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Dr. Ikramul Haq
There is a general consensus that Pakistan needs full throttled reforms in all areas of governance and institutions if it has to achieve high, equitable and sustainable growth of seven percent and above assuring prosperity for all citizens—PIDE Reform Agenda for Accelerated and Sustained Growth(Pakistan Institute of Development Economics (PIDE), April 2021). This level of growth is, however, not possible unless fundamental reforms are made in the existing tax structure as highlighted in Towards Flat, Low-rate, Broad and Predictable Taxes (PRIME Institute, Islamabad, December 2020).
There are a number of studies and models presented by local economists, authors and researchers for tax reforms facilitating higher growth, but none was considered by successive governments. Reliance on International Monetary Fund (IMF) and prescriptions by World Bank and others for reforming the outdated and oppressive tax system have failed to yield desired results as highlighted in Tax Reforms in Pakistan: Historic & Critical View (PIDE, 2020).
Presently, all broad-based and buoyant sources of revenue are with the federal government and contribution of provinces in total tax revenues [Rs. 5273 billion] for fiscal year 2020-21 [11.1 % of GDP] was merely 9.6% and in overall national revenue base (tax and non-tax revenue) of Rs. 6903 billion [14.5% GDP] it was 9.5% against the total national expenditure of Rs. 10307 billion[21.6% of GDP]. All provinces together generated taxes of Rs. 508 billion [1.1 % of GDP] and non-tax revenues of only Rs. 150 billion.
The federal government spent Rs. 1316 billion on defence and Rs. 2750 billion on debt servicing and after transfer to provinces of Rs. 2742 billion under the 7th National Finance Commission Award (NFC), these two alone were Rs. 2067 billion higher than net revenue collection of the federal government. This is our main perpetual fiscal dilemma. While the federal government is accumulating debts, the provinces are heavily dependent on transfer from NFC Award. What makes the situation more disturbing is the fact that right of provinces to levy sales tax on services is encroached by federal government through levy of presumptive/minimum taxes on services under the Income Tax Ordinance, 2001, sales tax on gas, electricity and telephone services and excise duty on a number of services.
Before independence, the provinces had the exclusive right to levy sales tax on goods and services within their respective physical boundaries. The subject of sales tax was on the Provincial Legislative List at Serial No.48 in the Government of India Act, 1935 and was described as “Taxes on sale of goods and on advertising”. In the Constitution, 1956, “tax on sales and purchases” was mentioned at serial No.26 of the Federal Legislative List, and therefore, for the first time it became a federal subject. The position was maintained in 1962 Constitution, which mentioned “tax on sales and purchases” in the Federal Legislative List as clause (j) at serial No.43 in the Third-Schedule. In 1973 Constitution as originally adopted ‘tax on sales and purchases’ was kept on Federal Legislative List at serial No.49 of Part I of the Federal Legislative List given in the Fourth Schedule. The item was, however, completely substituted by Constitutional 5th Amendment Act, 1976 with effect from September 13, 1976 that read “Taxes on sales and purchases of goods imported, exported, produced, manufactured or consumed”. The second half of the amended entry appears to have been taken from the amendment made in Sales Tax Act, 1951 by Finance Ordinance, 1960. Through that amendment the words “consumption of goods” in the preamble were substituted by “importation, exportation, production, manufacture or consumption” [see details in WAPDA v. Collector of Central Excise and Sales Tax (2002 PTD 2077 and also in Pakistan through Chairman FBR and others v Hazrat Hussain and others (2018) 118 Tax 260 (S.C. Pak)].
The solution is to move towards harmonised sales tax on goods and services. The total collection by imposing unified sales tax on goods and services can reach around Rs. 6500 billion as against collection of Rs. 1990 billion by FBR in 2020-21 through sales tax on goods and provinces cumulatively of Rs. 294 billion through sales tax on services. The additional revenue collection of nearly Rs. 4200 billion will not only give fiscal space to the federal government to narrow down fiscal deficit but would also enhance distribution amount to the provinces. Distribution would be strictly as per Constitution of the Islamic Republic of Pakistan [“the Constitution”].
The retail sector alone has potential of nearly US$ 5 billion, if not more. In Retail sector: has a US$ 5 billion tax potential, TNS, [Political Economy] The News, September 6, 2020, it is shown how low-rate retail sales tax on retailers with fool-proof point-of-sale (POS) connectivity can bring prices down, yield higher revenues and accelerated growth provided that fundamental structural reforms are made and taxation rights between the federation and its units are reconsidered to make Pakistan a self-reliant entity.
