Fiscal justice beyond the tax trap—II Why lower rates & predictability matter

A tax system can punish the same people repeatedly and still fail to finance the state. Pakistan’s answer has too often been another rate increase, another deduction at source or another demand on the documented economy. The result is a false choice: accept escalating burdens or be accused of opposing revenue mobilisation. Fiscal justice requires a more demanding question. What combination of rates, coverage, enforcement and expenditure produces the best outcome for society?

Part I of the series argued for bringing ownership into the fiscal bargain while protecting livelihoods. The next step is to examine the case for lower and predictable taxation without replacing one article of faith with another. A high statutory rate does not establish strong fiscal capacity. Equally, a low rate does not establish that its own reduction will generate additional revenue. Both propositions must be tested against behaviour and institutions.

In Towards Broad, Flat, Low-rate and Predictable Taxes, we proposed simpler 10% income taxation for individuals and 20% for companies, an 8% unified goods and services sales tax, harmonisation and a federalised collecting agency.^[1] These were components of a common programme. Selecting the rate reduction while retaining arbitrary enforcement, blocked refunds and selective concessions would abandon much of its rationale. The proposal concerns how the state taxes, as well as how much.

The arithmetic is straightforward. Revenue equals the rate multiplied by the effective collected base. If a rate falls from 18% to 8%, that base must become 2.25 times as large to preserve receipts from the instrument. If the underlying taxable base expands by 20%, compliance will have to improve by a factor of 1.875; an increase from 40% to 75% would meet that illustrative condition. These are break-even calculations, not estimates of what Pakistani taxpayers will do.^[2] This distinction matters because public debate often counts the same gain twice.

Formalisation may improve reported activity without increasing actual production. Inflation can raise nominal collections while purchasing power declines. Delayed refunds can flatter revenue figures while transferring working capital from businesses to the treasury. A serious comparison must use consistent tax bases, real economic outcomes and receipts reconciled with refunds. Gross sales cannot simply be treated as the base of a properly functioning value-added tax (VAT).

Russia is often invoked as proof that a flat tax works. In 2001, it introduced a 13% personal income-tax rate. Research by Anna Ivanova, Michael Keen and Alexander Klemm found a substantial improvement in compliance, estimated at about one third, but no evidence of a strong supply-side response.

The researchers could not establish whether compliance gains arose from the changed tax parameters or accompanying enforcement.^[3] Russia supplies evidence worth examining, not a universal revenue guarantee.

A subsequent International Monetary Fund (IMF) working paper reviewing flat taxes found no evidence that the tax-cut elements of the reforms studied generated Laffer-type revenue gains. It also emphasised variation between systems and ambiguity in distributional effects.^[4]  Those qualifications should sharpen our argument.

Simplification, a broad effective base and predictable treatment remain valuable even where a particular rate cut requires transitional financing. Their merit should not depend on an exaggerated promise that every reduction pays for itself.

Pakistan itself supplies challenging evidence. Michael Carlos Best and his co-authors used corporate administrative records and bunching around tax-liability kinks to study the choice between profit and turnover taxation. They found that easier-to-observe turnover could constrain evasion under limited tax capacity.^[5]

This does not vindicate every minimum tax or every present withholding arrangement. It does show why a reformer must explain how removing an administratively convenient instrument will be accompanied by better information and credible enforcement.

Collection convenience, however, cannot be the final measure of justice. A charge on turnover can bear very differently on two firms with identical sales but different profit margins. A loss-making firm and a profitable firm do not have identical capacity to contribute. Administrative research should therefore guide the transition towards better taxation, rather than become a permanent justification for ignoring actual income. Distribution and productive survival belong in the assessment alongside receipts.

Predictability has an economic value of its own. An investor needs to know the treatment of costs, losses, refunds and future returns, not merely the headline rate on the day a project begins. The joint IMF–Organisation for Economic Co-operation and Development report on tax certainty treats uncertainty in policy and administration as a substantive concern.^[6]

For Pakistan, a credible multiyear framework should mean prospective changes, consultation, clear transition rules and timely dispute resolution, while preserving Parliament’s authority to legislate.

A predictable system need not freeze privileges. Exemptions should be published, costed and reviewed. Nor does a simple system require an identical average burden on every household. A meaningful allowance can make a single marginal rate progressive in average-rate terms; a short graduated schedule may also be simple. What matters is the complete distribution of taxes and benefits. The state’s duty to protect subsistence should be part of the design, not a concession negotiated after hardship becomes visible.

How would we test our case? Compare taxpayers affected by a clearly identified reform with a credible comparison group, before and after implementation. Examine earlier trends, inflation, sectoral shocks and simultaneous enforcement changes. Track investment, employment, real net receipts and compliance costs.

Where implementation occurs at different times, the estimator must account for those differences; a routine before-and-after comparison can produce misleading conclusions.^[7] If rates and administration change together, the estimated effect belongs to the package unless their separate contributions can be identified.

The same discipline applies to claims of failure. An early revenue shortfall may reflect a transition, while a lasting shortfall may reveal unrealistic assumptions. Neither should be concealed. Publish conservative forecasts and a financing plan for essential services. Stage reductions against verifiable additional coverage, improved collection and defensible expenditure savings. Refund arrears should never become the hidden loan that makes a reform appear affordable.

The real weakness in Pakistan’s prevailing approach is its willingness to treat additional extraction as reform without establishing who ultimately bears it. Our alternative must meet a higher standard. Lower rates should reduce the reward for concealment and the burden of compliance; predictable law should permit productive planning; a broader base should reach protected capacity to pay. These are propositions to evaluate through a coherent programme, with results open to independent scrutiny.

We should defend low and predictable taxation because a fair state must raise necessary revenue with the least avoidable harm. We should also specify the conditions under which the proposed rates succeed. That makes the case harder to dismiss and harder to misuse. The next question is equally important: which assets and forms of ownership should enter the base, and how can their contribution relieve the pressure on work, production and ordinary consumption?

Endnotes

^[1] Huzaima Bukhari and Dr Ikramul Haq, Towards Broad, Flat, Low-rate and Predictable Taxes, 3rd ed. (Islamabad: PRIME, November 2024), Executive Summary, pp. vii–xi, especially pp. x–xi. Rates discussed here are proposals in the book, not a statement of current law.

^[2] Author’s illustrative calculation: R = tBc, where t is the rate, B the consistently defined taxable base and c the collected share. Revenue neutrality requires (B₁/B₀)(c₁/c₀) = t₀/t₁. Thus 18/8 = 2.25 and 2.25/1.20 = 1.875. No behavioural coefficients are estimated; actual VAT measurement must reconcile credits and refunds.

^[3] Anna Ivanova, Michael Keen and Alexander Klemm, The Russian Flat Tax Reform, IMF Working Paper WP/05/16 (2005), abstract and conclusions. The compliance result should not be described as a separately identified effect of the rate reduction. Working papers report authors’ research, not necessarily institutional policy.

^[4] Michael Keen, Yitae Kim and Ricardo Varsano, The “Flat Tax(es)”: Principles and Evidence, IMF Working Paper WP/06/218 (2006), abstract and conclusions. Its findings concern the reforms reviewed and should not be treated as a theorem about every possible tax reform. Source

^[5] Michael Carlos Best, Anne Brockmeyer, Henrik Jacobsen Kleven, Johannes Spinnewijn and Mazhar Waseem, “Production versus Revenue Efficiency with Limited Tax Capacity: Theory and Evidence from Pakistan,” Journal of Political Economy 123(6) (2015): 1311–1355. See also the published erratum, DOI 10.1086/685753. The paper combines administrative-data evidence with a calibrated model; the latter is not an observed nationwide reform outcome.

^[6] IMF and OECD, Tax Certainty: Report for the G20 Finance Ministers (March 2017), reproduced in Annex 1 of the OECD Secretary-General’s March 2017 tax report. The report informs the discussion of uncertainty; it does not provide a Pakistan-specific investment multiplier.

^[7] Brantly Callaway and Pedro H. C. Sant’Anna, “Difference-in-Differences with Multiple Time Periods,” Journal of Econometrics 225(2) (2021): 200–230. This supplies an evaluation method, not results for Pakistan. A research design must justify treatment assignment, parallel trends and the handling of anticipation and spillovers.

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 served Civil Services of Pakistan from 1984 to 1996.