Mini-Budget: The good news and the bad news

The bad news is that the Finance (Supplementary) Bill 2021 (mini-budget) will increase prices, mainly of luxury items. The good news is that the impact of the general sales exemption withdrawal on the price hike will not be very significant, as claimed by many commenters. Before I explain how, let me give you some background.

Most economies in the world have a multi-stage tax levied at a uniform rate, at each stage of the supply chain of goods and services, with a set-off for the tax paid at the earlier stages of the chain. Apart from revenue collection, it helps in documenting the economy as an intermediary in the supply chain would only be able to set off its paid tax when it submits its tax return.

Successive governments have tried to introduce such taxes to document the economy’s undocumented sectors and broaden the tax net since the late eighties. A general sales tax (GST) under the Sales Tax Act, 1990 (STA) was introduced by replacing the Sales Tax Act, 1951. At that time, different rates of GST were allowed for different sectors, keeping in view their economic priorities and problems. Certain sectors were zero-rated (meaning that there is no output tax on goods but the input tax borne is refundable to the supplier), while others were charged a reduced rate, and certain others were exempt from the GST (where output is exempt from tax whereas the input tax borne is not refundable). This created anomalies and distortions, turning the refund into a cumbersome process.

To remove these distortions, the PPP regime in 2011-12, on the advice of the International Monetary Fund (IMF) programme, tried to introduce a reformed GST (RGST) system but failed and had to terminate the IMF programme prematurely.

Ten years down the road, the current government, on the advice of the IMF, took the right step – proposed, till the National Assembly approves it – to remove the distortions in the GST through the withdrawal of exemptions and by levying GST at a uniform rate across the board. The GST reforms will also help document the undocumented sectors of the economy.

Essential food items used by the people, such as wheat, wheat flour, wheat bran, rice, vegetables, fruits, pulses, fresh poultry, fish, meat, fresh milk, etc, are exempt from the GST. So are educational books and stationery items, imported parts for computers and laptops, and imported plants and machinery for special economic zones. Agriculture tractors, fertilizers, inputs into the fertiliser sector, pesticides, used clothing and footwear, and cinematographic equipment will continue to be charged at a reduced rate of GST.

The monetary impact of the mini-budget is Rs 343 billion. Rs 160 billion worth of exemptions were withdrawn from the pharmaceutical sector, Rs 112 billion worth of exemptions were removed from machinery, and Rs 71 billion from goods. GST on pharmaceuticals and machinery is refundable and adjustable. Hence, their net impact on retail prices would be zero.

Contrary to the common perception, this will actually help reduce the price of medicine. Previously, medicines were ‘exempt’ from GST, and so the input tax borne by the manufacturer in the form of packing materials and other items was not refundable. In the mini-budget, medicines have been made ‘zero-rated’. This means that the input tax borne on packing materials and others (worth Rs 35 billion), which was being passed on to consumers) would now become refundable. Likewise, GST has been levied on imported ingredients to manufacture medicine, but this would again be refundable. Bringing this sector into the GST regime will assist in documenting – and thus expanding the tax net – Rs 530 billion in undocumented supply chain.It will also help fight counterfeit drugs, tax evasion, transfer pricing, and misuse of exemptions.

Like medicines, the withdrawn GST exemption on machinery is also refundable or adjustable, and does not affect consumers. In the case of goods, the withdrawal of Rs 36 billion worth of exemptions is on goods classified as luxury items and includes imported branded meat, fish, poultry, etc. Their users are usually upper - or upper-middle-income earners, but middle-income earners also use them. The latter would feel the maximum pinch of the price hike on ‘luxury items’.

Exemptions worth another Rs 31 billion have been withdrawn from business goods. At the same time, Rs 2 billion worth of exemptions has been removed from business goods used by the government (like those in public hospitals) and goods used by the people.

On top of the exemption withdrawal, the FBR has levied an advance tax on cellular services, an advance tax on vehicle registration to discourage on-money (premium), and an advance tax on foreign TV series, dramas, and advertisements. The FBR has also proposed raising federal excise duties on motor vehicles with displacements greater than 1000cc by 2.5–10%.The advance tax is recalculated in the final tax liability.However, those using pre-paid phone services would find it difficult to adjust their advance tax.

A commendable step in the mini-budget is introducing a marketable system for promoting documentation and bringing transparency to the real estate business as per internationally prevalent practices. The Real-estate Investment Trust (REIT), introduced in the Income Tax Ordinance 2001, can now have subsidiary companies (particular purpose vehicles, or SPV). The income of a REIT SPV is tax-free if 90 percent of the profit is distributed among trustees (REIT investors).

Through the mini-budget, the FBR has sought the power to obtain information from banks and financial institutions about a list of people containing particulars of their business accounts opened or re-designated during each calendar month. This amendment will discourage tax evasion.

Besides the supplementary finance bill, the government has also introduced the State Bank Amendment Act 2021. In line with established best practices, the purpose is to give the State Bank of Pakistan (SBP) functional and administrative autonomy and strengthen its accountability. Again, on the advice of the IMF, this is yet another step in the right direction. An independent board will govern the SBP. Non-executive directors of the board, governor, deputy governors, and external members of the monetary policy committee would be appointed by the president/government of Pakistan for a five-year term (eligible for a second term). They can be removed by the appointing authority for serious misconduct as determined by a court of law. The government will not borrow from the SBP, and the central bank’s objectives would be to control inflation, bring financial stability, and support the government’s economic policies to foster development.

The bill could be improved by adding that the government would provide a medium-term inflation target (defining inflation as whether CPI or core) target. Likewise, the accountability mechanism for not delivering on targets needs to be strengthened beyond submitting an annual report to parliament. The clause of zero borrowing should be changed to provide flexibility for borrowing in emergencies (while also defining ‘emergency’).

The government also seems to be moving from tax exemptions to targeted subsidies. After refunds and adjustments, Rs 33 billion of the revenue raised through the mini-budget is allocated for targeted subsidies, including Rs 10.5 billion for infant formula milk, Rs 7.86 billion for (cotton, maize, other) seeds, Rs 6.1 billion for poultry, cattle, and fish feed raw materials and preparation, Rs 5.1 billion for oil cake, Rs 1.3 billion for goods supplied to government hospitals, Rs 1 billion for agronomic equipment, and Rs 400 million for imported laptops and computers. How well these targeted subsidies are distributed is yet to be seen. However, the government is running out of chances and should ensure that the subsidies reach the target beneficiaries quickly and transparently.

We should not dismiss the mini-budget and SBP amendments, merely because they were initiated on the IMF’s advice. One thing is certain: Pakistan desperately needs economic documentation in order to broaden its tax base, and some of the initiatives in the mini-budget are likely to have a massive impact in achieving that goal.Let’s give them a try.

Originally published in The News