Savings

Taxing national savings – but at what cost? – Opinion

The 2022-2023 budget follows a series of budgets in recent years that have increased tax rates and removed exemptions, primarily increasing the tax burden on existing taxpayers.

Like all previous budgets, the current one also aims to reduce the budget deficit which has remained in the range of 7-8% of GDP for the past two decades, mainly through an attempt to increase revenue.

However, in most cases this approach has not worked well as successive governments have failed to raise revenue (in real terms) or contain the deficit.

One of the unique aspects of this budget is to remove rebates and rebates given to retail investors for their investments in life and health insurance, voluntary pension plans and mutual funds. The abolition of these deductions provided for by articles 62 and 63 of the ordinance on income tax proposed by the finance bill, which will be voted by the National Assembly in the coming days, will amount to de facto taxing formal sectors that promote savings; this will be extremely counterproductive to the capital market, insurance and mutual fund sectors of the economy.

Chronic problems of the Pakistani economy

The answer to the question of how the above proposals will further aggravate the deep rooted problems of our economy is briefly given below:

1) The savings rate in Pakistan has remained very low, below 15% of GDP, compared to other similar economies like Bangladesh and India where savings rates have remained between 28 and 30% . Due to a paltry savings rate, investment rates have also remained below 15%, as any additional investment must come from borrowing or foreign direct investment, which has largely dried up due to budget deficits. and persistent currents and low investor confidence.

2) Currently, Pakistan’s capital market is at an all-time low as the total market capitalization of all companies listed on PSX has fallen to only 7.1 trillion rupees or approximately $34.6 billion, which means that it represents less than 10% of GDP. At this level, both in absolute terms and as a proportion of GDP, it has fallen to the lowest level that I can remember in the last 2 decades.

Budget proposals

Currently, under sections 62 and 63 of the Income Tax Order 2001, individuals are entitled to certain tax credits for making investments in unit trusts, life and health insurance and contributions to registered pension plans, which results in a reduction of their tax liability within certain specified thresholds. It is these rebates and tax credits that the 2022 finance bill proposes to abolish. Removing these small tax incentives/cuts from retail investors will not only be counterproductive to these formal sectors — life and health insurance, voluntary pension schemes, the mutual fund industry, and the capital market as a whole — but will also undermine levels of savings and investment, which are already the lowest in the world. In addition, the proposed changes, together with the increase in tax rates for salaried individuals, will result in a further increase in the tax liability of the salaried class.

Life insurance and mutual funds are instruments through which savings are mobilized from retail investors for investment in productive sectors, particularly the capital market. It can be noted that we have just under 300,000 investors in the capital market compared to almost 50 million in India – only 0.6% of the number of investors in India – which highlights serious gaps in our ecosystem of investment.

Given Pakistan’s paltry savings rate (one of the lowest in the world) and the lowest penetration of life and health insurance – less than 0.6% compared to 3% in India and a global average of 3.7% – and the mutual fund industry’s market capitalization of just 1.3% compared to 15% in India and over 50% globally, this is a very regressive step for the industry. economy as a whole and especially the formal sectors of the economy.

Impact on RBF revenue

The government estimated a tax saving of Rs 3.9 billion as a result of the withdrawal of these tax savings, but ignored the negative impact of these withdrawals due to the reduction in tax payable due the reduced profitability of insurance companies and mutual funds and the consequent reduction in the dividend. distributions by these entities which are also taxable in the hands of the beneficiaries. It should be noted that insurance companies are taxed at much higher rates and dividends from these companies and mutual funds are also taxed.

At present, the retail investor base in the mutual fund industry stands at over Rs 340 billion in open-end schemes and over Rs 39 billion in pension schemes , and the majority of these investments are made by employees to benefit from tax advantages. Similarly, a huge amount of insurance premiums are paid by individuals for health and life insurance, which also qualify for tax relief.

Considering the high interest rate and the growing market base of the insurance sector due to better financial awareness, these sectors are expected to register growth of at least 20% or even more, and this will have a direct impact on the profitability; and corporation tax to be collected from corporations, if these changes are not made. However, if the proposed withdrawals are applied, this measure will have a negative impact on the activities of these entities, eroding their profitability and, consequently, their tax obligations.

In fact, there is a risk that even existing consumers who no longer benefit from these tax reductions will withdraw their investments/discontinue their insurance policies. The resulting loss of tax revenue for these business sectors will certainly outweigh the expected tax benefit of these tax savings.

Another important aspect that needs to be considered is the huge amount of investments by insurance companies and mutual funds in the capital market and money market. According to an estimate given by the Insurance Association of Pakistan, the overall investment by insurance sector is 2 trillion rupees.

Since a significant part of this amount comes from life insurance and health insurance, it can be assumed that 60% or 1.2 trillion rupees of investment comes from life insurance and health insurance. health insurance. Similarly, 200 billion rupees out of the total assets of the mutual fund industry of about 1.2 trillion rupees are invested in the equity market.

A natural consequence of reduced investment by retail investors in insurance and mutual funds will be reduced growth or stagnation in these sectors, which means reduced flows to capital and money markets.

As a result, there is a serious risk that the capital market, which is already at its lowest level, will contract further, thus increasing capital losses and eroding capital gains, which will also have a negative impact on the RBF revenue from capital gains tax.

Considering all of these factors, it is more likely that the impact of these proposals on RBF revenue will be negative, as potential tax revenue from the natural increase in profits, dividends and capital gains of companies will be greater than the increase in tax due to the withdrawal of rebates.

Although I hope that the aforementioned proposals which make no economic sense will be reversed, I am actually amazed that such an anti-savings measure, which denies the government policy of promoting formal sectors of the economy, investments and savings, has been proposed in the budget.

Copyright Business Recorder, 2022