AS the government prepares to unveil the federal budget on June 12, negotiations between the finance ministry and the Inter­national Monetary Fund (IMF) are ongoing regarding the extent of adjustments asked by the latter. The agreement on the size of the adjustment between revenues and expenditures will determine the revenue collection target for the Federal Board of Revenue (FBR) in the fiscal year 2024-25.

Since 2018, the IMF has shifted its focus from budget deficit to ‘primary balance’, which is the difference between revenue and expenditures, excluding interest payments. This indicator determines the sustainability of a country’s debt accumulation trend. Additionally, the IMF has revised its tax policy to prioritise ‘elastic income sources’, disregarding the FBR’s flawed estimates of tax proposals. This new approach focuses on areas or sectors where changes in tax rates lead to predictable and reliable revenue increases.

The IMF’s shift in focus stems from its scepticism towards the FBR’s tax proposals, which have consistently underperformed due to their inelastic nature, such as the failed gift tax programme or measures vulnerable to being overturned in higher courts. It has been observed that even after imposing taxes on products or sectors, only half of the predicted revenue is realised, and in some cases, the estimated tax plans yield no revenue at all.

As part of the adjustment, the government has agreed with the IMF to partially reverse the provincial transfers under the 7th NFC Award. In FY25, the provinces are expected to generate surpluses totaling Rs1.2 trillion, with Punjab contributing Rs700 billion, Sindh Rs300bn, Khyber Pakhtunkhwa Rs175bn, and Balochistan Rs111bn. To generate additional revenue for the Centre, the petroleum development levy on petroleum products will be increased further. While the IMF has requested a reduction in current expenditure, the government is either unwilling or lacks the fiscal space to implement such a cut.

Since 2018, Fund has shifted its focus from budget deficit to ‘primary balance’

The unwillingness of the finance division to cut current expenditure has led to an ambitious FBR tax target of Rs13tr for FY25, exceeding the IMF’s target of Rs12.4-12.6tr and the FBR’s own indigenous working-based target of Rs12tr. This means the government will need to generate an additional Rs1.8tr through tax policy initiatives. The IMF’s goal is to maximise revenue collection from predictable sources to ensure sufficient funds for debt servicing to its major creditors.

New slabs for salaried class

The IMF has recommended that the government introduce four new tax slabs for the salaried class, with two additional slabs at both the lower and higher income levels, and increase the maximum tax rate from 35pc to 45pc. According to the FBR, the salaried class is expected to contribute Rs280bn in tax revenue in FY24, which is projected to increase to Rs350bn in FY25 with the adjusted tax rates.

The second area of focus is withholding tax rates, particularly for non-filers, which account for approximately 70pc of overall income tax collection. The IMF is seeking to boost revenue through easy and predictable means, and as such, withholding tax rates will be increased across the board. Additionally, the property value table, which has been due for revision for the past two years, will be updated with higher rates in 20 cities to maximise revenue.

The ongoing effort to register around 3,000 retailers nationwide, which is expected to be completed by today, may not necessarily lead to an increase in income tax revenue. Instead, it may result in a significant number of nil filings, with no actual contribution to tax collection. In March this year, the government increased the general sales tax rate from 17pc to 18pc. The IMF has now recommended a further hike to 19pc and up to 25pc for specific categories. This 1pc increase is expected to generate an additional Rs100bn in revenue for the government. However, implementing this hike would require the government to make a difficult decision about revoking exemptions on essential items such as food, international agreements, including CPEC-related projects, and medicinal products.

The share of sales tax in total FBR revenue declined to 34.06pc in 11MFY24, down from 37.27pc in the previous year. This decline is primarily attributed to two factors: weak domestic sales tax collection and reduced sales tax collection due to sluggish import growth.

Increase in smuggling activities

The imposition of hefty import taxes has led to a surge in smuggling in the country. Various tax measures have resulted in a decline in regular imports, accompanied by an increase in smuggling activities. Consequently, the share of customs duties in total revenue decreased to 12.24pc in 11MFY24, down from 13.28pc in the previous year.

Published in Dawn, June 9th, 2024