Sustainable Development Policy Institute Budget for Sustainable Development and Job Creation 1 1 Pre-budget Proposals 2015-16 A Green Budget for Sustainable Development and Job Creation Sustainable Development Policy Institute April 10, 2015 Islamabad
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Sustainable Development Policy Institute
Budget for Sustainable Development and Job Creation
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Pre-budget Proposals 2015-16
A Green Budget for Sustainable Development and Job Creation
Sustainable Development Policy Institute April 10, 2015
Islamabad
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1. About SDPI
The Sustainable Development Policy Institute (SDPI) is an independent, non-profit policy research institute and oldest civil society think tank in Pakistan, which produces knowledge on sustainable development to enhance the capacity of government and private sector in making informed policy decisions. Over the past 23 years, SDPI has produced and advocated policy research on all facets of sustainable development, including inclusive economic growth, social justice, societal sustainability, climate change and environmental protection. The institute’s advice is sought for targeted interventions through change in legislation, policy rules, policy practice, budgetary allocations and efficiency with which these allocations are disbursed. An important area of SDPI’s work has been to bridge research policy gaps through continued and sustained involvement of citizens. The citizen’s involvement is particularly important for improving service delivery in social sectors especially education and health.
2. Background
PML-N Government inherited a weak economy, with all macroeconomic indicators at their historic low. During the past five years, Pakistan’s average economic growth remains around 3.4% per annum. This growth rate is hardly enough to absorb: a) existing unemployed labour force, and b) increased young entrants into working age population. The public sector with meagre resource mobilization may not be able to provide adequate jobs whereas for private sector, sustained energy supplies and structural reforms such as removal of distortions from taxation regime is urgently required to create jobs. To let formal economy flourish, the public sector needs to put in place measures that curtail the growth of undocumented and informal economy. An important pillar of inclusive growth is openness of trade and investment. The trade regime in the country is unfortunately not in line with the vision set in the Strategic Trade Policy Framework. The past governments have struggled to fund the well intentioned interventions of the trade policy. The facilitation measures for exporters are sporadic and uncertain. A similar pattern of weak facilitation is seen in Pakistan’s foreign direct investment. The fiscal incentives provided for such investors are rarely possible in practice and in turn lead to costly tax expenditures. The recent difficulties in repatriation of profits by foreign investors signify the gap between approved and in-practice Central Bank policy measures. The confidence of domestic investor remains low despite an improvement in macroeconomic fundamentals during 2014-15. This is reflected from heavy official and non-official outflow of capital from Pakistan into Middle East, EU and other investor-
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friendly destinations. Only meaningful reforms in energy sector, public sector enterprises, trade facilitation, currency alignment and debt management can boost the confidence of domestic investors. As Pakistan’s investment to GDP ratio fell below the average of South Asia and even sub-Saharan Africa, job creation process will continue to struggle. This is also a security challenge as youth who remain unemployed for a longer time period are prone to social evils like radicalization and terrorism. The challenges associated with sustainable development inform us that the inter-generational justice is becoming difficult to achieve. While the 18th Amendment and increased fiscal transfers to the provinces have allowed some improvement in the public service delivery of education and health, there are key aspects of social justice and environmental protection that lack ownership both in terms of agenda-setting and budgetary allocations. The issues of climate change and food security will continue to threaten the future of our coming generations. While current government is appreciative of participatory decision making and always willing to include the suggestions from concerned stakeholders in policy formulation and implementation, many of the stakeholders including consumers, labourers, marginalized groups and right based groups are not organized enough to meaningfully engage the policy makers through solid evidences. SDPI considers linking stakeholders to the policy making circles a public duty and thus not only bridges research policy gaps but also the gap between people and decision makers.
