STATE OF THE ECONOMY

Research Report No.86 June 2013

Imperatives for Fiscal Policy in the Federal Budget of 2013-14

SOCIAL POLICY AND DEVELOPMENT CENTRE

Research Report No.86

IMPERATIVES FOR FISCAL POLICY IN THE FEDERAL BUDGET OF 2013-14

By

Hafiz A. Pasha*

June, 2013

SOCIAL POLICY AND DEVELOPMENT CENTRE

The author is the Senior Technical Advisor of SPDC and a former Managing Director. He has also served as the Finance Minister of Pakistan. Views expressed here are the sole responsibility of the author.

CONTENTS
Page Numbers

1. 2.

TREND IN FEDERAL FINANCES ............................................................................ 4 TAX REVENUES...................................................................................................... 9 Direct Taxes ...................................................................................................... 14 Indirect Taxes .................................................................................................... 15 Tax Administration ............................................................................................. 16

3. 4. 5. 6. 7. 8. 8.

NON-TAX REVENEUS .......................................................................................... 16 NET REVENUE RECEIPTS ................................................................................... 18 CURRENT EXPENDITURE ................................................................................... 19 DEVELOPMENT EXPENDITURE .......................................................................... 22 FINANCING OF THE FISCAL DEFICIT ................................................................. 23 PROSPECTS FOR 2013-14 .................................................................................. 24 SUMMARY OF RECOMMENDATIONS ................................................................. 27 Tax Reforms ........................................................................................................... 27 Tax Administration.................................................................................................. 28 Non-Tax Revenues ................................................................................................ 28 Subsidies ................................................................................................................ 29 Development Expenditure ...................................................................................... 29

List of Tables and Figures Table 1: Summary of Trends in Federal Finances, 2006-07 to 2011-12 ...................... 4 Table 2: Key Fiscal Ratios of the Federal Government ................................................ 6 Table 3: Projected Budgetary Magnitudes of the Federal Government in 2012-13 ..... 7 Table 4: Contribution of Different Factors to the Increase in the Fiscal Deficit from 2006-07 to 2012-13........................................................... 8 Table 5: Federal Tax-to-GDP Ratio .............................................................................. 9 Table 6: Trend in Non-Tax Revenues ........................................................................ 17 Table 7: Net Revenue Receipts of the Federal Government...................................... 19 Table 8: Trend in Components of Current Expenditure .............................................. 20 Table 9: Federal Employees, Pay, Allowances and Pensions ................................... 22 Table 10: Development Expenditure of Federal Government ...................................... 22 Table 11: Outstanding Government Debt ..................................................................... 24 Table 12: Net Flow of External Assistance ................................................................... 25 Table 13: Feasible Scenario for the Budget of 2013-14 ............................................... 27 Figure 1: Federal Fiscal Deficit ...................................................................................... 5 Appendix I: Statistics on the Federal Budget 2006-07 to 2012-13 (July-March) ........ 27 Appendix II: Taxation Proposals in Budgets ................................................................. 28

Imperatives for Fiscal Policy in The Federal Budget of 2013-14

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ACRONYMS
AJK AOPs BISP BMR BODs CNG CSF CVT FBR FDI FED GARVs GDP GHPL GST IMF LPG MAT MOF MTB NBP NEPRA NFC OGDCL OMO PIBs PIT PML(N) POL PPP PSDP PSE PTA PTCL SBP SMEs SROs TDS VAT WAPDA WTO Azad Jammu and Kashmir Association of Persons Benazir Income Support Program Balancing, Modernization and Replacement Board of Directors Compact Natural Gas Coalition Support Fund Central Value Tax Federal Board of Revenue Foreign Direct Investment Federal excise duty Gross Annual Rental Values Gross Domestic Product Government Holidays (Private) Ltd. General Sales Tax International Monetary Fund Liquefied Petroleum Gas Minimum Assets Tax Ministry of Finance Market Treasury Bill National Bank of Pakistan National Electric Power Regulatory Authority National Finance Commission The Oil and Gas Development Company Limited? Open Market Operations Pakistan Investment Bonds Presumptive Income Tax Pakistan Muslim League (Nawaz) Petroleum Oil and Lubricants Pakistan Peoples Party Public Sector Development Program Public Sector Enterprise Pakistan Telecommunication Authority Pakistan Telecommunication Company Limited State Bank of Pakistan Small and Medium Enterprises Statutory Regulatory Order Tariff Differential Subsidy Value Added Tax Water and Power Development Authority World Trade Organization

Imperatives for Fiscal Policy in The Federal Budget of 2013-14

Research Report No.86

IMPERATIVES FOR FISCAL POLICY IN THE FEDERAL BUDGET OF 2013-14

By Hafiz A. Pasha

The public finances of the Government of Pakistan are in a state of disarray today. The revenues to GDP ratio has fallen sharply, current expenditures have shown explosive growth especially in the heads of debt servicing, grants and subsidies, while development expenditure has been slashed to critically low levels. The budget deficit has risen exponentially to unsustainable levels and is being financed by relatively high cost borrowings. Today, the country is effectively in the debt trap. All convenents of the Fiscal Responsibility and Debt Limitation Act have been increasingly violated over the last few years.

The situation has reached a point where the capital market and the banking system are unable to pick up the large amounts of government paper which are being floated to finance the fiscal deficit without massive injections of liquidity by the Central Bank. This has inevitably meant more printing of money by the SBP, increasing thereby the risks of an upsurge in the rate of inflation.

There are, therefore, hard policy choices in the Budget of 2013-14 if the fiscal situation is to be even partially restored. Fortunately, the recent elections have given a strong mandate to the party of PML(N) which will assume power prior to the presentation of the Federal Budget and can start afresh the process of economic policy making.

The objective of this paper is to highlight the imperatives for fiscal policy in the Budget of 2013-14. Section 1 gives a summary of trends in federal finances. Thereafter, different sections of the paper deal with different parts of the budget, namely, tax revenues, non-tax revenues, net revenue receipts, current expenditure, development expenditure, financing of the fiscal deficit and prospects for 2013-14. The last section presents a summary of recommendations for the 2013-14 Budget.

Research Report No.86

Imperatives for Fiscal Policy in The Federal Budget of 2013-14

1.

TREND IN FEDERAL FINANCES

The summary of trends in federal finances is given in Table 1 and the details in Statistical Appendix. The first budget was presented by the PPP government for 2008-09 and the last budget for 2012-13. The last year prior to the induction of the PPP government witnessed a big jump in the size of the federal fiscal deficit by almost 3 percent to 7.7 percent of the GDP. This was caused primarily by the failure to adjust domestic POL prices to the sharp jump in the international price of oil and by large pre-election spending.

The PPP government initially took some difficult decisions and adjusted fully the POL prices. Fiscal deficit reduction was also facilitated by higher defence receipts from the Coalition Support Fund (CSF). Consequently, the fiscal deficit was brought down to 5 percent of the GDP.

