The slippery revenue slope

LAHORE: After the appreciation of the rupee and the sobering of imports, maintenance of the revenue growth will be a big challenge for the present government, as it would require vigorous efforts to bring tax evaders into the tax net.

It is not advisable to depend on imports for enhancing revenues, which must come mainly from domestic commerce and trade. When the rupee is depreciating the import revenues tend to grow even if imports are static. The imports push revenue further up if the rupee is depreciating and the imports are increasing as happened in the last year of the previous government. Import revenue at that time was higher than the domestically collected revenues.

The imports took time to come down when the present government imposed heavy regulatory duties on luxury items. The heavy duties somewhat compensated for the revenues from gradually declining imports, more so because the rupee was depreciating.

However, in the last three weeks, the rupee has appreciated against the US dollar by almost 9 percent. That would translate into a decline in import duties to the tune of 12 percent as import levies include the import duty on an item and then sales tax on the duty paid value of the invoice.

The withholding tax is also collected on duty paid value of the invoice. This cut in revenues would be reflected in October’s import revenues. It would be more pronounced in November when the rupee is expected to appreciate further.

The import revenues if the imports remain at the current level would decline by approximately Rs100 billion.

The government must take steps to cover this expected shortfall.

One way of doing it is to increase the tax rates which the present regime cannot afford. The other is to bring almost 50 percent of the undocumented economy under the tax net. Taxing compliant sectors would result in price hikes, but taxing evaders will have no impact on the prices of daily-use items.

The tax evaders sell their goods and services at open market rates. If their quality is inferior, they charge less. Documentation would force them to improve their quality. The reason that the tax-to-GDP ratio remains below 10 percent is that now even the documented sectors are concealing part of their production to avoid the 17 percent sales tax and compete with products and services of tax evaders.

The production of compliant sectors could be monitored through technology by installing surveillance cameras at their entry and exit points.

The FBR is in the process of doing that, but the implementation is slow. This indicates that even under-filing of production is not possible without paying rent to the tax collectors. The rent-seekers are going slow on this project.

However, to avoid this malpractice by tax-compliant sectors, the state must eliminate non-tax compliance from the tax-evading ones.

These include traders that import finished products at extremely low rates and get away by paying fewer rupees in sales tax and import duty than compliant industries. Those compliant industries that do not resort to under-filing production are booted out of the local market while those that under-file compete with under-invoiced imports.

Apart from importers the traders generally avoid documentation through street power of strikes. Planners would be forced to depend on higher taxes and import revenue if tax evasion is not strictly checked.