Projecting Disappointment – Dr Ashfaque H Khan

Projecting tax revenue with a fair degree of accuracy is an essential element of sound fiscal management. Pakistan has been failing to do so far the last several years and as such has been fixing unrealistic revenue target with all its adverse consequences.

Why have we been setting an unrealistic target? Because we have been treating revenue as a residual item in our budget deficit equation. The fault lies with the way we prepare our budget. The government finalises its expenditure plan first and then, given the budget deficit target set by the IMF, the revenue is derived as a residual. In other words, the revenue target set by the FBR is invariant with respect to the level of economic activity.

Unrealistic revenue target not only gives birth to fiscal indiscipline but also affects the quality of spending. What are the pitfalls of setting unrealistic revenue target in the budget? First, when we fix an over-ambitious revenue target for the FBR, the provincial revenue targets become inflated as well. While preparing the provincial budgets, the provinces take into account the revenue allocated to them under the NFC Award. Since transfer to provinces is based on actual collection, the provinces face revenue shortfall from day one but it becomes difficult for them to roll back their expenditures, leading to fiscal slippages.

Second, under the NFC Award, the federal government is bound to provide Balochistan on the basis of projected revenue and not on the basis of actual collection. For example, on the basis of unrealistic revenue target of Rs2475 billion in the budget 2013-14, Balochistan will get Rs133.3 billion. As will be shown below, the federal government will collect far less than the targeted revenue. Accordingly, the federal government will pay Balochistan from its own meagre share, thus reducing federal government resources even further.

Hence, forecasting revenue with fair degree of accuracy will save federal resources as well as avoid fiscal indiscipline. For this to happen, the government will have to make a fundamental departure from the past by not treating revenue as a residual item. What should then be the revenue target for the FBR for the year 2014-15? For this, we need a firm revenue base for the current year.

Revenue collection for the first ten months (July-April) of the current fiscal year has not been up to the mark and as such the FBR has embarrassed its own finance minister. The FBR has collected Rs167 billion in April 2014 compared to Rs154 billion in the same month last year, thereby showing a growth of only 8.4 percent. Apart from the perennial problem of inefficiency in the FBR, the appreciation of the rupee has started hurting revenue collection as 40 percent of the FBR’s revenue is import-related. 

The FBR has collected Rs1746 billion in the first ten months (July-April) of the current fiscal year as against Rs1509 billion during the same months last year, thus registering an increase of 15.7 percent. To achieve the revenue target (Rs2345 billion) for the year, the FBR will have to collect Rs599 billion in the remaining two months (May-June) as against Rs437 billion in the same months last year. 

In other words, FBR needs to collect 37.1 percent more in the remaining two months over the same months last year. Considering the fact that it has collected 15.7 percent more in the first ten months, collecting 37.1 percent more in the midst of the rupee appreciation impact in the remaining two months is a tall order. 

What would be the likely collection for the year? If the FBR collects 16 percent more in the remaining two months it will collect Rs2253 billion in 2013-14 as against the original target of Rs2475 billion and the revised target of Rs2345 billion. Given that what has happened in the month of April as a result of rupee appreciation it is difficult to expect revenue to grow by 16 percent in the remaining two months. Even then I would settle at Rs2250 billion at the most.

Was projecting FBR revenue a difficult task? On July 23, 2013, in my article ‘Review the tax target’ I urged the finance minister to review the FBR tax target as this was grossly unrealistic. On January 21, 2014, I wrote again and said “My calculation suggests that in the absence of additional tax measures, the FBR may collect Rs2250 billion at the most – up by 16.2 percent over last year”. 

The finance minister, the concerned officers of the Ministry of Finance, the FBR and the IMF read my articles. They must have read my assessment about the revenue collection but failed to take any action or additional measures to achieve the target. Forecasting FBR revenue was one of my prime responsibilities during my stay at the Ministry of Finance. Along with Dr Ather Maqsood, the then member, Fiscal Research of the FBR, I used to set the FBR revenue target which was then also accepted by the IMF mission.

The performance of the FBR has been dismal at best. This level of performance must be viewed keeping in mind several tax measures that were taken during the budget. The most important measures included increasing the sales tax rate from 16 to 17 percent, mobile phone subscriber from 10 to 15 percent, increasing the income tax rates, expanding withholding tax, reducing tax exemption of university teachers from 75 percent to 40 percent and so on. Adjusting the increases in tax rates alone will flatten the revenue growth. 

This level of performance must also be viewed at the back of the reported holding of refunds amounting Rs97 billion as well as forcing businesses across Pakistan to pay taxes in advance. In other words, severe coercive measures are being taken to reach closer to the target – bringing a rather bad name for the political leadership. After adjusting holding of refunds, the actual collection in the first ten months amounts to Rs1649 billion or an increase of only 9.3 percent over last year. By adjusting rate hikes and holding of refund, the revenue collection growth may have turned negative. I would urge the FBR to release the tax collection number after taking into account these two facts as well.

What should be the revenue target for 2014-15? As readers would know by now, a lot of information is not available to the public. Notwithstanding these limitations, my projection for FBR revenue for the year 2014-15 is Rs2533 billion. I have used Rs2250 billion as base year, nominal GDP growth at the market price of 14 percent and tax elasticity of 0.9. If the government takes additional tax measures worth Rs100-120 billion and ensures that these will be collected, FBR revenue for 2014-15 should not be more than Rs2650 billion. 

The FBR has certainly disappointed its minister this year. Will it do so again in 2014-15? Given its track record, the answer unfortunately is in the affirmative.