Pakistan’s tax system: an overtaxing Leviathan? By Muhammad Raza - Printable Version

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Pakistan’s tax system: an overtaxing Leviathan? By Muhammad Raza - Ather Saleem - 05-08-2025

Business Recorder published this article (Click to Read Full)

Summary: Pakistan's Tax System and Budget Challenges
By Muhammad Raza, Chartered Accountant

With federal and provincial budgets due soon, there’s rising concern over Pakistan’s fiscal direction. The IMF projects revenue at Rs 20 trillion for next year—a steep rise from the current Rs 17.8 trillion. While this aligns with inflation (7.7%) and GDP growth (3.6%) forecasts, it masks deep structural and behavioural issues in the tax system.
Key Problems:

• Complex and Contradictory Tax System:
  • Unlisted capital gains taxed up to 59.5%, deterring investment.
    
  • Tax burdens vary greatly depending on legal structure and other variables.
    
  • Frequent major budget changes discourage long-term business plans.
    
• Erosion of the Four Tax Equity Pillars:
  • Horizontal Equity: Unequal treatment across sectors and income sources.
    
  • Vertical Equity: Progressive taxes become punitive (55%+ effective tax on corporates).
    
  • Exchange Equity: Citizens pay high taxes but receive poor public services.
    
  • Process Equity: Taxpayers face audits, penalties, and uncertainty despite self-assessment rules.
    
• Disengagement from the Formal Economy:
  • High taxes and complexity push people toward informal sectors.
    
  • Documented, compliant taxpayers feel unfairly targeted.
    
  • Foreign investors shy away due to unpredictability.
    

Reform Recommendations:

1. Unified Direct Tax Regime: Remove presumptive/minimum taxes; focus on net income.
   
2. Fairer Personal Taxes: Progressively applied to all income sources with lower top rates.
   
3. Capital Gains Reform: Lower long-term capital gains taxes with cost indexation.
   
4. Lower Corporate Tax Rates: Align with regional averages.
   
5. Intercorporate Dividend Relief: Remove double taxation and encourage holding companies.
   
6. Streamline Withholding Taxes: Reduce and rationalize; exempt sales tax filers.
   
7. Clarify Constitutional Tax Structure: Differentiate direct vs. indirect taxes legally.
   

Final Thought:
Pakistan risks crossing the Laffer Curve’s inflection point—where higher taxes reduce revenue due to taxpayer disengagement. The solution lies not in raising targets but in building a fair, simple, and growth-oriented tax system. Without meaningful reforms, the tax base will continue to shrink despite increasing demands.

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