The budget passed by the incumbent government has a strong implicit imprint of the archetypal Pakistan Muslim League (PML-N) financial czar, Ishaq Dar. There are inherent anti-documentation and anti-export/anti-manufacture biases, which was also the case from 2013 to 2018.
The government has imposed a supertax on sectors that are already heavily taxed while there is an inherent amnesty in the form of a flat tax regime for retailers (excluding Tier 1). It looks like Dar is running the show behind the curtains, and he’s pondering the option of coming back and running the economy from the forefront while Miftah is cast as a scapegoat.
The fundamental problems of the economy have worsened. The government is taxing those who are already overtaxed more. The fundamental economic problem of the country is the lack of investment and the lack of export competitiveness. The measures taken could potentially further erode the incentive for capital accumulation and the incentives to expand exports. The manufacturing sector is hard hit. Industrialists are not happy at all. The potential for investment in the industrial sector could further erode.
The government has not only increased the tax burden on the manufacturing sector which does not even account for 15% of the economy, while at the same time the efforts of the FBR (Federal Board of Revenue) (under the government Pakistani Tehreek-e-Insaf) to bring retailers and traders out of the tax net have been relegated to the back burner.
A fixed tax regime for retailers (non-Tier 1) has been introduced. Tax experts have described this as the worst possible tax regime. These will be taxed on the basis of the electricity bill to be treated as the final tax debt. The maximum tax liability for these retailers would be 360,000 rupees per annum, which would imply that the maximum income of a retailer (excluding Tier 1) is considered to be 233,000 rupees/month (or 2.8 million rupees/year).
Now that this is a clear discrimination against the manufacturing sector where an additional 10% tax is imposed while retailers party. Then there is no additional tax on the huge commercial sector. Incentives are perverse with a discouragement against documentation and exploitation in formal manufacturing. Incentives have been introduced to encourage gray operations. Manufacturers have a greater incentive to show lower profitability by reducing documented sales.
FBR, over the past two years or so, had accelerated “track and trace” efforts to reduce the incidence of undocumented sales. Under the new regime, this no longer seems to be a priority. Second, global digitization efforts were slowed by the removal of tax cuts and other incentives. There was a campaign on digitization of retail and supply chain happening with emphasis from FBR and Ministry of Finance. Then-Finance Minister Shaukat Tarin was also pushing for it. Now the new finance minister has a bigger fish to fry and then there are internal party splits for the hot seat that have put these documentation and digitization efforts simply on the back burner.
Then, to comply with the condition of the IMF (International Monetary Fund) to have higher revenues to compensate for the subsidy deployed in recent months on petroleum products and to finance subsidies on utility stores and the like, a supertax was imposed on already taxes sectors.
The 10% supertax is imposed on thirteen industries and a 1-4% supertax on income above a certain threshold has been introduced. However, in practice, the tax will be collected from a handful of companies. Calculations on the back of the envelope show that 80-90% of the supertax will be collected from 25-30 already heavily taxed businesses. It is proposed that supertax revenues be used to fund subsidies for utility stores. Historically, these have proven ineffective in reducing poverty. USC subsidies create price distortions in a country where lack of compliance and enforcement is common, and could potentially lead to corruption.
Either way, regardless of the use of the collection, a higher tax on manufacturing while reducing the priority given to retail and trade would result in lower investment in productive sectors. Policies are similar to the previous PML-N regime – in which the ratio of goods exports to GDP fell from 10.6% in FY13 to 6% in FY17. There were higher taxes on raw materials and intermediate goods. The import tariff policy was unbalanced. Tax refunds for exporters used to be blocked. The currency was kept overvalued and the precious foreign exchange reserves of the SBP (State Bank of Pakistan) were burned to keep the currency artificially overvalued at a time when oil prices were at a decade low.
There are signs that similar politics could be back, especially if Dar is back. Miftah, on the other hand, is the proponent of a pro-export and industrialization policy. However, he no longer appears to be the primary decision maker. And while during his short tenure (so far) the tough decisions are being made, it seems like he’s not in the party leadership’s good books and maybe Dar is turning this into an opportunity to make a return. Word in the halls of power of the PML-N is that Dar has been given the green light by the party leadership to return to Pakistan.
Dar’s decision to return and take over the reins of economic management depends on the outcome of the July 17 by-elections. And if he’s back in full control, the country could see an illusion of improvement over the next few quarters, especially if global commodity prices pull back. Otherwise, his magic illusion may end. However, in all cases, exporters and manufacturers are not satisfied, and for good reason.
Copyright Business Recorder, 2022