Super Tax: A Bitter Pill Corporate Sector Should Swallow To Help The Country

Super Tax: A Bitter Pill Corporate Sector Should Swallow To Help The Country
A few weeks ago when I wrote about taxing the big and rich corporates, some experts told me it was unrealistic and part of a long-term structural reform agenda. How fast things change when you want money from the IMF, and IMF wants to see higher tax revenue and a lower budget deficit.

Shehbaz Sharif’s government finally had to give in to the IMF’s demand for a higher collection target by imposing a one-time super tax on profits of large industries. The prime minister announced the additional tax measures on Friday, just two weeks after his finance minister Miftah Ismail presented the budget proposals in the National Assembly. It is believed that the IMF was not satisfied with the proposed measures to cut the fiscal deficit, which rose to 6.3 per cent of the GDP during the last fiscal year due to the rise in federal government spending to 22.6 per cent of the GDP from 18.5 per cent in 2020-21 and a fall in the tax to GDP ratio to just 9 per cent in FY 2021-22 from 9.4 per cent in the prior year.

The budget proposals, announced on June 10, had set a tax collection target of Rs7trillion. This was based on an unrealistic assumption of a 5 per cent growth in the economy and an inflation rate of just 11 per cent. The IMF was not impressed and demanded additional steps to cut the fiscal deficit by eliminating subsidies on petrol and setting a higher target for tax collection.

Pakistan's government hiked petrol prices by around 29 per cent on June 15, removing fuel subsidies in yet another attempt to secure the critical IMF support as Pakistan’s foreign exchange continued to drop. The new prices came into effect from June 15 at midnight and showed a massive hike of Rs 24 per litre in petrol prices and Rs 59.16 per litre of high-speed diesel (HSD).

The finance minister declared that prices of all products had now been brought to their purchase price and the element of subsidy or price differential claim had been eliminated. He had hoped that the IMF would relent but apparently, even the complete removal of the petrol subsidy was not enough to satisfy the IMF. The current negotiations are probably the toughest Pakistan ever had and should remove the completely unfounded perception that the present government came into power with the help or blessings of the United States.

The latest decision to impose a super tax should be viewed in the context of the tough negotiations. Pakistan is in a tight corner and desperate to resume the IMF programme. The risk of default will become a real possibility if the IMF programme is not resumed immediately and the budget is not passed within a few days. 

The super tax of 4 per cent will apply to all sectors. But for the specified 13 sectors, another 6 per cent will be added for a total of 10 per cent.  Those 13 sectors are Banking, Oil and Gas, Fertilizers, Textile, Cement, Steel, Textile, Sugar, LNG terminals, Automobile, Cigarettes, Beverages, Chemicals, and Airlines.

High net worth individuals will also be subject to a "poverty alleviation tax". Those whose annual income exceeds Rs150 million will be subject to 1pc tax; for Rs200 million, 2pc; Rs250 million, 3pc; and Rs300 million will be taxed 4pc of their income.

It should be noted, however, that the long-term capital gains from property, incomes from agriculture of large landlords, and those of retailers and wholesalers remain effectively tax-free. The budget proposals included a deemed rental income tax on more than one immovable property and 2.5 to 15 per cent capital gains tax on the sale of property, depending on the holding period, provided it was not more than six years. 

Agricultural income, strangely, is a provincial subject and the provinces collect hardly much. For example, Punjab collected just Rs2.5 billion from agriculture income tax in 2020-21 and Sindh just Rs646 million.  Since agriculture accounted for 22.7 per cent of the GDP during 2021-22, its contribution to taxes is almost negligible (approximately $18 million) compared to its huge size in the economy, that is, $86 billion. In other words, while it is around 1/5th of the economy, its contribution to the total taxes is around 1/5th of one per cent of total taxes. 

Similarly, while there are around 9 million retail establishments, very few pay income tax. One estimate puts the number of retail and wholesale traders around 3 million. The retail/wholesale trade, which accounted for 18.8 per cent of the GDP during FY 2021-22, is effectively outside the tax net. Due to ineffective and corrupt tax machinery and strong resistance from the traders to pay taxes, even the 17 per cent sales tax is either not collected from consumers or is not paid to the government despite charging the consumers for the sales tax. 

Given that no government has been able to collect taxes from two of the largest sectors of the economy, agriculture and retail/wholesale trade, with nearly 40 per cent of the GDP, and the difficulties involved in bringing them into the tax net, the government decided to impose additional taxes on the well-documented sectors: large corporations and salaried class.

The large corporate sector has been doing well. The top 100 companies listed on the Pakistan Stock Exchange (PSX) posted a hefty increase of 47 per cent in their net profit to an all-time high at Rs940 billion in 2021, and 60 per cent higher compared to what they made in 2018. While the corporate sector has been doing well for years, Pakistan’s GDP per capita in purchasing power parity terms (or real income of an average person) remained stagnant between 2017 and 2020, according to the World Bank. More likely, it declined in real terms for lower and lower-middle-class families.

In 2021, just six sectors accounted for 76 per cent or Rs785 billion out of the aggregate net profits of Rs1,025 billion reported by the companies listed on the Pakistan stock exchange. These sectors and their profits were as follows:

Given the profitability of these sectors, it is unlikely that the imposition of a one-time super tax would dent their long-term profitability or the attractiveness of their stocks to long-term investors. The Karachi stock exchange index closed down 1665 points or 3.9 per cent on Friday after PM Shehbaz Sharif announced the super tax.

The super tax may contribute around Rs150 billion to the tax revenues and would help in trimming the fiscal deficit and concluding an agreement with the IMF. It is a bitter pill the corporate sector should swallow in the greater national interest.

The writer is former head of Citigroup’s emerging markets investments, and was responsible for managing investments and macro-economic strategy across 40 countries in the emerging markets, covering Asia, Latin America, Eastern Europe, Middle East and Africa.