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Published 12 Jul, 2021 07:10am

Taxing NSS income

While managing the domestic debt, the government has to decide how much it should borrow from banks and non-bank sources. Pakistan is currently caught in a debt trap. Making such decisions is not easy. Lots of trade-offs are made, each with an opportunity cost. This process keeps compounding the existing issues of domestic debt management and makes them even more complex for the future.

Instruments of National Savings Schemes (NSS) provide the government with a relatively easy way of non-bank borrowings. But promoting NSS is not possible without paying savers a substantially higher return than they earn on saving products of banks. Banks do not like this idea. And, they use their extraordinary clout in the financial sector to block any move that makes NSS instruments substantially more lucrative than their savings products.

That is why the share of non-bank borrowing through NSS remains very low. And that is why investments in NSS have been falling — more so after the discontinuation of high-denomination prize bonds of Rs40,000, Rs25,000 and Rs15,000.

In fact, net investments in NSS turned negative in the first 11 months of the last fiscal year: investors made net withdrawals of about Rs193.5 billion, according to the statistics released by the State Bank of Pakistan (SBP).

Unregistered prize bonds — regardless of their denomination — contribute to the expansion of the parallel economy and are, thus, undesirable anyway. A decline in non-bank borrowing via NSS amidst a high fiscal deficit, however, makes the government even more dependent on bank borrowing. That crowds out the private sector, undermining the economy’s growth potential. These are plain, undeniable facts.

A decline in non-bank borrowing through NSS often makes the government panicky

A persisting decline in non-bank borrowing through NSS often makes the government panicky. It tries to manage the situation with occasional — and minimal — increase in the rates of return on NSS. But that does not work. Borrowing by the government from banks keeps growing. Banks have long been enjoying the benefits of this cyclical issue of domestic debt management. The government keeps watching with helplessness and people continue to suffer in the absence of high-yield savings instruments of NSS.

In this backdrop, increasing the tax on investment income from NSS becomes questionable. But here again the challenge of containing the high fiscal deficit does provide a justification for this move — however weak this might be. Governments lacking the nerve to tax the untaxed can only think of taxing the already taxed even more.

After all, a large sum of money that is parked in NSS is the taxed income of people. In recent years, however, the government has started taxing at a higher rate the untaxed money (i.e. the money invested in NSS by people that do not regularly file their income tax returns). In the new fiscal year, the tax rate on NSS income is 15pc for regular tax return filers and 30pc for the non-filers, up from 10pc and 20pc until last year.

This hike in the withholding tax on NSS returns may further dissuade people, particularly small investors, from parking funds in NSS. There are two key reasons for this: first, the majority of individuals who invest in NSS are not on the active taxpayers’ list and, hence, liable to pay 30pc withholding tax, which is too high to keep them away. And second, the rates of 15pc for tax return filers and 30pc for non-filers are applicable only if their profits from investment in NSS remain up to half a million rupees.

If the profit exceeds this limit, both will have to pay 35pc withholding tax, according to a notification of the Central Directorate of National Savings (CDNS).

This seems like encouraging non-filers to invest larger sums of money into NSS so that they can earn returns of more than half a million rupees and are treated on a par with the filers. CDNS must clarify this point to end the confusion in the minds of ordinary people.

The stock of investment in CDNS exceeds Rs4.3 trillion. It is not known how much of it has been invested by small investors. But as far as the number of investors is concerned, more than 60pc of them are thought to be small investors.

It is true that in the first 11 months of 2020-21, net investments in NSS turned negative chiefly due to the encashment of unregistered prize bonds but investments in other NSS products also remained negative on the net basis. The only product that attracted net investments of about Rs23.6bn was regular income certificates.

Increasing the tax rate on NSS income for non-filing small investors holds some merit on account of the documentation of the economy. But the government could have increased the rate gradually. It is also not clear whether senior citizens and widows enjoy any sort of exemption from the high rate of tax on NSS income.

Confusion prevails. To remove it, the government must publish detailed FAQs and their proper responses in English and Urdu and display them prominently at all National Savings Centres across Pakistan.

Perhaps the rapid parking of funds in rupee-denominated Naya Pakistan Certificates via Roshan Digital Accounts has emboldened the government to ignore the importance of NSS. Because such funds effectively constitute the government’s non-bank borrowing.

But policymakers must not forget that this additional non-bank borrowing is only offsetting a decline in non-bank borrowing of the government through the sales of treasury bills, bonds and Islamic bonds to insurance companies, mutual funds, corporates and other non-bank entities. At the end of March, investments in the government bills and bonds held by non-bank entities constituted 21pc of the total, down from 25.8pc in March 2020, according to SBP data.

Published in Dawn, The Business and Finance Weekly, July 12th, 2021

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