No truths and a lie

Business Recorder

12-06-2025

If there is one thing governments do really well, it is self-congratulation at minor victories that mask deeper structural problems.Here is a direct quote from the Economic Survey for 2024-25, and it goes: 'The increase in direct taxes relative to indirect taxes reflectsthe government's commitment to make taxation progressive and equitable'. This sounds promisingbut the truth is less flattering. As much as we like to talk about tax reforms in Pakistan—the urgent need of them versus the objective lack of them—and as much advice the country's administrators have received from IMF and the likeson tax reforms, the tax system remains flawed,growing less progressive and less equitable over time, not more.
For decades, the federal tax-to-GDP ratio has languished between 8 and 10 percent. In FY25, it nudged just above 10 percent, a marginal improvement from 8.8 percent in FY24. Yet this modest gain came alongside missed collection targets.When collections are unable to meet an already constrained budget, necessary spending inevitably gets slashed which is what frequently happens to PSDP disbursements. In FY25, development spendingwas roughly 2.5 percent of GDP. Contrast that tomark-up payments that chipped away tax collections at 7.9 percent of the GDP. The government's fiscal space remains perilously narrow, propped up by central bank financing and growing debt servicing needs.
The challenges of the tax system are not unknown. The government and FBR acknowledges the issues of tax evasion, poor compliance and weak enforcement. They know that these challenges keep collections low whilst transferring the burden of tax on those easiest to tax—consumers. In FY25, indirect taxes contributed 57 percent to the total tax collections, up from 51 percent in FY24. Since 2000, indirect taxes have averaged 62 percent of all federal taxes, which corresponded with an average contribution of 38 percent for direct taxes. During this period, average growth for direct taxes has been higher—17 percent vs the growth rate of indirect taxes at 14 percent. Certainly, direct taxes have grown faster than indirect taxes. But whether they reflect the move toward a more equitable and progressive tax system is entirely debatable.
Two critical data points stand out. First, most direct taxes are income taxes (a historic 40-year average of 96%) and most income taxes are withholding taxes (68% average in the past decade). In essence, a majority of what constitutes as income taxes are withheld through the presumptive taxation mechanism where various rates are levied on various categories and sub-categories of transactions such as imports and contracts, dividends and utility bills. Salaries withheld by employees constitute only 10-12 percent of the total withholding tax collections. In many cases, these taxes are final, especially given the large number of non-filers, which means the government loses the ability to assess actual income levels.
In a seminal paper on withholding taxes, Former FBR Chairman Ashfaq Ahmedaptly described this phenomenon as the state's 'aggressive grabbing' of economic activity through presumptive taxation.
He argues that progressivity of a tax— taxing individuals based on their ability to payso that those with a higher income would pay a higher proportion of said income in tax—is the first casualty of withholdingization.
This has not been done to the tax system by accident. The government does not seem to have the capacity or motivationto determine the trueincome tax base by measuring individuals' ability to pay taxes. By using the withholding tax collection mechanism, direct taxes have been indirectised where uniform rates are applied across transactionsirrespective of the income level. This distorts the meaning of equity. The fact is, even if direct taxes have been growing in recent years faster than indirect taxes, they are not inherently progressive by virtue of the collection mechanism.
Second, the government is forgoing an ever-growing share of potential revenue. Tax expenditures—exemptions and concessions granted to favored sectors—reached an estimated 5.5% of GDP in FY24, equivalent to 63% of total federal tax collections.Tax expenditures are also growing faster than the actual tax revenues that the FBR collects. For comparison, average growth in revenues between 2011 and 2024 was 15 percent while the growth in foregone taxes averaged 32 percentduring this period.
Tax incentives are not inherently bad. Many countries use them to stimulate investment or exports. But countries with higher revenue foregone also tend to collect a lot more taxes. They can afford to be so generous! Pakistan, with its chronically low tax-to-GDP ratio, cannot afford such largesse. Contrast Pakistan's dormant tax to GDP of 8-9 percent to Asia Pacific's 20 percent or OECD's 33 percent where tax foregone is a small proportion of the GDP at roughly 3 and 4 percent. Taxes foregone in Pakistan are much higher than any of these high tax collecting regions. In the context of a large informal economy, and unfettered tax evasion, the foregone revenues are simply unsustainable, and importantly, inequitable.
Let's be clear. The growth in tax revenues, particularly from direct taxes, does not signal a structural shift toward progressivity, nor does it reflect a fairer system. Instead, it reveals a patchwork regime bolstered by indirect levies and presumptive taxation to paper over fiscal shortfalls. What passes for reform in Pakistan has done little to make the tax system more equitable.The influential tax pockets hide in plain sightwhile the burden of the tax system falls on the usual suspects. Anything else the government claims is a lie.