Zafar Iqbal
Pakistan is at a critical juncture in its economic management, grappling with a dual challenge of underperforming revenue collection and an urgent need for fiscal reforms. Recently, a private-sector-led working group on income tax proposed tax reliefs amounting to Rs975 billion, a measure aimed at boosting investment and easing the burden on the corporate and salaried classes. In response, the Prime Minister has directed authorities to engage the International Monetary Fund (IMF) on this proposal, recognizing its potential importance for the economy.
However, the timing of this proposal presents a significant hurdle. The Federal Board of Revenue (FBR) has fallen short by Rs428 billion, or 8 percent, of its target in the first five months of fiscal year 2025-26 (5MFY26). At best, the government can seek a waiver from the IMF for missing the revenue target, but this will likely involve avoiding contingency measures in the second half of the fiscal year. In practical terms, there is virtually no chance that any tax relief can be implemented mid-year. Any meaningful reductions are likely to be considered only in the next fiscal year, highlighting the structural constraints facing policymakers.
That said, the logic behind lowering income tax rates is sound. Current rates are excessively high and skewed toward the formal corporate and salaried sectors, discouraging new investment. Corporate income tax currently stands at 29 percent, plus a 10 percent super tax for entities exceeding a certain threshold. Dividend income is taxed at 15 percent, including inter-corporate dividends, resulting in an effective tax burden in some cases exceeding 60 percent. Such rates significantly deter fresh investment, particularly as business groups increasingly perceive insufficient incentives for capital formation within Pakistan.
Salaried individuals also face substantial pressure. The top tax slab for this group is 35 percent, with an additional 10 percent surcharge beyond a certain income threshold. Middle-class employees, who are the backbone of the formal economy, are increasingly seeking alternative avenues, such as freelancing or emigrating, to reduce their tax liabilities. This exodus has created a growing shortage of mid- to senior-level managerial talent within the corporate sector, further straining productivity and growth.
The structure of taxation is inadvertently encouraging informality. Export services, including freelancing income, are subject to only 1 percent final tax, whereas goods exports face 29 percent tax. As a result, there are rising reports of goods exports being routed through the services sector, which is growing rapidly even as goods exports stagnate. This structural distortion undermines the overall tax base and compromises the government’s revenue potential.
High taxation is also dampening consumption, a critical driver of domestic demand. Excessive reliance on formal sector taxation discourages spending and investment, while government expenditures are dominated by current spending that is inefficient and delivers suboptimal results in governance and service delivery. The current model is clearly unsustainable, and the government appears to be recognizing this reality only now.
In recent statements, the Prime Minister acknowledged the need to reduce income and sales tax rates to stem the flight of financial and human capital. Similarly, the Special Investment Facilitation Council (SIFC) National Coordinator emphasized that reforms in taxation are crucial for improving the country’s investment climate. The thinking is correct, but a concrete plan for implementation remains absent, reflecting a lack of policy readiness and strategic clarity.
Sources close to the IMF indicate that relaxing tax requirements mid-year is unlikely, particularly when the FBR continues to miss revenue targets. At best, discussions of tax reductions can be considered during preparations for the next budget, with any reductions needing to be offset by expenditure cuts to maintain fiscal and primary surplus targets. Without such measures, tax relief remains aspirational rather than actionable.
A critical flaw in the current approach is the government’s inability to downsize itself meaningfully. While the Finance Minister has highlighted the abolition of vacant positions, this is insufficient. The real need is to eliminate redundant roles within the bureaucracy and state-owned enterprises (SOEs), which continue to burden the fiscal system. Without addressing the size and inefficiency of government, tax reductions alone will not produce the desired economic outcomes.
The FBR Chairman has cited successes, such as over Rs100 billion in additional collections from the cement and sugar sectors through AI-enabled track-and-trace mechanisms. While these achievements are commendable, they have not translated into meeting overall revenue targets. The gap between actual and projected collections is widening, and more comprehensive measures are required to plug leakages across the economy. Future plans targeting sectors such as textiles, tobacco, and tiles are promising but will need consistent execution and monitoring.
Equally important is the expansion of the tax base. While new filers are being registered, most do not contribute meaningful revenue, highlighting the need for systemic reforms. A focus on formalizing economic activity, ensuring compliance, and enhancing digital monitoring can significantly improve collections without overburdening existing taxpayers.
In conclusion, Pakistan’s challenge is clear: the desire to reduce income and sales taxes aligns with economic wisdom, but the absence of structural reforms, fiscal discipline, and bureaucratic downsizing limits its feasibility. Tax relief cannot be considered in isolation. Without credible efforts to strengthen the FBR, curtail government inefficiency, and reduce SOE losses, lowering tax rates will remain a wish list, and ambitions of attracting new investment will remain unfulfilled. Sustainable economic growth requires a holistic approach, combining targeted tax relief with genuine governance reforms and fiscal prudence.
<a href=”http://republicpolicy.com”>Follow Republic Policy</a>