The potential of retail sector is yet not fully tapped by FBR through POS connectivity as target to register all the outlets is still a far cry as highlighted in FBR falls short of POS target [The Express Tribune, April17, 2022]. Retail sector: a US$ 5 billion tax potential, as a pilot project, is elaborated in detail along with other tax policy and administrative reforms in Towards Flat, Low-rate, Broad and Predictable Taxes (PRIME Institute, Islamabad, December 2020) but none paid heed. Thus revenue generation at federal level remains short of annual current expenditure what to speak of meeting development outlays. Provinces are also not meeting their constitutional obligations towards the citizens even after getting larger shares under the NFC Award—courtesy improvement in the collection of FBR.
On the basis of collection of first six months of the current fiscal year, share under the NFC Award of the four provinces was Rs. 1941 billion as compared to Rs. 1280 billion in the corresponding period of the last fiscal year. It squeezed the fiscal space for the federal government to meet the ever-increasing cost of debt servicing at Rs. 1453 billion.
Pakistan has been facing grim challenges on the fiscal front as Summary of Consolidated Federal and Provincial Fiscal Operations, 2021-22 (Provisional), available on the website of Ministry of Finance (MoF), for July 2021 to December 2021, shows that even part of defence spending is now funded by borrowing. It is more than a fiscal fiasco—a serious cause for concern threatening economic viability and national security of the country. The negative impact of mindless and costly borrowing, both external and internal, resulted in debt servicing of Rs.1453 billion with fiscal deficit reaching Rs 1.37 trillion.
The facts for fiscal year 2021 were highlighted in Budget FY 22: Tarin faces Herculean task, Business Recorder, May 20, 2021, Shaukat Tarin’s challenge, TNS, [Political Economy] The News, April 25, 2021 and More on the fiscal fiasco, TNS, [Political Economy] The News, February 28, 2021.
Total tax revenue collection by FBR from July 2021 to December 2021 was Rs. 2920 billion and after transferring the shares to provinces under NFC Award (Rs. 1225 billion), the net available to federal Government from tax and non tax revenue (Rs. 3635 billion) was Rs. 1940 billion that could not even meet the two major heads, debt servicing (Rs. 1453 billion: domesticRs. 1312 billionandforeign Rs. 140 billion) and defence (Rs. 520 billion). It means that all other expenses, including development outlays, to be funded by borrowed money.
According to a report, the position at the end of the current fiscal year will be as under:
“The record Rs4.3 trillion federal budget deficit will be equal to 8% of the gross domestic product (GDP) on the basis of old base year of the economy and 5.8% of the new base year. The Rs4.3 trillion deficit was Rs318 billion higher than the target set by the government in June last year.
The deficit will stay high despite the fact that the government has squeezed the federal development budget by at least Rs200 billion, showed the Mid-Year Budget Review Report 2022.
The gap of Rs4.3 trillion is being bridged by taking more domestic and international loans.
The report has been submitted to the cabinet under the statutory requirement and covered actual results of the first half of current fiscal year and the expected outcome in the remaining period.
It came despite the fact that the government imposed a Rs360 billion mini-budget and the Federal Board of Revenue (FBR) made windfall gains in tax collection on higher imports and higher inflation.
Against the budgeted amount of Rs7.5 trillion, the government now expects current expenditures at Rs7.7 trillion. The report has shown PSDP spending at Rs700 billion against the budgeted estimate of Rs900 billion.
Total expenditures of the federal government are still shown at less than Rs8.5 trillion, although huge slippages are expected due to the PM’s relief package-related spending.
On the revenue side, the FBR’s target has already been revised upwards to Rs6.1 trillion against the budgeted number of Rs5.83 trillion.
The cabinet has been informed that against the budgeted figure of nearly Rs2.1 trillion, the non-tax revenue collection could be around Rs1.65 trillion – a reduction of Rs428 billion, or 21%.
This will have a direct bearing on the next federal government revenues, which are now projected at just Rs4.1 trillion – lower by Rs344 billion against the budgeted target.
Due to the increase in FBR’s tax collection, the provincial share will rise from Rs3.4 trillion to Rs3.6 trillion. The government expects them to generate Rs570 billion in cash surplus to show the overall budget deficit at a lower level.
During the first half, the FBR’s tax collection grew one-third to Rs2.9 trillion.
The federal budget deficit in the first half was Rs1.85 trillion while the primary deficit, after excluding interest payments, stood at Rs400 billion, according to the report.
