Informal market expands as organized sector shrinks under tax pressure

Increase in excise tax not only reduces sales but also leads to significant job losses 

Writing for Dawn, author Nasir Jamal explains that Pakistan’s poor tax revenues, which are below 10 percent of GDP and among the lowest globally, are a major factor contributing to the country’s persistent fiscal deficits and overall economic crisis. 

The author believes that successive governments have failed to increase the tax-to-GDP ratio primarily due to a lack of political will to bring powerful interest groups, such as retailers, wholesalers, real estate owners, and large farmers, into the tax net.

When the government requires funds to finance its growing budget deficit, it often resorts to imposing more taxes or raising tax rates on the easier target: organized industries and businesses. Unfortunately, these changes in tax policies negatively impact businesses and their entire supply chains. A recent example is the government’s decision to reintroduce a 10 percent Federal Excise Duty (FED) on the packaged juice industry, including juices, nectars, and juice drinks. This decision was made in response to the International Monetary Fund’s demand to cover revenue gaps.

The imposition of the FED this year has resulted in a significant 45 percent decline in the sales volumes of the formal packaged juice industry in March and April. This decline has substantial consequences. The shrinking business size not only adversely affects the government’s sales tax revenue but also projects a plummet in the industry’s sales from around Rs 60 billion to Rs 43 billion in 2023. This decline is contrary to earlier industry projections, which anticipated an increase to over Rs71 billion based on recent industry growth rates.

The decrease in sales will significantly impact the government’s tax revenue from the industry, which was expected to contribute almost Rs 14 billion in taxes. Surprisingly, the government did not learn from the impact of its previous decision to impose a 5 percent FED on the packaged fruit-based juice industry in July 2019. That decision resulted in a sharp 22 percent decline in sales, causing revenue loss for the government and an increase in the market share of the informal juice industry.

The increase in excise tax not only reduces sales but also leads to significant job losses for workers involved in the manufacturing, distribution, and sale of these products. Furthermore, the industry’s connections to the rural economy help fruit growers receive fair prices for their produce and minimize wastage.

Due to the drop in sales of fruit-based beverages, manufacturers will reduce their purchases from farmers. In 2022, the industry procured an estimated 100,000 tonnes of mangoes, in addition to other fruits like oranges and peaches, for pulp production. However, a drastic reduction in fruit pulp purchase (from 61,000 tonnes to approximately 31,500 tonnes) is expected in 2023 following the FED imposition, which will adversely affect the rural economy and its formalization.

The organized packaged juice industry, with an investment of Rs 40 billion and over 5,000 direct employees, provides consumers with safe and healthy fruit-based juices and drinks. However, the imposition of the 10 percent FED negatively affects the affordability of these products produced by legitimate players. As a result, a significant proportion of consumers are shifting to low-priced, low-quality, and potentially unsafe alternatives offered by the undocumented sector.

This situation will not only lead to a loss of tax revenue for the government, as the undocumented sector constitutes 20 percent of the industry’s total size and is expected to grow further if the FED is not reversed, but also result in unemployment within the industry. The contraction of the industry will also discourage planned investments for 2023-24. 

In a time when people’s purchasing power is severely impacted by skyrocketing prices and job losses are rampant due to economic stagnation, the government should reconsider the FED on juice-based drinks and beverages and remove it.

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Monitoring Desk
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