The estimated revenue collection of the Federal Board of Revenue (FBR) in the first 11 months of 2021-2022 is expected to be close to Rs 5.35 trillion. This represents an unprecedented jump of 28.5% from the collection of 4,163 billion rupees during the corresponding period of 2020-21. This is probably the highest growth rate ever recorded.

However, such an assessment should be viewed with some caution. The main reason underlying this result is the extraordinary dynamism of the import tax base. The rupee value of imports increased by 58% in the first 10 months of the current financial year. But, import-based taxes such as customs duties and sales tax on imports showed a combined growth rate of 35% during this period, FBR needs to explain why the revenue growth rate has been significantly lower than the growth rate of the tax base. .

A worrying development is the growing share of indirect taxes in RBF revenues, which makes the tax system more regressive. The share was 63.5% in 2020-21 and is expected to reach 65% by the end of 2021-22, with over 52% of total tax revenue collected at the import stage. This is an unwelcome development and the federal budget for 2022-23 should focus on restoring progressivity through more revenue-generating proposals in the income tax.

Another development that requires closer examination is the decline in the effective trade-weighted average tariff on imports. It should be close to 8% this year. According to the World Trade Organization publication, World Tariff Profiles, it was almost 11% in 2015. This drop in the effective rate of import duties is one of the factors contributing to the growth in the volume of imports and consequently to the aggravation of the trade deficit. . Again, the next federal budget should consider raising the import tariff in different bands as a short-term measure.

Having indicated the direction of reforms that should guide proposals for the upcoming federal budget, we now turn to examine the potential RBF revenue target for 2022-23.

The IMF, being a key player in determining such a target, offered it at Rs 7.255 billion in the staff report released after the completion of the sixth review of the program. This implies a growth rate of almost 19% on the projected level of income, in line with the target of Rs6,100bn for the year to end. Based on a likely revenue shortfall of Rs 100 billion, the target growth rate for 2022-23 translates to 21%.

So what is the probability of achieving revenue of Rs 7.255 trillion in 2022-23? What is the likely normal increase in revenue and what will be the required amount of revenue that may be generated by the Tax Proposals to achieve this goal? To begin with, there are some special factors to consider.

First, the sales tax on petroleum products has been eliminated. This implies an average monthly revenue loss of more than Rs 40 billion. If revenues up to February 2022 of almost Rs 300 billion from this tax are excluded, the actual base year revenues for the purpose of assessing the feasibility of the target drops to Rs 5.7 trillion. rupees. Therefore, if the removal of sales tax on petroleum products is to continue in 2022-23, meeting the revenue target of Rs 7.255 billion will effectively require a growth rate of over 27%.

Second, the dynamism of the import tax base in 2021-22 is obviously unsustainable. And with strong policy action, the likely import level this year of nearly $78 billion will have to be reduced to nearly $70 billion next year if pressure on the already rather low level of foreign exchange reserves must be mitigated. Indeed, the import tax base in rupees may either remain unchanged or show only modest growth in rupees.

Other factors will also limit RBF’s revenue growth in 2022-23. First, among income tax withholdings, the two main sources of income are contracts and imports, with shares in total income tax revenue of 16% and 13% respectively. . The likely restriction in the size of the PSDP will reduce the rate of growth of revenue from contracts. Similarly, the constraint on the growth of imports will limit the increase in withholding taxes on imports.

Third, 24% of income tax revenue comes from withholding tax on corporations. Income from this source will be limited by the reduction in taxable profits due to the sharp increase in interest rates and fuel and energy prices, the contribution of inflation to the increase in the cost of other inputs manufacturers and the drop in demand due to the compression that will be experienced by households in their disposable income.

The domestic tax base is expected to increase by almost 18% next year, which is equal to the real GDP growth rate plus the inflation rate. Therefore, the combined normal growth of domestic and import-based taxes is projected at nearly 10%, suggesting that without any taxation proposals, the likely level of RBF revenue in 2022-23 will be around 6.27 trillion. rupees; assuming there will be no sales tax on petroleum products. As such, the revenue required from the additional taxation proposals is very significant, at Rs 985 billion, to meet the IMF target.

The government must assess the implications of the return of sales tax and petroleum tax on petroleum products by July 1, 2022. This will need to be preceded by a third round of price increases to eliminate the subsidy altogether. Indeed, this will imply a jump in oil prices of up to 50% compared to the level prevailing in February 2022, before the announcement of the reduction in oil prices of Rs 10 per litre.

Fortunately, as outlined above, there are opportunities to improve import duties. This should be the preferred policy measure rather than imposing import bans on luxury and non-essential goods, which will actually lead to a loss of revenue. Appropriate upward adjustment of import duty bands could bring in an additional Rs 250 billion. This will largely offset the loss of revenue from the sales tax on petroleum products or, failing that, require fewer proposals for taxation in other tax bases.

The suggested achievable target is Rs 6.9 trillion. In the absence of the sales tax on petroleum products, this will imply an RBF revenue growth rate of 21%. With normal growth of 10%, the amount of revenue from taxation proposals in the 2022-23 Federal Budget will imply substantial additional taxation of Rs 630 billion. A higher target is considered unachievable given the likely state of the economy in 2022-23. Beyond improving import tariffs, emphasis should be placed on mobilizing resources from direct taxes. Some very progressive proposals are identified below:

· Reforms to the income tax proposal whereby the eleven brackets are reduced to six. The exemption limit is increased from Rs 600,000 to Rs 1,000,000. The top marginal tax rate will apply to income above Rs 25 million, from the current level of Rs 75 million.

· Conversion of fixed and final taxes on dividends, interest, rental income, etc., to be converted into withholding taxes. Income from these sources must be reported on the tax return to determine the total amount of tax payable less any advance taxes paid.

· Taxation of real long-term capital gains on real estate and shares at 10 pc. The exemption provision beyond the specified holding period should be removed, the actual appreciation in the case of real estate being estimated by means of appropriate indexation, in order to take into account inflation rates higher.

· Reintroduction of wealth tax in the form of capital value tax initially at the rate of 1 pc.

· Careful consideration of the exemptions in the Second Schedule of the Income Tax Ordinance and the exemptions removed from legal persons and NGOs not operating in the fields of health or education.

· Minimum tax on rental income from commercial properties, equivalent to 3% of market value as reported by FBR on assessment of properties in various neighborhoods of different cities.

· Improved withholding tax rates on electricity bills for commercial consumers and residential consumers consuming more than 1,000 units per month. This is considered essential to reduce the import demand for fuel used in electricity generation.

· The pitching of the tax on commercial banks to 45pc. This, admittedly, is the second best option. Given the inability of public finances, even in the medium term, to generate a surplus of almost 5.2% of GDP to service the interest payments on the domestic debt, the first best option is to cancel a part of the face value of the debt. However, as it would be difficult, for various reasons, to take this course in the short term, the second best option is offered as a measure to recover something from the commercial banks on the huge profits they have made.

· Strong urge to provincial governments to expand farm income tax and urban property tax in their respective 2022-23 budgets.

Overall, finalizing the federal budget for 2022-23 presents a formidable challenge for the new coalition government. Convincing dialogue with the IMF is needed to reach agreement on the proposed revenue target of Rs 6.9 trillion in 2022-23.

The authors are respectively a former Federal Minister and a former Governor of the State Bank of Pakistan.

Posted in Dawn, June 8, 2022