Table 1 Summary of Trends in Federal Finances, 2006-07 to 2011-12 (% of GDP)

2006-07 A. Gross Federal Receipts Tax Revenues Non-Tax Revenues Less Provincial Share Net Federal Receipts B. Total Expenditure Current Expenditure Development Expenditure Net Lending Others C. Fiscal Deficit Source: Fiscal Operations, MOF 0.3 -4.8 0.1 -7.7 0.1 -5.0 0.1 -6.4 0.1 -7.3 0.0 -8.1 14.2 9.8 4.4 -4.6 9.6 14.4 11.6 2.5 2007-08 13.7 9.9 3.8 -4.5 9.2 16.9 14.2 2.6 2008-09 13.7 9.1 4.6 -4.1 9.6 14.6 12.1 2.4 2009-10 13.3 9.6 3.7 -4.3 9.0 15.4 12.4 2.9 2010-11 11.9 9.1 2.8 -5.5 6.4 13.7 11.9 1.7 2011-12 11.7 9.4 2.3 -5.3 6.4 14.5 12.6 1.9

Thereafter, as shown in Figure 1, there has been a continue increase in the deficit, to almost 6.5 percent in 2009-10, to 7.3 percent in 2010-11 and 8.1 percent of the GDP in 2011-12. Latest estimates, inclusive of unpaid claims, by the Planning Commission, of the federal fiscal deficit indicate that it may even exceed 9.0 percent of the GDP. This is an unprecedented level and highlights that public financial management at the federal level has, more or less, lost control.

Imperatives for Fiscal Policy in The Federal Budget of 2013-14

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Figure 1 Federal Fiscal Deficit

(%ofGDP)
10 9 8 7 6 5 4 3
200607 200708 200809 200910 201011 201112 201213

Source: Fiscal Operations, MOF

A number of key fiscal ratios are presented in Table 2 and discussed below: Tax-to-GDP Ratio: has consistently been below 10 percent of the GDP, with a somewhat declining trend. Share of direct taxes: The share of direct taxes has fluctuated at around 38 percent and has shown a tendency to decline somewhat in recent years. Share of non-tax revenues: Non-tax revenues have demonstrated slow growth and their share in total revenues has fallen sharply from 31 percent in 2006-07 to below 20 percent in 2011-12. Provincial share in federal receipts: The share of provinces is mandated by the NFC. Prior to the 7th NFC Award, this share stood at below 33 percent, which has jumped to almost 47 percent after the Award. Revenue Surplus/Deficit as % of GDP: This key ratio indicates a very alarming trend. Revenues are proving to the increasingly inadequate in even financing current expenditure. The revenue deficit which was about 2 percent has increased to above 5 percent of the GDP. In effect, a large part of current expenditure is being met through borrowings. Therefore, the country is effectively in the debt trap.
Research Report No.86 Imperatives for Fiscal Policy in The Federal Budget of 2013-14

Table 2 Key Fiscal Ratios of the Federal Government (%)

Ratio 1. Tax-to-GDP Ratio (%) 2. Share of Direct Taxes (%) 3. Share of Non-Tax Revenues in Total Revenues (%) 4. Provincial Share in Federal Receipts (%) 5. Revenue Surplus (+) / Deficit (-) as % of GDP 2006-07 9.83 39.18 30.88 32.42 -1.94 2007-08 9.86 38.40 27.89 32.66 -4.98 84.09 2.74 -7.67 19.26 67.26 13.48 2008-09 9.10 38.00 33.39 30.22 -2.54 82.71 1.68 -5.06 23.26 40.42 36.32 2009-10 9.58 37.28 28.19 32.08 -3.38 80.66 1.98 -6.36 20.07 33.34 46.59 2010-11 9.07 36.38 23.76 46.60 -5.52 86.58 1.29 -7.37 8.1 56.29 35.61 2011-12 9.42 37.60 19.73 44.96 -5.22 86.59 1.51 -8.08 7.7 60.67 31.63 Trend

6. Current Expenditure as % of 80.33 Total Expenditure 7. PSDP as % of GDP 8. Fiscal Deficit as % of GDP (federal) 9. % of external financing 10. % of bank financing 11. % of non-bank financing Source: Fiscal Operations, MOF 2.90 -4.77 48.21 n.a. n.a.

Current Expenditure as % of Total Expenditure: Rising levels of current expenditure are increasingly crowding out development expenditure, mostly on the PSDP. The share of the former in total expenditure has increased from 80 percent to 87 percent. Only 13 percent of the federal budget is being devoted to development activities. PSDP as % of GDP: The cut backs on the development side have implied that the size of the PSDP as percent of GDP has fallen to a critically low level, from almost 3 percent to only 1.5 percent of the GDP. At this level, even the replacement needs of public infrastructure are probably not being met and the productive capacity of the economy is not expanding significantly. External financing of deficit: Another adverse development is the large decline in access to external assistance, especially to grants and concessional aid. The net contribution of external financing to the federal fiscal deficit has fallen precipitously from 48 percent to less than 8 percent. Financing by the Banking System: This has emerged as the principal source of financing the deficit, with a share of 61 percent in total borrowing in 2011-12, with its concomitant implications on inflation and crowding out of the private sector.
Imperatives for Fiscal Policy in The Federal Budget of 2013-14 Research Report No.86

Non-Bank Financing: The dependence on non-banking sources, especially through the National Savings Schemes, reached a peak share of 47 percent in 2009-10 and has since declined to below 32 percent. What is the likely budgetary outcome in 2012-13? The Ministry of Finance has released the data on the fiscal operations for the first nine months. Our projections for the year are given below in Table 3, based on estimates by the Planning Commission and on reports in the media.
Table 3 Projected Budgetary Magnitudes of the Federal Government in 2012-13 (Rs in Billion)
Budget Estimate Revenue Receipts Tax Revenues (FBR) Non-Tax Revenues Less Transfers to Provinces Net Revenue Receipts Total Expenditure Current Expenditure Development Expenditure and net Lending Fiscal Deficit Unpaid Claims Overall Fiscal Deficit 3234 2504 (2381) 730 1458 1776 2986 2395 591 1210 1210 5.1 5.1 % of GDP Projection 2807 2115 (2000) 692 1231 1576 3374 2833 541 1798 377 2107 % of GDP 11.9 8.9 (8.5) 2.9 5.2 6.7 14.3 12.0 2.3 7.6 1.6 9.2 897 Difference -427 -389 (-381) -38 -227 -200 388 438 -50 588

Source: Budget-in Brief, 2012-13, MOF and own estimates.

It appears that there will be a massive slippage in the Federal Budget of 2012-13, probably the largest in the history of the country. Not only is there likely a very large short fall in revenues but also substantial over expenditure. FBR was given a target for revenue collection at the start of the year of Rs 2381 billion. Following successive downward revisions in the target, it is expected to close the year with revenues of about Rs 2000 billion, a shortfall of almost 16 percent in relation to the original target. Reasons for the shortfall are discussed in a subsequent section. On of the expenditure side, current outlays are expected to exceed budget estimates by as much as Rs 438 billion. Subsidies to the power sector are likely to be higher than anticipated by Rs 215 billion, interest payments by Rs 114 billion, defence expenditure by Rs 30 billion and other expenditure by Rs 79 billion.
Research Report No.86 Imperatives for Fiscal Policy in The Federal Budget of 2013-14

Overall, the federal fiscal deficit is projected at 7.6 percent of the GDP as compared to the original target of 5.1 percent of the GDP. In addition, the Planning Commission expects that there will be pending unpaid claims of Rs 377 billion due to the fertilizer subsidy, commodity operations (especially in wheat) and the Tariff Differential Subsidy (TDS) in the power sector. If these are accounted for, then the federal fiscal deficit rises to the unprecedented level of 9.2 percent of the GDP in 2012-13. This represents the culmination of four years of flagrant busting of the budget by the previous Government. It leaves behind a mountain of debt, which is also quantified in a subsequent section. As shown in Table 4, the projected increase in fiscal deficit over the level in 2006-07 is due almost 64 percent to lower net revenue receipts. The remaining 36 percent is contributed by higher expenditure, especially on the current account.
Table 4 Contribution of Different Factors to the Increase in the Fiscal Deficit from 2006-07 to 2012-13 (% of GDP)
2006-07 Revenue Receipts Tax Revenues (FBR) Non-Tax Revenues Less Transfers to Provinces Net Revenue Receipts Total Expenditure Current Expenditure Development Expenditure and Net Lending Fiscal Deficit 14.2 9.8 (9.6) 4.4 -4.6 9.6 14.3 11.8 2.5 -4.7 2012-13 (Projected) 11.9 8.9 (8.5) 2.9 -5.2 6.7 15.9 13.6 2.3 -9.2 Difference -2.3 -0.9 (-1.1) -1.4 -0.6 -2.9 1.6 1.8 -0.2 -4.5 31 13 64 36 40 -4 100 % Contribution to Higher Deficit 51 20

Source: Fiscal Operations, MOF and own estimates.

