The return of the 1990s - Dr Ashfaque H Khan - Tuesday, March 22, 2011

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After a long delay, the government has finally announced a series of budgetary measures through the Presidential Ordinances to keep the budget deficit in the range of five to 5.5 percent of GDP in the current fiscal year. On the revenue side, the measures include a flood surcharge of 15 percent, increase in special excise duty from one percent to 2.5 percent, withdrawal of sales tax exemptions on agricultural inputs and zero-rating on plants, machinery and equipment including five major export-oriented sectors (textiles, carpets, leather, sports and surgical goods).

On the expenditure side, the measures include a reduction in current expenditure and a cut of Rs 100 billion in the federal PSDP for the year. The government also increased power tariffs by two percent to reduce subsidy on this account. While some of the above listed measures are in the right direction and should have been taken in the Budget 2010-11, the delay in taking them has seriously affected Pakistan’s fiscal balance.

The ad hoc revenue and expenditure measures taken on March 15, 2011 reminded us of the 1990s when governments used to impose a series of ‘mini-budgets’ in the midst of the ongoing fiscal year. Even then, Pakistan used to be in the IMF Program and used to set senseless revenue targets to achieve a budget deficit consistent with the IMF Program. The government would finalise its expenditure plan based first on its political priorities and second on the budget deficit target set by the IMF. The government used to fix the revenue target. The latter was never in keeping with economic activity and tax administration.

After every quarter, the IMF mission used to visit Pakistan to monitor economic performance. Since revenue projection was not based on a sound footing, revenue shortfall for the quarter was very much expected. Both the IMF and Pakistani teams would sit in the library of the Federal Board of Revenue (FBR) to finalise additional tax measures to meet revenue shortfall.

The same exercise used to be repeated every quarter to meet the revenue targets. Senseless taxation continued in the 1990s and in the process we created enormous tax anomalies, adversely affecting Pakistan’s industrial sector. Frequent changes in tax rates made importing cheaper than producing the same goods within the country.

The current economic team repeated the mistakes of the 1990s by setting a grossly overambitious target for the FBR revenue for 2010-11. Also, the government set its expenditure plan first and then to achieve the budget deficit target of four percent of the GDP as agreed with the IMF, the economic team came up with an overstated revenue target for the FBR. The government took nine months to take additional tax measures as opposed to quarterly majors in the 1990s. It is hoped that these tax measures will not create tax anomalies, promote the culture of ‘flying invoices’, and promote piling up of refunds.

Let me share my thoughts on various budgetary measures. On the revenue side, the withdrawal of exemption of sales tax is analogous to the broadening of tax bases and must be supported. The withdrawal of zero-rating on plant, machinery and equipment including five major exports sector is a step in the right direction.

However, it is expected that an effective mechanism of quick disbursement of refund and prevention of the re-emergence of the culture of ‘flying invoices’ have been put in place in the FBR. The finance team must note that the stakes are high and any failure would kill the imposition of the RGST for ever.

Taxing agricultural inputs is a bad economic policy. It is inconsistent with the government’s poverty reduction strategy. However, it is the only option considering the government’s inability to tax income originating from agriculture. The government must bring agricultural income under direct tax net in the Budget 2011-12. Once this is done, it should withdraw sales tax on agricultural inputs.

A 15 percent flood surcharge is against the principle of equity and justice. The floods took place some nine months ago but the government has only now decided to raise revenue for the victims. Nowhere else in the world would one see such a senseless measure to raise revenue. This tax will be imposed on salaried persons and the urban middle-class that are already paying income tax. The feudals, earning billions from agriculture, have remained outside the direct tax net and will remain exempt from flood tax as well. How ironic is this? The captive tax payers will be paying for the inefficiency and lethargy of the economic team.

The government has also taken several measures to cut unnecessary expenditure. These should have been taken in the Budget 2010-11. A cut of Rs 100 billion of development spending resembles measures of the 1990s. The quality of spending has been compromised as allocations to physical infrastructure and social sector are reduced by 41 percent and 34 percent, respectively.

I have been arguing for quite some time that increasing power tariff is no solution to our power sector. The people of Pakistan have been forced to pay for the inefficiency and corruption of WAPDA/PEPCO employees. The solution lies in reforms to the power sector which include elimination of free electricity provision to WAPDA employees, energy audit of WAPDA’s power plants, giving line losses reduction targets to the CEOs of all the DISCOs, and strengthening of WAPDA’s finance department.

The writer is principal & dean at NUST Business School (NBS) Islamabad.


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