Unrecovered VAT can push input cost up by 8.9pc: IMF study

ISLAMABAD: The International Monetary Fund (IMF) has highlighted significant distortions in tax systems that affect key economic decisions, noting that unrecovered value-added tax (VAT) can raise input costs by up to 8. 9 percent. In comparison, corporate taxation can increase the cost of capital by 15-19 percent. Shafik Hebous, deputy division chief in the IMF’s fiscal affairs department, presented these findings in its latest Fiscal Monitor chapter on “Taxing Better to Boost Growth” at a discussion jointly hosted by the IMF and the Urban-Brookings Tax Policy Center at the Brookings Institution. The event reviewed how better-designed tax systems could support economic growth without sacrificing revenue. READ ALSO: FY27: IMF projects Rs15. 3trn tax collection “Many governments face the challenge of supporting economic growth without sacrificing revenue. But how can a better tax system support economic growth? ” he questioned. Shafik stated that the tax distortions are sizable and influence key economic decisions, particularly those relating to investment, production and employment. He said that the unrecovered VAT raises input costs by up to 8. 9 percent, while corporate taxes raise capital costs by 15-19 percent. Further distortions arise from employment taxes, poorly designed tax incentives and weak tax implementation. He stressed that better taxation can lead to substantial output gains, with common priorities across countries including restoring neutrality in investment and work decisions. For advanced economies (AEs), the IMF deputy division chief called for better-targeted research and development (R&D) incentives, aimed at ensuring that tax support is directed towards productive innovation rather than creating unnecessary distortions. For emerging market and developing economies (EMDEs), he identified three key priorities: restoring VAT neutrality, avoiding size-based tax thresholds that discourage firms from growing, and strengthening tax implementation. He said that a comprehensive reform of the VAT systems to ensure broad base coverage and full input-tax recovery can significantly reduce production costs and raise economic welfare by up to 0. 8 percent of GDP. Shafik pointed out that the unrecovered VAT due to exemptions and incomplete input-tax credit mechanisms distorts firms’ input choices and raises production costs by 2. 3 to 8. 9 percent of input value, depending on the sector. The sectors affected included finance & insurance; real estate; arts, entertainment & recreation, construction, utilities, information & communication; accommodation & food services and manufacturing. He explained that the better-designed tax incentives can support firm growth and innovation, but incentives linked to the size of firms may encourage businesses to remain small in order to stay below tax thresholds. Such size-based tax incentives could have adverse effects on investment, firm growth and productivity, as businesses may have an incentive to avoid crossing tax thresholds rather than expanding their operations. He expressed concerns regarding certain R&D tax incentives, observing that such measures may subsidise profits rather than generate additional innovation. IMF deputy division chief suggested that tax policy aimed at promoting innovation needs to be carefully designed to ensure that incentives generate additional investment and innovation rather than merely increasing firms’ existing profits. He also talked about the importance of better-designed tax incentives to ensure that public revenue foregone through tax expenditures translates into genuine economic gains, including higher investment, productivity, firm expansion and innovation. The panel discussion was attended by Laura Alfaro, Chief Economist and Economic Counselor, Inter-American Development Bank; Michael Best, Associate Professor of Economics, Columbia University; Era Dabla-Norris, Deputy Director, Fiscal Affairs Department, IMF; Elena Patel, Pozen Director’s Chair, Senior Fellow, and Co-Director, Urban-Brookings Tax Policy Center, Brookings; and moderator: Victoria Perry, Professor from Practice, Georgetown University Law Center. Copyright Business Recorder, 2026

Read full story on Business Recorder