A major chunk of current expenditures went to interest payments that consumed Rs1.45 trillion, or 47% of the annual interest payment estimates. Compared to that, the defence expenditure during the first half was equal to 38% of the annual estimate.
A major chunk of Rs171 billion was shown as social protection spending, which was Rs100 billion more than the first half of the preceding fiscal year”.
It is worth mentioning that planning, in the period following Constitution (Eighteenth Amendment) Act, 2010, received assent of President on April 20, 2010, should have been federalised rather than centralised. But even after a lapse of 12 years, nobody has raised this issue, what to speak of implementing it in letter and spirit. The Constitution (Eighteenth Amendment) Act, 2010 [commonly called the 18th Amendment] has redefined National Economic Council (NEC) on the pattern of Council of Economic Interests (CCI). NEC forms part of Chapter 3 of the Constitution entitled ‘Special Provisions’. In view of Article 167(4), the role of NEC has become very important though it has yet not been realised by the centre and provinces. Debts needed by provinces and their servicing plus repayment should be borne by provinces to relieve the federal government of the enormous amount that takes away of tax revenues and non-tax revenues. Article 167 of the Constitution after addition of clause (4) by the 18thAmendment reads as under:
Borrowing by Provincial Government
167. (1) Subject to the provisions of this Article, the executive authority of a Province extends to borrowing upon the security of the Provincial Consolidated Fund within such limits, if any, as may from time to time be fixed by Act of the Provincial Assembly, and to the giving of guarantees within such limits, if any, as may be so fixed.
(2) The Federal Government may, subject to such conditions, if any, as it may think fit to impose, make loans to, or so long as any limits fixed under Article 166 are not exceeded give guarantees in respect of loans raised by, any Province, and any sums required for the purpose of making loans to a Province shall be charged upon the Federal Consolidated Fund.
(3) A Province may not, without the consent of the Federal Government, raise any loan if there is still outstanding any part of a loan made to the Province by the Federal Government, or in respect of which guarantee has been given by the Federal Government; and consent under this clause may be granted subject to such conditions, if any, as the Federal Government may think fit to impose.
(4) A Province may raise domestic or international loan, or give guarantees on the security of the Provincial Consolidated Fund within such limits and subject to such conditions as may be specified by the National Economic Council.
[bold and underlined by us for emphasis]
The 18th Amendment gives provinces equal rights over their natural resources. Article 172(3) confers 50% ownership of hydrocarbon petroleum resources to the provinces. The subject was earlier held by the federal government. There still exist legal and administrative bottlenecks for implementing this provision.
Presently, many economists and politicians are arguing that 7th NFC Award and 18th Amendment are harming fiscal stability of federation. Their argument needs consideration. The issue of NFC Award vis-à-vis provisions of 18th Amendment must be examined holistically. The performance of provinces in collecting tax from the rich and mighty e.g. agricultural income tax is extremely appalling. This is a common issue both at federal and provincial levels arising from absence of political will to collect income tax from the rich—the meagre collection of agricultural income tax—less than Rs. 3 billion by all provinces and federal government in fiscal year 2020-21 is lamentable.
It is imperative that right to collect tax on income, including agricultural income, should be given to the Centre through dialogue and in a democratic way under Article 144 of the Constitution which says:
Power of Majlis-e-Shoora (Parliament) to legislate for one or more Provinces by consent
144. (1) If one or more Provincial Assemblies pass resolutions to the effect that Majlis-e-Shoora (Parliament) may by law regulate any matter not enumerated in the Federal Legislative List in the Fourth Schedule, it shall be lawful for Majlis-e-Shoora (Parliament) to pass an Act for regulating that matter accordingly, but any act so passed may, as respects any Province to which it applies, be amended or repealed by Act of the Assembly of that Province”.
In the same manner, the Centre and provinces should levy harmonised sales tax on goods and services. The division should be strictly according to formula agreed under Article 160 of the Constitution so collection will be efficient and citizens/taxpayers will have a one window facility. This will help the State to collect taxes of Rs. 12 trillion as per actual potential—details are available in ‘Towards Flat, Low-rate, Broad and Predictable Taxes’. This is the only way to meet the emergent economic challenges faced by the State and achieve fiscal stabilisation in Pakistan without disturbing the 18th Constitutional Amendment and achieve the cherished goal of self-sustainability.
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Dr. Ikramul Haq, Advocate Supreme Court, is Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE).