Reform the reformers—VIII   Towards a Pakistani model of consumption taxation

Good tax policy is not about copying international fashions. It is about designing institutions that suit national constitutional arrangements, administrative capacity and economic realities—Tax Reforms in Pakistan Historical and Critical Review & Towards broad, Flat, Low-rate and predictable taxes by Huzaima Bukhari & Dr. Ikramul Haq

For more than three decades, Pakistan’s tax debate has oscillated between two extremes. One school insists that international best practices should be transplanted without modification. The other resists every reform as though the existing system were beyond criticism. Both approaches have failed.

The real lesson from Asia is altogether different. No successful Asian economy imported its consumption tax system as a ready-made package. Three very successful models namely, Japan, Singapore and Malaysia, are glaring examples.

Even those having common colonial heritage with us, India, Bangladesh, Sri Lanka never the prescriptions of the International Monetary Fund, World Bank, et al.  Each designed a model reflecting its own constitutional structure, economic development, business culture and administrative capacity. That is precisely the lesson Pakistan has consistently ignored.

Japan offers perhaps the clearest example. Its Consumption Tax, introduced in 1989, was never presented as a miracle instrument for revenue mobilisation. The Japanese government first built an economy characterised by high levels of documentation, formal employment, sophisticated accounting systems and extraordinary voluntary compliance. Only within that institutional environment could a broad-based multi-stage consumption tax function efficiently.

Even today, Japan combines moderate rates with strong compliance, extensive invoicing requirements and comparatively high public trust in tax administration. The tax works because the institutions work—not the other way round.

Singapore followed a different but equally pragmatic path. When it introduced the Goods and Services Tax in 1994 at only 3 percent, it did not attempt to maximise immediate revenue. The emphasis was on simplicity, predictability and maintaining international competitiveness.

Over three decades the rate was increased gradually to 9 percent as administrative capacity matured and public confidence strengthened. The tax base remained broad, exemptions were kept relatively limited and compliance costs were consciously controlled. GST became one component of an integrated fiscal strategy rather than the sole instrument of revenue mobilisation.

Malaysia provides perhaps the most instructive lesson for Pakistan. After introducing a classical Goods and Services Tax in 2015, Malaysia concluded that implementation problems, compliance costs and public acceptance required a different approach. In 2018, it abolished GST and reinstated the ), effectively returning to a predominantly single-stage consumption tax.

The Malaysian Government itself openly explains the evolution from SST to GST and back to an improved SST, acknowledging that different systems involve different trade-offs and that administrative practicality matters as much as theoretical elegance.

The lesson is not that Pakistan should imitate Malaysia’s SST or Singapore’s GST or Japan’s Consumption Tax. The lesson is that each country adapted its consumption tax to its own economic circumstances rather than forcing its economy to fit an imported model. Pakistan has often proceeded in the opposite direction.

Instead of asking what type of consumption tax best suits an economy dominated by cash transactions, fragmented wholesale markets, constitutional fiscal federalism and extensive informality, policymakers have repeatedly attempted to preserve the legal vocabulary of VAT while gradually abandoning many of its defining characteristics.

Today in Pakistan, retailers under the presumptive regime, Third Schedule taxation, numerous special procedures, withholding mechanisms and extensive exemptions have already transformed Pakistan’s GST into a hybrid system. Yet policymakers continue defending it as though it remained a classical value-added tax. The contradiction is becoming increasingly difficult to sustain.

A tax system should be judged not by its name but by its performance. If an 18 percent statutory rate produces an effective incidence of only about 8 percent; if fake and flying invoices remain endemic; if refund frauds continue to consume administrative resources; if manufacturers function as tax collectors for the entire supply chain; and if millions of retailers remain outside effective documentation, then the time has come to reconsider first principles rather than merely adding further administrative layers.

The experience of successful Asian economies suggests several common themes. First, consumption taxation should remain simple enough for ordinary businesses to understand and comply with. Second, the tax base should be broad while the rate remains moderate, reducing incentives for evasion.

Third, technology should support economic documentation rather than substitute for it. Fourth, administrative complexity should never exceed administrative capacity. Finally, tax design must complement constitutional arrangements instead of creating permanent conflict between different tiers of government.

These principles are particularly relevant after the Constitution (Eighteenth Amendment) Act, 2010. Pakistan cannot indefinitely maintain separate provincial sales taxes on services, a federal sales tax on goods, overlapping withholding regimes and fragmented documentation while simultaneously aspiring to operate a seamless value-added tax. Fiscal federalism requires cooperation, not duplication.

The next stage of Pakistan’s tax debate should therefore move beyond the sterile choice between preserving the present GST and abolishing it altogether. The real challenge is to design a Pakistani model of consumption taxation—one that reflects constitutional federalism, administrative realities, technological capability and the predominance of small and medium enterprises. Such a model should minimise litigation, reduce compliance costs, encourage documentation, eliminate opportunities for invoice fraud and broaden the tax base without imposing punitive rates upon the shrinking documented sector.

That is not an exercise in rejecting international experience. It is an exercise in learning from it. Japan teaches the importance of institutional capacity. Singapore demonstrates the virtues of simplicity, gradualism and stability. Malaysia reminds us that governments must remain willing to redesign tax systems when experience proves that theoretical perfection does not translate into practical success.

Pakistan’s reformers would do well to remember one final lesson. Successful Asian economies did not become prosperous because they adopted a particular tax model. They adopted tax models that complemented their economic strategies, constitutional structures and institutional capabilities. Pakistan has too often attempted the reverse.

[To be continued]

____________________________________________________________________

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.