The Shehbaz Sharif-led government, earlier today, announced the imposition of a super tax of 4 per cent across all sectors and 10pc on 13 sectors, including banks, automobiles, cement, chemicals, sugar, energy and textile companies, in a bid to shore up tax revenues and bridge the fiscal deficit, which is critical for the resumption of the IMF programme.

On the face of it, the move makes sense: the continuation of the IMF programme remains critical for the country's external solvency, and to avoid a potential default scenario — thereby making it essential that tough decisions are taken, even though they may not be feasible in the mid- to long-term.

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The imposition of the super tax also comes after record profitability of companies across the spectrum as the economy started to show some cracks after a two-year binge of 5pc plus growth rates, fuelled by subsidised financing and amnesty schemes.

As is typical of the boom-bust cycle that we have become all too familiar with, the import-driven consumption eventually led to a burgeoning balance of payments crisis, which can only be managed through a timely closure of the IMF programme, followed by restructuring, or rollover of other multilateral, and friendly sovereign debt.

Giving back

A review of the segments on which the 10pc super tax has been imposed reveals that the sectors have largely benefited from government’s largesse in one form or another, either through the government being the largest customer, or through the government guaranteeing returns via a virtual monopoly, or by simply providing concessional financing in one form or another.

Segments benefiting from such largesse may not feel the heat by sharing some of the profits they had generated through public finances, and guarantees. It is estimated that more than 80pc of the tax collected in this way would be from banks and oil and gas companies.

The government is itself the largest customer of banks, with the sector's exposure to the government being greater than 60pc of its asset base. In effect, due to the government's insatiable funding requirements, it continues to crowd out private-sector funding. Meanwhile, the banks are all too happy to lend to it at ever-increasing interest rates, considering it to be ‘risk-free’.

For the last few years, banks have essentially been conduits for sovereign borrowing, and most of their profitability can be traced back to the sovereign as well. In such a scenario, the state is simply taking back some of the profits from the banks to manage its deficit. After all, it is also not in the banks' favour for the country to default, in which case they will be carrying sovereign papers worth a few paisas to the rupee.

Similarly, a tax on LNG terminals is also basically the government taking back some of the profits it allowed the companies to accumulate through various off-take guarantees issued earlier on.

Inflationary pressure

There is also an expectation that due to the imposition of the super tax, prices would increase, which would feed into the overall inflationary spiral. That may not necessarily be true, as the world isn't really as linear.

Pricing is a function of demand and supply. Any entity increasing prices may eventually see a fall in demand of their product, as another entity would try to capture their market share with a lower price.

Inflation, during the next twelve months is certainly going to be in double digits, but the impact of additional taxation on it would be minimal, as pricing will follow market dynamics. The impact of a higher one-off tax on inflation would be minimal at best, and would be dwarfed by other supply side considerations.

The risk

But will the move pay off? Or will it do more harm than good?

Finance Minister Miftah Ismail has said that the super tax is a one-off event, and will not be a recurring feature. One hopes that is the case, and that it doesn’t become a precedent, eventually leading to higher effective tax rates. Moreover, arbitrary changes in tax rates significantly hurt policy continuity, and reduces faith in a government that is already operating on very low levels of trust.

Due to such arbitrary decisions, future investment and injection of fresh capital in the economy take a back seat as investors reevaluate, often notching up the risk associated with an economy due to policy inconsistency.

Furthermore, through arbitrary imposition of taxes, as well as arbitrary amnesties, governments continue to maintain an environment of uncertainty where any serious long-term capital decisions cannot be taken. This hurts the formal investment activity in the country, as capital holders are more inclined towards areas of the economy that remain untaxed, or are favoured by policy makers.

This further perpetuates the incentive to reallocate capital towards real estate, agriculture, and other largely untaxed, and undocumented segments of the economy — thereby keeping the formal investment rate at levels much below other peer economies. A band-aid driven approach can only take an economy towards the next crisis, unless serious reforms are done.

The end goal

In this case, however, most entities on which the 10pc super tax is being levied have been benefiting from taxpayer money in one form or another — and it may be kind of justified for them to cough up some of the profit to ensure the solvency of the sovereign. It is estimated that the after-tax profits for these entities would reduce by an average of 10pc.

The measure is crude at best, but does provide the necessary impetus to ensure solvency.

Nonetheless, it remains essential that the government initiates a reform programme and plugs the infinite amount of leakages that exist in the machinery, and within state-owned enterprises.

Similarly, it is imperative that real estate and agriculture holdings be brought into the tax net, such that a sizeable recurring source of taxation can be developed, instead of exclusively relying on a handful of corporate taxpayers to bail out the government in every crisis.

The corporate tax needs to be lowered to incentivise more investment and more corporatisation. Pakistan has had a lost decade where per capita income has largely stagnated, and we now have a recurring solvency crisis every three years — if reforms are not done, things are only going to get worse, and there will be no golden goose to cull at that point.