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3. Objectives
The key objectives of this exercise include:
Reaching out to a maximum number of representatives from business community,
consumer associations, trade associations, labour unions and rights-based
organizations and solicit their feedback on the current state of economy
Based on the feedback from various stakeholders, suggest removal of distortions in
the taxation and expenditure regime
Suggesting compensatory mobilization measures to bridge any revenue gap created
by the removal of tax-related distortions
Creating fiscal space for growth-enhancing and job-oriented infrastructure spending
Mobilizing resources and improving coordination between federal and provincial
governments for more targeted and efficient investments in social sectors, climate
change adaptation and food security
Protecting social sector spending on education, health, clean water supply,
sanitation, women’s empowerment and youth mobilizaton
Revisiting debt management strategy in order to lessen burden on current and
future generations
Thematic Focus of Proposed Budgetary Interventions
Sustainable Development
Job creation
Food security
Industrial competiti
veness
Education
Health Peace & Social Justice
Energy
Boosting Exports
Social Safety Nets
Environmental
sustainability
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4. Methodology
This document is the result of in-depth consultations with the business community, economists, representatives of non-governmental organizations, members of Tax Reforms Commission and academia over a period from January to March 2015. Our in-depth interviews included interaction with members of Pakistan Business Council, All Pakistan Business Forum, and sector-specific associations, e.g. auto sector, pharmaceutical sector, dairy, industry and Farmers Association of Pakistan. In order to provide robust policy advice, consistent with macroeconomic fundamentals, SDPI uses a three-layered macro-meso-micro economic model. The top layer is a financial programming model providing a set of key macroeconomic identities and behavioural equations aimed at providing forecasts related to growth, investment, consumption, taxes, government expenditures, exports, imports and current account balance. The middle tier is a dynamic computable general equilibrium (CGE) model which provides forecast related to goods and factor (labour and capital) markets. Finally at the bottom tier we have a microsimulations model which computes the poverty and welfare impact of macroeconomic policies using household income and expenditure survey data.
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5. Tax Proposals
Our proposed interventions which have been discussed in our consultations and latter evaluated through the macro model indicate that with minimum fiscal effort (explained below), removal of distortions, and better documentation of economic sectors, federal and provincial revenue authorities can collectively achieve PKR 700 billion additional tax revenues. If the economy is able to achieve a real GDP growth of 5% in 2015-16 these revenues can increase depending upon the sectoral growth elasticities (with respect to revenue collection). Our focus here is to provide a maximum relief to lowest and middle income quintiles, which in turn increases their disposable income and potential for job creation.
Mapping of Sustainable Development Outcomes and Proposals1
Priority Outcomes Proposals Job creation in private sector
Reduce burden of tax compliance
Simplify income and corporate tax
regime
Reduce tax rates and slabs
Increase in value added
Clear pending tax refunds
Lower corporate tax rate
Lower customs duty on agricultural and
industrial inputs and machinery
Reduction in slabs of customs duties
Create a level playing field through
removal of distortionary tax exemptions
Reduce reporting requirements for
compliance in corporate sector
Limiting use of excise duties for
regulating consumption of harmful
goods
Targeted investments in skilled labour
Ease of accessing formal financial sector
1 This table provides mapping with respect to proposed interventions by the Federal Government. However the
detailed proposals (in latter sections) also carry recommendations for Provincial Governments.
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Priority Outcomes Proposals for working capital
Boosting Exports Focus on reducing tariff and non-tariff
barriers to trade with neighbouring
countries
Clear pending refunds of exporters
Investing in trade facilitation measures
for both exports and imports
Open more land routes for trading with
Afghanistan, India and Iran and created
integrated customs management units
Reduce customs duty on import of raw
materials and machinery from China and
India. Increase the number of items
allowed for trading at land routes
Social Safety Nets and Social Protection Integrating and strengthening social
safety nets under one umbrella
programme to avoid duplication of
efforts and reduce resource wastage
Replace hidden and cross subsidies with
targeted subsidies
Increasing efficiency of fiscal
instruments for workers welfare (e.g.
Workers Welfare Fund)
Removal of any duplications between
federal and provincial social safety net
programmes
Minimum rural employment guarantee
scheme in pilot districts
Enhanced allocations for skills training
to facilitate mobility
Ensuring compliance of minimum wage
laws and workplace safety standards
Increase allocations for ensuring food
security
Increase allocations for women and
children in conflict areas
Natural resource management and environmental protection
Increase allocations for projects related
to climate change adaptation, disaster
risk reduction and environmental
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Priority Outcomes Proposals protection
Rigorous implementation of carbon tax
Reduce customs duty on green
technologies (inputs) for industry
Agriculture Implementation of previously
announced crop & livestock insurance
programme
Exemption from GST for agricultural
inputs such as seeds, fertilzers, and
chemicals.
