There are around two million individuals within a labour force of more than 80m that can be considered salaried and employed formally. The operating word is ‘formal’, wherein they are employed through either a long-term or contractual contract and have their salaries deposited in their bank accounts after income tax is withheld from their salaries.

It is estimated that the salaried class paid more than Rs280 billion in taxes last year. The amount paid by the salaried class has increased consistently over the years, largely as a function of increasing tax rates and increasing salaries (mostly due to inflation), eventually bumping up their overall contribution.

A salaried taxpayer mostly has an urban orientation, does not necessarily have any sizeable land holdings, and largely covers expenditures such as education, health, etc, through their own pockets. A salaried taxpayer, being employed in the formal sector, is also marginally more educated on aggregate, and thereby, it can be deemed that it contributes significantly to the country’s intellectual capital stock.

As taxes are withheld from their salaries before they are disbursed to the bank account, a salaried taxpayer is the lowest-hanging fruit, or easiest kill, for the tax authorities. Increasing the tax rate or manoeuvring the tax slabs can yield excess tax for the tax authorities through a stroke of a pen and with little to no effort.

Over the last five years, the salaried middle class has lost 45pc of its purchasing power through a mix of inflation and taxes

The incentive structure is broken for the tax authorities. Why would anyone bother with enforcement or sifting through the wealth and income sources of the unemployed when a stroke of a pen can generate sufficient incremental taxes without much effort?

As an illustration, we can consider a salaried individual earning Rs100,000 in 2019 and track their journey over the years. We assume that the increment that the said individual gets is in the range of 70 per cent of the previous year’s inflation, which is generous. We also track how their tax rate changes as their salary increases due to inflation. Since 2019, the cumulative inflation has been in excess of 109pc as per the compounded effect of the Consumer Price Index (CPI).

As the salary of the individual increases at a lower rate than inflation, so do taxes — which means that their after-tax income further grows at a slower rate than inflation. Adjusting for updated tax rates, we can see that cumulative inflation during the period is in the range of 109pc, while the increase in post-tax salary is in the range of 55pc. Adjusting the post-tax salary for inflation and looking at the same in real terms, we see that real post-tax salary has actually increased by only 33pc.

Effectively, after adjusting for inflation, and taxes, a salaried individual who was earning Rs100,000 in 2019 would be earning around Rs133,000 post-tax in 2024 in real terms. To preserve their purchasing power as of 2019, they ought to have a post-tax salary of Rs237,000, which is a far cry from their current post-tax salary. Effectively, their post-tax real salary is only 55pc of what it was in 2019. Such is the compounded effect of inflation and taxes on the salaried class.

The incentive to be a non-filer is higher than for dutifully paying taxes

More importantly, a lot of factors such as house rent, educational expenses, and healthcare expenses, which are borne mostly from private pockets, are not truly captured in the CPI here — inflation levels may differ for different households, but their destructive effects are the same across the board.

A metric that can demonstrate that all is not well across households is electricity consumption per capita, which has largely remained flat over the last five years. On a household level, it has actually declined, mainly due to the more than 100pc increase in prices over the last five years, which led to budget constraints for households.

The same destruction in real incomes can be seen across all salary levels, where real incomes have fallen anywhere between 25-50pc, depending on the tax slab and starting value. The government through perpetual deficits first erodes purchasing power through inflation, then taxes the same people, who have been dutifully paying their taxes — further reducing their disposable income.

A taxpayer is penalised heavily for being a taxpayer. On the contrary, it may actually be economically feasible to be a non-filer, since the penalty on being a non-filer is far lower than the value destructive properties of being a taxpayer. Over the last five years, the salaried middle class has been rapidly dwindling, such that it has lost 45pc of its purchasing power through a mix of inflation and taxes. The government fails to realise that destroying the same also means destroying the income of its most tax-compliant cohort, effectively implying that the real taxes it collects from this cohort will also decline.

By completely failing to widen the tax net, the government has squeezed more than its fair share from those that are the most tax compliant citizens. Such a disincentive structure does not work for long — as there has been an accelerated exodus from the country, eroding the already dwindling intellectual stock that existed.

The incentive to work formally in Pakistan and pay taxes has never been so low. The economic incentive to evade taxes and pay all penalties for being a non-filer is still in favour of not paying taxes rather than dutifully paying taxes.

The writer is an Assistant Professor of Practice at the Institute of Business Administration, Karachi

Published in Dawn, The Business and Finance Weekly, June 17th, 2024