Pakistan has made tax compliance a competitive disadvantage

Every budget season, Pakistan returns to the same ritual: how much did the Federal Board of Revenue collect? If there is a shortfall, another tax package follows. If the number rises, it is presented as reform. Those of us who deal with the system know this is misleading. A government can collect more and still leave factories weaker, exports less competitive and ordinary households poorer.

The question should not be whether the state can take more. It should be whether it can raise revenue without damaging production, jobs, investment and family incomes. On that test, Pakistan is failing. The message sent by the present system is painfully clear: stay invisible and you may prosper; become documented and you will be squeezed.

FBR collected Rs11.74 trillion in FY2025, or 10.3 percent of GDP. Officially, 49.3 percent was classified as direct taxation and 50.7 percent as indirect taxation. That neat split flatters the system. Much of what is legally called direct tax is collected at the point of transaction: on imports, contracts, electricity bills, property transfers, exports and other gross flows. Some is a genuine advance against income tax. Some operates as a minimum or final liability with little relationship to actual profit.

No reclassification of withholding taxes will ever be mathematically perfect. Still, an economic reading suggests that genuinely income-based direct taxation is closer to one-third of federal revenue, while indirect and transaction-based taxation is nearer two-thirds. The better shorthand is roughly 35:65, not 49:51. That distinction matters because a tax on profit is paid when income is earned; a tax on turnover or a transaction bites even when the business is barely surviving.

This is why the familiar complaint that Pakistanis do not pay taxes is so untrue. They pay whenever they buy food, fuel, electricity, medicines, mobile services or basic household goods. What Pakistan lacks is not taxation; it lacks fairness in who is taxed and how. Through consumption and transaction taxes, the poor and lower middle class pay all the time, while wealth, privilege and informality too often find shelter. In a country with widespread poverty and a deep gulf between those who own assets and those who do not, Pakistan must at least ask whether the present tax-to-GDP ratio is already near its social and economic limit. There may still be room to tax undertaxed wealth and protected incomes. There is very little moral or economic room left to tax poverty in order to subsidise privilege.

International comparisons are useful, but only up to a point. Pakistan’s tax take looks low beside many economies. World Bank data show much higher tax-revenue ratios in Denmark, New Zealand, Austria, France and many other advanced economies, and several emerging economies also collect more as a share of GDP. But richer countries do not collect more simply because they wish harder. They have larger formal wage sectors, deeper corporate profits, better records, stronger local taxation and higher trust. Pakistan cannot borrow their headline ratios while keeping its own narrow base, weak documentation, poverty, informality and heavy dependence on consumption and transaction taxes.

The same caution applies to the fashionable use of the Laffer curve. It is invoked in Pakistan as if it can settle every tax argument. It cannot. Pakistan’s problem is not a clean textbook choice between one income-tax rate and one rational taxpayer. It is a maze of withholding, turnover taxes, indirect levies, exemptions, refunds, informality and weak enforcement. The poor consumer paying tax on every purchase has no Laffer-curve choice. A formal business is not only reacting to a statutory rate; it is reacting to uncertainty, cash-flow damage and the cumulative weight of the system. Rate slogans distract from the harder question: who is actually being taxed, who is being protected, and what damage is collection doing along the way?

That is the central failure. Pakistan does not find enough of those who should pay. It leans harder on those who already do.

A salaried employee cannot hide from deduction at source. A registered manufacturer leaves traces everywhere: electricity bills, imports, payroll, banking and sales-tax filings. A listed company is visible by design. But large parts of retail, property income, agriculture and the informal economy remain harder to reach. So when the state needs another few hundred billion rupees, it too often returns to the taxpayer already standing in the queue.

A formal business may face corporate income tax, super tax where applicable, minimum turnover tax, sales tax, customs and regulatory duties, provincial taxes, withholding obligations and a costly compliance apparatus. It must also act as the state’s unpaid collection agent. Its informal competitor may avoid much of this burden, sell cheaper, keep looser books and sleep better. The formal firm begins the race with a weight tied to its ankle, and then it is told to run faster.

This is not only unfair; it changes behaviour. Investors do not need lectures on productivity when the incentives point elsewhere. If a documented factory carries heavier taxes, greater scrutiny and higher compliance costs than property speculation or informal trade, money will move away from productive enterprise. Firms will stay small to remain less visible. Pakistan will then keep lamenting weak investment and poor documentation, as if these were mysteries rather than the predictable result of the rules it has written.

Turnover taxation shows the damage clearly. Suppose a firm sells Rs100, incurs costs of Rs95 and earns Rs5. A 30 percent tax on profit takes Rs1.50. A 2 percent tax on turnover takes Rs2 – 40 percent of profit. If the margin falls to 2 percent, the turnover tax takes the entire profit. The example is illustrative, but the economics is not: taxes on gross activity can destroy low-margin, high-volume businesses even when those firms are efficient and fully compliant.

