As Pakistan faces mounting economic challenges, the government’s ambitious proposal to raise Rs1.2 trillion to Rs1.3tr in the upcoming budget through new taxation measures signals a bold attempt to stabilise the nation’s fiscal health.

However, the effectiveness of these measures is tempered by the inherent weaknesses in Pakistan’s tax system, which is fragmented and unfair and leaves entire sectors of the economy under-taxed, exacerbating structural economic imbalances. The government seems to be adhering once again to the easier route of imposing more taxes on imports and withholding taxes, along with some good proposals, such as the rationalisation of tax rates.

The tax system is heavily skewed towards import and consumption taxes, with around 50 per cent of tax revenue coming from indirect taxes, while direct taxes constitute only about 33pc, primarily from advance and withholding taxes.

Income tax collection in Pakistan is reliant on only a few sectors and the salaried class. Sales tax, similarly, is largely collected from imports and domestic manufacturing rather than the entire value chain. This reliance on indirect taxes not only makes the system regressive but also worsens economic imbalances by disproportionately burdening the lower and middle-income groups.

A fair and unbiased tax policy backed by strong political will and improved monitoring, collecting, evaluating and spending mechanisms is the only way forward

One of the key proposals in the upcoming budget is to increase the difference in withholding tax rates between filers and non-filers of tax returns, aiming to improve compliance and broaden the tax base. Additionally, the government plans to raise import tax on the import of machinery and raw materials, which could generate significant revenue.

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However, these measures risk escalating production costs, potentially dampening industrial investment and affecting economic growth. According to economic theory, higher import tariffs on inputs like machinery can reduce the competitiveness of domestic industries in international markets, leading to a decline in exports.

Another critical aspect of the government’s proposal is the rationalisation of income tax rates by removing the distinction between salaried and non-salaried individuals and reducing the number of tax rate slabs. This move aims to simplify the tax system and make it more equitable.

Unfortunately, implementing such measures requires a robust and efficient tax administration — an area where the Federal Board of Revenue has historically faced significant challenges with enforcement due to inadequate technology, limited resources, and bureaucratic inefficiencies.

The under-taxation of agricultural income, urban properties, and retailers further worsens the imbalances in Pakistan’s tax system. Agriculture, which accounts for about one-fifth of Pakistan’s economy, contributes a disproportionately small amount to tax revenue.

Large agricultural landowners, who form a powerful pressure group, often evade taxation. Effective taxation of agricultural income and urban properties is crucial in addressing these imbalances and incentivising investment in more productive sectors.

The retail and wholesale sector remains largely outside the tax net despite its significant contributions to the GDP. This sector’s tax contribution stands at a mere 4pc, highlighting the need for better incorporation into the tax network. The government’s efforts to tax this sector more effectively have so far been met with limited success.

The lack of comprehensive documentation is a fundamental issue underlying Pakistan’s inefficient tax system. Without proper documentation, it is challenging to accurately assess and tax economic activities, especially in sectors like agriculture and retail.

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Expanding the tax base requires a concerted effort to document all economic transactions and entities. This can be achieved through the digitisation of records, mandatory registration of businesses, and stricter enforcement of existing laws.

As a way forward, tax policy must be fair and not skewed towards certain sectors or just the salaried class. Each segment and sector should be appropriately taxed to ensure equity and efficiency in the tax system. Moreover, the government must improve the quality and delivery of services to the common people. Public money should not be used to provide unnecessary luxuries to politicians or government officials.

Citizens are more likely to comply and less likely to engage in tax evasion if they see tangible benefits from their tax contributions. So, the usage of public funds must be subjected to rigorous cost-benefit analyses and strict evaluation. This ensures public money is spent wisely and effectively, enhancing trust in the government’s fiscal management.

Furthermore, the tax collection process should be decentralised. Local governments should be empowered to collect taxes within their jurisdictions, ensuring better compliance and accountability. Decentralisation can lead to more efficient and effective tax administration, as local authorities are more familiar with the economic activities in their areas and can tailor tax policies accordingly.

Finally, the implementation and will to enforce policy changes are crucial. Many past reforms have failed due to the lack of political will and effective enforcement. The government must demonstrate a strong commitment to implementing these new measures and overcoming resistance from vested interests.

As Pakistan stands at an economic crossroads, these new taxation measures represent a critical test of the government’s ability to implement effective fiscal policies. The outcome will impact the immediate fiscal landscape and shape the long-term trajectory of Pakistan’s economic health and development.

A balanced, well-considered approach that fosters compliance, encourages investment and protects the vulnerable will be key to ensuring that these measures contribute to a more stable and prosperous economic future for Pakistan.

The writer is an assistant professor and a researcher at the Centre of Economic Planning and Development,

Minhaj University Lahore.

Published in Dawn, The Business and Finance Weekly, May 27th, 2024