Features of taxation system of Pakistan

The objective of this article is to highlight the key features of the taxation system of Pakistan, such that strengths and weaknesses can be identified. This will provide the basis for identification of the tax reform agenda from the viewpoint of raising the level of revenues, improving equity of the tax system and enhancing the efficiency in tax collection. The long-term trend in total tax revenues as a percent of the GDP has been U-shaped. Tax revenues include the revenue from the petroleum levy, which emerged from the withdrawal of the sales tax in 2022-23. The federal government classifies it as a non-tax revenue, but the IMF also treats it as a tax. The likely estimate of the total tax-to-GDP ratio in 2025-26 is 12. 6 percent. This ratio rose sharply in 2024-25 to 12. 2 percent of the GDP in 2024-25. The tax-to-GDP ratio stood at a low of 7. 1 percent of the GDP in 2003-04. Considerable progress has been made since then. The taxation system is imbalanced between the federal and provincial levels. Federal tax revenues constitute over 92 percent of the total national level of tax revenues. The extremely low share of 8 percent of the provincial tax revenues is despite the presence since 2015-16 of a potentially large tax, the sales tax on services. India is also a federation, with almost 30 percent of the national tax revenues collected by the States. There has been another major improvement in the tax system of Pakistan in the form of a big increase in the share of direct taxes. In the early 90s, the share was only 20 percent of the share of direct taxes. The share now stands at almost 45 percent. This has led to a more progressive tax system in the country. Withholding taxes are currently yielding almost 60 percent of the income tax revenues. Within indirect taxes at the federal level, the major share is of the combined collection from the sales tax and the petroleum levy of over 71 percent. The importance and contribution of the customs duty and excise duty has diminished sharply over the years. Their combined contribution currently is 1. 7 percent of the GDP. A comparison can be made of the overall tax-to-GDP ratio of Pakistan with that of some Asian countries. At 12. 2 percent of the GDP in 2024-25, it is significantly higher than the ratio in Bangladesh and Sri Lanka. However, it is lower than the tax-to-GDP ratio of India, Malaysia and Thailand, which ranges from 14 percent to 18 percent of the GDP. Pakistan still has a considerable amount of ‘catching up’ to do. There is perhaps a surprising finding that the sales tax rate at the federal level is relatively high in Pakistan at 18 percent and at the middle level in import tariffs, with an average of 9. 9 percent. The important comparison is with respect to income tax rates. The corporate income tax in Pakistan at 29 percent is in the middle of the range from 20 percent to 35 percent in other Asian countries. However, the highest personal income tax rate at 35 percent is somewhat on the higher side. For example, it is 25 percent in Bangladesh and 30 percent in India. Various approaches have been adopted to determine the potential tax-to-GDP ratio of Pakistan. A ‘representative tax system’ approach using economic indicators of potential tax revenues in a sample of Asian countries reveals that despite the increase in 2024-25, the actual tax-to-GDP ratio is lower than the potential ratio by almost 3 percent of the GDP. In other words, the target should be attainment of a tax-to-GDP ratio of at least 15 percent of the GDP. This leads to the quantification of the revenue potential in individual taxes by adoption of the ‘bottom up’ approach to estimation of the ‘tax gap’. For example, revenues of the personal income tax could be more than twice the actual level, while sales tax revenues could be higher by 25 percent. There is, in fact, a huge ‘tax gap’ in provincial taxes. The ‘tax gap’ in the agricultural income tax in 2023-24 has been estimated at Rs 880 billion, while the actual revenues are only Rs 10 billion. Similarly, the ‘tax gap’ in the sales tax on services is close to Rs 650 billion. Therefore, the real challenge is the adequate development of the provincial tax system in Pakistan. There is also a large gap in property-related tax revenues. There are five taxes at the federal and provincial levels on property in Pakistan. However, the actual revenue is less than 0. 3 percent of the GDP, when the potential revenue could be significantly higher at over 0. 8 percent of the GDP. Turning to an important issue of who bears the burden of taxes in Pakistan, there is the need to appreciate the rise in progressivity mentioned earlier due to the substantial increase in direct taxes share of revenues. However, the big enhancement in the petroleum levy has significantly added to the regressive nature of the tax system. Overall, research on incidence of taxes by income quintile in Pakistan reveals that the tax system remains ‘mildly regressive’. International comparisons reveal that the tax system of Pakistan is more progressive than the tax systems of Bangladesh and Sri Lanka, but more regressive than Indonesia’s, India’s and Malaysia’s. There is also a big variation in the incidence of taxes of taxes among sectors of the economy, as measured by the total tax collection from different taxes as percentage of value-added. The incidence by sector is given in Table 1. A review of the regime of the fiscal incentives in different countries reveals that successful incentives include the following: • Tax holiday on investment in many countries • Higher exchange rate on exports and tax exemption in Bangladesh • Cost of energy inputs to be taken as more than the actual amount for computation of profits in Thailand • Investment allowance or tax exemption on specific capital investments in India. Overall, the above description of the tax system in Pakistan and in other countries has provided insights for the following tax reforms and development of the tax system in Pakistan: • Top priority to development of provincial taxes like the sales tax on services, agricultural income tax and property-related taxes. • Target for increasing the overall tax-to-GDP by 1 percent of the GDP each year from 2026-27 to 2027-28 to take the ratio to above 15 percent of the GDP. • Rationalization of the structure of the personal income tax and reduction in rates of the petroleum levy. • Targeting a reduction in the overall tax burden on sectors like large-scale manufacturing, banking and insurance, and construction, while simultaneously raising collection from agriculture, wholesale and retail trade and real estate. • Establish of a regime of fiscal incentives to promote investment and exports. Copyright Business Recorder, 2026

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