Food Security Implementation of previously
announced zero hunger programme
Fortified meals for expecting mothers,
breast feeding mothers, and children
below 5 targetted from recipients of
BISP.
5.1. Direct Taxes
In order to avoid the ongoing misrepresentation, the distinction between taxable income of
salaried and non-salaried class should be eliminated. All incomes in excess of minimum
exemption should be taxed at the same rate. The top tax rate for salaried and non-salaried
taxpayers should be brought down to 25%. Already there is a wide margin between
statutory top tax rate and effective tax paid. The top tax rate should be applied to income in
excess of PKR 5,500,000 per annum.
The number of slabs for Association of Persons (AoPs), self employed and salaried persons
should be reduced to 3 for making the overall taxation structure relatively more
progressive. For the benefit of small tax-payers, the exemption limit should be indexed with
annual inflation
Employer organizations should be given a relief particularly during times of economic
slowdown. We therefore recommend linking social security and Employees Old Age Benefit
(EOAB) contributions to growth in key productive sectors of the economy. If the provisional
real GDP growth rate crosses the targeted growth rate, it is then proposed that social
security contribution by employers may be increased by one per cent of salary of insurable
employees. One per cent increase is also recommended in the case of EOAB.
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Advanced income tax on functions and gatherings is easy to avoid and evade given the lack
of proper documentation. It is recommended that this tax should be removed.
The taxable income on which there is zero% tax rate should remain unchanged during
2015-16. This will help in curtailing tax expenditures
Given the high returns in stock market observed during 2014-15, the tax rates on such
profits should be considered for an upward revision with any exemptions removed.
Similarly the taxation of dividend income may be at 12%. The definition of ‘securities’ under
section 37A of Income Tax Ordinance should include the government’s debt securities
The efficiency of Workers’ Welfare Fund (WWF) needs to be reformed. Equally important is
to better manage welfare schemes under this fund. The operations at WWF should be in line
with predetermined key performance indicators. There should be an alignment with other
social protection programmes such as Benazir Income Support Programme. The rampant
evasion in WWF contributions2 can be checked by putting in place biometric systems
available with NADRA and State Bank of Pakistan. Better fund management will require
expertise in risk assessment by officials at WWF and EOBI
FBR in the past has sent notices to owners of property (above a certain limit) for respecting
their tax liability. Little success has been achieved in this area. It is, therefore, proposed that
persons who own property above a certain limit and are full time residents of Pakistan
should not be allowed to transfer or sell their property if they have not paid past year’s
income tax return. The same treatment should apply to assets such as cars above 800Cc
engine capacity
The withholding tax in telecommunications sector is one of the highest in comparison to
peer economies. A reduction of 5% is recommended.
There is a WHT on cash withdrawal from banks (beyond a certain threshold). The
percentage of WHT may be charged upon telegraphic transfer (outward) of foreign
exchange from Pakistan. It is also proposed that declaration of income should be mandatory
for money remitted outside of Pakistan
At provincial levels, urban property tax needs immediate reform. There are issues related
to: a) valuation (owner-sellers undervalue their property on official documents), b) lack of
motivation / incentive at revenue authorities to improve collections, c) exemptions (e.g.
preferential treatment allowed to owner-occupied property), and d) poor coverage (over
half of urban property in each province goes untaxed).
5.2. Corporate Income Tax
In order to encourage corporatization and job creation, the corporate tax rate should be
lowered to 29%. However a gradual phasing out of exemptions should be initiated
(discussed in section 5).3 This will also incentivize formalization and documentation of
businesses
2 2% of profits of business establishments go to WWF contributions.
3 The Indian general budget 2015-16 envisages a reduction in corporate tax rate from 30 to 25% in the next four
years.
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The current structure of taxation is a disincentive to corporatize. FBR’s own report co-
authored with a consortium of economic experts states: ‘Public and private limited
companies pay the same tax rates, though the former have slightly more reporting
requirements than the latter. The public limited company pays out its entire net income in
dividends. The shareholders will thus not only pay a corporate income tax, but also a tax on
the dividend income. The effective tax rate in the case of an incorporated business comes to
41.5%. In the non-corporate sector there are two sub-sectors: Associations of Persons
(AoP) and Business individuals. An AoP does not have the limited liability protection but
does face a significantly lower tax rate than a company. In addition, an AoP’s income tax
represents the full and final income tax liability for the individual partners, who then do not
need to make any additional payments for personal income tax. The effective rate of
taxation is 25%. In respect of business individual, it may be said that they are simply
persons who does business as a sole proprietor and does not incorporate their enterprise.