Imperatives for Fiscal Policy in The Federal Budget of 2013-14

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2.

TAX REVENUES

The trend in the federal tax-to-GDP ratio since 2006-07 is given in Table 5. In 200607, the ratio was already very low at below 10 percent of the GDP, making Pakistan one of the least taxed countries in the world.
Table 5 Federal Tax-to-GDP Ratio (% of GDP) (Rs in Billion)
Years 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 (E) Direct Taxes 3.85 3.59 3.29 3.57 3.30 3.54 3.20 Sales Tax 3.56 3.76 3.55 3.49 3.50 3.92 3.73 Excise Duty 0.83 0.82 0.91 0.81 0.76 0.59 0.49 Customs Duty 1.52 1.47 1.17 1.09 1.03 1.06 1.07 FBR 9.76 9.64 8.92 8.96 8.59 9.11 8.49 Petroleum Levy 0.88 0.60 0.46 0.29 0.41 Total 9.76 9.64 9.80 9.56 9.05 9.40 8.90

(E) = Estimated Source: Fiscal Operations, MOF

The performance, thereafter, has been even more disappointing. The tax-to-GDP ratio has continued to fall and by 2012-13 it is expected to be even below 9 percent. The only tax which has shown a rising trend with respect to the GDP is the sales tax, which has emerged now as the largest source of tax revenue. Despite being a potentially buoyant tax, income tax has not performed well, and the direct tax-to-GDP ratio has fallen by 0.65 percent of the GDP since 2006-07. Excise duties are consciously being phased out, while the customs duty contribution has been limited by the large non-dutiable imports and presence of SROs. Overall, the FBR tax-to-GDP ratio has fallen by as much as 1.27 percent of the GDP. The fall in the FBR tax-to-GDP ratio has been partially compensated for by the introduction of the petroleum levy, a carbon tax, in 2008-09. This yielded 0.88 percent of the GDP in the first year of its introduction. However, given the specific nature of the levy, its contribution is expected to fall to 0.41 percent in 2012-13. Also, the levy has been effectively reduced in periods of rising oil prices, as in 2011-12.

Research Report No.86

Imperatives for Fiscal Policy in The Federal Budget of 2013-14

Why have federal taxes performed poorly during the last five years? Is this because of rampant and growing tax exemptions? Is it the consequence of slow growth in the economy and in the relevant tax bases? Or is it the result of a failure of tax administration in the presence of large-scale tax evasion and corruption? We have analysed the reasons for the fall in the FBR tax-to-GDP ratio between 2007-08 and 2010-11. It appears that 80 percent of the fall is due to the base effect, that is, relatively slow growth of tax bases like imports and large-scale manufacturing value added in relation to the growth of GDP. The remaining 20 percent is attributed to the rate effect indicating either a fall in tax rates, more exemptions and concessions or a deterioration in the quality of tax administration. How has tax policy evolved over the tenure of the PPP government? A listing of taxation proposals in the last four budgets is given in the Appendix. The following policy preferences emerge from the examination of the proposals: (i) Tendency to raise rapidly the exemption limit of personal income tax. It has more than doubled from Rs 180,000 to Rs 400,000 since 2009-10. This has limited the number of returns being filed. (ii) Propensity to tinker around with Presumptive Income Tax (PIT) rates. For example, the PIT on commercial importers was raised from 2 percent to 4 percent in the 2009-10 budget, increased further to 5 percent in 2010-11 and then brought down once again to 3 percent in 2012-13. (iii) More incentives for investment including for BMR, enlistment in the stock exchange, etc. (iv) Variation in the standard GST rate, increase from 16 percent to 17 percent in 2008-09 and brought down once again to 16 percent in 2011-12. (v) Enhancement in excise duty on cigarettes, while phasing it out on other items like cement, beverages, etc. Some innovations and measures to expand the tax base must be recognised as follows: (i) (ii) Introduction of the Petroleum Levy in 2008-09. Levy of a Minimum Income Tax at 1 percent on the turnover of companies in 2008-09.
Imperatives for Fiscal Policy in The Federal Budget of 2013-14 Research Report No.86

(iii)

Introduction of an excise duty in VAT mode on banking services, import cargo handlers, stock brokers, insurance companies and advertisements in 2008-09.

(iv) (v) (vi)

Introduction of a PIT on short-term capital gains on shares in 2010-11. Imposition of a withholding tax at 5 percent on air travel in 2010-11. Elimination of zero-rating of domestic sales in six export-oriented industries, including textiles in 2010-11.

(vii)

Withdrawal of exemption from sales tax to agricultural inputs like fertilizer, tractors, etc, in 2010-11.

(viii)

Introduction of withholding tax on bank withdrawals at 0.3 percent on transactions above Rs 25,000 in 2010-11.

However, some of these proposals were withdrawn subsequently due to pressure from influential lobbies or not implemented effectively. Overall, discretionary changes in tax policy have not been enough to raise the tax-to-GDP ratio or even sustain it. In fact, the fiscal effort appears to have visibly slackened after 2010-11, following Pakistans exit from the IMF SBA. The 2012-13 Budget is the last pre-election budget of the PPP government. As such, it contains a relatively large number of concessions including the following: (i) Enhancement in the income tax exemption limit from Rs 300,000 to Rs 400,000. (ii) (iii) Minimum Income Tax reduced from 1 percent to 0.5 percent of turnover. Reduction in PIT rates: 5 percent to 3 percent for commercial importers, 1 percent to 0.5 percent for exporters and from 3.5 percent to 2.5 percent for supplies. (iv) (v) (vi) (vii) Reduction in GST rate to 16 percent on all items. Elimination of excise duty on 10 items. Further reduction in excise duty on cement. Scaling down of the highest tariff from 35 percent to 30 percent.

