The introduction of withholding tax (WHT) on non-cash bank transactions has backfired as the tax has been instrumental in boosting currency circulation and a decline in private business deposits, highly placed Finance Ministry officials confirmed.
According to the FBR estimates, instead of creating any impact on revenue collection or providing any help in tax filing, the WHT on non-cash bank transactions had been instrumental in multiplying currency in circulation. On the other hand, the WHT has also been implicating in a decline in private business deposits.
The documents available with Pakistan Today show that currency in circulation grew by 21.5 per cent on average during 2015 to September 2017 against an average growth of 14.0 per cent recorded in the past 11 years prior to its imposition that is from July 2004 to June 2015.
Private business deposits as a percentage of total deposits, on the other hand, declined from 27.6 per cent to 25 per cent after imposition of the WHT on banking transactions. FBR data shows that the imposition of the WHT on bank transactions apparently defeated the very purpose for which it was imposed that was to discourage the cash economy.
Finance Ministry officials said though the likely impact on the behaviour of currency and deposits had been flagged earlier, the lack of information prevented any early impact assessments of these taxes on the financial sector.
The government has imposed a withholding tax on non-filers of income tax returns through the Finance Bill 2015, initially at the rate of 0.6 per cent on all non-cash bank transactions. Later, the tax rate was lowered to 0.4 per cent after opposition from some section of society. Through the Finance Act, 2005, the government imposed withholding tax, initially at the rate of 0.1 per cent, on cash withdrawals from banks exceeding Rs 25,000 in a day. Both tax rate and cash withdrawal limit have changed since then. For FY18, a WHT of 0.3 per cent and 0.6 per cent applies on filers and non-filers respectively on cash withdrawal exceeding Rs 50,000 per day. However, filers can claim for refund of the amount paid in this tax.
They told that to determine whether there was a structural shift coinciding with the introduction of advance tax on bank transaction, structural break tests were applied on both currency and deposit series. The results show that these have experienced structural shifts: growth in currency in circulation since June 2015 in and deposit from November 2015 onwards, instead of July 2015 when WHT on banking transaction became effective. “In case of the latter, there was considerable uncertainty following the imposition of WHT, as the business community was strongly resisting imposition of the tax’, they said adding that by November 2015, the policymakers might have realised that the tax was not going to be withdrawn and adjusted their behaviour accordingly.
The result of the currency in circulation model suggests that the imposition of WHT on cash withdrawal has a negative but statistically insignificant impact on growth. As the objective of the WHT on cash withdrawals was to discourage the cash economy, the negative coefficient of WHT on cash withdrawals was expected.
On the contrary, results suggest that imposition of WHT led to decline in the deposit ratio.
The estimation result of the model for FBR tax collections confirms that the WHT had significant positive impact on the FBR tax revenue. In case of revenue, however, WHT on cash withdrawal has strong positive impact compared to the tax on non-cash bank transaction. In particular, a 0.1 per cent increase in the WHT on cash withdrawals leads to 0.13 per cent increase in the FBR tax revenue, while similar increase in the tax on bank transactions leads to only 0.009 per cent increase in the FBR tax revenue.
