Beyond Public Finance: Towards Constitutional Political Economy of Pakistan—IX     From measuring Pakistan’s tax gap to confronting the state behind it

The previous part VIII of this series concluded that a just tax system must satisfy more than the requirements of arithmetic. It must rest upon legislative competence, representative consent, rational classification, due process, protection against arbitrary deprivation, transparent expenditure and effective remedies. Parliament, while levying taxes cannot constitutionalise injustice merely by enacting it. Pakistan’s fiscal crisis will not be resolved by asking citizens to finance an unreformed state through increasingly coercive instruments.

A recent book by Dr Hafiz A. Pasha, Fatima Malik and Hafsa Tanveer, Pakistan: Reforming an Inefficient and Inequitable Tax System, provides an appropriate opportunity to carry that argument forward.

The volume is ambitious, data-rich and deserving of serious attention. Few recent studies attempt, within a single work, to map federal and provincial taxation, estimate tax gaps through different methodologies, examine incidence across income groups and sectors, evaluate fiscal incentives and finally present a quantified reform programme.

Its central diagnosis is familiar but supported by extensive empirical work. Pakistan combines high statutory rates with a low tax-to-GDP ratio, excessive dependence on indirect taxation, pervasive evasion, severe sectoral disparities and weak provincial revenue mobilisation. The authors propose reforms that, in their estimation, can increase the national tax-to-GDP ratio by approximately three percentage points by 2027–28.

The principal difficulty lies not in what the book measures. It lies in what the framework of measurement necessarily leaves outside its calculations.

The usefulness—and limits—of the tax-gap lens

The organising idea of the book is the tax gap. Through cross-country regressions, a representative-tax-system approach, monetary estimates of evasion and bottom-up calculations, the authors conclude that Pakistan possesses the potential to collect approximately three percent of GDP more in taxes. This is analytically valuable. It also risks converting a constitutional and political problem into an accounting exercise.

A tax gap is not necessarily a reservoir of revenue waiting to be collected. Parts of it may reflect privileges protected by influential groups. Other parts arise from low productivity, fragmented enterprises, unemployment, weak financial inclusion and the regulatory costs created by the state itself. Informality is not always a voluntary choice made for the purpose of evasion; it can also be a survival strategy in an economy where formalisation invites multiple taxes, withholding obligations, inspections and compliance costs without ensuring reliable public services.

Citizens also judge taxation in relation to expenditure. Their reluctance cannot be understood solely as non-compliance when additional revenue appears likely to finance debt servicing, administrative expansion, elite concessions, loss-making state enterprises and politically negotiated subsidies rather than education, healthcare, transport, security of property and equal economic opportunity.

The decisive question is consequently not only how much more can be collected. It is who controls the state, who bears its burdens, who receives its rents, and why technically sound reforms repeatedly fail. Public finance asks how the gap should be closed. Constitutional Political Economy asks why the beneficiaries of the existing arrangement would permit it to be closed fairly.

The selective fiscal state

The book repeatedly recognises the presence of powerful vested interests. It identifies the under-taxation of property, agriculture, wholesale and retail trade, real estate and parts of the services sector. At the same time, it finds a disproportionate burden upon large-scale manufacturing, banking and formal businesses.

Its estimate that industry bears taxes equivalent to 23.8 percent of its value added, with the incidence on large-scale manufacturing exceeding 36 percent, is particularly revealing. These figures demonstrate that Pakistan does not suffer from a uniformly low-tax equilibrium.

Pakistan has created a selective fiscal state: coercive towards visible and organised taxpayers, accommodating towards politically protected or administratively difficult constituencies.

This conclusion should change the design of reform. Where political influence determines the tax structure, another catalogue of proposed rates and bases cannot alter the equilibrium by itself. Reform must address the rules through which fiscal choices are made, concessions are granted and enforcement is selectively applied. A technically perfect proposal remains politically irrelevant when those who must enact it derive power from the arrangements it seeks to dismantle.

Withholdingisation is not income taxation

The book correctly notes that withholding and advance taxes generate overwhelming part of total income-tax revenue and have failed to eliminate evasion.

It also recognises the distortions created by presumptive/mimum taxation and the fragmentation of income into separately taxed blocs. The consequences are more serious than those of an imperfect collection technique.

Withholdingisation represents the gradual abandonment of income taxation as a levy on net accretion to economic power. Banks, utility companies, telecom operators, employers, import authorities, registrars and purchasers have been converted into unpaid tax collectors. Gross transactions are taxed without determining actual income, allowable expenditure, losses or the taxpayer’s real capacity to contribute.

The revenue authority obtains money without developing the institutional capacity to examine accounts, conduct intelligent audits and establish taxable income. Compliant businesses suffer liquidity costs and wait for adjustments or refunds, while informal and influential sectors remain beyond meaningful assessment.

The reform of income taxation must restore the return, assessment and audit as its foundations. Withholding should remain confined to situations where it is a genuine advance payment—principally salaries, dividends, profit on debt and payments to non-residents (mostly covered under tax treaties). It should remain fully adjustable against the final liability.

A system based upon extracting money from every visible transaction may achieve collection targets. It cannot be described as a coherent income tax.

Contradictions within the reform programme

The book advocates broad-basing and criticises presumptive taxation, but later recommends restoration of a one-percent fixed tax on export proceeds. It supports neutrality while proposing a general five-year tax holiday for investment, enhanced deductions for energy costs and other selective allowances.

