Tax expenditure & myth of fiscal deficit—IV Agricultural Rent & Untaxed Capacity

The second announcement of federal budget for fiscal year 2026-27 for June 10, 2026 is further delayed (original was for June 5, 2026). Though official date is not available at the times of writing these lines, Press reports says it will be announced now on June 12, 2026. In this routine and ritualistic budget, whenever announced, there certainly will be self-praise for managing economy in difficult times, unforeseen external challenges, and the customary emphasis on fiscal discipline, revenue mobilisation etc.

In Pakistan, fiscal deficits are commonly attributed to inadequate taxation, excessive expenditure and weak compliance.  The preceding articles in this series examined another dimension of the problem: tax expenditures running into trillions of rupees, hidden subsidies delivered through the tax code and the growing reliance on petroleum levy at the expense of constitutional fiscal federalism.

However, an even larger structural issue rarely receives serious attention. Pakistan continues to leave substantial taxable capacity untouched while simultaneously imposing heavier burdens on documented businesses, salaried individuals and ordinary consumers. The most prominent example is agricultural rent.

The political debate on agricultural taxation is often clouded by misconceptions. Any discussion of taxing agriculture immediately encounters the argument that taxing farmers would threaten food security and damage rural livelihoods. This argument confuses agricultural income derived from productive cultivation with economic rent arising from ownership of valuable land.

Classical economists made a distinction between the two more than two centuries ago. David Ricardo defined rent as that portion of produce paid to the landowner for the use of the original and indestructible powers of the soil.

Rent, in Ricardo’s formulation, was not a reward for labour, enterprise or investment. It arose because certain lands possessed superior fertility, location or economic advantage. As population expanded and demand increased, owners of superior land captured gains they had not themselves created.

Modern economics continues to recognise this distinction. Taxing productive effort may discourage investment and output. Taxing economic rent generally does not. Since rent arises from scarcity, location and market conditions rather than productive activity, its taxation creates relatively little distortion.

This distinction once found expression in Pakistan’s tax law. The Income Tax Act, 1922 defined agricultural income primarily in relation to land used for agricultural purposes and income derived from cultivation. The original legislative framework reflected a clear understanding that agricultural activity and agricultural rent were not necessarily identical concepts.

Over time, however, political considerations overwhelmed economic logic. The debate ceased to focus on rent and increasingly became a debate about whether “agricultural income” itself should be taxed. The consequences are visible today.

Pakistan’s crop sector and rurual lands used for cultivation, which are the subject matter of provicial taxation domain, contribute significantly to GDP. These employ a large share of the labour force and encompasses some of the country’s most valuable landholdings. Large agricultural estates, peri-urban landholdings benefiting from urban expansion and substantial rental arrangements generate considerable economic gains. Much of this remains undertaxed. The issue became even more significant after the Constitution (Eighteenth Amendment) Act, 2010 [18th Amendment] effective from April 19, 2010.

Entry 50, Part I of the Federal Legislative List, Fourth Schedule to the Constitution  since enforcement of 18th Amendment excludes capital value taxes of any nature on immovable property. Agricultural income taxation falls within provincial jurisdiction. For understanding what is “agricuture income”, one needs to read Article 260 of the Constitution with section 41 of the Income Tax Ordinance, 2001—see text and details in The IMF & ‘Agricultural Income’ Reforms, Friday Times, July 20, 2024 and Agriculture Income Tax, PIDE Discourse, November-December 2023.

The constitutional framework is clear. Provinces possess the authority to design systems capable of taxing ‘agricultural rent and related gains’. However, provincial tax efforts remain modest compared with the economic potential involved. Finance Bill 2026 after approval from President can exclude agricultural rent from the definition of ‘agricultural income’ so it becomes taxable under the federal income tax law.

This failure has important fiscal consequences.Every year governments cite fiscal deficits to justify additional taxation. Petroleum levies are increased. Withholding taxes are expanded. Electricity consumers face higher charges. Formal businesses encounter new compliance obligations. Simultaneously, large segments of economic rent remain outside effective taxation. The contradiction becomes difficult to defend. A country cannot credibly claim a shortage of taxable capacity while leaving significant forms of wealth and rent largely untouched.

Supporters of the status quo frequently argue that agriculture already bears substantial risks from climate change, water scarcity and volatile commodity prices. That observation is correct but irrelevant to the issue under discussion.

Small cultivators operating near subsistence levels should not be the focus of revenue mobilisation. Taxation of economic rent does not require burdening vulnerable farmers. The objective is to distinguish productive income earned through labour and investment from gains arising primarily from ownership of scarce and valuable assets. Many successful economies have adopted precisely such approaches.

Property taxation, land value taxation and taxation of economic rents have long been recognised as efficient revenue instruments. They broaden the tax base without discouraging productive activity. They also promote equity by ensuring that gains arising from public infrastructure, urban expansion and rising land values contribute to public finances. Pakistan has moved in the opposite direction.

Instead of systematically taxing economic rent, policymakers have increasingly relied upon indirect taxation. The burden falls disproportionately on those already documented within the system. The result is a fiscal structure in which compliance is concentrated while untaxed capacity persists elsewhere. The issue extends beyond revenue.

Untaxed economic rents contribute to speculative behaviour. Capital flows into land acquisition rather than productive investment. Wealth accumulates through appreciation of assets rather than innovation and entrepreneurship. Resource allocation becomes distorted and economic dynamism suffers. Fiscal deficits are therefore not merely budgetary outcomes. They reflect broader political economy choices.

Part I of this series demonstrated that trillions are foregone through tax expenditures. Part II examined the beneficiaries of those concessions. Part III showed how petroleum levy has altered fiscal federalism. Together these articles reveal a recurring pattern: governments repeatedly seek additional revenue from visible and compliant taxpayers while avoiding politically difficult reforms that would broaden the tax base.

Agricultural rent represents one of the clearest examples of this reluctance. The objective should not be punitive taxation of agriculture. Nor should it be another confrontation between urban and rural interests. The real challenge is designing a fair system that distinguishes cultivation from rent, productive activity from passive gains and small farmers from large beneficiaries of land-based wealth.

Such reform and harmonised sales tax on goods and services [Provincial sales tax chaos—I: Crossing constitutional boundaries, Minute Mirror, May 11, 2026] would strengthen federal and provincial finances, reduce overwhelming provincial dependence on federal transfers and broaden the tax base and tax-to-GDP ration without imposing additional burdens on those already carrying the weight of the fiscal system. Simultaneouls, the tax rates for corporate should be reduced to 25% and for individuals and firms at 30%.

The final article in this series will examine how Pakistan can substantially reduce fiscal deficits without imposing new taxes. The solution lies not in higher rates or additional levies but in rationalising tax expenditures, taxing untapped economic capacity and restoring coherence to the country’s fiscal architecture.

[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.