Tax Proposals Budget 2027—I High taxes, low yields

The main argument underpinning this series is that taxation cannot succeed in a polity where the state itself lacks moral legitimacy in expenditure priorities. Citizens resist taxation not merely because taxes are high, but because governance remains elitist, extractive and visibly unequal. Thus, genuine reform requires reciprocal accountability: a broad-based, low-rate and predictable tax system linked with constitutional obligations relating to education, health, social protection and equal opportunity. This series may eventually evolve into perhaps the most comprehensive public roadmap for tax reform produced outside official committees—one grounded not in donor templates, but in Pakistan’s constitutional structure, aspirations of masses, economic realities and decades of documented experience. 

 Pakistan today stands trapped in perhaps the most paradoxical fiscal situation in its history: tax rates continue to rise, new levies are imposed every year, withholding provisions multiply endlessly, electricity and petroleum taxes crush households and businesses alike, yet not only does the tax-to-GDP ratio remain persistently low but even the state remains perpetually dependent on borrowing.

Every budget claims to be “historic”, every Finance Bill promises “broadening of the tax base”, and every programme of International Monetary Fund (IMF) demands “revenue enhancement”, but the outcome is always the same—shrinking economic activity, growing informality, declining investment and rising distrust between citizen and state.

The real problem is not absence of taxable capacity. Pakistan possesses enormous untaxed and undertaxed wealth. The crisis lies in the structure of taxation itself.

This structural contradiction has been highlighted in our earlier works such as Tax Reforms in Pakistan: Historic & Critical View, Towards Broad, Flat, Low-rate, Predictable Taxes, Budget 2024: out of box solutions of IMF agenda? MinuteMirror, June 3, 2024, Need for fair & efficient taxation, MinuteMirror, May 18, 2025 Taxation beyond constitutional mandate, MinuteMirror, June 17, 2025, and numerous analyses published over the years in  Business Recorder, The Friday Times, The News, Dawn and Minute Mirror.

The recurring theme in these writings has been consistent: Pakistan imposes higher taxes but collects lower revenues because the system is designed to overtax the documented economy while leaving vast segments of wealth and income either politically protected or administratively untouched. The evidence is overwhelming.

According to official statistics of the Federal Board of Revenue (FBR), an overarching proportion of direct taxes is contributed by a very small segment of corporate entities and salaried individuals. Nearly three-fourths of total income tax collection originates from withholding and advance taxes rather than voluntary declarations through returns.

In substance, the taxation machinery has gradually transformed into an extraction regime where banks, electricity companies, telecom operators, exporters, manufacturers and other withholding tax agents collect taxes on behalf of a tax administration increasingly unable to perform core functions of assessment, investigation and documentation.

This phenomenon was described years ago as “withholdingization” of the tax system. Instead of broadening the base, the state found it easier to keep squeezing those already documented. The result was inevitable: the formal economy became progressively uncompetitive while the undocumented economy flourished.

Pakistan today taxes production more heavily than speculation, industry more heavily than trading, and documented income more heavily than concealed wealth. This inversion of rational taxation lies at the heart of the fiscal crisis.

The sales tax regime presents perhaps the clearest example of policy failure. The standard sales tax rate climbed to 18 percent and beyond, yet actual effective collection remained abysmally low. The report of the Tax Reforms Commission itself acknowledged that despite a higher standard rate, the effective incidence around 2016 hovered merely near 3–3.5 percent due to exemptions, distortions, leakages, concessions, special regimes, corruption and administrative inefficiencies.

Even subsequent improvements did not fundamentally alter the situation because the structure itself remained defective. Effective incidence may have risen modestly, but it still remained far below statutory levels.

Thus, compliant sectors continued paying punitive rates while large segments escaped taxation altogether. Instead of fixing this structural imbalance, policymakers repeatedly opted for cosmetic adjustments: higher rates, more withholding taxes, advance collection mechanisms and mini-budgets dictated by short-term IMF conditionalities. The consequences have been devastating.

Pakistan’s manufacturing sector steadily lost competitiveness. Exporters suffered under delayed refunds, cascading taxation and excessive compliance burdens. Small and medium enterprises increasingly moved outside the documented framework.

Real estate speculation remained undertaxed compared to productive investment. Retail and wholesale sectors continued operating with negligible effective taxation despite constituting one of the largest components of the economy. Meanwhile, the salaried classes became easy targets because taxes could be deducted at source without resistance. The deeper tragedy, however, is constitutional and political.

Taxation in modern states rests upon reciprocal legitimacy: citizens agree to pay taxes when the state demonstrates fairness, transparency and constitutional fidelity in expenditure and governance. In Pakistan, however, taxpayers increasingly perceive the system as coercive, discriminatory and elitist. This trust deficit did not emerge overnight.

