In fragile economies, a small political shake-up can disturb a country’s entire development process, slowing down the pace of economic activity, creating a sense of insecurity in the financial sector, and diverting the nation’s progress toward economic security. All of this can result in another set of problems. This is exactly what happened in Pakistan almost three months before the announcement of the federal budget for 2022–23.
Economic and Political Background to the Budget
The coalition government faces mountainous issues: spiraling inflation, massive devaluation of the Pakistani rupee against major world currencies, increasing fuel prices, and the drying-up of foreign currency reserves. Surrounding all of these challenges is the fear of a debt default.
According to recent data from the State Bank, Pakistan has:
- Net reserves of $8.8 billion;
- Commercial bank reserves of $5.67 billion;
- A current account deficit for the financial year 2021–2022 of $17.41 billion and for July 2022 of $3.13 billion; and
- A balance of trade deficit for the financial year 2021–2022 of $44.71 billion and for July 2022 of $3.35 billion.
In July 2022, national Consumer Price Index inflation increased to 24.9% (from 21.3% in the previous month). So far this year, GDP has grown at a rate of 5.97% (against a target for 2022–2023 of 5%).
Much of Pakistan’s political history consists of decisions that were made without considering the economic consequences. Moreover, many previous governments could not succeed in the economic realm because they did not have a good team of economists who could formulate sustainable economic policies. Governments relied mostly on bankers or chartered accountants to run the Ministry of Finance and failed to put the country on a sustainable development track.
The continuing economic problems have been caused by inconsistent economic policies, pursuit of the wrong priorities, and bad governance. This is why Pakistan has not significantly developed over the last 75 years. Fiscal policies have also lacked consistency—subsequent governments changed policies to prioritize certain sectors, resulting in unstable economic conditions.
Some of these facts were highlighted by the new finance minister in his budget speech:
“Every year, a different person used to present budget and every year … economic policies of the government would change due to which confidence of investors and development partners was shaken.”
“In emerging market countries, tax-to-GDP ratio is around 16%, but in Pakistan it is 8.6% at the moment.”
Each new government has blamed the previous one for the bad economy, but none of them has been serious about pulling the country out of the economic crisis. Governments have joined the International Monetary Fund program to overcome fiscal problems and reduce the budget deficit, but they then spend more (and earn less), using most of their revenue to repay the national debt.
In the fiscal year 2022–23, Pakistan’s total debt servicing payment is estimated to be 3.95 trillion Pakistani rupees ($17.9 billion). Public debt (as of March 2022) was 4.44 trillion rupees (72.5% of GDP).
Pakistan’s tax governance remains weak. The state has never been able to create an iron will to collect revenue through good governance, better policies, and a strong tax culture. There is no serious documentation initiative to register retail businesses, even in large cities, and tax them according to their income.
Total tax collected in financial year 2021–22 is 6.125 trillion Pakistani rupees. The revenue target for the year 2022–23 is 7 trillion rupees. Most of the time, the Federal Board of Revenue meets the revenue targets, but that does not mean that the collected amount is the tax due from a nation of 220 million. According to an estimate, tax theft has amounted to around 3 trillion rupees.
Successive governments have failed to improve tax governance, despite funding from the World Bank and other international institutions established to help reform and restructure tax systems. Instead of stopping tax evasion and increasing the number of taxpayers, the government has increased taxes on those who already pay them. This has further burdened businesses and slowed down economic activity. Less than 2% of Pakistan’s population of 220 million people file tax returns.
Fixed Tax Regime for Retailers
This year, the government proposed introducing a special fixed tax regime for retailers, through the Finance Bill 2022, whereby retailers, other than tier one and specified service providers, would pay fixed amounts of income tax, ranging from 3,000 to 10,000 Pakistani rupees, through their commercial electricity bills.
The coalition government estimated that more than 30 billion rupees of tax would be collected from retailers through these measures. Millions of retailers operate in Pakistan and successive governments, despite several attempts, have failed to bring them under the tax net. Various schemes, including fixed tax schemes, have been tried, but every time retailers have threatened strike action that would shutter businesses until the disputed tax laws were withdrawn. Consequently, the government has withdrawn every tax scheme that would have applied to small retailers.
However, this time the government, after initially postponing the proposed fixed tax levy, then decided to reduce its tax impact. Now, tax on retailers other than those falling in the tier one category is chargeable at the rate of 5% where the monthly electricity bill does not exceed 20,000 rupees, and 7.5% where the monthly bill exceeds 20,000 rupees.
The 2022–23 budget contains a number of measures designed to relieve various sectors of the economy. They include:
- Energy: exemptions from sales tax for the import and local supply of solar panels, to encourage the use of renewable energy;
- Agriculture: exemptions from sales tax for the supply of tractors, agricultural implements, and various seeds including wheat, rice, maize, sunflowers, canola, and rice;
- Health: exemptions from sales tax for imports or donations to charitable hospitals and local supplies, including electricity to charitable/non-profit hospitals with 50 or more beds;
- Agri-based industry: exemptions from customs duties for agricultural machinery for irrigation, drainage, harvesting/post-harvest handling and processing, greenhouse farming, plant protection equipment, and machinery, equipment and other capital goods for agri-based industries;
- Industry: reduced duties for various industrial manufacturing sectors;
- Textiles: decreased tariffs for synthetic filament yarn;
- Pharmaceuticals: exemptions from customs duties for over 30 active pharmaceutical ingredients;
- Oil: reduced minimum tax on turnover of oil marketing companies (from 0.75% to 0.5%).
