Budget Announced for a “War Economy”

Posted on June 6, 2010
Filed Under >Adil Najam, Economy & Development
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Adil Najam

The newly minted Minister of Finance and Revenue, Dr. Abdul Hafeez Sheikh, presented the national budget for 2010-11 in the parliament. In his speech the Minister set high targets for tax revenue and justified this in the current economic context of the country as a “war economy.” The first may well prove to be too ambitious. The latter is probably a fair assessment.

While the “war economy” descriptor is apt, the implications of just what that means in how the economy is managed seems not to have hit home just as yet.

As Dawn’s editorial aptly puts it:

…in the face of some necessary and inevitable expenditure increases, why has no attempt been made to make substantive cuts where they can be made? It is not enough to simply freeze non-salary current expenditure, as Mr Sheikh pledged. Islamabad is chock-full of various federal government-funded agencies, institutes and centres few Pakistanis have ever heard of. Why not at least announce a rationalisation of government-funded boondoggles? Given the government’s refusal to clean up its own house first, it is perhaps too ambitious to have hoped for some sort of explanation on military expenditures. But what a political government cannot ask, an ordinary taxpayer can: with extraordinary counter-insurgency demands on the military, has it made any attempt to rationalise its other expenditures, to trim the fat? All tax-paying Pakistanis are told is that things like the largest military exercises in over two decades conducted earlier this year are ‘necessary’ and in the ‘national interest’.

Pakistan’s most serious problem, though, is on the revenue side of things. The government spends twice as much as it earns in tax revenue, a scarily unsustainable state of affairs. More tax revenue must be raised, it must be raised urgently and it must be raised from people and sectors that have connived with governments past to stay out of the tax net. The finance minister and his team are aware of this, but here is where the political straitjacket is doing the most damage. On Saturday, Mr Sheikh told parliament: “The tax measures being proposed by the government are fair, just and equitable guided by the ‘ability to pay’.” The finance minister would have been aware that his statement is thoroughly untrue. First, no measures to wean the state off its reliance on indirect taxes, which hurt the poor, and towards direct taxes were announced. Second, even though it is a provincial matter, a true ‘ability to pay’ approach would have meant the federal government announcing it will lead the way on the imposition of tax on agriculture. Nothing was said on either front. But even within the unjust, sales-tax oriented tax regime, there are some serious questions marks. The delay in the switch over to VAT until at least Oct 1 could jeopardise revenue projections as a change midstream could lead to a dip in projected revenues. If the budget deficit increases — already projected at a staggering Rs685bn — the fiscal mangers may opt for the usual path, notwithstanding the pledges by Mr Sheikh yesterday: development expenditure could be curtailed.

Soon to be forgotten in the world of the daily news cycle is the Economic Survey released on Friday. It reads in part, “The prudent course for policy in the near term remains the pursuit of greater fiscal consolidation through domestic resource mobilisation, in conjunction with reducing the size of government, and improving the efficiency of public-sector spending.” Unhappily, a day later, the government appears to have ignored its own advice while announcing the budget.

Beyond that, I must say I am still trying to understand all the implications of the budget speech – like all budget speeches this one seems to have many things one instantly agrees with and many that raises eyebrows. Even more important might be those elements that go unnoticed at first blush but can have long term consequences.

As I surveyed all the major papers to find details of exactly what is and is not in the budget speech, unfortunately I found more opinion and fact. A notable exception was Dawn’s report of the speech; here are the highlights:

The government announced on Saturday an overall consolidated budget of Rs3.259 trillion for 2010-11, including additional taxation measures of Rs133 billion, and offered some relief to the poor and salaried people.

The budget outlay of Rs3.259 trillion (including provinces) is about 11 per cent higher than the Rs2.897 trillion budget for the outgoing financial year.

The budget sets a tax revenue target of Rs1.779 trillion, compared with the last year’s Rs1.494 trillion — an increase of about 19 per cent. The Federal Board of Revenue has been given a collection target of Rs1.667 trillion which is 20 per cent higher than the current year’s target of Rs1.380 trillion.

Dr Hafeez said the budget aimed at seven major objectives — protecting economic recovery, controlling inflation, achieving self-reliance through domestic resource mobilisation, targeted social protection regime for poverty reduction, controlling losses of public sector entities, reducing unemployment, improving investment climate and overcoming energy shortages.

The FBR’s revenue target of Rs1.667 trillion includes direct taxes of Rs657.7 billion and indirect taxes of Rs1.121 trillion. Direct taxes are about 22 per cent higher than the current year’s revised estimate of Rs540.4 billion. Indirect taxes are about 19 per cent higher than the current year’s Rs943 billion. Indirect taxes include Rs675 billion sales tax, Rs153 billion federal excise and Rs181 billion customs duty.

Against a total outlay of Rs3.259 trillion, the new budget forecasts total revenue at Rs2.574 trillion, leaving a fiscal deficit of Rs685 billion or four per cent of the gross domestic product (GDP). It will be met through net external financing of Rs186 billion, net non-bank borrowing of Rs332.6 billion and banking borrowing of Rs166.5 billion. An amount of Rs1.033 trillion will be transferred to the provinces under the seventh NFC award, compared to Rs655 billion during the current year, showing a substantial increase of about 58 per cent.

The next year’s current expenditure has been estimated at Rs1.998 trillion against the current year’s original estimate of Rs1.699 trillion, up about 17.6 per cent. This includes expected defence expenditure of Rs442 billion which is 17 per cent higher than the current year’s revised estimate of Rs378 billion.

Allocations for the Public Sector Development Programme have been increased by 2.6 per cent to Rs663 billion. The current year’s original allocation was Rs646 billion.