These proposals arise from genuine concerns. Pakistan’s investment rate remains dangerously low, exporters face high energy and financing costs, and industry competes under an unstable exchange-rate and tariff environment.

The proposed remedies nevertheless risk recreating the same exceptionalism that has made Pakistan’s tax system discriminatory, unpredictable and vulnerable to lobbying.

A fixed tax on export proceeds is not a tax on income. It taxes turnover irrespective of profitability, penalises low-margin exporters and confers an unintended advantage upon businesses earning higher margins. A general tax holiday invites the relabelling, reconstruction or transfer of existing activities into supposedly new entities. Special deductions obscure the measurement of real income and create fresh opportunities for classification disputes.

Investment, both domestic and foreign, is better encouraged through macroeconomic stability, competitive energy prices, accelerated depreciation, loss carry-forwards, neutral investment allowances, efficient infrastructure and predictable low-rate taxation. These measures reward actual capital formation without permanently fragmenting the tax base. Pakistan’s history shows that every temporary concession develops a permanent constituency.

Property taxation and constitutional competence

The book estimates substantial revenue potential from urban immovable property tax, capital value tax, rental income, capital gains and property transactions. Its empirical emphasis is justified. Wealth accumulated in real estate has remained inadequately taxed, while speculative investment in land has diverted capital from productive activity. Its constitutional classification, however, requires reconsideration.

The book places capital gains arising from immovable property among federal revenues and appears to assume that federal and provincial taxes may operate simultaneously over different manifestations of property. Such an assumption cannot be sustained without confronting Entry 50 of Part I of the Federal Legislative List, Fourth Schedule to the Constitution.

Constitutional competence depends upon the true nature of a levy, not the label assigned to it by Parliament. Rental income is the fruit produced by property and may properly fall within federal income taxation. Appreciation realised upon disposal concerns the capital value of immovable property—the tree itself. The distinction is not semantic. It determines the constitutional allocation of taxing authority between the Federation and provinces.

Revenue expediency cannot enlarge a legislative entry. A federal tax cannot become constitutionally valid merely because it is inserted into the Income Tax Ordinance, 2001 and described as capital gain.

A serious reform programme must therefore distinguish between the taxation of income derived from property, the taxation of its capital value, and transaction-based levies associated with its transfer. Fiscal federalism cannot be redesigned through statutory labels.

Revenue without expenditure transformation

The book seeks an additional three percent of GDP in revenue so that fiscal deficits and debt accumulation may be contained and social and development expenditure expanded. The objective is desirable. Its achievement depends upon an assumption that Pakistan’s political economy has repeatedly contradicted: that additional revenue will automatically produce socially productive expenditure.

Revenue mobilisation has repeatedly been absorbed by rising debt servicing, security imperatives, administrative expenditure, energy-sector losses, subsidies benefiting influential groups and the continued financing of inefficient state-owned enterprises.

Tax reform without expenditure reform may create a larger state without creating a better one. Citizens cannot indefinitely be asked to finance institutions whose priorities they do not determine and whose benefits they do not receive equitably. The legitimacy of taxation depends not only upon lawful collection but also upon transparent, accountable and constitutionally defensible expenditure.

The tax-to-GDP ratio, viewed in isolation, tells us little about justice, productivity or state capacity.

A higher ratio obtained through petroleum levy, regressive consumption taxation, turnover-based income taxes, blocked refunds and coercive withholding may deepen rather than cure structural weaknesses.

Beyond another catalogue of reforms

Hafiz Pasha and his co-authors have produced an important statistical map of Pakistan’s tax system. Their estimates of tax incidence, evasion, property under-taxation and sectoral inequality deserve careful engagement.

Their discussion of the PIDE-PRIME Tax Reforms Commission, 2024 also brings into the book proposals for a citizen-friendly, transparent and predictable regime; taxation of income without discrimination by source; reduction of corporate taxation; withdrawal of super tax and turnover tax; abolition of presumptive regimes; harmonisation of sales tax on goods and services; reduction of VAT; and eventual elimination of most withholding taxes.

The limitation is not a lack of sound proposals. It is that the analysis remains largely within public finance.

The book asks what a more efficient and equitable tax system should look like. Constitutional Political Economy asks why Pakistan persistently chooses—and preserves—an inefficient and inequitable one.

The next reform effort does not need another catalogue of rates, exemptions and revenue estimates. It must address the distribution of political power, constitutional allocation of taxing authority, independence of tax adjudication, accountability for public expenditure, federal-provincial coordination, and the incentives confronting legislators and tax administrators.

Pakistan’s tax crisis is not a shortage of proposals. It is the predictable fiscal expression of a rent-distributing, externally dependent and weakly accountable state. Until that state is transformed, even the best-designed tax system will remain another technically persuasive plan defeated by the political order it was never designed to change.

The next [concluding part] will highlight that ultimate purpose of taxation is not to enlarge the power of the state over citizens, but to enable citizens, through a constitutionally restrained state, to secure justice, dignity and shared prosperity. Only then will taxation cease to be an instrument of extraction and become an expression of constitutional citizenship.

[To be continued]

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Dr. Ikramul Haq, Advocate Supreme Court, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds an LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also s