Zafar Iqbal

Increasing Pakistan’s tax base has been a long-standing and complex challenge. Despite rising tax rates, both direct and indirect, the country’s tax collection as a percentage of its GDP has failed to show a corresponding increase. The issue lies not only in the rising tax rates but in the significant tax evasion and the shrinking formal sector, which together have undermined any efforts to broaden the tax base.

The government’s approach has been to increase tax rates in a bid to boost revenues. However, this strategy has had unintended consequences. As tax rates rise, the temptation to evade taxes also increases. Businesses and individuals seeking to reduce their financial burden may choose to hide their income or manipulate figures to avoid paying the full amount of taxes. The growing incentive to evade taxes, in turn, erodes the ability of formal businesses to compete fairly and pay their dues. A further increase in tax rates risks pushing more entities into the informal economy, exacerbating the problem of tax evasion and further diminishing the already narrow tax base.

A stark indication of Pakistan’s tax woes is the declining number of taxpayers filing returns. In the 2024 tax year, only 5.9 million entities filed tax returns, a decrease from 6.8 million in 2023. This is against a potential tax filing base of 15 million people. These statistics are alarming, as they reveal that a significant portion of the potential taxpayer base, approximately one-third, is either not filing returns or paying their fair share of taxes. Furthermore, those who do file are often reporting no taxable income. Almost half of the returns filed showed zero taxable income, and the number of individuals declaring significant taxable income is minuscule.

The fact that only 8,000 individuals reported taxable incomes exceeding Rs50 million, with fewer than 4,000 declaring income above Rs100 million, raises serious doubts about the accuracy and transparency of the tax filings. This suggests widespread tax evasion, as the actual wealth in the country seems to be underreported or hidden from the tax authorities.

Instead of addressing the root causes of tax evasion, the government’s solution has been to further increase tax rates. Corporations in Pakistan are subject to an income tax of 29%, with an additional 10% super tax, alongside various other taxes. Shareholders then face a further 15% tax on dividends, pushing the overall tax burden to over 60% for many corporations. Similarly, salaried individuals face tax rates as high as 38.5%, and for non-salaried individuals, this figure can climb to 48%.

While higher tax rates are common in many economies, these countries often offer quality public services in return, such as healthcare, education, and infrastructure. However, Pakistan lags behind in providing these essential services, making it difficult for the average citizen to see the value in paying taxes. Pakistan’s tax-to-GDP ratio remains below 13%, one of the lowest in the world, even when accounting for non-tax revenues. In comparison, countries with high tax rates often have tax-to-GDP ratios exceeding 30%.

The disconnect between the taxes paid and the services received has led to a breakdown in the social contract between the government and its citizens. Taxpayers feel little incentive to pay taxes when they receive so little in return. Moreover, businesses that evade taxes gain a competitive advantage over those that comply with tax regulations. With the general sales tax (GST) at 18% — one of the highest in the world — businesses operating in the formal economy are at a severe disadvantage compared to those in the informal sector, who evade taxes entirely.

This situation discourages formal businesses from expanding, as the cost of compliance is high, while the informal sector remains stagnant because businesses are hesitant to register formally due to the high tax burden. This lack of formal sector growth is one of the reasons why many businesses in Pakistan struggle to scale.

The impact of widespread tax evasion is far-reaching. Wealth accumulated through evasion often finds its way into unproductive sectors such as real estate, foreign currency holdings, and bullion. This wealth is rarely reinvested in productive industries that could drive economic growth. A significant portion of Pakistan’s wealth is also parked in overseas real estate markets, particularly in the UAE, depriving the country of valuable capital that could otherwise be invested in productive sectors.

The private sector has shown a noticeable reluctance to invest in large-scale projects over the past decade. Aside from independent power producers (IPPs), the lack of new mega projects indicates a lack of confidence in Pakistan’s economic environment. The country’s investment-to-GDP ratio is at a historic low, reflecting the broader stagnation in both financial and human capital investment.

The high tax burden in Pakistan has also led to an exodus of both financial and human capital. Professionals, especially those in mid-level positions, are leaving Pakistan in search of better economic opportunities abroad. Many professionals have migrated to the Middle East, where they face little to no tax burden, in contrast to the high tax rates in Pakistan. This migration has contributed to a drain of skilled labor, further exacerbating the country’s economic challenges.

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The government’s response to these issues has been inadequate. The finance minister has acknowledged the problem of high tax rates but has yet to take substantial steps to rationalize them. The introduction of the new category of “ineligible persons” by the Federal Board of Revenue (FBR) — who are barred from certain economic transactions — seems more focused on expanding the FBR’s power to harass existing taxpayers rather than addressing the root causes of tax evasion.

Many taxpayers complain of receiving frivolous notices from the FBR, which often lead to unnecessary harassment. Salaried individuals, for example, are being asked to provide additional documentation, such as Computerized Payment Receipts (CPRs), despite having already submitted tax certificates issued by their employers. This bureaucratic overreach only further alienates taxpayers and encourages evasion.

Pakistan’s tax issues are compounded by external pressures, notably its obligations under the IMF program. The government is under intense pressure to meet ambitious tax targets, but this has led to piecemeal solutions, such as efforts to tax retailers and real estate developers. However, these efforts have yielded minimal success, and the burden continues to fall on the shrinking formal sector.

The government is now pinning its hopes on agricultural taxes, with provincial governments working on the necessary legislation. However, this is unlikely to yield significant results, and the reliance on the formal sector to carry the weight of the nation’s tax burden will continue.

The current tax system in Pakistan is unsustainable. The combination of high tax rates, widespread evasion, inadequate public services, and ineffective government responses has created a vicious cycle that hampers the country’s economic growth. To break this cycle, the government must rethink its tax strategy, focusing on rationalizing tax rates, improving transparency, and expanding the formal sector. Until these fundamental changes are made, the tax base will continue to shrink, and the economy will remain stunted.