Tax burdens and fiscal discipline

After an inflation-ridden Fiscal Year 2023-24 (“FY24”), wherein the average inflation for the FY24 was 23.4%, there was some hope that the budget for the FY25 may bring respite to the public-at-large. However, the Fiscal Policies enacted by the Federal Government (“FG”) were proven to be largely revenue driven, and for short-term purposes; thus proving the common man to be naive once again.

Pakistan can achieve growth and stability through a homegrown strategy rather than relying on the IMF’s complex policies. Moreover, uncertainty arises with the Fiscal Deficit and Current Account Deficit (“CAD”), compelling us to seek IMF assistance and adhere to stringent policies like interest rate hikes, which hinder Pakistan’s economic growth. The recent decision of the State Bank of Pakistan (“SBP”) to reduce the interest rate to 19.5% is a welcoming sign; however, it is still infeasible for businesses to operate at 19.5%.

Through the Finance Bill 2024-25 (“the Bill”) and thereafter the Finance Act 2024-25 (“the Act”), the purchasing power of the salaried class has been suffocated by increasing the effective tax rates on them; a measure that has rightly met peaceful protests across the country. The salaried class is one of the most documented sectors in the country, as their tax is deducted at source by their employer. It has been reported by Shahbaz Rana, in his article published on the 25th July 2024 titled “Salaried class taxed record Rs368 Billion” that the salaried class paid PKR 368 billion income tax for FY 24, whereas exporters and retailers paid a combined PKR 111 billion in income tax. It may be noted that exporters only paid a minimal income tax of PKR 93.5 billion against an earning of USD 30.6 Billion. Further, as per our estimates, considering the additional taxation measures taken, the electricity and gas price adjustments done or that may be done in the immediate future, the inflation for the FY25 may record at 25% instead of 12% as projected by the FG.

Moreover, the FG proposed imposing a record PKR 1.7 trillion in additional taxes to achieve an ambitious PKR 12.97 trillion tax revenue target for FY25, which is expected to unleash an inflationary storm in Pakistan due to heavy indirect taxation and further reductions in individual incomes. Further, the Government expects to collect another PKR 1.5 trillion through automatic increases in collection due to the inflation projected by the Government. Despite heavy taxation, there remains a PKR 512 billion tax gap between the measures taken in the budget and the new tax target.

Way forward:

In view of the above, it is proposed that tax on the salaried income up to PKR 1,200,000/- must be a bare minimum PKR 100/- or 500/- considering the inflation in the previous two Fiscal Years and our estimates for the inflation in the ongoing FY. The reason for a meagre income tax on salaried income up to PKR 1,200,000/- is so that they remain within the tax net.

There have been some difficult and positive steps taken by the FG that are balanced, which will help document the economy and generate good amount of revenue for the Government. These measures are as under:

A. Bringing the exporters into the minimum and normal tax regime

The FG has, vide the Act, brought exporter of goods into the Minimum Tax Regime and the Normal Tax Regime. This measure was proposed by the Reforms and Resource Mobilization Commission of Pakistan (“RRMC”) through its interim report submitted in April 2023. Before the said amendment, a 1% income tax was levied on the exports proceeds of goods exported from Pakistan. The said 1% levied was full and final discharge of tax liability of the exporter of goods. Now, the said 1% income tax levied shall be minimum tax, and an additional 1% advance tax shall also be withheld on the exports of goods. Therefore, exporters shall now file their income tax returns at the end of the fiscal year and compute their normal income tax liability, and will also be subject to super tax. This measure encourages documentation; however, had this measure been taken vide Finance Act 2023, the FG may have generated an additional PKR 300 – 400 billion in tax revenue in the FY24 on account of an additional PKR 1.7 trillion windfall gain due to currency devaluation.

Economic impact:

Transitioning exporters to the minimum and normal tax regime can significantly increase government tax revenue, which can be used to fund public services and infrastructure projects, driving economic growth. Requiring exporters to file detailed income tax returns will promote greater documentation of economic activities. This measure will help increase inclusion of the wholesale, trade, and agriculture sectors into the formal economy, improving transparency and enabling better economic planning and policy-making. A more equitable tax regime ensures all exporters contribute their fair share, fostering a more competitive business environment. This move can discourage tax evasion, create a level playing field, encourage fair competition, and potentially attract more investment into the sector.