increase tariffs by 36% in six months (April-October 2021)”. The Federal Cabinet on March 16, 2021 “approved the promulgation of an Ordinance aimed at preparing a legal path to increase power tariff by a minimum of Rs. 5.65 per unit from now till October to collect a whopping Rs884 billion from consumers”. This news report gives the following main features of IMF’s Country Report No. 2021/073 of April 8, 2021 as agreed by the PTI Government:
- “The tax burden of salaried class will mount and the cost of consumer goods will also go up due to withdrawal of sales tax exemptions with effect from July 2021.
- FBR’s tax collection target at Rs. 5.963 trillion—higher by Rs. 1.3 trillion or 27% over current year’s downward revised tax collection target.
- The target of petroleum levy is shown at Rs. 607 billion for fiscal year 2021-22, that the global lender released two weeks after its board revived Pakistan’s $6 billion loan programme. For this fiscal year, the petroleum levy target is Rs. 450 billion, but the IMF report has projected collection at Rs. 511 billion on the basis of higher petroleum product prices.
- We remain committed to broadening the tax base and gradually increasing the tax-to-GDP ratio by more than 3% of GDP through FY 2023, with a cumulative fiscal primary adjustment of 3.3% of GDP,” states the Memorandum of Economic and Financial Policies (MEFP).
- MEFP underlined that in the next step, the government would change both general sales tax (GST) and personal income tax rates with the fiscal year 2021-22 budget, yielding an estimated 1.1% of GDP or Rs. 570 billion.
- The tax measures on account of federal excise duty and customs duties are expected to be over and above these measures, which will bring the total burden of additional taxes to around Rs. 700 billion, according to the FBR sources.
- The government has informed the IMF that it “will eliminate all zero-rated goods, currently protected under fifth schedule, except on export and capital machinery goods and move them to the standard sales tax rate. It will remove reduced rates under the Eighth Schedule and bring all those goods to the standard sales tax rate”.
- Similarly, it will “eliminate exemptions (Sixth Schedule) excluding a small subset of goods (i.e., basic food, medicines, live animals for human consumption, education and health-related goods) and bring all others to the standard rate” of 17%.
- The government will also “remove the Ninth Schedule to replace a specific tax rate for cell phones with the standard rate” of 17%. These changes in the GST law are expected to yield an estimated 0.7% of GDP or Rs390 billion on an annualised basis.
- There will also be significant changes in the income tax rates by reducing the number of tax slabs, confirms the report. In line with IMF recommendations, we will seek to change the existing tax rate structure by reducing the number of rates and income tax brackets from eleven to five and decreasing the size of the income slabs,” according to the MEFP.
- Pakistani authorities told the IMF that this will simplify the system and increase progressivity; reduce tax credits and allowances by 50% (except for Zakat and those provided for disabled and senior citizens). Note: FBR and IMF even do not remember that these benefits were abolished through Finance Act, 2018 (passed on May 22, 2018) by the Government of Pakistan Muslim League (Nawaz) when rates were drastically reduced. The PTI restored the old high rates through Finance Supplementary (Amendment) Act, 2018 (received assent of President on October 8, 2018) but willfully or ignorantly failed to insert these benefits!
- The income tax rates and slab changes will yield additional revenue equal to 0.4% of GDP or Rs208 billion, according to the report.
- The government will also introduce a special tax procedure for very small taxpayers aimed at preventing further tax base erosion and facilitating the formalisation of the economy; and adopt a long-term strategy to reduce labour informality and to bring additional taxpayers into the personal income tax net.
- The IMF report noted that Pakistan has to increase its revenues and ensure fiscal consolidation to contain the public debt that it projected at colossal 93% of GDP by June this year”.
In view of conditions contained in IMF’s Country Report No. 2021/073 of April 8, 2021, the Government of PTI in the coming days, as hinted by Shaukat Tarin, will have to re-negotiate with IMF as further taxation can be detrimental for economy. On the contrary, there is need to reduce the rates and broaden tax base, if the PTI Government is to ensure survival and revival of businesses adversely affected by Covid-19 pandemic. The measures suggested by IMF and agreed by the PTI Government will lead to further unemployment that already is in millions as highlighted by many leading economists. Overwhelming majority of businesses in the wake of lockdown necessitated due to third wave of Covid-19 epidemic is on the verge of closure—all were in fact suffering and struggling due to sluggish economic activities, high utility bills and markup rate and heavy burden of dozens of withholding tax provisions in the Income Tax Ordinance, 2001, Sales Tax Act 1990 and even under the provincial sales tax on services. They are asking for relief and IMF is asking for further taxation. The inflation, as per noted economist Milton Friedman, is taxation without legislation. In April, food inflation was the highest during the current fiscal year. According to figures released by Pakistan Bureau of Statistics (PBA), in cities, it increased from 11.5% to 15.7%, 4.2% within a month. In rural areas, it jumped from 11.1% to 14.1%.
