Pakistan: Excessive taxing is disastrous for economy

Today I have found Asad Ali Shah* one of the supporters of my propagations. I have picked up the following text from one of his posts at LinkedIn. He has talked why excessive tax in the name of super tax and poverty alleviation tax on corporate entities is disastrous for Pakistan’s economy:

1) Pakistan already has highest tax rates in the world, imposition of additional taxes will increase the rates in range of 39 – 49 percent (specified sectors and banks). Add workers welfare fund (2%), and workers profit participation fund (5% on industrial entities) and dividend 15% ‑ tax rate on shareholders goes up in range of 55 to 65 percent;

2) In most countries, corporate tax rates are significantly lower than individual rates- as large scale value addition, productivity and innovation happens in corporate sector. Further, most countries have been competing to reduce tax rates to attract investment and multinationals to locate their head quarters/operations in their country. For instance tax rates for Corporates in a developed economy like UK is 19%, while tax rates for high income individuals are 40% and 45%. Similar trend prevails in most economies. Therefore, all economies promote corporate entities- in land of pure, Pakistan does exactly the opposite.

3) Considering very large portion of Pakistan’s economy is informal, imposing excessive tax on few corporate entities that are in formal sector and transparently report higher profits tantamount to punishing them for honesty. It will naturally prove counterproductive and will promote tax evasion. As saying goes, "No good deed goes unpunished".

4) Biggest cause of Pakistan's bankruptcy is huge cost and inefficiency of public sector- the Government of Pakistan spends 22% of GDP vs. 15% in Bangladesh. Much of such spending is wasted- payments of salaries to much larger number of people than required and other costs against which service delivery remains substandard. Even the so called development expenditure (aggregating Rs2.3 trillion for federal PSDP and provincial ADPs in current budget) is poorly spent on projects that do not generate adequate economic benefits. Most projects are initiated based on political considerations without adequate economic justification; poorly executed resulting in huge cost over runs and inordinate delays. It would have been far better, if such development spending was cut by 50% for reducing fiscal deficit rather than imposing such exorbitant taxes on private sector corporates.

5) All over the world, it is through private sector that countries produce goods and services at lower cost for their citizens and become competitive to generate exports. Bulk of employment is also created in private sector. All of this happens when the governments have small role ‑ promoting efficiently and regulating private sector through competitive and adequate fiscal and monetary policies.

Unfortunately, in Pakistan the keep governments have kept growing the public sector through excessive taxation on a very small formal sector that is shrinking with time.

It is unfortunate that in Pakistan economic and social indicators continue to get worse; but the governments keep on going back to IMF every 3 years, but unwilling to learn.

*Asad Ali Shah is a Fellow Chartered Accountant, engaged in management consultancy, tax, corporate and financial advisory services for over 35 years. He has been advising large national and international organizations across a range of industries and markets in the areas of strategy development, organization design, governance and Consulting. Have advises clients to help them improve their governance, strategy, operations, internal control and risk management systems. He frequently writes on macro economy, governance and matters of public interest.

Pakistan stock market closes the week almost flat

The benchmark of Pakistan Stock Exchange PSX‐100 Index closed flat for the week ended 27^th May at 36,694. The index returns underperformed the region by 2.40% due to heavy‐weight sector banking’ disappointing run amidst unexpected 25bps cut in policy rate by the State Bank of Pakistan (SBP). This also caused average daily traded volumes to plunge by 23%WoW to 249 million shares as compared to 325 million shares exchanging hands a week ago.

Though, foreign selling continued, it stood at US$3.81 million as compared to US$6.98 million a week ago. Leaders during the outgoing week included: HASCOL, PSMC, DAWH, SNGPL and ENGRO, while laggards included: MCB, MEBL, EPCL, HBL and SSGC.

Key developments during the week included: 1) MCB said to be in preliminary non‐binding discussion with Fullerton Financial Holdings for a possible merger with NIB, 2) GoP decided to increase PSDP outlay by 11% for FY17 to Rs1.675 trillion from current year’s allocation of Rs1.514 trillion, 3) GoP likely to increase the tax on dividend income to 20% for non‐filers while 15% tax on dividend income for return filers and it may also start charging advance tax on the alternate corporate tax, 4) SBP slashed the policy interest rate by 25bps to 5.75% in view of its assessment that inflation would remain below the target set for the FY16 and 5) the current subsidy on DAP to the tune of Rs20 billion (Rs500/bag) shared on a 50‐50 basis by the federal and provincial governments is likely to continue in the next fiscal year with Ministry of Food proposing to remove the GST on DAP and other fertilizers.

Anticipations about next fiscal year’s budget, due to be presented next week, continue to build up and will keep the index range bound. Analysts expect the budget to remain neutral for most sectors, with chances for some negativity in foods and other import‐based sectors, amidst proposals for customs duty hikes. Additionally, increased spending on infrastructure, farmer subsidies (proposal to remove GIDC, continuation of DAP subsidy) and provincial schemes would keep cements, fertilizers and steel sectors in lime light. However, with Ramadan around the corner, the theme of lackluster volumes and listless trading is expected to prevail.

I posted a blog ‘too little too late’ after SBP announced 25 basis points reduction in interest rate. However, Pakistan leading brokerage house AKD Securities has a different stance. In its report it has said that contrary to market's consensus of interest rates having bottomed out, the SBP in its latest announcement cut the policy rate by 25bps to 5.75% (DR: 6.25%). The surprise move came with little justifications where the statement highlighted: 1) higher inflation projections for FY17 on expectations of global commodity price recovery and higher domestic tariff and tax incidence, 2) limited credit uptick (8.4%YoY as of Mar'16) despite prior 400bps rate cut, 3) BoP risks in the form of higher trade deficit, decelerating remittance growth and weak capital inflows ‐ all key macro trends warranting a prudent stance. With tighter fiscal targets, the 25bps reduction is unlikely to serve as a growth catalyst, where analysts view GoP to emerge as the key beneficiary with nearly Rs1.6 trillion PIB maturities due July'16. With macro risks in place, a quick reversal in the monetary policy remains a possibility, though key determining factors from here onwards are likely to SBP's target for real interest rates and PIB roll‐over.

With Budget FY17 less than two weeks away, market expectations regarding are running high. Targeting GDP growth rate of 6.2% (4.71% in FY16), news flow is shaping budget FY17 to be unpopular in nature, where additional taxes will be imposed, to boost up FBR related up revenues, are already under consideration. In this regard, super tax extension, withdrawal of remaining SROs, increase in Withholding tax on banking transactions to 0.6% for non‐filers, are some of the important ones. While continuation of Super Tax undermines profitability growth of the  bluechip companies, positives for Fertilizer is removal of GST/GIDC on urea, subsidy extension on DAP to aid offtake growth) and Autos (lowering of import duties in order to incentivize incumbents) whereas negativity could come in Foods Producers (imposition of 10% sales tax on milk). That said, market level developments (such as increased taxation on dividend income, removal of tax exemption on pension funds) are not very encouraging either. While initial market reaction could depict volatility, investors' sentiment and attention are most likely to soon turn towards the MSCI reclassification (EM status) announcement on 14th June.