Budget-making is an unenviable job. It requires the government to devise a complex package which leads to an increase in revenues, reduces the fiscal deficit, keeps inflation at bay and promotes economic growth. The difficulty is that vested interests who demand accommodation — business lobbies, politicians, IMF — tend to pull and push in such different directions that the final budgetary proposals end up becoming inconsistent and unrealistic.
The budget exercise this year is proving especially problematic because the economic figures for FY 1994-95 are in and the government is off target on most fronts. The fiscal deficit, which was targeted at 4 per cent, is up to 5.8 per cent. And GDP growth is only 4.7 per cent, significantly below the 6.5 per cent targeted. Revenue targets have also gone awry.
In June 1994, revenues for FY 1994-95 were targeted at Rs 259.90 billion, an increase of Rs 76.40 billion over the figure of Rs 183.2 billion in FY 1993-94. Of this targeted revenue increase, Rs 45.5 billion was expected to come from new tax measures imposed last year (including 15% sales tax on a wide range of items) while the rest was targeted to accrue from autonomous GDP growth. But things didn’t work out as planned. So the revenue target was revised to Rs 240 billion three months ago. It was revised again to Rs 230.50 billion last month. On the eve of the new budget, the fear is that revenue may be lower still — about Rs 210 billion. What has gone wrong?
In FY 1993-94, gross budgetary receipts were distributed as follows: Tax revenues 63%, non-tax revenues 29%, import surcharges 8%. Of all tax revenues, direct taxes contributed 26%, customs duties 37%, sales tax 17%, federal excise duties 20%.
In FY 1994-95, gross budgetary receipts were targeted thus: Tax revenues 71.77%, non-tax revenues 21.06%, import surcharges 7.16%. Of all tax revenues, direct taxes were expected to contribute 24%, customs duties 35%, sales tax 23%, federal excise duties 18%.
The sharp targeted rise in tax revenues over the earlier year — from 63% to 71.77% — was crucial to the budgetary exercise last year. Except for sales tax (whose substantial increase became pivotal), all other shares were targeted to decline. The revenue increase from sales tax was expected to go up from Rs 32.1 Billion in FY 1993-94 to Rs 59.8 Billion in FY 1994-95.
When the revenue targets for FY 1994-95 were revised from Rs 260 billion to Rs 230 Billion in April, the shortfalls were duly noted: 3.3% or about Rs 2 billion in Direct Taxes, 21.2% or about Rs 13 billion in Sales Tax, 11% or about Rs 10 billion in Customs Duties and 6.6% or about Rs 3 Billion in Federal Excise Duties.
The shortfalls in Direct Taxes and Federal Excise Duties are related to the lower than targeted growth rate of the economy (4.7% against 6.5%). Revenues from Customs Duties have fallen largely because of a reduction in the rates of import duties from a maximum of 95% to 70% without an offsetting increase in the volume and value of imports due, once again, to a lower than expected GDP growth rate. But the largest shortfall (in sales tax collections) is due to two main factors: the lack of an administrative structure to monitor and collect the newly imposed 15% sales tax and the fierce resistance of the business community to additional taxes during recessionary times. Businessmen are also loathe to fall in line with the sales tax proposals because this entails keeping detailed records of accounts which can later be perused by the tax authorities to track down income tax evaders.
Critics of the finance ministry argue that, in view of the government’s high expenditure targets, the original revenue targets in FY 1994-95 were deliberately inflated to unrealistic levels in order to please or hoodwink the IMF. A more accurate view is that the Central Board of Revenue (CBR) just does not have the intellectual capacity or resource data base to frame proper tax policies or the administrative ability to implement them efficiently. Prime minister Benazir Bhutto was so angered by the CBR’s inefficiency that mid-way through the tax collection drive in early 1995, when revenue receipts were well below targets, she fired the chairman of the CBR along with his deputies and handed over charge of the department to the finance secretary Javed Talat. The irony is that Mr Talat was chairman of the CBR when the 1994-95 budget was framed and was subsequently “promoted” as finance secretary by Ms Bhutto because his “excellent” tax proposals were tailored to meet her exorbitant revenue demands.
This is exactly what could happen all over again if the CBR’s proposal to impose over Rs 50 billion in additional taxes in the next budget is approved by the prime minister. The counter-arguments in favour of a reduced tax burden are more weighty.
Revenue receipts in FY 1993-94 of Rs 190 Billion were expected to increase to Rs 260 Billion in FY 1994-95. Of the net targeted increase of about Rs 70 billion, Rs 25 billion were expected to accrue from autonomous economic growth while Rs 45 Billion were targeted from new tax measures, including sales tax. In actual fact, however, they have turned out to be as low as Rs 210 billion. What has happened is that apart from the revenue shortfalls emanating from a lower than targeted GDP growth rate, the sales tax measures have fallen radically short of expectations.
The finance ministry should not use the original revenue target of Rs 260 billion as a base for levying over Rs 50 billion in new sales taxes. The fact is that the revenue base should properly be Rs 210 billion which is what has been realised. On this basis, a target of over Rs 50 billion is both excessive and highly unrealistic. Customs and sales tax were originally targeted at Rs 150 billion but were revised to Rs 126 billion in April and are expected to be about Rs 111 billion on the eve of the new budget. Since the tax/GDP ratio has remained constant at about 12 per cent, the likelihood is that the CBR’s new proposals, if accepted, are going to end up way off target once again.
The CBR’s proposals are also thought to be politically suicidal for Ms Bhutto’s government. With inflation running in double digits, the squeeze on the urban middle classes by the imposition of additional taxes on utilities and basic goods may lead to unrest on the streets. In fact, the opposition is banking upon an unpopular budget to create the political climate for renewed attempts to overthrow the government.
The counter proposals are more sensible. On the revenue side, the new tax burden should be as low as possible; maximum customs duties should be reduced to 55% and not 40%; and the sales tax on additional items should be lower than 15% and staggered over a few years. On the debit side, government expenditures should be restrained and waste reduced by abolishing innumerable unproductive government departments and institutions (the government should not act as an employment agency bestowing political patronage). More significantly, the proceeds from privatisation should be used to retire the government’s expensive domestic debt (over 80 % of total public debt) so that the burden of interest payments (Rs 83 billion or 40% of revenues) on the budget is reduced, freeing resources for development expenditures and the Social Action Programme.
Ms Bhutto does not have a full-fledged federal finance minister. “I’m my own finance minister because I know more about economics than anyone else in government” she once snapped at a journalist who thought the country desperately needed an economic “Czar” to put the economy on the rails again. Having mucked about last year, the prime minister had better be right in her economic prognosis for next year. Or else.