Demystifying the mini-budget

The writer heads the Sustainable Development Policy Institute.

The bad news is that the Finance (Supplementary) Bill 2021 (mini-budget) will increase prices, mainly of luxury items. The good news is that the impact of the general sales exemption withdrawal on the price hike will not be very significant, as claimed by many commenters. Before explaining how, let me give you some background.

Most economies in the world have a multi-stage tax levied at a uniform rate, at each stage of the supply chain of goods and services, with a set-off for the tax paid at the earlier stages in the chain. Apart from revenue collection, it helps in documenting the economy as an intermediary in the supply chain would only be able to set off its paid tax when it submits its tax return.

Successive governments have tried to introduce such taxes to document the economy’s undocumented sectors and broaden the tax net since the late eighties. A general sales tax (GST) under the Sales Tax Act, 1990 (STA) was introduced by replacing the Sales Tax Act, 1951. At that time, different rates of GST were allowed for different sectors keeping in view their economic priorities and problems. Some sectors were zero-rated (meaning that there is no output tax on goods but the input tax borne is refundable to the supplier), while others were charged a reduced rate, and certain others were exempt from the GST (where output is exempt from tax whereas input tax borne is not refundable). This created anomalies and distortions, turning refund into a cumbersome process.

To remove these distortions, the PPP regime in 2011-12, on the advice of the International Monetary Fund (IMF) programme, tried to introduce a reformed GST (RGST) system but failed and had to terminate the IMF programme prematurely.

Ten years down the road, the current government, though on the advice of the IMF, took the right step – proposed, till the National Assembly approves it – to remove the distortions in the GST through withdrawal of exemptions and levying GST at a uniform rate across the board. The GST reforms will also help document the undocumented sectors of the economy.

Essential food items used by the people such as wheat, wheat flour, wheat bran, rice, vegetables, fruits, pulses, fresh poultry, fish, meat, fresh milk, etc, are exempt from the GST. So are educational books and stationery items, imported parts for computers and laptops, and imported plant and machinery for special economic zones. Agriculture tractors, fertilizers, inputs of fertilizer sector, pesticides, used clothing and footwear, and cinematographic equipment will continue to be charged at a reduced rate of GST.

The monetary impact of the mini-budget is Rs343 billion. Rs 160 billion worth of exemptions stand withdrawn from the pharmaceutical sector, Rs112 billion worth of exemptions removed from machinery, and Rs71 billion from goods. GST on pharmaceuticals and machinery is refundable/adjustable. Hence their net impact on retail price would be zero.

Contrary to the common perception, this will actually help reduce the price of medicine. Previously, medicines were ‘exempt’ from GST – and so the input tax borne by the manufacturer in the form of packing material and others was not refundable. In the mini-budget, medicines have been made ‘zero-rated’. This means that the input tax borne on packing materials and others (worth Rs35 billion, which was being passed on to consumers) would now become refundable. Likewise, GST has been levied on imported ingredients to manufacture medicine, but this would again be refundable. Bringing this sector to the GST regime will help document – and hence broaden the tax net – Rs530 billion worth of undocumented supply chain. It will also help fight counterfeit drugs, tax evasion, transfer pricing, and misuse of exemption.

Like medicines, withdrawn GST exemption on machinery is also refundable/adjustable, and not affecting consumers. In the case of goods, withdrawal of Rs36 billion worth of exemptions is on goods classified as luxury items and include imported branded meat, fish, poultry, etc. Their users are usually upper - or upper-middle-income earners, but middle-income earners also use them. The latter would feel the maximum pinch of the price hike on ‘luxury items’.

Exemptions worth another Rs31 billion stand withdrawn from business goods. At the same time, Rs2 billion worth of exemption each has been removed from business goods used by the government (like those in a public hospital) and goods used by the people.

On top of exemption withdrawal, the FBR has levied an advance tax on cellular services, advance tax on vehicle registration to discourage on-money (premium) and advance tax on foreign TV serials, dramas, and advertisements. The FBR has also proposed to increase federal excise duties, in the range of 2.5-10 percent, on motor vehicles exceeding 1000cc. Advance tax is adjustable in the final tax liability. However, those using pre-paid phone services would find it difficult to adjust their advance tax.

A commendable step in the mini-budget is introducing a marketable system for promoting documentation and bringing transparency in the real estate business as per internationally prevalent practices. The Real-estate Investment Trust (REIT), introduced in the Income Tax Ordinance 2001, can now have subsidiary companies (particular purpose vehicles SPV). The income of an REIT SPV has been exempted from tax if 90 percent of the profit is distributed among trustees (investors in the REIT).

Through the mini-budget, the FBR has sought the power to obtain information from banks and financial institutions about a list of persons containing particulars of their business accounts opened or re-designated during each calendar month. This amendment will discourage tax evasion.

Besides the supplementary finance bill, the government has also introduced the State Bank Amendment Act 2021. In line with established best practices, the purpose is to give the State Bank (SBP) functional and administrative autonomy and strengthen its accountability. Again, on the advice of the IMF, but this is yet another step in the right direction. An independent board will govern the SBP. Non-executive directors of the board, governor, deputy governors, and external members of the monetary policy committee would be appointed by the president/government of Pakistan for a five-year term (eligible for a second term). They can be removed by the appointing authority for serious misconduct as determined by a court of law. The government will not borrow from the SBP, and the central bank’s objective would be to control inflation, bring financial stability and support the government’s economic policies to foster development.

The bill can be improved by adding that the government would provide a medium-term inflation (defining inflation whether CPI or core) target. Likewise, the accountability mechanism of not delivering on targets needs to be strengthened beyond submitting an annual report in parliament. The clause of zero borrowing should be changed to provide flexibility for borrowing in emergencies (while also defining ‘emergency’).

The government also seems to be moving from tax exemptions to targeted subsidies. After refunds and adjustments, Rs33 billion from the revenue raised through the mini-budget is allocated for targeted subsidies, including Rs10.5 billion for infant formula milk, Rs7.86 billion for (cotton, maize, other) seeds, Rs6.1 billion for poultry, cattle, and fish feed raw material and preparation, Rs5.1 billion for oil cake, Rs1.3 billion for goods supplied to government hospitals, Rs1 billion for agronomic equipment and Rs400 million for imported laptops and computers. How well these targeted subsidies are distributed is yet to be seen. However, the government is running out of chances and should ensure that the subsidies reach the target beneficiaries quickly and transparently.

We should not dismiss the mini-budget and SBP amendments, merely for having been initiated on the IMF’s advice. One thing is for sure: Pakistan badly requires documentation of the economy to broaden its tax base, and some of the initiatives in the mini-budget are likely to have a mega-impact in achieving that objective. Let’s give them a try.

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