Taxation system needs fundamental reform
EDITORIAL: Reportedly, the World Bank (WB) deferred the approval of additional International Development Association (IDA) credit equivalent to $70 million for the Pakistan Raises Revenue (PRR) project. It is concerning that official documents reveal Pakistan's tax system raises little revenue, creates economic distortions, and imposes a disproportionate burden on the poor — largely due to systemic inefficiencies.
Alarmingly, the World Bank's analysis shows that Pakistan's fiscal policies have a more pronounced effect on increasing poverty and a weaker impact on reducing inequality compared to other lower-middle-income countries.
The WB analysis reflects ground realities. Pakistan's taxation system is heavily skewed towards indirect taxes, while even a significant portion of direct taxes is collected through indirect mechanisms. The result is: even the direct taxes levied in this manner get priced in similar to indirect prices that are passed on and exacerbate the burden of high rates of indirect taxes on the people with disproportionately higher onus on the poor, while the wealthy remain immensely undertaxed.
A major share of taxes is collected at the import stage — on average, around 60 percent of GST during FY19–FY24. Additionally, a sizable portion of direct taxes is collected at the import stage. Compliant businesses adjust this against their income tax liabilities, but informal players simply pass the cost on to consumers. Even within the domestic supply chain, taxes intended to target traders and retailers are eventually transferred to the end consumer. These tax inefficiencies are embedded in domestic goods, making them more expensive and reducing the competitiveness of local firms. This is a key reason why Pakistan's exports have failed to diversify beyond traditional sectors. Large exporters with access to FBR (Federal Board of Revenue) officials and the PMO (Prime Minister's Office) get their tax refunds, while smaller or newer players struggle to achieve the same.
You cannot export inefficiencies — this is why exports have stagnated, while distortions remain priced into domestic goods and services. The lower the income, the higher the burden — especially when essentials like milk are taxed at one of the highest GST rates in the world. The government has also imposed Super Tax on corporates, which in some cases — particularly in relation to FMCGs — has been passed on to consumers. This is evident from the fact that net margins for these companies have remained stable, while gross margins have increased. Higher income taxes are, in effect, also being passed on through price hikes.
Higher taxation partly explains the unprecedented inflation witnessed over the past couple of years. This has pushed poverty levels up — now estimated at a staggering 44 percent. The poor are being strangled while the middle class is sliding into poverty. Meanwhile, the wealthy continue to enjoy rising incomes and pay a far smaller share of taxes leading to widening of the already yawning inequality. Another structural issue is tariff protection, which allows big businesses to protect their margins while raising prices for consumers — placing a heavier burden on low-income segments.
Under the current tax structure, achieving productive growth and export expansion is nearly impossible. The system needs fundamental reform. All income — regardless of source — should be treated equally in both letter and spirit. Reliance on indirect taxes must be reduced. Corporate income tax rates should be lowered, and, most importantly, GST rate should be slashed. However, these goals remain pipe dreams without political will and enforcement. There must be a starting point. The government should capitalise on falling inflation, subdued global commodity prices, and improving economic sentiment to initiate long-overdue tax reforms in the FY26 budget.
Copyright Business Recorder, 2025
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