Farm to failure: higher taxes feeding informal sector

The federal government in the past few years has imposed hefty taxes on the documented sector, fueling the informal economy. It’s a double whammy, as not only are the higher prices lowering consumption in a country where nutritional and safe food intake is already abysmally low, but also spurring the informal products market, which is neither tax compliant nor conforming to the stipulated food standards.

The cases in hand are fruit juices and dairy products (including infant formula), where the demand curve was growing and businesses were investing in the value chain. Market forces were addressing the long-standing issue of wastage in perishable food items—fruits and milk—which was letting the farmer community benefit. Then, the investment in the right infrastructure was paving the way to open export markets.

However, the industries are in reverse gear now due to the imposition of general sales tax (GST) and federal excise duty (FED).

The fruit beverages market was growing at healthy volumes before the FED’s imposition. The government was collecting decent chunks from GST as well. In FY20, 5 percent FED was imposed and industry volumes dipped by 7 percent from double-digit growth. The very next year, the government reversed the decision, which resulted in a growth revival.

However, with the economic crisis deepening in FY23, the government imposed 10 percent FED mid-year and increased it to 20 percent in the FY24 budget. Since then, industry volumes are down by 45 percent, and in the ongoing year, government revenues are falling too.

Here, the Laffer curve is in play, making higher tax rates counterproductive. There is more to the story. The enforcement is weak, which is incentivizing undocumented sectors to share the pie. The consumer is price sensitive. The combined tax is 42 percent, which gives enough room for non-compliant players to penetrate. They don’t adhere to food standards, and price-sensitive consumers are shifting to low-quality products.

The former players are no longer investing in the value chain, and that is hurting the pulp-making industry and increasing wastage. The export potential and quality domestic market products are going down the drain. The government must rethink the strategy.

The story of processed milk is not very different. The packaged milk market is in the nascent stage, as less than 10 percent of the dairy market is packaged milk, as opposed to 40 percent in Egypt and 60 percent in Turkey. The market was growing, and new players (both foreign and local) were entering.

However, after moving from zero rating to 18 percent GST in FY24, industry volumes took a 20 percent plus dip. The tax is only on packaged dairy products, while prices in loose milk increased too, to maintain the delta. There is a loss in consumer welfare and potential government revenues.

The health risks of loose milk are well documented, as it has issues of adulteration and the presence of carcinogenic substances. Minimum pasteurization deals with the majority of problems. That is why it is promoted, and the vast majority of countries have low (or no) VAT/GST on packaged dairy products. The issue is more pressing in Pakistan, where over 70 percent of nutrition intake comes from wheat flour. People need to have alternatives, and dairy is a cheaper source.

However, our finance minister last year deflected the issue by saying it is mainly consumed by the elite. That is grossly incorrect, as almost two-thirds of packaged milk consumers are from low-middle income groups.

The tax is also imposed on infant formula, baby food, and fortified nutrition products. That is an absurd policy in a country where malnutrition is very high in mothers and stunting is prevalent in children. Breastfeeding is undoubtedly the best option, but for women with deficiencies, infant formula is the scientifically recommended viable option. This policy must be revisited in the upcoming budget.

Apart from health, economic loss is evident. The value chains in both dairy and fruit juice markets are suffering. The loss is for all the players, including farmers. The wastage has the potential to convert to export. The dairy industry has the potential to generate $150 million in export revenues per annum, while the numbers are not minuscule in fruit juices, where already 30 countries are tapped, and consumers have developed a taste for our fruits and Halal products.

Copyright Business Recorder, 2025