Inflation Makes Pakistan's Fiscal Deficit And Taxation Problems Worse

At the heart of Pakistan's dysfunctional fiscal system is a regressive taxation scheme. Too many poor individuals are overtaxed, and the recipients of state privileges pay little to no tax at all. This protection of powerful segments has given rise to our fiscal ...

Inflation Makes Pakistan's Fiscal Deficit And Taxation Problems Worse

Inflation is always and everywhere a monetary phenomenon”—Milton Friedman

“A deficit is only evidence of overspending if it sparks inflation…. The threat to our common wellbeing isn’t the budget deficit. It’s excessive inflation”Stephanie Kelton in The Deficit Myth

owing to 10% sales tax on poultry feed, chicken prices rose by 12% to Rs382 per kg compared to the pre-budget month. Powdered milk got expensive by 17%, or Rs140, to Rs992 per pack following the imposition of sales tax and withholding tax. PBS data revealed that sugar prices increased to an average of Rs146 per kgBudget accelerates inflation in July, The Express Tribune, August 2, 2024.

Successive governments in Pakistan, year after year, have proved that they have no desire to achieve fiscal consolidation, overcome monstrous fiscal deficit and control inflation. They love to borrow, both internally and externally, push inflation by overspending, increasing regressive taxes and prices of electricity and items of daily use. The twin menace of reckless overspending and mindless insatiable borrowing have pushed Pakistan in a dark debt prison, emerging out of which poses a daunting challenge. For the overwhelming majority of the citizens, the real issue now is economic survival due to the ever-rising cost of living and rapidly deteriorating quality of life.

Much has been written on debtocracy and debt enslavement from the perspective of constitutional political economy in the world, but in Pakistan scanty literature is available about its historical evolution (Pakistan: Drug-trap to Debt-trap). The deadly debt trap, in which Pakistan is presently caught, is not an isolated economic issue. It has serious political connotations (crisis of an elitist economy and neo-colonial subjugation). It has also other serious aspects e.g. naked and blatant violation of fundamental rights of the downtrodden who are ruthlessly taxed to fund the luxuries of the militro-judicial-civil complex and their cronies in politics, trade, commerce, industry (including media) etc.

The dilemma of our successive governments—civil and military alike—has remained the same: on the one hand, they want to lower inflation and on the other have been praising growth in regressive taxes!

According to the Summary of Consolidated Federal and Provincial Fiscal Operations, 2023-24  released by the Ministry of Finance on July 30, 2024, on the basis of provisional data, in the fiscal year (FY) 2023-24, Pakistan suffered historic high fiscal deficit of Rs. 7.2 trillion—16% higher than the FY 2022-23. The total revenues (federal and provincial) were Rs. 13.27 trillion while total expenditure reached Rs. 20.48 trillion. The debt servicing alone was Rs. 8.159 trillion.

The federal government had net revenues (tax and non-tax) of Rs. 7.079 trillion, after transferring Rs. 5.263 trillion to the provinces. It borrowed funds of Rs. 1080 billion to meet burgeoning shortfall in debt servicing alone—thus entire defence expenditure of Rs. 1.859 trillion and others expenses were met from expensive borrowed fund.   

The dilemma of our successive governments—civil and military alike—has remained the same: on the one hand, they want to lower inflation and on the other have been praising growth in regressive taxes! By reducing and rationalizing taxes on fuel used for electricity generation (ultimately passed onto consumers), the government in 2023 could have avoided further increase in tariffs, especially permanent electricity surcharge of Rs. 3.23 per unit imposed on March 1, 2023. The same is true for the recent unbearable hikes in electricity charges where element of taxes/cess/charges is enormous

It needs to be highlighted that the Federal Board of Revenue (FBR) collects sales tax based on 100% billed amount irrespective of recovery or otherwise. The exorbitant sales tax of 18% plus additional charge of 4% in case of unregistered persons is contributing largely in cost-push inflation.

In FY 2023-2024, against the assigned target of Rs. 9415 billion, FBR collected Rs. 9311 billion. According to the Summary, FBR has collected Rs. 4.53 trillion as direct taxes, Rs. 3.99 trillion as sales tax, Rs. 1.10 trillion as custom duties and Rs 577.4 billion as federal excise duty. It is well-established that many withholding provisions in Income Tax Ordinance, 2001 bear the nature of indirect taxes that not only adversely affect the salaried class and the poor but are also among the factors triggering high inflation that reached 31.5% in February 2023.

Contrary to the claim of FBR and perception in media that shopkeepers do not pay any tax, the fact is that all retailers, having commercial connections but not falling in Tier-1, pay 5% sales tax with electricity bills where total monthly bill does not exceed Rs. 20,000, and at the rate of 7.5% where the monthly bill exceeds this threshold and additional 4% sales tax in the case of unregistered retailers. The electricity supplier is bound to deposit this amount without adjusting any input tax.