Clearly, these tax breaks have implied some revenue losses. In addition, the tax base of imports, in particular, has grown slowly. For example, POL products are the largest contributor to indirect taxes, with a share of 35 percent. Imports of these products have grown at 7 percent upto to March in 2012-13, as compared to over
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22 percent in 2011-12. Automobile imports, the other major revenue spinner, are down by 7 percent. On top of all this, the morale of FBR has been badly affected by frequent changes of the Chairman and large-scale transfers of officials during 201213. Consequently, the growth rate of FBR revenues is projected at only 6 percent in 2012-13, the lowest since 2001-02. This will imply a fall in the tax-to-GDP ratio of FBR of 0.62 percent in one year. Clearly, one of the primary tasks ahead for the newly elected government will be to raise the tax-to-GDP ratio, after the fall over the last five years. The PML(N) has already indicated in its Manifesto the key elements of its tax reform strategy as follows: x x x x x x x x x x x x x x Informal economy to be brought into the tax net Tax base will be broadened Taxation of all incomes Documentation of the economy Reduction in tax evasion by rationalizing tax rates Reform of tax administration Publication of a Tax Directory No increase in tax rates, subsequently reduction to attract FDI Provincial governments to raise their tax revenues Broadening of the scope of the sales tax Elimination of money laundering and whitening of black money Reduction in number of taxes Improvement in the process of self-assessment and audit Discouragement of non-essential imports by regulatory duties

The PML(N) manifesto targets for an increase in tax revenues from 9 percent to 15 percent of the GDP by 2017-18. This implies an increase annually of 1.2 percent of the GDP. Based on the assumption of a nominal increase in GDP of 12 percent in 2013-14, the tax revenue target will have to be set accordingly at Rs 2677 billion, an increase of Rs 562 billion or 26.5 percent over the projected level of Rs 2115 billion in 2012-13. This is an ambitious target, and will require an extraordinary level of fiscal effort, especially if tax rates are not to be enhanced. It carries the risk of further slowing down the economy.
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We have prepared a menu of potential tax reforms which are largely consistent with the principles of tax reform enunciated above in the PML(N) manifesto and promise greater equity in the tax system, while yielding additional revenues. These reforms both in the tax policy and in tax administration are listed below. Effective Agricultural Income Taxation: The present structure, as per the Agricultural Income Tax Act enacted by the Provincial governments in 1947, is either a fixed presumptive tax (with an exemption limit) per acre or a progressive rate structure on actual agricultural income (with scope for substantial deductions). The presumptive tax rates vary from only Rs 150 to Rs 250 per acre, which are less than 1 percent of the net income per acre. These rates need to be raised substantially. Simultaneously, the penalty for non-filing of a return may be raised from a maximum currently of Rs 1000 only to 100 percent of the assessed tax following the detection of non-filing. Development of PIT is considered as a pre-requisite for signaling greater equity of the tax system. This could help in raising tax payer compliance generally. Taxation of Assets: As indicated earlier, there was wealth tax on individuals upto 2000. It was an indicator of equity in the tax system and wealth returns also provided collateral evidence on income. This tax may be re-introduced. Alternatively, a Minimum Assets Tax (MAT) may be levied at 1 percent of global net assets, as the minimum income tax payable. Minimum Tax on Turnover: A small percentage, less than 10 percent, of companies actually pay the corporate income tax. As such, a minimum tax on turnover was introduced in the Finance Bill of 2009-10 but has been partially withdrawn in the Finance Bill of 2012-13. There is a strong case for re-introduction of this tax, with the usual carry forward provisions, in order to curb corporate tax evasion. Withdrawal of Tax Expenditures: There is need for introducing transparency and proper accounting of tax expenditures (cost of exemptions and concessions) in Pakistan, as part of the information provided at the time of presentation of the Budget to the Parliament, as in India. This will enable public debate on which exemptions and concessions are justified.

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Direct Taxes In direct taxes, the following tax expenditures need to be effectively targeted initially: a) Capital gains (short and long term) on shares and property b) Elimination of tax holidays beyond five years except for investment in the power sector c) Reduction in the first year depreciation allowance except for export-oriented industries and power sector d) Tax deduction on loan provisioning by banks to be only allowed only for priority sectors like SMEs, agriculture and exports. Rationalization of Tax Rates: The divergence in tax rates between individuals, small and large companies needs to be eliminated. The corporate tax rate on large companies (especially publicly quoted) may be brought down gradually to 30 percent and raised to 30 percent for AOPs, small companies and individuals. This will encourage the process of corporatization in the economy and imply a more progressive personal income tax structure. Moving from Schedular to Comprehensive Income Taxation: Currently, most forms of unearned income are taxed at source as separate blocks of income at a fixed and final rate of 10 percent. As highlighted earlier, this has reduced progressivity. As such, these fixed taxes may be converted into withholding taxes in the case of income from bank deposits, savings schemes, dividends, interest on securities, prize bonds, etc. This will also enable persons with total income below the exemption limit to claim refunds. Further, fixed taxes are also levied on income proxies. In the case of contractors, suppliers, service providers and importers a scheme is proposed whereby the current fixed rate may be raised for tax payers who want to make this the final payment and a lower rate be prescribed for those who prefer to make a withholding tax payment and include the income derived in their returns. This could promote the process of documentation in the economy. Development of the property Tax: This will involve extension of rating areas, higher taxation of commercial properties and reassessment of Gross Annual Rental Values (GARVs).
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Incentives for Filing Returns: Numerous incentives may be offered to taxpayers (AOPs and small companies) who have regularly filed a return over a period of two years with no under-declaration or short payment. These incentives could include the following: a) Some preference in contracts for supplies to government departments b) Guaranteed refund within the stipulated time c) Access to a bank loan up to certain limit d) Provision for carry forward of losses e) Partial or full exemption from withholding taxes, contributing thereby to improvement in the case flow position f) Preferential treatment in getting access to public services like issue of passport; electricity or gas supplies, etc., g) A tax credit. These incentives could induce a significantly higher number of tax returns. Indirect Taxes Proposals in the domain of indirect taxes include the following: Introduction of a Broad-based Integrated VAT: There is need to reconsider

passage of the VAT Bill of 2010. Recent developments like the establishment of a separate tax machinery for collection of the sales tax on services by the Provincial Governments of Sindh and Punjab have made the task of integration more difficult. It has complicated the process of input tax invoicing of services in manufacturing and of manufactured goods in services. There is need for introducing a system of recording tax invoices issued across provincial boundaries and of credits/refunds between governments. Broad-basing has considerable scope, especially in the area of services. For example, the Services Tax in India is levied on 125 services and generates 1 percent of the GDP. Major services which have not been covered by the Sales Tax on Services in Pakistan include credit card services, security services, consultancy services, accountancy services, legal services, airport services, air travel agents, etc. These services are mostly consumed by corporate entities or upper income groups. The standard rate may be brought down to 12.5 percent once again, following the broad-basing.
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Rationalization of Customs Duties: The statutory tariff rates (by nature of the good in terms of value added) must be adhered to with essentially three slabs only of 5 percent, 15 percent and 25 percent respectively. Simultaneously, most of the SROs, except those pertaining to trade agreements, may be withdrawn. Also, in order to eliminate the problem of underinvoicing, a system of minimum import prices may be introduced for some commodities, with the provision that these prices will be revised periodically. This system was in operation in Pakistan in the 90s and is not violative of WTO rules, if used selectively.

Tax Administration FBR: Radical changes are required to make FBR more effective in implementing reforms in tax policy and collecting more revenues. The following measures are needed to be undertaken on a priority basis: a) Conversion of FBR into an autonomous Revenue Authority b) Strengthening of the Revenue Division in the federal Ministry of Finance for formulation of tax policy c) Filling of asset declaration periodically by tax officials d) Strengthening the Tax Ombudsman and vesting him/her with judicial powers e) Internal strengthening of FBR in the areas of audit and intelligence f) Development of a Data Warehouse, linked particularly to withholding tax payments g) Streamlining the process of payment of refunds h) Augmenting the quality of human resources i) Publishing a Tax Directory annually of payments by tax payers. 3. NON-TAX REVNEUS

Non-tax revenues are seldom focused on discussions on the budget. Historically, they have been a fraction of tax revenues. But what has not been realized is that, as shown in Table 4, these revenues are responsible for a bigger part, over 60 percent, of the fall in the revenue-to-GDP ratio since 2006-07. Yet the emphasis has primarily been on tax revenues.