Big to small and medium enterprises (SMEs) have been demanding a comprehensive bailout, including tax reliefs. They are complaining of facing difficulties in securing loan facility announced by SBP to pay salaries/wages. Those on rent are demanding remission/deferment/loan to pay the same. Contrary to prescriptions of IMF and World Bank, there is demand of massive tax reduction, deferment of old and forthcoming liabilities, zero taxation for employees earning up to Rs. 100,000 per month, waiver of advance income tax and over 75 withholding tax provisions contained in the Income Tax Ordinance, 2001, Sales Tax Act, 1990 and all provincial laws relating to sales tax on services.
Unfortunately, nobody is suggesting out-of-box measures. Somebody must convince the Prime Minister that the iniquitous prescription of erratic and oppressive taxes in the forthcoming federal budget will not solve our problems especially in the prevalent circumstances.
The federal and provincial governments need to generate and spend more money for infrastructure improvement to create more employments and ensure higher growth, engaging private sector to take part in public projects. This would kick-start the economy. Simultaneously, the governments need to reduce wasteful expenditure, right-size the monstrous size of their machinery, monetize all the perquisites of civil servants and make taxes simple and low-rate. State lands, lying unproductive owned by the federation and provinces, should be leased out for industrial, business and commercial ventures. It will generate substantial funds, revenue (through public auction 5% as full and final tax can be collected amounting to billions) and facilitate rapid economic growth.
While the rich remain outside the tax net, the poor are paying exorbitant GST on items of daily use. We need to overhaul theincompetent, inefficient, fragmented and corrupt tax machinery. The untapped income/wealth in Pakistan is monstrous at federal and provincial levels. If we manage to collect tax of Rs. 8 trillion in the coming two years at federal and Rs. 2 trillion at provincial level, the federation and the federating units with total revenues of Rs. 10 trillion in the kitty will not require fresh domestic and foreign loans.
Devising a rational policy and revenue mobilisation strategy is the biggest challenge before Shaukat Tarin. All agree that we need to adopt economic policies aimed at rapid growth and investment. On taking charge, Shaukat Tarin rightly highlighted that his top most priority would be sustainable growth and prosperity for all the citizens. Taxes will increase with growth and not by high taxes and withholding provisions. The contrary prescription by IMF of higher taxes and costly energy will lead to unemployment and dismal growth.
Apart from fixing the fragmented tax laws and tax agencies’ merger into a single national tax revenue board, the federal and provincial governments must decide under Article 156(2) of the Constitution to earmark revenues for specific purposes placing the same in funds created for debt retirement, training of youth in various vocational disciplines, especially in Information and Communications Technology (ICT) and Artificial intelligence (AI), innovations, creation of employment zones and provision of social services, such as free education and health, affordable housing, transport, all civic amenities, like clean drinking water, sewerage, solid waste management, roads and designate areas for small/street vendors. Simultaneously, the federal and provincial governments must drastically reduce their wasteful expenses, right-sizing the governmental machinery to bring efficiency and monetize all the perquisites of government servants. The economic policy should focus on reforms and growth and not taxes as highlighted in various studies conducted by PIDE.
The above may be considered while remaining in the programme of IMF and after undertaking fundamental structural reforms, we can even exceed the targets required by the lender of last resort with higher and accelerated growth. Finance Minister Shaukat Tarin must immediately take fundamental structural reforms to achieve sustainable growth rate of at least 7% in the next three years which is not possible without simplification of tax system as highlighted in FBR, tax potential & enforcement—I, Business Recorder, March 5, 2021 and FBR, tax potential & enforcement—II, Business Recorder, March 7, 2021.
The growth path as suggested in PIDE Reform Agenda for Accelerated and Sustained Growth, (April 2021) will induce investment and revenue mobilisation to achieve fiscal consolidation, inclusive development and prosperity for all the citizens. The prerequisites are all-out reform in administrative, judicial and other colonial-style institutions, drastic reduction, rather elimination of wasteful expenses on monstrous state machinery that is costly as well as inefficient and corrupt.
Debt retirement and reduction in debt servicing need out of box solution for which special task should be given to PIDE and establishing a commission, headed by its VC, with all chief economists of federal and provincial governments as members, representatives from national and provincial assemblies and Senate and renowned experts in the field to suggest short, medium and long term actionable steps to overcome the twin menace of debt burden and high fiscal deficit. On the issues of broadening of tax base, improving voluntary tax compliance, lowering tax rates, withdrawing all withholding provisions (except on salary, dividend, interest and payment to non-residents), a comprehensive study is already provided to Finance Minister by the Federation of Pakistan Chamber and Industry (FPCCI) in a meeting held on April 30, 2021. The implementation of plan of FPCCI and others can lead Pakistan towards higher growth resulting in enhancement of tax collection, reduction in fiscal deficit and ensuring how we can ‘return to prosperity’—the title of book by Dr. Arthur B. Laffer & Stephen Moore that must be read by all legislators, policymakers, tax administrators and researchers at PIDE.
The writers, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE)