Reducing fiscal deficit

Article written by M. Sharif

The most pressing challenge confronting the economy during 2011-12 would be to keep the rising fiscal deficit under control by containing the expansionary fiscal policy (EFP), which according to the Annual Plan Coordination Committee is expected to remain between 5.5 and 6.5 per cent of the GDP by the end of this financial year provided the provinces contribute atleast 0.6 per cent of GDP surplus to it.

The federal finance secretary has put the fiscal deficit figure at Rs1.1 trillion, 6.2 per cent of GDP including Rs20 billion required for settling circular debt of power sector. In the national economic team’s latest round of negotiations with the IMF held in Dubai, the multilateral agency expressed its dissatisfaction over the progress made by the country thus far in dealing with chronic fiscal hindrances and implementation of tax reforms. Hence, the IMF did not disburse the sixth tranche but added that it remained committed to the ongoing dialogue with Pakistan and a mission is planned for July 2011. It is an uphill task for the managers of national economy to remain focused on addressing overwhelming economic issues and reduce fiscal deficit to 4.0 per cent of the GDP in the next fiscal year, which can be achieved by moving away from the government’s stance of EFP.

In the current fiscal year the political leadership pursued an EFP by borrowing excessively from the central and commercial banks because of its inability to implement RGST for raising tax revenue and lack of sufficient external funds that were reduced to Rs89 billion in the first 10 months of current fiscal year against the anticipated inflows of Rs566 billion for the entire year. The announcement of a mini-budget in early March was indeed “an important milestone” according to the IMF, but it did not deliver the desired result. Regarding tax revenue collection, FBR is finding it exceedingly hard to achieve the revised revenue target of Rs1.588 trillion. Instead, it might collect Rs1.533 trillion which would further reduce the tax-to-GDP ratio from 9.2 per cent to 8.8 per cent this year.

In order to contain EFP, the government will have to remove all the hurdles in the way of fiscal improvement which include enhancing the role of provinces in raising tax-to-GDP ratio to 15 per cent by FY2014-15 as envisaged under the National Finance Commission (NFC) award, restructuring inefficient state-owned enterprises, curtailing circular debt issue and introducing wide ranging structural reforms.

The seventh NFC award envisages that the federal and provincial governments take all the necessary administrative and legislative steps to effectively tax the agriculture and real estate sectors. They are also to develop and enforce mechanisms for maintaining financial discipline. According to the Budget Strategy Paper 2011-14, during current fiscal year hardly any such measures had been taken with the result that transfer of funds to provinces from the federal divisible pool (FDP) initially estimated at Rs1,034 billion would now be reduced to Rs993 billion due to inadequate revenue collection in the FDP. The provinces have to collect CVT on immovable properties and the Eighteenth Amendment further empowers them to collect sales tax on services, but aside from Sindh no other province has displayed its desire to collect the tax. In fact, they have asked the FBR to collect it on their behalf against a collection charge. FBR is willing to do so to satisfy the provinces and IMF for the latter wants the tax to be collected centrally. Sindh’s provincial government, however, might need further persuasion to allow the FBR to collect sales tax on its behalf.

The federal budget is to be presented in the current month. The tax revenue target has been set but it is not clear if RGST would be imposed or not. It is projected at Rs1.950 trillion, 16 per cent higher than the tax revenue target for the present fiscal year on the basis of projected growth rate of 4.3 per cent and 12 per cent inflation. Keeping the prevailing economic scenario in mind, the revenue target seems fairly ambitious and it might be subjected to revisions as was the case in the ongoing fiscal year. The Lahore Chamber of Commerce and Industry had suggested setting a realistic revenue target of Rs1.699 trillion.

FBR is working on multiple plans to boost tax revenue collection. Plan A envisages imposition of RGST and in case it cannot be imposed because of lack of political support in the national assembly, plan B would be implemented. Plan B entails removal of all exemptions and zero ratings with additional revenue to be generated from the existing sales tax rate of 17 per cent.

The government is aware of its inability to introduce fundamental economic reforms that has made it indispensible for it to pursue EFP thus far. It wants to focus on bringing down the fiscal deficit to a manageable level by evolving a consensus among different stakeholders in the forthcoming budget. It will be a difficult job for the government because political parties with a large urban base are not prepared to support imposition of RGST; urban taxpayers are also not willing to accept any additional taxation unless agriculture and real estate sectors are brought under tax net. In this regard, the most pertinent question is whether the political management is willing to go to that extent in its quest to implement tax reforms. A complete overhaul of the tax system to make it equitable and bring into tax net all incomes is likely to emerge as one of the most severe constraints that the ruling party would have to face and it might compel it to resort to EFP again.

Under the existing conditions of sluggish economic growth, uncertain political and security environment, and irregular inflow of funds from donors and multilateral financial institutions, the federal government might face numerous constraints that could make it difficult for it to make a visible departure from EFP next fiscal year. It is understandable that a total departure is not a feasible solution at this point in time, nevertheless all the necessary measures to raise tax revenue, bring down fiscal deficit and contain EFP must be given foremost priority in the next budget.

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