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What do non-tax revenues consist of? There are three types of non-tax revenues, viz, income to the federal government from property and enterprises, receipts from civil administration and other functions and miscellaneous receipts. The first type includes profits, dividends from and interest payments by provincial governments and PSEs. The second type consists primarily of SBP profit, defence receipts (especially from the CSF since 2002), and revenue from user charges on different services. The third type of non-tax revenues are primarily royalties and surcharges on oil and gas and passport fees. The trends in different non-tax revenues since 2006-07 is given in Table 6. Overall, between 2006-07 to 2012-13, there is likely to be major fall in the non-tax-to-GDP ratio of over 1.4 percent as compared to 0.9 percent in the tax-to-GDP ratio.

Table 6 Trend in Non-Tax Revenues (% of GDP)

2006-07 Income from property and Enterprise Receipts from Civil Administration Miscellaneous Receipts Total Non-Tax Revenues *inclusive of petroleum levy Source: Fiscal Operations, MOF 1.18 1.72 1.50 4.39 2007-08 1.28 1.32 1.22 3.82 2008-09 0.79 1.85 1.92* 4.56 2009-10 0.55 2.35 0.85 3.76 2010-11 0.44 1.40 0.99 2.83 2011-12 0.35 1.04 0.93 2.32 2012-13 0.33 1.60 0.99 2.92

The biggest decline of 0.85 percent of the GDP has occurred in income from property and enterprises. This is yet another indicator of the decline in the performance of state enterprises. Organizations like NBP, GHPL, OGDCL, PTCL, etc., have not generated profits in line with the growth in the nominal GDP. Others like WAPDA and Pakistan Railways have been unable even to honor their debt servicing obligations with the federal government. Receipts from civil administration and other functions have been the largest source of non-tax revenues. They have fluctuated in line with the variation in SBP profits and in receipts from the CSF. Miscellaneous receipts have fallen by 0.50 percent of the GDP as royalties/surcharges on oil and gas are mostly specific in character and have not been adjusted in line with inflation. The federal government has had little
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incentive to develop this source in view of the fact that most of the revenues are reverted to the provincial governments as straight transfers. Clearly, more emphasis will have to be laid on the revival of non-tax revenues in the Budget of 2013-14 by implementing some or all of the following measures: (i) Replacement of government nominees in the Board of Directors of the PSEs by sector professionals, financial experts and persons of proven integrity and management experience. Profitability targets may be set by these BODs on the basis primarily of enhancement of efficiency in operations, such that dividend pay outs increase. (ii) Ensure that revenues of upto Rs 79 billion are realized finally by PTA by the auctioning of 3-G Licences. (iii) (iv) (v) (vi) (vii) 4. Ensure that the disbursement of the CSF funds due takes place in 2013-14. Index charges on services like issue of passports to inflation. Raise rents on government land leased out. Introduce a levy, similar to the levy on LPG, on consumption of CNG. Increase regulatory fees on insurance companies.

NET REVENUE RECEIPTS

As shown in Table 4, the share of transfers to the Provincial Governments has increased sharply after 2009-10, following the 7th NFC Award. These transfers are of two types, viz, transfers from the divisible pool and straight transfers respectively. The former are based on a share determined by NFC, while the divisible pool consists mostly of FBR taxes. Table 7 presents the evolution of net revenue receipts of the federal government from 2006-07 onwards. These have declined from 9.6 percent to 6.7 percent of the GDP in 2012-13. It is estimated that 80 percent of this fall is due to lower gross revenue receipts as percentage of the GDP. The remaining 20 percent is due to the increase in transfers to the provinces. It has sometimes been argued that the 7th NFC Award is one of the major reasons for deterioration in the state of federal finances and a corresponding improvement in provincial finances. It has undoubtedly contributed to greater fiscal decentralization

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in the country. Perhaps the problem is more due to the failure to faithfully implement the provisions of the 18th Amendment on devolution of functions. The federal government has accepted the responsibility to continue funding a number of devolved functions including higher education, vertical programs, etc.

Table 7 Net Revenue Receipts of the Federal Government (% of GDP)

2006-07 Gross Revenue Receipts Less Transfers to Provinces Net Revenue Receipts Source: Fiscal Operations, MOF 14.22 -4.61 9.61 2007-08 13.67 -4.46 9.21 2008-09 13.67 -4.57 9.10 2009-10 13.33 -3.76 9.57 2010-11 11.89 -5.54 6.35 2011-12 11.74 -5.28 6.46 2012-13 (Projected) 11.90 -5.20 6.70

The 8th NFC is likely to be constituted in 2014-15, the last year of the present award. Any downward adjustment in transfers is precluded by the Article 160(3A) of the Constitution as follows: The share of the Provinces in each award of the National Finance Commission shall not be less than the share given to the Provinces in the previous Award Therefore, discussions in the 8th NFC will need to primarily focus on the appropriate sharing of expenditure. 5. CURRENT EXPENDITURE

As highlighted earlier, one of the principal reasons for the malaise in federal finances is the explosive growth in current expenditure, especially after 2010-11. The increase in current expenditure between 2006-07 and 2012-13 is estimated at almost 2 percent of the GDP as shown in Table 8. The big jump is in the subsidy bill, especially to the power sector, of 2.80 percent of the GDP. Interest payments and grants have been, more or less constant in relation to the GDP while defence expenditure has declined by about 0.5 percent of the GDP.

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Table 8 Trend in Components of Current Expenditure (% of GDP)

2006-07 Interest Payments Defence Grants Subsidies Others TOTAL Source: Fiscal Operations, MOF 4.25 2.88 1.29 0.97 2.17 11.56 2007-08 4.78 2.78 1.17 1.49 3.97 14.19 2008-09 5.01 2.59 1.22 1.09 2.16 12.07 2009-10 4.34 2.53 2.24 1.57 1.74 12.43 2010-11 3.87 2.50 1.58 2.20 1.72 11.87 2011-12 4.30 2.46 1.35 2.95 1.53 12.58 2012-13 4.39 2.43 1.31 3.77 1.70 13.60

The outlook for 2013-14 depends on actions on the following fronts: Interest Payments: In 2012-13, the fiscal deficit is expected to be virtually financed completely by domestic borrowing in the absence of net inflows of external assistance. The former are relatively high cost borrowing in terms of the rate of interest, which is estimated at 10 percent in 2011-12. Therefore, if the present pattern of financing continues in 2013-14, then the level of interest payments may rise from Rs 1040 billion in 2012-13 to over Rs 1200 billion, an increase of almost 15 percent. This rapid increase implies, as highlighted earlier, that today Pakistan finds itself in the domestic debt trap. It has been argued that interest costs have been held down by the high share of incremental debt in the form of short-term borrowing, with lower interest rates. But while this is the optimal policy in period of falling interest rates it may imply higher costs when interest rates are rising. If, for example, interest rates rise in 2013-14 by one percentage point then this could add over Rs 50 billion to the debt servicing bill. Susbdies: The largest component of subsides, almost 80 percent, is the Tariff Differential Subsidy (TDS) to the distribution companies in the power sector. The budgeted allocation on this head has been consistently exceeded by a wide margin in recent years. For example, it was expected that the TDS would be restricted Rs 185 billion in 2012-13 but the year is likely to end with the figure at over Rs 400 billion. The TDS per kwh is the difference between cost (as determined by NEPRA) and the average tariff. Estimates are that in the presence of rising costs and lack of any upward adjustment in tariffs upto now in 2012-13, the TDS per kwh now exceeds
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Rs 5. This implies that if business continues as usual then the total TDS will approach Rs 500 billion in 2013-14. The challenge for the newly elected government is to proceed on a priority basis to implement measures to contain the TDS to, say, to about Rs 300 billion, if there is to be any success in reducing the overall fiscal deficit in 2013-14. A feasible plan that could be implemented is as follows:
Reduction in Subsidy (Rs in Billion)

x x x x x

10 percent increase in power tariffs 20 percent increase in gas supplies to the power sector 20 percent reduction in transmission and distribution losses 10 percent higher rate of recovery of bills 25 percent recovery of arrears each year TOTAL

