Fiscal and monetary coordination is attaining greater importance with the country’s evolving democracy, creating new challenges for economic progress and with prudent monetary management becoming even more challenging.

In July 2015, the government imposed withholding tax (WHT) of 0.6 per cent on banking transactions exceeding Rs50,000 a day, but later on reduced the rate to 0.4pc; only non-filers had to pay this tax.

Withholding tax on cash withdrawals from banks also continued in the meantime and a higher tax rate was applied on non-filers whereas filers could pay a lower rate and also claim a tax refund. Currently, the limit for WHT on cash withdrawals from banks is 0.3pc for filers and 0.6pc for non-filers.

The twin moves were expected to increase the number of taxpayers, boost collection of taxes and discourage growth in the parallel economy.

However, “while WHT on banking transactions seems to have had a negligible impact on revenue collections and incentivising tax filing, it instead led to an increase in currency in circulation [CiC] and a decline in private business deposits,” reveals a SBP research presented in its annual report for FY17.

Private business deposits, as a percentage of the total deposits, declined from 27pc to 25pc after the imposition of WHT on banking transactions, according to SBP.

“Currency in circulation grew by 21.5pc on average during July 2015 to June 2017 against an average growth of 14pc recorded in the past 11 years prior to its imposition, that is between July 2004 and June 2015,” it said.

“This shows that the imposition of the WHT on banking transactions apparently defeated the very purpose for which it was imposed, that is to discourage the cash economy.”

Though the report does not mention it, sources close to the SBP say that in FY16 the stock of CiC as a percentage of the stock of money supply, or M2, reached close to an all-time high of 26pc, against 22.6pc in FY15. (Measuring CiC as a percentage of M2 is a better way of analysing its impact on the economy).

Opinions were divided, right from the beginning, on whether the imposition of WHT on non-cash banking transactions could achieve the desired results. Many business lobby groups and analysts warned that the move could backfire in our context. Now, the SBP also says in its report that their detailed analysis “suggests that the economic cost of imposing WHT on non-cash banking transactions needs rethinking.”

The report admits that the imposition of WHT on cash withdrawals and on banking transactions “has contributed on average to 0.9pc and 0.6pc annually to the FBR tax revenue, since July 2015.”

It points out that the introduction of the transaction tax led to some increase in the number of income tax filers but not in case of sales tax filers.

“The reason is that many salaried persons who were already paying income tax but were not filling tax returns started to do so to qualify for the adjustment against the advance tax payments. Despite this, the number of non-filers as a percentage of the registered income taxpayers remained high, around 70pc, in FY16.”

The SBP report says that though the incentive of tax adjustment is also available for sales taxpayers, delays in processing of refund claims may have discouraged potential and current sales tax filers from filing their returns.

“Tackling a very complex issue of expanding the cash economy through an abrupt fiscal move isn’t advisable particularly when the economy is not at full employment, political polarisation is high, corruption is rampant and various state institutions keep struggling for their share in state control,” says a former senior central banker.

“This is where we need fiscal and monetary coordination; we need a sincere broader consensus of all political, business and other stakeholders.”

WHT on non-cash banking transactions has made life difficult, particularly for tens of thousands of retailers, distributors, shopkeepers, commission agents and small businessmen. They complain that they regularly issue and receive lots of cheques that keep changing hands due to the nature of their business.

This leads to the deduction of WHT multiple times on the money that keeps rolling in their bank accounts. That is why many small businessmen are keeping banking transactions at a minimum, and often use cash for settling claims of daily or weekly payments, people running small businesses say.

Despite SBP’s advice of a ‘rethink’ on the policy of WHT on banking transactions, it is difficult to predict whether the government would make any change in it right now or at the time of presenting the next budget.

In 2016-17, additional flow of CiC was recorded at Rs577bn, down from Rs779bn in 2015-16. But private business deposits as a percentage of total deposits rather slipped marginally to 24.9pc in 2016-17 from 25pc in 2015-16.

Published in Dawn, The Business and Finance Weekly, October 30th, 2017