This person does not get any legal protection from liability, and in turn faces tax rate much
lower than either an AoP or a company, since they are taxed only at the individual income
tax rate. Their actual rate comes to 7.25%’.
5.3. Indirect Taxes
The sales tax on prescribed thresholds of monthly electricity bills of retailers located in air
conditioned shopping malls should be uniformly set at 10%.
The sales tax on the purchase of high-end mobile and smart phones (above price/unit PKR
20,000) should be 17%. An excise duty of similar magnitude may also be considered.
All provincial sales tax on services laws should be harmonized.
As an incentive to increase compliance, the threshold level in sales tax may be increased to
PKR 8 million. Furthermore, zero rating (under sales tax) should only be allowed to sectors
which represent consumption of the poorest of the poor. Any zero rating or exemptions
allowed on the grounds of boosting exports, industry or services sectors should be
eliminated. There is robust evidence to suggest that such fiscal incentives (in isolation from
other complimentary policies) have not contributed to increase in productivity or exports.
It is recommended that exemption from GST for selected agriculture inputs may be allowed
to ensure food security and rural development.
In order to restore the confidence of business community (on tax authorities), a deadline of
two months should be placed on clearance of sales tax refunds. For new businesses, sales
tax registration is still a lengthy process and can take up to several months.
The provision of self-assessment and voluntary compliance under the Sales Tax Act 1990
compromises revenue as it is not supported by extensive or randomised audit. Third party
oversight can also help improving audit function at tax authorities.
Federal excise duty (FED) on locally produced cigarettes, may be increased by another 5%.
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In order to give boost to construction sector and construction related jobs, it is proposed
that FED on cement sector may be modified to 3% on retail price.
FED on international travel in economy class is proposed be increased to PKR 10,000 per
ticket. Similarly for business class FED may be increased to PKR 20,000 per ticket. Services
by chartered flights may be charged FED at 20%.
In view of the ongoing energy crisis, need for conserving environment and maintenance of
road infrastructure it is proposed that locally manufactured cars and imported motor
vehicles should be treated equal and FED charged at 17%.
Maximum general tariff on import may be brought down to 20%. The minimum general
tariff should be 0%. The number of tariff slabs should be brought down to 3. The regulatory
duty on luxury items may be increased by another 5%.
In order to protect environment and conserve energy, it is proposed that for the domestic
consumers adjustable advanced tax on the monthly bill exceeding PKR 50,000 should be
17%.
In order to protect environment, customs duty on import of inputs of alternative and
renewable energy equipment may be brought down to 0%.
In order to check the conspicuous consumption behaviour an adjustable advance tax of 5%
may be imposed on multinational food chains currently operating in Pakistan.
As an incentive to increase compliance, the input tax invoicing of machinery may be brought
in line with accelerated depreciation allowance in income tax.
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6. Tax Expenditures
A five-year income tax exemption was proposed in Budget 2014-15 for locally grown fruits
in Balochistan, G-B and FATA. As it is difficult to audit the origin of agricultural produce and
hence curtail fraud, therefore it is proposed that this exemption be removed. Any machinery
important for this purpose and region was also allowed exemption from customs duty. This
may be reviewed to assess its contribution in province’s economic development.
The RoI still remains encouraging on most energy projects. It is proposed that tax
exemption allowed to coal mining projects (for power generation) in Sindh be removed. The
dividends from such projects should be taxed at a rate applied to all other power generation
units.
The capital gains tax (CGT) on securities held for any time period should be made uniform.
In view of the improved performance of securities markets in Pakistan, it is proposed that
CGT should be applied at a uniform rate of 17.5%.
The reduction in corporate tax rate, allowed to foreign direct investment in Pakistan, should
be removed. This is prone to misuse by domestic investors. The corporate tax rate should be
the same for both domestic and foreign investors.
The sales tax concessions allowed to five leading export oriented sectors (textile, leather,
carpets, surgical and sports goods) caused a loss of PKR 65 million to FBR collections in
2013-14. There is a vast evidence in recent economic studies that there was no link
between these concessions and export performance. Therefore, it is recommended to