47 39 34 61 25 206

Grants: The provision for grants in 2012-13 is Rs 312 billion. This includes Rs 56 billion to the Provincial Governments and Rs 256 billion to others. The latter consist of grants of Rs 31 billion to Pakistan Railways, 11 billion to the AJK government and Rs 17 billion to the government of Gilgit-Baltistan. In addition, there is a provision of Rs 150 billion for contingent liabilities and Rs 35 billion for miscellaneous grants. Presumably these provisions mostly cover the cost of subsidy on imported fertilizer, commodity operations and potentially even higher power subsidy. In 2013-14, efforts will have to be made to reduce contingent liabilities. Costs of Civil Administration: The costs of civil administration have also risen rapidly due to frequent and large hikes in pay and allowances. The PPP government has been prone to give big annual increases, of 15 percent in 2009-10; 50 percent in 2010-11; 15 percent in 2011-12 and 20 percent in 2012-13. On top of this, a few days prior to the exit of the PPP government, the Prime Minister announced a special allowance at 20 percent of basic pay with effect from 1st of March 2013 to all the officers and staff working in the Federal Ministries/Divisions only. The rise in costs of pay, allowances and pensions of federal employees is given in Table 9. These have risen by almost 21 percent per annum, over 10 percent above

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the annual rate of inflation. As such, federal employees have seen substantial increases in their real incomes during the tenure of the previous government.
Table 9 Federal Employees, Pay, Allowances and Pensions (Rs in Billion)
2009-10 Employees Pay and Allowances Pay Allowances Employees Retirement Benefits TOTAL Source: Fiscal Operations, MOF 92.7 43.4 49.2 76.3 169.0 2010-11 113.9 47.7 66.2 98.6 212.5 Budget Estimates 2011-12 2012-13 123.0 44.0 79.0 104.2 227.6 155.0 69.7 85.3 144.1 299.1 ACGR (%) 18.7 17.1 20.1 23.6 20.8

This generosity will have to be more restricted in coming years. Already, the Federal Budget of 2013-14 will have to factor in the full year cost of the 20 percent special allowance. Future increases may at best be indexed to the rate of inflation. Salary increases have a disportionate impact (almost three times) on provincial governments. 6. DEVELOPMENT EXPENDITURE

One of the unfortunate developments is the crowding out of development expenditure, primarily on the PSDP, due to the phenomenal increase in current expenditure, especially after 2009-10. The trend in development expenditure is given in Table 10. The size of the federal PSDP will fall by 1.4 percent of the GDP from 2006-07 to the projected level of 1.9 percent of the GDP in 2012-13. This is an extremely inadequate level of outlay on development projects, at a time when critical bottlenecks have emerged in infrastructure, especially of power and water.
Table 10 Development Expenditure of Federal Government (% of GDP)
2006-07 PSDP Net Lending Other TOTAL 2.90 -0.43 0.00 2.47 2007-08 2.74 -0.13 0.00 2.61 2008-09 1.68 0.34 0.40 2.42 2009-10 2.92 0.29 0.65 3.86 2010-11 1.29 0.13 0.25 1.66 2011-12 1.52 0.11 0.32 1.95 2012-13 1.50 0.34 0.36 2.30

Source: Fiscal Operations, MOF

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A new category of expenditure, called other development expenditure was added to the budget in 2008-09. This primarily includes the allocation for the Benazir Income Support Program (BISP), subsidy on fertilizer import, transfer to export investment development fund, etc. the allocation for BISP is probably more legitimately a current expenditure and should be included under the head of social protection. This would imply that the revenue deficit is actually somewhat higher. The low level of allocation in the budget for the PSDP has not been accompanied by efforts at rationalizing the portfolio of on-going projects and formulating clear priorities for funding. Currently, the throw forward (cost to be incurred yet on ongoing projects) is close to Rs 2500 billion, equivalent to over seven times the present size of the PSDP. With regard to the power sector, the total allocation for projects is Rs 145 billion, equivalent to 40 percent of the planned size of the PSDP in 2012-13. The throw forward of power projects (excluding Daimer-Basha dam) is Rs 473 billion. As such, the on-going projects will take on average three years to execute. The process of implementation of power projects needs to be expedited. The recommendations on the development side for the budget of 2013-14 are as follows: (i) The size of the PSDP may be set at Rs 450 billion, as proposed in the Budget Strategy Paper of the MOF. This will imply a growth rate of 25 percent and a rise in the level of PSDP to 1.7 percent of the GDP. By 2015-16, this should be raised to 3 percent of the GDP. This increase will promote the process of revival of the economy. (ii) The share of the PSDP allocated to projects in the power sector must be increased to 60 percent. This will raise the outlay by over 86 percent in 2013-14 and enable completion of bulk of the on-going projects within two years. (iii) The BISP may be continued with changes, following an independent third party audit. The Peoples Works Program may be converted into a Rural Employment Guarantee Scheme, especially for youth in backward districts.
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7.

FINANCING OF THE FISCAL DEFICIT

Financing of the fiscal deficit has become a really daunting task in the face of the massive increase in the absolute size of the deficit from Rs 414 billion in 2006-07 to the projected level of Rs 1786 billion in 2012-13, an increase of 331 percent! The consequential impact of these deficits on the level of outstanding government debt is given in Table 11. Domestic government debt is estimated to reach Rs 9815 billion by end of 2012-13. This represents an increase of Rs 6540 billion on the level at the time at the time of assumption of power by the PPP, equivalent to cumulative growth of almost 200 percent. The increase in external debt is Rs 1823 billion, equivalent to a jump of 66 percent. Therefore, the composition of outstanding debt has changed substantially, with the share of domestic debt rising from 54 percent in 2006-07 to 68 percent in 2012-13. Total outstanding debt of the government as percentage of GDP is expected to exceed the ceiling of 60 percent imposed by the FDRL Act of 2005.
Table 11 Outstanding Government Debt (Rs in Billion)
2007-08 Government Domestic Debt Stock Increase % of GDP Government External Debt Stock Increase %of GDP Total Government Debt Stock Increase Government Debt as % of GDP Source: Fiscal Operations, MOF 3275 (end of year position) 2008-09 2009-10 2010-11 3861 586 4651 790 6012 1355 2011-12 7638 1626 2012-13 9815 2177

2762

3452 690

3667 215

3988 321

$46.2 (4364) 376

4685 221

6037 58.93

7313 1276 57.48

8318 1005 56.19

10000 1682 55.45

12002 2002 58.11

14400 2398 60.84

The flow of external assistance has collapsed and there is virtually no net inflow expected in 2012-13. This has been pronounced after 2009-10, following Pakistans withdrawal from the IMF SBA, as shown in Table 12. In 2009-10, the net inflow of external assistance was large at Rs 430 billion, which fell to Rs 162 billion in 201011, to Rs 89 billion in 2011-12 and expected at virtually zero in 2012-13.

