THE estimated revenue collection of Federal Board of Revenue (FBR) in the first 11 months of 2021-22 is likely to be close to Rs5,350 billion. This represents an unprecedented jump of 28.5 per cent over the collection of Rs4,163bn in the corresponding period of 2020-21. This is probably the highest growth rate ever.

However, such an assessment should be viewed with some circumspection. The principal reason underlying this outcome is the extraordinary buoyancy in the import tax base. The rupee value of imports has increased by 58 per cent in the first 10 months of the current financial year. But, with import-based taxes like customs duty and the sales tax on imports having shown a combined growth rate of 35pc during this period, FBR needs to explain why the growth rate of revenue has been significantly less than the growth rate of the tax base.

A worrying development is the rising share of indirect taxes in FBR revenues, which is making the tax system more regressive. The share was 63.5pc in 2020-21 which is likely to rise to 65pc by the end of 2021-22, with more than 52pc of total tax revenues being collected at the import stage. This is an unwelcome development and the federal budget for 2022-23 will have to focus on the restoration of progressivity by more revenue-yielding proposals in the income tax.

Another development which requires a more careful review is the falling trade-weighted average effective duty on imports. It is likely to be close to 8pc this year. According to the World Trade Organisation publication, World Tariff Profiles, it was almost 11pc in 2015. This drop in the effective rate of import duty is one of the factors contributing to the growth in the volume of imports and thereby the worsening of the trade deficit. Here again, the forthcoming federal budget will need to consider the scaling up of the import tariff in different slabs, as a short-term measure.

Having indicated the direction of reforms that should drive the proposals for the next federal budget, we turn now to an examination of the potential target for FBR’s revenues for 2022-23.

The IMF, being a key player in the determination of such a target, has proposed it at Rs7,255 billion in the staff report issued after the completion of the sixth review of the programme. This implies a growth rate of close to 19pc on the projected level of revenues, as per the target of Rs6,100bn for the year coming to a close. Based on a likely shortfall of Rs100 billion, the targeted growth rate for 2022-23 translates to 21pc.

So, what is the likelihood of achieving revenues of Rs7,255bn in 2022-23? How much is the likely normal increase in revenues and what will be the required quantum of revenues that can be generated from taxation proposals to achieve this target? To begin with, there is a need to take some special factors into account.

First, the sales tax on petroleum products has been withdrawn. This implies an average monthly revenue loss of more than Rs 40bn. If the revenue up to February 2022 of close to Rs 300bn from this tax is excluded, then the effective base year revenues for the purposes of assessing the feasibility of the target fall to Rs 5,700bn. Hence, if the withdrawal of the sales tax on petroleum products is to continue in 2022-23 then the achievement of the revenue target of Rs 7,255bn will effectively require a growth rate of over 27pc.

Second, the buoyancy of the import tax base in 2021-22 is obviously unsustainable. And through strong policy steps, the likely import level this year of close to $78bn will have to be brought down to near $70bn next year if the pressure on the already-rather low level of foreign exchange reserves is to be eased. In effect the import tax base in rupees may either remain unchanged or show only modest growth in rupee terms.

There are other factors which will also limit the growth in FBR revenues in 2022-23. First, among the withholding taxes in income tax the two big revenue sources are on contracts and imports, with shares in total income tax revenues of 16pc and 13pc respectively. The likely restriction in the size of the PSDP will reduce the growth rate in revenues from contracts. Similarly, the constraint to growth in imports will limit the increase in withholding tax on imports.

Third, 24pc of income tax revenues accrue from the advance tax on companies. Revenues from this source will be limited by the reduction in taxable profits due to the big increase in interest rates and fuel and energy prices, the contribution of inflation to the increase in cost of other manufacturing inputs and lower demand due to the squeeze that will be experienced by households in their disposable incomes.

The domestic tax base is likely to grow by close to 18pc next year, equivalent to the real growth rate of the GDP plus the rate of inflation. Therefore, the combined normal growth of domestic and import-based taxes is projected at close to 10 percent, suggesting that without any taxation proposals, the likely level of FBR revenues in 2022-23 will be neighbouring Rs 6,270bn; on the assumption that there will be no sales tax on petroleum products. As such, the revenue required from additional taxation proposals is very large, at Rs 985bn, for meeting the IMF target.

The government needs to evaluate the implications of bringing back the sales tax and petroleum levy on petroleum products by the 1st of July 2022. This will have to be preceded by the third round of price increases to fully eliminate the subsidy. In effect, this will imply a jump in petroleum prices of at up to 50pc over the level prevailing in February 2022, prior to the announcement of the decrease in petroleum prices by Rs 10 per litre.

There is fortunately, as highlighted above, scope for enhancement in import tariffs. This should be the preferred policy measure rather than the imposition of import bans on luxury and non-essential imports, which will actually imply a loss of revenues. Appropriate upward adjustment in the import duty slabs could yield an additional Rs 250bn. This will largely compensate for the loss in revenues from the sales tax on petroleum products or alternatively require fewer taxation proposals in other tax bases.

The suggested feasible target is Rs 6,900bn. In the absence of the sales tax on petroleum products this will imply a growth rate in FBR revenues of 21pc. With normal growth at 10pc, the quantum of revenue from taxation proposals in the federal budget of 2022-23 will involve substantial additional taxation of Rs 630bn. A higher target is considered infeasible given the likely state of the economy in 2022-23. Beyond the enhancement in import tariffs, the focus will have to be on resource mobilization from direct taxes. Some very progressive proposals are identified below:

· Reforms in the proposal income tax whereby the eleven slabs are reduced to six. The exemption limit is enhanced from Rs 600,000 to Rs 1,000,000. The maximum marginal tax rate will apply on income above Rs 25m, as compared to the present level of Rs 75m.

· Conversion of fixed and final taxes on dividends, interest, rental income, etc., to be converted into advance taxes. Income from these sources to be reported in the tax return for determination of the total tax liability minus the advance taxes paid.

· Taxation of long-term real capital gains on property and shares at 10pc. The provision of exemption beyond the specified holding period should be withdrawn, with the real capital gain in the case of real estate being estimated through appropriate indexation, to factor in higher rates of inflation.

· Reintroduction of the wealth tax in the form of the capital value tax initially at the rate of 1pc.

· Careful review of exemptions in the Second Schedule of the Income Tax Ordinance and exemptions withdrawn from corporate entities and from NGOs not operating in the areas of health or education.

· Minimum tax on rental incomes from commercial properties, equivalent to 3pc of the market value as reported by FBR on valuation of properties in various neighborhoods in different cities.

· Enhancement in the withholding tax rates on electricity bills of commercial consumers and residential consumers where the consumption is more than 1,000 units per month. This is considered essential to reduce the import demand for fuel used in power generation.

· Pitching the tax on commercial banks at 45pc. This, admittedly, is the second best option. In view of the inability of the public finances, even in the medium term, to generate surplus of close to 5.2pc of GDP to service the interest payments on domestic debt, the first best option is to write-off some of the face value of the debt. However, since it would be challenging, for a variety of reasons, to adopt this route in the short term, the second best option is being proposed as a measure to get something back from the commercial banks some of the massive profits that they have made.

· Strong exhortation on the provincial governments to develop the agricultural income tax and the urban immoveable property tax in their respective budgets of 2022-23.

Overall, the finalisation of the federal budget for 2022-23 represents a formidable challenge to the new coalition Government. There is need for a persuasive dialogue with the IMF for agreement on the proposed revenue target Rs 6,900bn in 2022-23.

The writers are a former federal minister and a former governor of the State Bank of Pakistan, respectively

Published in Dawn, June 8th, 2022