Budget Preempts Electoral Test
By Nadeem Malik
Islamabad: The fiscal stimulus-packed budget for 2005-06 has been announced with an eye on the crucial political situation to counter increasing pressures of jobs and inflation.
“By virtue of the fiscal stimulus embodied in the budget, coupled with the fact that monetary policy is still insufficiently tight, policy settings are overly-stimulatory. In the context of an overheating economy, this can be potentially dangerous for macroeconomic stability,” maintains Sakib Sherani of the ABN-Amro Bank in its post budget review.
It observed that fiscal consolidation and broad basing of the tax net have taken a back seat, making way for policy stimulus via a mix of tax incentives and popular relief. The report observed that the budget coincides with an electoral test for the ruling coalition at the local level later this year and then again at the national level in 2007. However, for an economy that grew 8.4 percent in the current year, policy settings are overly rich, with potentially serious ramifications for macroeconomic stability down the road. Among the slew of incentives to industry, the most far reaching is the decision to exempt the entire textile chain, along with other major export sectors, from the sales tax regime.
The disappointing feature of the budget is a virtual absence of effort to broad base the tax net via increased documentation of the economy. “The minimalist expectation that real estate transactions would be taxed has also been thwarted.”
The government’s fiscal intentions have been spelled out with an eye on the general elections in 2007 outlays have been raised 22 percent, with development spending up 35 percent. “The federal budget for 2005-06 (FY06) has been presented in a political context where the ruling coalition is heading into crucial elections later this year. The government is under increasing pressure to create new jobs in the economy while keeping inflation under check.”
While economic growth has accelerated impressively over the past three years, reaching its fastest pace in 20 years in the outgoing year, much of it has been generated by higher utilisation of existing industrial capacity. “Hence it has proven to be largely ‘jobless’ so far. While the official labour force survey 2003-04, released earlier this year, shows cumulative job creation since 2001-02 at 2.9m, the category of unpaid family workers has bolstered the headline figure by 1.97 million. Adjusted for this category, only 0.9 million new jobs were officially created between FY02 and FY04. The government has shown increase in the unpaid family helpers from 8.11 million in 2001-02 to 10.08 million in 2003-04.
“Even though there is evidence of a rising pace of job creation this year, as domestic fixed asset investment gathers momentum, the government has been under increasing political pressure to pull a rabbit from its hat.” The report maintains that the ability of the government to meet its fiscal deficit target for FY06 is under doubt. The bulk of the spending in FY06 is slated for debt servicing (Rs 327 billion), defence (Rs 224 billion), and development expenditure (Rs262 billion). Budgeted outlay for defence (inclusive of estimated pension liability) and total debt servicing (inclusive of repayment of short-term credits) amounts to 53 percent of total federal expenditure, down from a peak of 94 percent in 2001-02. The report also anticipates Rs 10 billion operational shortfall in the development spending.
The report maintains that the macroeconomic assumptions on which the budget is based appear slightly ambitious. While assumed real GDP growth of 7 percent in FY06 is realistic, the bases for revenue and expenditure targets seem optimistic. Tax revenue collection by the Central Board of Revenue (CBR) is targeted to increase 17 percent in FY06 (to Rs 690 billion), higher than projected nominal GDP growth. In FY05, CBR tax revenue rose 13.7 percent and nominal GDP growth was at 18 percent, indicating low buoyancy.
“The almost exclusive reliance on economic growth to generate tax revenue in FY06 accentuates the risk to budgetary assumptions.” In any case, there is little justification for a continuation of the inequitable incidence of taxation on different sectors of the economy and segments of society. The more potent risk is embedded in the contingent liabilities, notably the heavy fiscal drain imposed on the budget on account of Wapda and Kesc, the power utilities. In FY05, budgetary support to the two entities amounted to Rs 118.5 billion (1.8 percent of GDP), while almost Rs 80 billion has been earmarked for FY06.
By virtue of the fact that principal sectors of the economy such as agriculture and services are largely outside the tax net, the incidence of taxation is heavily skewed against formal sectors that are documented and taxed. The manufacturing sector bears the brunt of the taxation effort, contributing an estimated 61 percent to total taxes, as against its 18 percent share in GDP.
Agriculture, on the other hand, contributes only 1.2 percent to overall taxes compared to a 23 percent share in GDP. The contribution of the services sector is similarly low, with the largest sector of the economy (53 percent of GDP) contributing 26 percent of total taxes.
The inability (or unwillingness?) of successive governments to increase documentation of the economy and credibly broaden the tax base is also manifested in the low, and marginally declining, share of direct taxes. Over the years, indirect taxes (mainly sales tax) have become the primary drivers of the tax effort, with evidence that their regressive nature is adding significantly to the burden of the vulnerable income groups.
The widespread expectation that real estate transactions would be taxed in the FY06 budget has been proven incorrect. Along with other untaxed sectors of the economy - such as agriculture and services, property transactions amounting to a conservatively estimated Rs 200 billion-300 billion each year have virtually eluded the tax net, contributing around Rs 6.5 billion (0.1 percent of GDP) to the exchequer in the first 10 months of FY05. In fact, the revenue contribution of the real estate sector is continuously falling over the last four years.
With inflation at an elevated level, and developing pressure on the external account, the fiscal antidote is misplaced. The untaxed sectors of the economy have eluded the tax net once again, highlighting a lack of political will (or, at its worst, possible policy capture by vested interests).
ENDS.
