Tax expenditure & myth of fiscal deficit—III Petroleum levy, GST & fiscal federalism

Fiscal deficits are often presented as unavoidable consequences of economic reality. Governments spend more than they collect, borrowing fills the gap and taxpayers are told that additional sacrifices are necessary to restore fiscal balance.

Part I and Part II of this series challenged this conventional narrative by demonstrating that trillions of rupees are voluntarily foregone every year through exemptions, concessions, preferential rates and special tax regimes. The most controversial aspect of this hidden fiscal management lies in the treatment of petroleum products.

A curious contradiction has emerged in Pakistan’s fiscal accounting since March 1, 2022. Petroleum levy is consistently classified as a non-tax revenue item in federal budgets, programme documents of International Monetary Fund (IMF) and fiscal operations reports. Simultaneously, the Tax Expenditure Report 2025 of  Federal Board of Revenue (FBR) no longer fully reflects general sales tax forgone on petroleum products. The question therefore arises: can a tax be replaced by a levy for collection purposes and then disappear from tax expenditure calculations?

The answer has important implications not only for tax transparency but also for fiscal federalism under the Constitution.

The turning point came on March 1, 2022 when the federal government issued SRO 321(I)/2022 under section 3(2)(b) of the Sales Tax Act, 1990, which can be read at: https://download1.fbr.gov.pk/SROs/2022311131211781SRO321OF2022DATED01.03.2022–CHANGEINRATEOFSALESTAXONPETROLEUMPRODUCTS.pdf

The notification reduced the rate of sales tax to zero percent on:

• Motor spirit (petrol)
• High speed diesel
• Kerosene oil
• Light diesel oil

The operative part of the notification reads: “The rate of sales tax specified in column (4) against S. Nos. 6, 7, 8 and 9 of Table-I of the said notification shall be zero percent.”

The reduction was initially presented as a temporary relief measure. It subsequently evolved into a major restructuring of petroleum taxation. Instead of imposing general sales tax (GST), successive governments increasingly relied on petroleum levy. What began as a short-term intervention became a permanent feature of fiscal policy.

This distinction matters because GST and petroleum levy are fundamentally different in constitutional terms.

GST forms part of the divisible pool under Article 160 of the Constitution. Provinces receive their constitutionally guaranteed share through the National Finance Commission (NFC) Award.

Petroleum levy does not form part of the divisible pool. Every rupee collected through petroleum levy remains with the federal government. Every rupee collected through GST is shared with provinces.

The issue of petroleum levy extends far beyond tax administration. It concerns the constitutional distribution of resources between the federation and provinces. Official budget documents consistently classify petroleum levy as non-tax revenue in the following documents (hyperlinks provided for easy access to original sources:

Economic Surveys of Pakistan: https://finance.gov.pk/budget_2026.html

Annual Federal Budget 2025-2026:  https://www.finance.gov.pk/budget/budget_2025_26/budget_in_brief_10062025.pdf

Fiscal operations statement (July 2024 to June 2025) by Ministry of Finance: https://www.finance.gov.pk/fiscal/july_march_2025_26.pdf

IMF Staff Reports: https://finance.gov.pk/survey_2025.html,

https://www.imf.org/-/media/files/publications/cr/2026/english/1pakea2026001.pdf  and

https://www.imf.org/en/Countries/PAK

All these documents distinguish petroleum levy from taxation. If petroleum levy is officially treated as non-tax revenue, an obvious question arises. Why should GST forgone on petroleum products cease to be treated as tax expenditure?

The Tax Expenditure Report 2025 issued by FBR estimates total tax expenditure for FY2023-24 at Rs. 2.435 trillion. The figure appears substantially lower than the Rs. 3.879 trillion reported in Tax Expenditure Report 2024. A significant part of the difference stems from the treatment of GST forgone on petroleum products to the tune of Rs. 1795.764 billion.

Tax Expenditure Report 2024 explicitly reported GST expenditure of Rs. 1.258 trillion attributable to petroleum products. The report adopts for year ending 30 June 2024 a different approach. As a consequence, total reported tax expenditure declines sharply even though GST on the four petroleum products covered by SRO 321(I)/2022, effective from March 1, 2022, remains zero.