The budget contains various proposals. They include:
- The rate of advance tax will be increased from 1% to 5% of the fair market value of any immovable property purchased by persons who are not active taxpayers.
- The rate of advance tax on registration of vehicles for non-filers will be increased by 200%.
- Advance tax rate on private vehicles with engine capacity of 1600cc and above will be increased.
- On the direction of the Federal Board of Revenue, gas and electricity distribution companies will discontinue the supply of gas and electricity of any person, including tier one retailers, not registered for sales tax or, in the case of notified tier one retailers, registered but not integrated with the Board’s computerized system.
- The Board has already started the integration of the point of sale system to document the retail sector. A total of 4,563 tier one retailers are now connected to the Board and a number of point of sale computerized lucky draws have been held. Prize money of 318 million Pakistani rupees has been paid out to 6,042 winners.
- The petroleum levy will be increased to 50 rupees per liter on several petroleum products, including high speed diesel oil, motor gasoline, superior kerosene oil, and light diesel oil. On locally produced/extracted liquefied petroleum gas, the levy will be increased to 30,000 rupees per metric ton.
- For the 2023 tax year and onward, the income of banking companies earned from investment in federal government securities will be taxed at 55%, 49% and 39% if the gross advances to deposit ratio is up to 40%, 40–50%, or above 50%, respectively.
- For the 2022 tax year and onward, a super tax ranging from 1% to 4% (based on graduated income slabs) will be levied on persons earning more than 150 million Pakistani rupees. The top rate of 4% applies to income exceeding 300 million rupees. However, for the tax year 2022 only, where the annual income of a person engaged wholly or partly in the business of airlines, automobiles, beverages, cement, chemicals, cigarettes and tobacco, fertilizer, iron and steel, liquefied natural gas terminal, oil marketing, oil refining, petroleum and gas exploration and production, pharmaceuticals, sugar, and textiles exceeds 300 million rupees, it will be taxed at a rate of 10%.
- For the 2023 tax year, banking companies will pay 10% super tax if their income for the year exceeds 300 million Pakistani rupees.
- For the 2022 tax year and onward, a resident person will be treated as deriving income equal to 5% of the fair market value of any capital assets situated in Pakistan on the last day of the tax year. Such income will be chargeable to tax at the rate of 20% provided certain exclusions (for example, self-owned property) do not apply. Also, where the fair market value of the capital assets in aggregate does not exceed 25 million Pakistani rupees, the tax will not be imposed.
- The whole amount of any capital gain arising on the disposal of immovable property will be subject to tax at rates ranging from 0% to 15%, depending on the length of time that the property has been held.
- For the 2023 tax year and onward, capital gains arising on the disposal of securities acquired after July 1, 2022, will be taxed at graduated rates ranging from 2.5% to 15%, depending on how long the securities were held. Gains resulting from securities acquired on or before June 30, 2022, will continue to be taxed at the flat rate of 12.5% (regardless of the holding period).
- Poverty Alleviation Tax: Tax has been imposed on higher earning persons for poverty alleviation for tax year 2022 and onward.
- Tax has been imposed on income from unutilized property above 25 million rupees, including luxury farmhouses but excluding one self-occupied house.
- Tax exemption on income payment plans invested out of pension/annuity account/plans has been withdrawn.
Pakistan’s economy is under pressure due to a current account deficit of around $10 billion and principal repayments on its external debt of around $24 billion. From April to July 2022, the rupee devalued by more than 10%. Due to the political uncertainty, demand for US dollars increased, the money markets fluctuated, and reserves decreased day by day. Inflation also rose, due to the increases in fuel and energy prices. The government is clearly in a bind; how should it meet the multiple challenges facing it, including the trade and current account deficits and inflation?
In April, the State Bank of Pakistan took some extreme measures by imposing 100% cash-margin requirements against 177 import items to minimize the gap between imports and exports, and requiring the bank’s prior approval before automobiles, mobile phones, and machinery could be imported. However, after four months, it relaxed such requirements. Currently, if the terms of payment for imports are 91 to 180 days, the cash margin requirement will be 25%. It will be 0% if the terms exceed 180 days. The cash margin requirement measures have had a positive impact on the import bill. It decreased from $7.9 billion Pakistani rupees in June 2022 to $6.1 billion in July 2022.
The International Monetary Fund ’s 23rd program for Pakistan has been approved and the first tranche of around $1.2 billion has been received. Bearing in mind the country’s foreign exchange reserves position, Pakistan needs extra support of $4 billion. A funding arrangement is being planned from different sources, including loans from friendly countries.
In view of the economic problems of developing countries such as Pakistan, effective and sustainable policy making and reform can only be done on the basis of proper data analysis. If Pakistan’s economy is not growing at the required pace, then policy makers must find out the causes and prepare a comprehensive development plan to implement sustainable growth without political interference. On the administrative front, there are various issues which need to be addressed; implementing the best policies will not work if there is weak enforcement—that is one of the biggest problems in Pakistan.
At the same time, Pakistan needs stability. Political instability ruins the process of economic development and creates bad governance, which ultimately takes over all the civil institutions, resulting in recurring financial crises.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
G.B. Sahqani is an international trade and tax consultant.
The author may be contacted at: firstname.lastname@example.org