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Table 12 Net Flow of External Assistance (Rs in Billion)

2008-89 I. EXTERNAL LOANS A. PROJECT LOANS Federal Provincial B. PROGRAMME LOANS C. OTHERS* II. EXTERNAL GRANTS Kerry Lugar Project Aid III. TOTAL IV. REPAYMENT V. NET EXTERNAL ASSISTANCE Source: Fiscal Operations, MOF 347.8 64.1 41.1 23.0 191.3 92.5 19.6 8.6 367.4 121.3 246.1 2009-10 450.2 90.5 77.5 13.0 172.0 187.7 127.8 15.8 578.0 148.1 429.9 2010-11 254.7 94.0 76.7 17.3 39.0 121.6 35.1 11.0 11.7 289.8 127.4 162.4 2011-12 180.5 165.7 127.2 38.6 4.6 6.2 45.6 20.4 18.7 226.2 136.9 89.3 2012-13 n.a.

n.a. n.a. n.a.

n.a n.a. -4.1

Within domestic debt, there have also been major changes in composition by tenure. Permanent debt is long term debt and includes PIBs, prize bonds, etc. The share of permanent debt has increased from 19 percent to 22 percent. Unfunded debt is also long term debt and consists primarily of the National Savings Schemes. It has witnessed a significant decline in share from 31 percent of 23 percent. Short term debt, referred to as floating debt, has the dominant share, which has increased from 50 percent to 54 percent. In fact, the Government appears to be having increasing difficulty in floating long term paper. In the 11 auctions upto now in 2012-13 of PIBs, only once has there been any interest shown in 20 year bonds and in the last five actions only once has there been any purchase of 5 or 10 year bonds. This indicates high perceptions of long- term risk. Also, the yield curve has a modest slope currently, with a return of 9.25 percent on 3 year bonds going upto 11.75 percent in the case of 30 year bonds. The failure to borrow on a long term basis also indicates that investors probably expect interest rates in Pakistan to rise on a secular basis. Bulk of the financing at the margin has been through the flotation of MTBs, with maturity period of upto 12 months. Commercial banks have been encouraged to buy MTBs by large OMO injections by the Central Bank, which currently stand at Rs 2.6 trillion on a weekly basis.
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The bottom line is that the access to borrowing from banks and the capital market is reaching limits. This reflects a growing loss of confidence in Federal operations. Simultaneously, external agencies are also shy of extending soft credits and loans to Pakistan. This has dangerous implications. First, it means that there will continue to be strong upward pressure on interest rates. Second, the Government may be compelled to print more money through SBP, thereby exacerbating inflationary pressures. 8. PROSPECTS FOR 2013-14

The following are proposed measures and assumptions made to develop the scenario for 2013-14: (i) Increase in tax revenues of Rs 400 billion or 20 percent, with taxation proposals of Rs 184 billion. Targeting an increase beyond this would be counterproductive as it could stifle the process of growth in the economy. (ii) (iii) (iv) (v) (vi) (vii) Finally auction of 3-G licences by PTA fetching about Rs 79 billion. Receipts of CSF funds at the same level as 2012-13. Increase in interest payments of Rs 200 billion. Reduction in subsidies, especially to the power sector by Rs 200 billion. Increase in the federal PSDP to Rs 450 billion. Other expenditure on the development account held constant, including the allocation to BISP. (viii) Reduction in costs of civil administration by Rs 30 billion in line with the proposed drive for austerity. As shown in Table 13, based on the above, the federal fiscal deficit on a cash basis can potentially be brought down from 7.6 percent to 6.2 percent of the GDP. Of course, if any of the assumptions does not materialize then the deficit could be higher. The consolidated fiscal deficit can be targeted at 6 percent of the GDP on the assumption that the four provinces combined will generate a cash surplus of 0.2 percent of the GDP.

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Table 13 Feasible Scenario for the Budget of 2013-14 (Change from 2012-13) (Rs in Billion)
Gross Revenue Receipts Tax Revenues Non-Tax Revenues Less Transfers to Provinces Net Revenue Receipts Total Expenditure Current Expenditure Interest Payments Defence Grants Subsidies Development Expenditure Fiscal Deficit Level of Fiscal Deficit GDP Fiscal Deficit as % of GDP Source: Fiscal Operations, MOF 500 400 100 -200 300 130 40 200 50 20 -200 90 -170 1630 26504 6.2

9.

SUMMARY OF RECOMMENDATIONS

The measures which have been identified above that can potentially be included in the Federal Budget of 2013-14 are as follows: Tax Reforms (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) Effective agricultural income taxation Taxation of assets Minimum tax on turnover of companies Withdrawal of tax expenditures Rationalization of tax rates Moving from schedular to comprehensive income taxation Development of property tax Incentives for filing returns Introduction of broad-based integrated VAT Rationalization of customs duties
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Tax Administration Radical changes are required to make FBR more effective in implementing reforms in tax policy and collecting more revenues. The following measures are needed to be undertaken on a priority basis: a) Conversion of FBR into an autonomous Revenue Authority b) Strengthening of the Revenue Division in the federal Ministry of Finance for formulation of tax policy c) Filing of asset declaration periodically by tax officials d) Strengthening the tax Ombudsman and vesting him/her with judicial powers e) Internal strengthening of FBR in the areas of audit and intelligence f) Development of a Data Warehouse, linked particularly to withholding tax payments g) Streamlining the process of payment of refunds h) Augmenting the quality of human resources i) Publishing a Tax Directory annually of payments by tax payers. Non-Tax Revenues (i) Replacement of government nominees in the Board of Directors of the PSEs by sector professionals, financial experts and persons of proven integrity and management experience. Profitability targets may be set by the BODs on the basis primarily of enhancement of efficiency in operations, such that dividend pay outs increase. (ii) Ensure that revenues of upto Rs 79 billion are realized finally by PTA by the auctioning of 3-G Licences. (iii) Ensure that the disbursement of the CSF funds due takes place in 201314. (iv) (v) (vi) (vii) Index charges to inflation on services like issue of passports. Raise rents on government land leased out. Introduce a levy, similar to the levy on LPG, on consumption of CNG. Increase regulatory fees on insurance companies.

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Subsidies A feasible plan for reducing power sector subsidies by over Rs 200 billion includes the following:
Reduction in Subsidy (Rs in Billion)

x x x x x

10 percent increase in power tariffs 20 percent increase in gas supplies to the power sector 20 percent reduction in transmission and distribution losses 10 percent higher rate of recovery of bills 25 percent recovery of arrears each year TOTAL

47 39 34 61 25 206

Development Expenditure (i) The size of the PSDP may be set at Rs 450 billion, as proposed in the Budget Strategy Paper of the MOF. This will imply a growth rate of 25 percent and a rise in the level of PSDP to 1.7 percent of the GDP. By 2015-16, this should be raised to 3 percent of the GDP. This increase will promote the process of revival of the economy. (ii) The share of the PSDP allocated to projects in the power sector must be increased to 60 percent. This will raise the outlay by over 86 percent in 2013-14 and enable completion of bulk of the on-going projects within two years. (iii) The BISP may be continued with changes, following an independent Third Party audit. The Peoples Works Program may be converted into a Rural Employment Guarantee Scheme, especially for youth in backward districts. The Budget of 2013 is of great importance. It will be the first budget of the newly elected government of PML(N). If the budget pushes for tax reforms and proposes strong measures for containment of expenditure, leading to a sizeable fall in the fiscal deficit, then this will reassure markets and enhance confidence of the private sector in the economy. As opposed to this, if the new Government opts for a relatively soft budget, with stimulatory policies for reviving the economy without proper macroeconomic stabilization, then this may precipitate a financial crisis down the road.

