Tax expenditure & myth of fiscal deficit—I Budget 2026-27: Taxes of trillions forgone

کیا جانئے کیوں تیز ہوا سوچ میں گم ہے

 خوابیدہ پرندوں کو درختوں سے اڑا کر

Mohsin Naqvi’s observation about the puzzlement of one who first disturbs the nest and then wonders at the resulting chaos provides an apt metaphor for Pakistan’s fiscal predicament. The ruling elite has presided over decades of debt accumulation, protected influential ones through exemptions and concessions, shifted the tax burden towards documented citizens and increasingly relied on levies outside the divisible pool. Having created these distortions, policymakers now cite fiscal deficit as justification for imposing still more taxes. As Budget 2026-27 approaches, the debate remains focused on extracting additional revenue rather than examining why trillions are deliberately foregone through tax expenditures.

The underlying assumption is that Pakistan suffers from inadequate taxable capacity. Evidence available in official documents points to a different conclusion. The country’s fiscal crisis is not merely the consequence of insufficient taxation. It is equally the product of deliberate policy choices that permit trillions of rupees in tax expenditures while simultaneously imposing increasingly harsh taxation on those already trapped within the documented economy.

Tax expenditure is a technical term used to describe revenue foregone through exemptions, exclusions, concessions, preferential rates, credits, allowances, zero-rating and special tax regimes. In effect, it is spending through the tax system rather than through the budget. Unlike ordinary public expenditure, however, these concessions often escape meaningful parliamentary scrutiny.

The Federal Board of Revenue’s latest Tax Expenditure Report 2025 estimates revenue foregone during fiscal year 2023-24 at Rs. 2.435 trillion. According to the report, this amount represented 26.18 percent of FBR’s tax collection and 2.32 percent of GDP. Such figures alone should have triggered a national debate about the sustainability and justification of these concessions.

Table: Tax Expenditure, FBR Collection and Fiscal Deficit (Rs. in billions)

*Tax Expenditure Report 2024 methodology, including GST forgone on petroleum products.
**Tax Expenditure Report 2025 methodology excluding GST forgone on petroleum products.

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Table reveals an uncomfortable reality. During FY2022-23, officially reported tax expenditure exceeded half of total FBR collection. Even under the revised methodology adopted in Tax Expenditure Report 2025, the amount remained above one-quarter of total tax collection. The abrupt decline from Rs. 3.879 trillion to Rs. 2.435 trillion was not the consequence of sweeping reform or withdrawal of concessions. It primarily reflected a change in accounting treatment relating to petroleum products.

The matter becomes more intriguing when the latest report is examined closely. Tax Expenditure Report 2024 estimated revenue foregone at Rs. 3.879 trillion for FY2022-23. The largest component was sales tax expenditure amounting to Rs. 2.387 trillion, including Rs. 1.258 trillion attributable to exemption and zero-rating of petroleum products. In contrast, Tax Expenditure Report 2025 reported total tax expenditure of Rs. 2.435 trillion. The principal reason was the exclusion of GST forgone on petroleum products from the computation. Tax expenditures reports for FY ending 2025 and 2026 when disclosed with show tax forgone including GST is above Rs. 5 trillion.

This accounting change deserves public scrutiny. Since March 1, 2022, general sales tax on petrol and diesel has effectively remained zero. The latest report nevertheless omits the revenue implications of this policy. If GST forgone on petroleum products were accounted for in the same manner as earlier reports, the total tax expenditure would be substantially higher, not less than Rs. 5 trillion.

The issue is not merely statistical. It has direct constitutional implications. General sales tax forms part of the divisible pool under Article 160 of the Constitution. Provinces receive their constitutionally guaranteed share through the National Finance Commission Award. Petroleum levy does not form part of the divisible pool. Every rupee shifted from GST to petroleum levy potentially alters the distribution of resources between the federation and provinces. What appears in fiscal documents as a technical adjustment has profound constitutional consequences.

The constitutional implications become even more significant when viewed against recent fiscal trends. During the last several years, petroleum levy has emerged as one of the principal instruments for achieving IMF-imposed fiscal targets.

Massive collections are generated outside the divisible pool, allowing the federal government to strengthen its fiscal position while reducing transfers that would otherwise accrue to provinces through GST collection. Such an approach may satisfy short-term fiscal targets, but it weakens the spirit of fiscal federalism embodied in the Constitution.

The debate on tax expenditure is frequently distorted by the assumption that every concession is undesirable. That is neither economically sound nor administratively practical. Certain exemptions may be justified for food security, exports, technological upgrading, social welfare or strategic sectors. The real issue is transparency and accountability. Every concession should be subjected to periodic review.

Beneficiaries should be identified. Revenue costs should be quantified. Outcomes should be measured. Exemptions that fail to achieve stated objectives should automatically lapse. Pakistan’s experience suggests the opposite. Temporary concessions often become permanent privileges. Tax incentives survive long after their original rationale disappears. Powerful sectors secure preferential treatment while the burden of adjustment is shifted towards captive taxpayers whose incomes are fully documented and easily accessible to the tax machinery.

The consequences are visible in every budget. Instead of broadening the tax base, governments resort to higher withholding taxes, advance taxes, regulatory duties, petroleum levies and indirect taxation. Compliance costs increase, economic activity slows and incentives for documentation weaken. Revenue collection rises in nominal terms, but the structural weaknesses of the tax system remain intact.

A comparison between tax expenditure and fiscal deficit reveals the magnitude of the issue. Successive governments have presented fiscal deficit as evidence of an unavoidable resource gap. Official tax expenditure figures show that the state voluntarily foregoes amounts equivalent to a substantial portion of annual deficits. Even after excluding economically justified incentives, the scale of revenue foregone demands serious examination.

The question is not whether all tax expenditures should be abolished. The question is whether Pakistan can continue imposing heavier burdens on compliant taxpayers while refusing to scrutinise concessions worth trillions meant for elites. Before introducing new taxes, increasing existing rates or expanding withholding regimes, the government must explain why such enormous tax expenditures remain largely untouched.

This issue becomes even more relevant in the context of the forthcoming budget. Public debate is already focused on new revenue measures required to satisfy IMF benchmarks. Much less attention is being paid to rationalisation of tax expenditures. The imbalance reflects a broader policy bias. Taxation of the documented economy is politically easier than confronting entrenched beneficiaries of preferential treatment.

The purpose of this series is not merely to quantify tax expenditures. It is to examine who benefits, who pays, how these concessions affect fiscal federalism and whether Pakistan’s chronic deficits are partly the result of policy choices rather than economic necessity. Future articles will analyse income tax concessions, sales tax exemptions, customs duty preferences, agricultural rent, provincial taxation powers and the constitutional dimensions of foregone revenue.

The conventional narrative treats fiscal deficit as proof that citizens are not paying enough taxes. The evidence points in a different direction. Pakistan’s documented sectors are already carrying a disproportionate burden through withholding taxes, advance taxes, indirect taxation and petroleum levies. Simultaneously, trillions are foregone through tax expenditures, many of which escape meaningful scrutiny.

The debate preceding Budget 2026-27 should therefore begin with a simple question: before imposing new taxes, why is the state unwilling to examine the revenue it deliberately chooses not to collect? The answer may reveal more about Pakistan’s fiscal crisis than another year of IMF-driven taxation.

[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 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.