An amount of Rs873 billion has been set aside for debt servicing, compared to the current year’s revised estimate of Rs815 billion, showing an increase of about seven per cent. The servicing of foreign debt will consume Rs251 billion against Rs219 billion of the current year. The servicing of domestic debt has been estimated at about Rs622 billion against the current year’s revised estimate of Rs596 billion.

The finance minister said the total federal budgetary outlay had been estimated at Rs2.229 trillion – 13.1 per cent of the GDP.

As an austerity measure, the non-salary current expenditure will stand frozen at the current year’s level. The government will be required to get an approval from the cabinet for any supplementary grant beyond 10 per cent of the approved budget.

The government has estimated total federal resources at Rs2.764 billion against the current year’s estimate of Rs2.462 trillion. Net revenue receipts have been estimated at Rs1.377 trillion. The current year’s estimate was of Rs1.352 trillion.

Dr Hafeez avoided discussing the much talked about value added tax (VAT), but said the general sales tax system would be reformed by October 1 in consultation with the provinces and other stakeholders. In the meantime, he said, GST rates would be raised by one percentage point to be replaced with the proposed single lower rate of 15 per cent on October 1.

Dr Hafeez said the reformed GST would not apply to health, education and food items consumed by the poor or to those whose annual turnover was less than Rs7.5 million. The proposed system would broaden the tax base instead of burdening the existing taxpayers.

Dr Hafeez said that federal government employees would be allowed an ad hoc increase of 50 per cent in their basic salary without giving additional increase to those who had already availed it. This increase will not be allowed to cabinet members whose salaries would be cut by 10 per cent.

The government has allocated Rs131 billion for hydel, thermal and nuclear energy projects to augment generation and improve transmission. Diamer-Bhasha dam will be launched as a mega project during the fiscal year.

Dr Hafeez said that Rs50 billion would be spent under the Benazir Income Support Programme to provide targeted cash grants to the poorest of the poor. At the same time, a comprehensive exist strategy scheme based on international best practices will be introduced like Waseela-i-Haq to provide self-employment through small business.

Following are the highlights of taxation measures announced in the budget for fiscal 2010-11.

• The system of General Sales Tax will be reformed to replace multiple tax rates with a single lower rate of 15pc.
• The reformed GST will not apply to health, education and food items consumed by the poor.
• The GST will not apply to turnover of less than Rs7.5 million per year whereas the current threshold is Rs5 million a year. The system will be automated, reducing the possibility of corruption and refund delays.
• It will broaden the tax base, instead of burdening the taxpayers.
• The GST reform is expected to be in place by Oct 1 after consultations with the provinces and other stakeholders.
• As an interim measure, the GST rates are proposed to be raised by 1 percentage point. Once the reformed GST is in place, the proposed single lower rate of 15pc will become effective.
• One per cent Special Excise Duty levied on most items of imports and manufactured locally has been abolished.
• Federal Excise Duty incidence on all categories of cigarettes has been enhanced and an FED levy of Rs1 per filtered cigarette has been proposed.
• The rate of FED on natural gas has been increased to Rs10 per mmbtu, while a levy of FED at 10pc ad valorem on air-conditioners and deep freezers is proposed.
• Income tax exemption limit for the salaried class has been enhanced from Rs200,000 to Rs300,000, benefiting approximately 430,000 taxpayers.
• Exemption limit for non-salaried income is also proposed to be raised from Rs100,000 to Rs300,000 per year, benefiting approximately 350,000 taxpayers.
• Rate of income tax collected along with monthly electricity bill from industrial and commercial consumers is proposed to be reduced from 10pc to 5pc, providing a relief of Rs4.5 billion to 66,000 taxpayers.
• Under the Prime Minister’s Fiscal Relief Package for Khyber Pakhtunkhwa, Fata and Provincially Administered Tribal Areas, an additional tax relief of about Rs2 billion has been provided to benefit 300,000 taxpayers.
• Instead of monthly withholding tax statements, only quarterly withholding statement will be required to be e-filed.
• Taxation on interest free/concessionary interest loans provided by an employer is proposed to be waived.
• Rate of final withholding tax on non-specified payments to non-residents is to be reduced from 30pc to 20pc.
• Tax-free payments to non-residents on profits on debt will be allowed 10pc tax credit for balancing, modernisation and replacement to all companies.
• A 5pc tax credit is proposed to be allowed to a company in the tax year of its enlistment.
• 10pc withholding tax has been announced as final charge on profit on debt (in debt instruments) and also for the investment in government securities (treasury bills and PIBs) to allow hassle-free compliance by non-residents.
• It has been proposed that income tax be raised for the association of persons (AOP) at a flat rate of 25pc against the existing progressive rate averaging up to 20pc.

I will be trying to digest all of this and make sense of its implications on Pakistan’s economy and on its politics. Meanwhile, would appreciate hearing from readers on their views on this.

32 responses to “Budget Announced for a “War Economy””

  1. auk says:

    The numbers popularly quoted for education and health are wrong. Education and health are both provincial subjects, and hence majority of those funds come from the provincial governments and not the federation. If you want to find the total allocated for education and health, you would need to dissect the provincial budgets as well.
    That does not mean that we are doing justice to social sectors – all I am trying to say is to get your facts straight.
    Adil, perhaps you can have a blog on those numbers.

  2. kohestani says:

    The priorities speak volumes. The Islam ka Qila has allocated $5.2 bn. for defence whereas only $400 million for education. The Islamic army will spend those billions of dollars to construct more defence housing societies for its victous Generals and more deadly bumbs wil be bought from kafirs that will at the end be dropped on the citizens of Islam ka qila. Jinnah tera ehsaan he tera ehsaan.

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