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APPENDIX I STATISTICS ON THE FEDERAL BUDGET

2006-07 TO 2012-13 (July March) Rs in Billion)
GDP (mp) 8673 2006-07 A. Gross Federal Receipts Tax Revenues Direct Taxes Indirect Taxes Non-Tax Revenues Less Provincial Share Net Federal Receipts B. Total Expenditure Current Expenditure Interest Payments Defence Grants Subsidies* Others Development Expenditure and Net Lending PSDP Other Net Lending Others C. Fiscal Deficit D. Financing External Internal Bank Non-Bank Memo Item: FBR Tax Collection 846.5 1007.2 1157.0 1327.4 1550.2 1906.5 1335.2 199.6 214.4 n.a. n.a. 151.3 634.2 528.3 105.9 149.7 494.0 260.2 233.8 188.9 752.1 313.8 438.3 107.7 1220.6 747.7 472.9 128.6 1540.1 1012.5 527.6 -4.1 1153.8 958.0 194.8 1233.9 852.9 334.2 518.7 381.0 -400.1 833.8 1248.0 1002.6 368.8 249.9 111.5 84.3 188.1 213.6 251.1 0.0 -37.5 31.8 -414.0 10242 2007-08 1400.5 1009.9 387.9 622.0 390.6 457.4 943.1 1728.6 1453.5 489.7 285.1 120.3 152.3 406.1
a

12723 2008-09 1739.5 1158.6 440.3 718.3 580.9 -525.6 1213.8 1857.6 1536.4 6378 329.9 154.9 138.7 275.1 308.3 213.2 51.3 43.8 12.8 -643.7

14804 2009-10 1974.4 1418.0 528.6 889.4 556.5 -633.4 1341.0 282.0 1840.7 642.3 375.0 332.4 232.9 258.1 432.4 293.9 95.5 43.0 8.9 941.0

18033 2010-11 2144.5 1634.8 594.7 1040.1 509.7 -999.3 1145.2 2473.4 2141.5 698.1 450.6 285.5 397.1 310.2 300.1 232.7 44.6 22.9 31.8 -1328.2

20654 2011-12 2424.2 1945.7 731.9 1213.8 478.5 -1089.9 1334.3 3003.0 2600.3 889.0 507.2 278.9 609.6
b

2012-13
(July-March)

1977.8 1418.3 491.3 927.0 559.5 -893.2 1084.6 2234.3 1935.5 772.2 405.8 188.6 323.0 245.9 251.3 203.8 37.3 10.3 47.5 1149.7

315.6 402.7 313.3 67.1 22.3 -1668.7

267.3 280.5 0.0 -13.2 7.8 -785.5

PSDP Other Net Lending Others Source: Fiscal Operations, MOF

251.1 0.0 -37.5 31.8

280.5 0.0 -13.2 7.8

213.2 51.3 43.8 12.8

293.9 95.5 43.0 8.9

232.7 44.6 22.9 31.8

313.3 67.1 22.3 -

203.8 37.3 10.3 47.5

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29 APPENDIX II TAXATION PROPOSALS IN BUDGETS

2009-10 x Exemption limit for personal income tax raised from Rs 180,000 to Rs 200,000 x x x x x x x Levy of Petroleum Levy (a carbon tax) Enhancement in excise duty on cigarettes FED in VAT mode levied on banking services, import cargo handlers, stock brokers, insurance companies and advertisements Withholding tax on importers raised from 2 percent to 4 percent Increase in rate on CVT from 2 percent to 4 percent As a way of financing relief for IDPs, levy for one year at 5 percent on every individual earning more than Rs 1 million and 30 percent on corporate bonuses Levy of a Minimum Tax on companies

2010-11 x Reduction in customs duty on import of crude palm oil from Rs 9000 to Rs 8000 per ton x x x x x x x x x x x x x GST rate raised from 15 percent to 16 percent and exemption limit of turnover raised from 5 Million to 7.5 million Rs Elimination of 1 percent special excise duty Increase in FED on gas Levy of 10 percent excise duty on air conditioners and deep freezers Exemption limit in income tax raised from Rs 200,000 to Rs 300,000 Reduction of withholding tax on electricity from 10 percent to 5 percent 10 percent tax credit for BMR 5 percent tax credit for stock market enlistment of companies Tax rate on AOPs raised to 25 percent Tax on capital gains on shares at 10 percent for less than six months and 7 percent for 6 to 12 months Withholding tax on commercial importers raised from 4 percent to 5 percent New withholding tax on bank transactions at 0.3 percent for transactions above Rs 25,000 Withholding tax on air travel at 5 percent of value of ticket

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2011-12 x Reduction in sales tax rate from 17 percent to 16 percent x x x x x Elimination of excise duties on 15 items Abolition of regulatory duties Phasing out of FED on cement in three years Elimination of excise duty on beverages in two years Revision of excise duty on cigarettes

2012-13 x Exemption limit raised to 400,000 Rs. Reduction in slabs to five x x x x x x x x x x x x Tax payer Honour Card Minimum tax rate reduced from 1 percent to 0.5 percent Reduction in PIT: 5 percent to 3 percent for commercial importers; 1 percent to 0.5 percent for exporters and from 3.5 percent to 2.5 percent for supplies Enhancement in threshold for bank withdrawal tax from 25,000 to 50,000 Rs Investment allowance limit raised from 15 percent to 20 percent and maximum enhanced from Rs 500,000 to Rs 1 million Adjustable sales tax at 1 percent to be collected from distributors and dealers by manufacturers All GST rates brought down to 16 percent on all items Import duty on black tea reduced from 16 percent to 5 percent Elimination of excise duty on 10 items Further reduction in excise duty on cement FED on foreign travel removed The highest import tariff reduced from 35 percent to 30 percent.

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The Social Policy and Development Centre (SPDC)

Established in 1995, SPDC is a civil society sector research organisation that serves as a focal point for policy-relevant research on social sector development. Using a multidisciplinary approach, SPDC assists both public and private sector institutions including nongovernmental organisations (NGOs) to plan, design, finance, execute and manage social sector programmes in a cost-effective manner. The results of its research are made available to policy makers, interested groups and general public to promote informed discussion and action on vital social sector issues. SPDC being an independent and non-partisan organisation cooperates and collaborates with organisations/institutions working on issues of common concerns (both) within Pakistan and abroad. Being an autonomous and independent organisation, the centre identifies its own research agenda and parameters remaining within the mandate and objectives identified. The main areas identified for research by SPDC are: poverty, inequality, governance, provincial finances, social sector policies, gender issues and macroeconomic policy issues. Having established its credibility, SPDC is considered as one of the outstanding research policy institutions of Pakistan focusing on public policy analyses and social sector development.

Social Policy and Development Centre

15-Maqbool Co-operative Housing Society Block 7 & 8, Karachi 75350, Pakistan Tel: (92-21) 111-113-113 Fax: (92-21) 34534285 E-mail: spdc@spdc.net.pk | spdc@cyber.net.pk

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