The economic substance, however, remains unchanged. A tax that would otherwise have been collected is not being collected. That is the very definition of tax expenditure.

The figures in Table I reveal a remarkable transformation. Petroleum levy has evolved from a supplementary revenue source into one of the largest components of federal non-tax revenue. In recent years, its yield has exceeded several major tax heads and it has become a central instrument of IMF-driven fiscal consolidation. The issue becomes clearer when examined alongside GST forgone on petroleum products.

Table I: Petroleum Levy Collections (2017-18 to 2025-26)—A Fiscal Transformation

*From July 2025 to March 2026. Budget target: Rs 1468.395 billion.

Sources:

https://finance.gov.pk/fiscal_operations.html

https://finance.gov.pk/budget_2026.html

https://finance.gov.pk/budget/budget_2025_26/explanatory_memorandum_on_federal_receipts_10062025.pdf

Table II: GST Forgone on Petroleum Products and Petroleum Levy Collections

Sources:

Tax Expenditure Report 2025: https://download1.fbr.gov.pk/Docs/202595159423458TaxExpenditureReport2025.pdf

Tax Expenditure Report 2024: https://finance.gov.pk/budget/Budget_2024_25/Annual_Budget_Statement.pdf

FBR Year Books: https://fbr.gov.pk/year-book/152353

The figures in Table I and Table II reveal the core issue. Petroleum levy collections have risen from hundreds of billions to well over one trillion rupees annually. During the same period, GST on petroleum products remained zero under SRO 321(I)/2022. If petroleum levy is treated as non-tax revenue in federal budgets and IMF documents, then GST forgone on petroleum products continues to meet the accepted definition of tax expenditure. Excluding it from tax expenditure reports reduces the reported magnitude of foregone revenue while simultaneously concealing its implications for provincial finances under Article 160 of the Constitution.

The issue becomes even clearer when examined through the lens of fiscal federalism. Suppose GST at the standard rate were imposed on petroleum products. The resulting revenue would enter the divisible pool and be shared with provinces under the NFC formula. When GST is reduced to zero and petroleum levy is increased instead, the federal government retains the revenue outside the divisible pool.

The transaction may satisfy short-term fiscal targets and IMF benchmarks, but it simultaneously alters the constitutional allocation of resources. This is why the exclusion of GST forgone from tax expenditure calculations is not a mere accounting matter.

It affects transparency, intergovernmental fiscal relations and constitutional federalism. Most importantly, it affects the ability of citizens and Parliament to understand the true fiscal cost of petroleum taxation policy. The broader issue is accountability.

Successive governments justify additional taxation by citing fiscal deficits and IMF obligations. Tax expenditure reports are intended to reveal revenue foregone through policy choices. If GST forgone on petroleum products is excluded while petroleum levy continues to be treated as non-tax revenue, the resulting picture becomes incomplete.

Parliament cannot effectively evaluate fiscal policy unless tax expenditures are reported consistently. Citizens cannot assess the true cost of concessions unless foregone revenues are transparently disclosed. Provinces cannot protect their constitutional rights unless changes affecting the divisible pool are openly acknowledged.

The debate is not just about methodology alone. It concerns honesty in fiscal reporting. If petroleum levy is recognised as non-tax revenue in federal budgets approved by Parliament, then GST forgone through SRO 321(I)/2022, effective from March 1, 2022 remains tax expenditure by any reasonable definition.

Excluding GST from official tax expenditure reports understates the true fiscal cost of petroleum taxation policy and obscures its implications for provincial finances.

Before demanding additional sacrifices from taxpayers in the name of fiscal deficit, policymakers should explain why more than a trillion rupees of forgone GST appears to have vanished from the tax expenditure debate. Fiscal responsibility requires transparency on both sides of the ledger. Without it, the discussion on deficits becomes less an exercise in public finance and more an exercise in fiscal illusion.

[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.