Repeated tax amnesties rewarded evaders and penalised honest taxpayers. Protection laws legitimised whitening of untaxed wealth through inward remittances and undocumented assets.

Fiscal policymaking became increasingly detached from constitutional principles of equity and federalism. Successive governments preferred indirect taxation because it imposed a political cost on the public while protecting entrenched interests. Consequently, taxation lost moral legitimacy. The irony is that despite extremely high nominal tax rates, Pakistan still collects far less than its potential.

The country’s direct tax-to-GDP ratio remains significantly below many regional economies even though Pakistani consumers and documented businesses often face heavier effective burdens than counterparts elsewhere. The explanation lies in narrowness of the actual tax base. A careful examination of Fiscal Operations data of the Ministry of Finance for the last ten years reveals the depth of this structural weakness. The direct tax-to-GDP ratio has been persistently low despite repeated increases in tax rates, introduction of super taxes, expansion of withholding tax provisions and aggressive enforcement measures.

Pakistan: Direct Tax to GDP Ratio (2014-15 to 2024-25)
(Source: Ministry of Finance – Fiscal Operations)

The table exposes a disturbing reality. Over ten years, despite aggressive taxation measures, Pakistan’s direct tax-to-GDP ratio increased only from about 3.7 percent to slightly above 5 percent. This performance is extremely pathetic when compared with emerging economies where direct taxes range between 7 percent and 10 percent of GDP, and developed economies where direct taxes exceed 15 percent of GDP.

Even more revealing is the fact that Pakistan’s reported direct taxes include withholding taxes, minimum taxes and presumptive taxes that are indirect in nature. Even Workers’ Welfare Fund contributions are accounted for in FBR’s direct tax collection! Once these components are adjusted, the actual direct taxation ratio becomes even lower. In practical terms, Pakistan’s effective direct taxation of wealth and income remains minimal.

This structural weakness has historical roots. Since the early 1990s, Pakistan gradually shifted from progressive taxation toward presumptive and withholding taxes. These taxes, though classified as income tax, function in practice as indirect levies imposed on transactions and consumption.

This shift distorted the tax base and weakened the redistributive role of taxation. The lesson from the past decade is clear: Pakistan’s tax system continues to tax the non-taxable while favouring the mighty militro-judicial-civil complex, politicians in power and powerful traders and property tycoons. Without structural reform, this imbalance will continue to undermine both economic growth and social justice.

A rational tax system does not require confiscatory rates. It requires broad coverage, simplicity, predictability and trust. Earlier reform proposals consistently argued for a broad, flat and low-rate model where lower rates are combined with elimination of distortive exemptions, integration of databases, documentation of untaxed sectors and simplification of compliance procedures. Such a framework would not only increase revenues but also revive economic activity and voluntary compliance.

The obsession with coercive collection has produced precisely the opposite outcome. Every year FBR announces “record collections,” yet these figures conceal deeper weaknesses. Inflation automatically inflates nominal revenues. Petroleum levies and indirect taxes raise collections without reflecting genuine expansion of the tax base. Advance taxes collected through electricity bills, banking transactions and imports artificially inflate numbers while masking administrative inefficiency.

At the same time, litigation continues multiplying because taxpayers increasingly perceive assessments as arbitrary and extractive rather than lawful and facilitative. This is why genuine reform cannot be confined to annual budget speeches. Pakistan requires a complete rethinking of tax philosophy itself.

The future lies not in multiplying withholding taxes but in restoring real tax administration. Not in burdening documented sectors further but in bringing untaxed wealth into the system. Not in punishing production but in encouraging investment, exports and productivity. Not in constitutional shortcuts and extra-budgetary levies but in transparent and accountable fiscal governance.

Most importantly, tax reform cannot succeed in isolation from governance reform. Citizens cannot be expected to finance limitless state inefficiency, elite privileges, wasteful expenditure and institutional opacity while basic constitutional obligations relating to education, health, housing and social welfare remain unmet. Sustainable taxation requires a social contract grounded in fairness.

The coming federal and provincial budgets therefore present a historic opportunity. Pakistan can either continue the failed cycle of extraction, mini-budgets and shrinking compliance, or it can adopt a growth-oriented and constitutionally sustainable taxation model capable of simultaneously broadening the base, lowering rates and increasing revenues. Contrary to prevailing assumptions, these objectives are not contradictory. They are mutually reinforcing.

The subsequent parts of this series will attempt to demonstrate, through concrete legislative, administrative and constitutional proposals, how Pakistan can realistically exceed IMF revenue benchmarks without crushing economic activity and without turning taxation into organised economic suffocation. The challenge is no longer technical. The challenge is political will.

[To be continued]

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Huzaima Bukhari, lawyer and author, is an Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Senior Visiting Fellow of Pakistan Institute of Development Economics (PIDE)

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.