Section 235 of the Income Tax Ordinance, 2001 also impose the income tax on all users of commercial and industrial users. Where gross amount of electricity bill exceeds Rs. 500 per month but does not exceed Rs. 20,000, rate of withholding tax is 10% and where the amount exceeds Rs. 20,000, it is Rs. 1950 plus 12% of the amount exceeding Rs.20,000 for commercial consumers, and Rs. 1950 plus 5% of the amount exceeding Rs.20,000 for industrial consumers. It is pertinent to mention that section 235(4)(a) says that in the case of a taxpayer other than a company, tax collected up to bill amount of three hundred and sixty thousand rupees per annum is treated as minimum tax on the income of and no refund shall be allowed. For domestic users, tax is withheld at the rate of 7.5% in the case of non-filers, if monthly bill is Rs. 25,000 or more.

The Prime Minister and his economic team need to be reminded of the famous quote of Milton Friedman that “inflation is taxation without legislation.” If they want to give relief to masses, they must reduce rates of all taxes, eliminate collection of sales tax and income tax at import stage and withholding taxes on electricity and internet/mobile use—in fact all withholding provisions having no nexus with income. 

Income tax collected on electricity consumption in FY 2023-34 was Rs. 130 billion. Sales tax collected through electricity bills in FY 2022-23 was Rs. 223. billion—FBR’s Year Book: 2022-23. It was the highest number, followed by petroleum, oil and lubricant (POL) products at Rs. 152 billion. These indirect taxes [withholding provisions] are inflationary and a huge burden on small & medium enterprises (SMEs) but never highlighted in any research or in briefings to the Prime Minister or Finance Minister by FBR stalwarts.       

The FBR, in a Press release issued on July 31, 2024, claimed that the “FBR has successfully achieved the revenue target for the first month of the current fiscal year, i.e. July 2024-25. Against the set target of Rs. 656 billion, a net revenue of Rs. 659.2 billion has been collected, despite the issuance of refunds amounting to Rs. 77.9 billion. During this period, Rs. 300.2 billion was collected under the head of Income Tax, Rs. 307.9 billion under the head of Sales Tax, Rs. 37.4 billion under the head of Federal Excise Duty, and Rs. 91.7 billion under the head of Customs Duty.”

The target of FBR for FY 2024-25, assigned in annual budget at Rs. 12,970 billion, is revised downward to Rs. 12913 billion in the wake of negotiations with the International Monetary Fund (IMF). The FBR deliberately fixed the target for July 2025 low to show as usual extraordinary performance (sic). Since July 2023 target was Rs. 534 billion, based on 40% increase in overall target this year, July 2024 target should not have been less than Rs. 735 billion. Historically, FBR collects 5.7% of its annual target in July, this number also comes to Rs 735 billion. Contrary to these facts/trends, the target for July 2024, was deliberately under fixed and exceeded (sic)! It will increase the burden for the coming months to be further steeper!

According to a Press report, “The month-on-month (MoM) inflation rate reached an eight-month high of 2.1% in July compared to the pre-tax-loaded period, impacting the consumers of food items the most due to direct and indirect taxes on supplies and sales”. The report further adds: “The impact was more pronounced in cities where the new tax measures hit the consumers hard. The monthly food inflation in July came in at 4.5% in urban centres–the highest since March 2023. The coalition government has imposed a record Rs1.8 trillion in new taxes in the new budget for winning a $7 billion bailout package from the International Monetary Fund (IMF). Taxes have been slapped on the salaried persons and the consumable goods used mostly by all segments of society, irrespective of their income levels.”

For reducing the unbearable burden imposed on the salaried class by inflationary budget, there is an urgent need for broadening of tax base with low rates. 

According to Pakistan Telecommunication Authority (PTA), the total cellular and broadband subscribers as on June 30, 2024 were 193 million (79.44% mobile density), 135 million mobile broadband subscribers (55.61% mobile broadband penetration), 3 million fixed telephone subscribers  (1.06 teledensity) and 138 million broadband subscribers (57.05% broadband penetration). Thus, with effect from I July 2024, the entire taxable population and even those having no income or income below taxable limit are paying advance and adjustable 15% income tax as filers and 75% as non-filers, being pre-paid or post-paid mobile and broadband users. 

Around 90 million unique mobile users paid advance/adjustable income tax during FY 2022-23 but yet labelled as “tax cheats”—a highly lamentable act. The total income tax filers, according to FBR’s latest Active Taxpayers’ List, updated on July 29, 2024, were 5,145,987, out of which individuals were 3,462,031. FBR should register all taxable persons from data available with telecoms to bridge huge tax gap and stop extorting 15%/75% oppressive advance income tax from the poorest of the poor.    

The Prime Minister and his economic team need to be reminded of the famous quote of Milton Friedman that “inflation is taxation without legislation.” If they want to give relief to masses, they must reduce rates of all taxes, eliminate collection of sales tax and income tax at import stage and withholding taxes on electricity and internet/mobile use—in fact all withholding provisions having no nexus with income. There is an urgent need to increase income tax for equity.

For reducing the unbearable burden imposed on the salaried class by inflationary budget, there is an urgent need for broadening of tax base with low rates. FBR has aroud 11.4 million registered income tax persons, but return filers are even less than 50% including registered companies. Those who paid Rs. 2,298 billion as withholding taxes in FY 2024 under the Income Tax Ordinance, 2001 alone, conducting transactions worth billions of rupees, but not filing returns, should immediately be tapped.  

The writer, Advocate Supreme Court, is Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE)