Budget Blues: Pakistan's high-stakes tax strategy

June 19, 2024 (MLN): Pakistan’s budget for the upcoming fiscal year reflects the necessity to shrink the fiscal deficit with somewhat harsh taxes spanning across various segments, but this might pave the way for an expanded IMF programme, an extension to the one reached a year ago and sailed the country towards stability.

The government unveiled the tax-heavy budget on June 12, introducing higher taxes on the salaried class, increased levies, enhanced FED, and revamps of various tax rates and their computations.

The goal through this is to achieve a tax revenue target of Rs12.97 trillion, which is around 40.2% higher compared to the revised estimates of Rs9.252tr for the current fiscal year (FY24). Meanwhile, the non-tax revenue is projected at Rs4.845tr, reflecting an estimated increase of 64.4% compared to FY24.

By expanding the revenue base, the country aims to cover its rising expenditure (Rs18.877tr) and shrink its fiscal deficit to Rs8.5tr, which is one of the key factors being considered by the global lender.

The budget documents unveiled the government targeting real GDP growth of 3.6% in FY25 while Nominal GDP is expected to grow 17% to Rs124.15tr.

With a higher base, the overall federal deficit as a percentage of GDP is expected to kick down to 5.9% in FY25, as compared to the revised budgeted estimates of 7.4% for FY24.

Federal balance + provisional balance= Fiscal balance

However, everything seems phenomenal only on papers as with such aggressive taxes, the targeted GDP growth appears questionable.

The economic sectors which had previously been burdened due to heavy borrowing costs, saw a relief after the central bank lowered its key policy rate by 150 basis points to 20.5% ahead of budget - a bigger than expected reduction and the first in almost four years.

This joy of monetary easing was short-lived for the industrial sector as the budget introduced a mountain of heavy taxes and removal of exemptions.

As soon as the budget was disclosed, the industrial sector along with the salaried class voiced their already burdened situation, warning that it would worsen if the government imposed the planned levies, duties and taxes.

The textile sector, which is the dominant source of foreign exchange earnings through exports and the largest sector of Pakistan described the budget as extremely regressive, one that threatens the collapse of the textile sector and its exports.

"This could have dire consequences for employment and external sector stability, as well as for overall economic and political stability and security of the country," All Pakistan Textile Mills Association (APTMA) said.

Identically, the ethanol industry representatives appealed the Finance Minister Muhammad Aurangzeb to reconsider the recent tax policy changes, which include eliminating the previously beneficial 1% full and final tax and imposing a burdensome 29% tax in the budget for FY25.

Chela Ram Kewlani, Chairman Rice Exporters Association of Pakistan (REAP) also strongly opposed the decision to convert the Export trade from Final Tax Regime (FTR) to a Hybrid model as this combination shall be disastrous for export business of country.

The above examples of industrial dissatisfaction express the grievances of certain segments of the economy, whereas the negative aspects spread across several sub-parts that are crucial for the government to address in order to achieve its desired growth targets.

This takes the entire economy and the government to an uncertain condition, questioning how the economy will grow and improve if it continues to face restrictions in the form of hectic taxes.

Pakistan is often highlighted as an economy that lacks persistent structural reforms. Hence, to support the growth target, will the government be forced to reconsider these reforms?

Perhaps with the next expanded programme with the IMF worth $6 to $8bn on the cards, and as the majority of the well-reputed agencies sight the highest probability of a successful conclusion due to the aggressive budget, the government might appear to be rigid to these newly introduced tax measures.

This means that the government might not be able to provide relief measures, as sectors desire.

However, IMF might also demand a true framework detailing how the revenue and GDP growth target would be met, as the real challenge lies in the successful and appropriate implementation of the budget proposals.

The targets are also exposed to the risk of social and political tensions, which were apparent during the budget release, probably the sole reason for the delay in budget speech.

Furthermore, as more than half the country’s revenue is expected to be paid off as interest payments, this indicates high debt sustainability risks and a constrained ability to meet social spending and infrastructure needs.

A notable fact to mention here is that the projected federal deficit of Rs8.5tr is expected to be covered by 91.8% through domestic markets during the upcoming fiscal year (July-June FY2025).

This involves Rs7.683tr to be raised through government securities including Treasury Bills (T-bills), Pakistan Investment Bonds (PIBs) and Ijara Sukuk, while the remaining is proposed to be filled through National Saving Schemes and other deposits.

This turns out to be a positive sign as the government is making efforts to reduce its dependency on foreign sources.

Additionally, the budget presents an extreme crackdown on non-filers who do not file returns even in response to notices, barring their exit from Pakistan.

This action comes with exceptions for Hajj and Umrah travelers, minors, students, overseas Pakistanis and other classes of persons as notified by the Board.

Bringing the undocumented economy into the tax net represents a considerable effort to help achieve the revenue target, yet uncertainty regarding these targets remains high.

Read:  Highlights of Budget 2024-25   Budget FY25 Visualized

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