Highest, income groups be taxed at higher effective rates: WB

Business Recorder

23-04-2025

ISLAMABAD: The World Bank has recommended that highest-income groups be taxed at higher effective rates while income tax regime in Pakistan can be made more progressive by removing exemptions for high income groups and raising the income bracket of the highest tax rate.
The bank in its latest report, 'South Asia Development Update, Taxing Times', also noted that industrial output contracted, driven by high input costs, increased taxes, and lower government development spending, and services growth was dampened by spillovers from weak agricultural and industrial activity.
Pakistan, ranks among the Emerging Market and Developing Countries (EMDEs) with the widest range of tax rates and the widest range of income thresholds across personal income tax brackets, which makes its income tax regime relatively progressive.
Pakistan's poverty rate to stand at 42.4%: World Bank
In Pakistan, the government has committed to raising tax revenues by the equivalent of 4–5 percentage points of GDP, reforming the energy sector, and allowing the exchange rate to be flexible, it added.
Pakistan provides a guaranteed price for sugarcane production, while subsidizing its consumption of water. Such subsidies that encourage the wasteful use of inputs could be replaced by direct, targeted transfers, with higher transfers for farmers that adopt sustainable land management practices, the report noted.
Only Pakistan's tax buoyancy falls in the bottom quartile of EMDEs, suggesting a reliance on taxation of slow-growing economic activities. In all South Asian countries other than Bhutan and Pakistan, greater shares of tax revenues are generated by consumption taxes—such as sales tax, excise taxes, and VAT—and trade taxes than in the average EMDE, with smaller shares derived from income taxes. In Pakistan and Sri Lanka, consumption tax rates were well above the EMDE average in 2024.
The report further noted that Pakistan, Sri Lanka, and Bangladesh—the three South Asian countries with the lowest overall revenue-to-GDP ratios—also have much lower tax revenue-to-GDP ratios compared with other EMDEs with similar tax rates in all categories of taxes.
Since 2020, Afghanistan, Bangladesh, Pakistan, and Sri Lanka have had sizable shortfalls in direct tax revenue, ranging from 1.4 percentage points of GDP to 2.6 percentage points of GDP, compared with an average shortfall of 0.8 percentage point among all EMDEs. In these four South Asian countries, revenue shortfalls have been nearly evenly split between personal income tax revenues and corporate income tax revenues.
Among four countries including Bangladesh, Bhutan, Pakistan and Sri Lanka, with above-average tax revenue shortfalls, the country characteristics account for one quarter of the overall shortfalls in Bangladesh and Bhutan and one-third in Pakistan and Sri Lanka. In particular, widespread informality and lack of financial development account for one-half, one-third, and one-quarter of the shortfall in personal income tax revenues in Bhutan, Pakistan, and Sri Lanka, respectively.
A large agriculture sector and lack of financial development together account for one-half of the shortfall in corporate income tax revenues in Bangladesh, Pakistan and Sri Lanka, as well as one-third of the shortfall in consumption tax revenues in Pakistan and Sri Lanka. But even after controlling for these country characteristics, the four countries still have tax gaps that are larger than the EMDE average.
The assessment for Pakistan identifies compliance risk management, the timeliness of tax declaration filings, tax dispute resolutions, and tax payments, as well as the monitoring of inaccurate reporting as the main areas needing improvement.
In Pakistan, the introduction of electronic VAT filing and computerized risk analysis reduced refund claims by one-half and led to the detection of a significantly larger number of fraudulent claims than had manual assessments.
Responsiveness of revenues to changes in tax bases in Bangladesh and India is comparable to that in other emerging market and developing economies (EMDEs); in Nepal responsiveness is in the top quartile of EMDEs, and in Pakistan it is in the bottom quartile.
In Bangladesh and India, tax buoyancies are broadly in line with those of other EMDEs, whereas Nepal's tax buoyancy ranks in the top quartile of EMDEs and Pakistan's in the bottom quartile.
Below-average tax buoyancies, as in Pakistan, indicate that economic growth is disproportionately generated by under-taxed economic activities. In Pakistan, the agriculture sector accounted for about one -fifth of cumulative growth during 2010–19, compared with less than one-tenth in the average EMDE. In many parts of Pakistan, the agriculture sector faces considerably lower income tax rates than do non-agriculture sectors. A priority for raising tax revenues is therefore to increase taxation of agricultural activity.
The report also noted that in Pakistan, the economy continues to recover from a combination of natural disasters, external pressures, and inflation, and is expected grow by 2.7 percent in fiscal year 2024-25 and 3.1 percent in fiscal year 2025-26.
In Pakistan, GDP grew by 2.5 percent in fiscal year 2023-24, after a small contraction in fiscal year 2022-23. Robust remittance inflows supported private consumption, but private investment growth continued to be weak, dampened by double-digit real interest rates and political uncertainty. On favorable weather conditions, agricultural growth reached a 19-year high while industrial activity contracted and services growth remained muted. Weak growth has carried over to first half of fiscal year 2024-25. Output increased by an average of 1.5 percent y-o-y in the first half of fiscal year 2024-25, slower than the 2.1 percent expansion in the first half of the previous year.
After last year's surge, agriculture posted muted growth in the first half of fiscal year 2024-25 amid drought-like conditions and pest infestations.
The government achieved a primary surplus in the first half of fiscal year 2024-25, with fiscal consolidation efforts supported by an IMF program. The current account was in surplus at the end of 2024, helped by higher remittances, stemming from reduced political uncertainty and exchange rate stability, that more than offset the wider trade and primary income deficits.
With depreciation pressures on the currency subsiding, a robust agricultural harvest, and administrative prices stabilizing, inflation declined steadily to 0.7 percent in March 2025 from its peak of nearly 40 percent in mid-2023. This allowed the central bank to lower its policy rate by 10 percentage points since June 2024 to 12 percent in January.
Copyright Business Recorder, 2025