The burden also cascades through supply chains. A proper value-added tax allows input credits so that only value added is taxed. Pakistan’s mix of withholding, minimum taxes, unrecoverable taxes, duties and delayed refunds can instead embed tax at successive stages. The result is tax upon tax, higher prices and weaker margins.

Exporters are hit hardest because they cannot send Pakistan’s dysfunction to the invoice. No foreign customer will pay more because an exporter is waiting for refunds, absorbing cascading taxes or hiring more tax advisers than the business should need. The buyer simply places the order elsewhere. Pakistan cannot credibly promise export-led growth while treating the export sector as a convenient cash machine.

Working-capital extraction is another hidden tax, and it is felt in very practical ways: delayed supplier payments, postponed investment, more bank borrowing and fewer resources for wages, energy efficiency or new orders. Sales-tax input credits accumulate when exporters and zero-rated suppliers pay tax upstream but cannot recover it promptly. Income-tax credits accumulate when withholding and advance payments exceed the final assessed liability. In both cases, the state holds money that does not belong to it. The business effectively lends to the government without consent, security or interest while borrowing its own working capital from banks at commercial rates.

The stock of unpaid refunds is also obscured by the way performance is reported. FBR announces how much it has disbursed, but the more important figures are how much remains refundable, how much has been formally claimed, how much has been verified, how old the claims are and how much is under genuine dispute. These are different categories, and the government does not publish a consolidated, regularly reconciled national statement covering all of them.

The Rs96.6 billion reported by the Overseas Investors Chamber of Commerce and Industry in September 2025 covered its members alone: Rs62.2 billion in income-tax refunds and Rs34.4 billion in sales-tax refunds. It was never a national estimate and should not be used as a proxy for the total. Industry submissions made in May 2026 placed blocked refunds and rebates in the textile and export sectors at more than Rs327 billion across sales tax, income tax, customs rebates and earlier export-support schemes. Even that larger figure is sectoral, not economy-wide. The true national stock of refundable and unpaid amounts may be several times the OICCI figure; the uncomfortable truth is that FBR does not publish the information needed to establish it cleanly.

An unpaid refund should be treated for what it is: a liability of the government, not a contribution to revenue. Validated claims should carry automatic interest after a firm statutory deadline. FBR should publish a monthly ageing schedule for sales-tax and income-tax refunds, separating claims under verification, claims under litigation and amounts finally approved but unpaid. Otherwise collection can be overstated simply by taking cash quickly and returning what is owed slowly.

The bookkeeping burden compounds the damage. Double-entry bookkeeping itself is not the problem; it is the foundation of reliable accounts. The problem is parallel bookkeeping. A formal firm maintains statutory financial accounts, then repeatedly recasts the same transactions for income tax, federal sales tax, provincial sales taxes, withholding statements, customs, EFS reconciliations, digital invoicing and sector-specific monitoring. Definitions, tax periods, valuation rules and admissibility tests do not always align. One commercial transaction can therefore generate several tax records, multiple reconciliations and several opportunities for an honest difference to be treated as non-compliance.

This duplication is not free. It means accountants, tax teams, software, consultants and endless reconciliation between company ledgers and government portals. For a business owner or finance head, it means proving the same transaction again and again instead of negotiating orders, improving production or managing cash flow. When portals do not speak to each other, the taxpayer becomes the systems integrator for the state. FBR may count the filing as successful digitisation; the business counts the people and hours pulled away from work that creates value. This is why initiatives such as Pakistan Single Window deserve recognition: when properly designed, they can reduce duplication, integrate data and make compliance less punishing. Pakistan should build on that principle by requiring one clean digital record of a transaction that can populate all relevant federal and provincial returns: enter once, reconcile once and use many times.

Against this background, some recent measures reveal a deeper conceptual confusion: technology is being mistaken for reform.

This is not because reform has been starved of money. Pakistan has spent and committed hundreds of millions of dollars on repeated attempts to modernise tax administration. The Tax Administration Reform Project launched in the 2000s carried a total financing envelope of USD 149 million. The World Bank’s Pakistan Raises Revenue project now has resources of USD 470 million. Those two programmes alone represent USD 619 million, before counting government counterpart expenditure, other donor assistance, PRAL and Pakistan Single Window costs, Track and Trace, point-of-sale integration, buildings, equipment and the recurring administrative cost of managing reform itself. It would be wrong to describe the entire USD 619 million as cash already spent by FBR, but it is equally wrong to pretend that reform has lacked resources.

The uncomfortable question is not whether Pakistan bought hardware, software and consultants. It is whether taxpayers have received relief, certainty and a wider base. More than two decades after the first major reform programme, the language hardly changes: integration, automation, data analytics, reduced discretion, taxpayer facilitation and a broader base. Some progress is real, especially in electronic filing and data availability. But when the same objectives are repackaged and refinanced every few years, procurement starts to masquerade as institutional transformation. A new portal is not reform if taxpayers must still maintain parallel records, chase refunds and negotiate arbitrary interpretations.

Nor should Pakistan outsource the imagination of its tax policy to the IMF, foreign consultants or donor-driven templates. External advice can be useful, especially where it brings comparative experience and discipline. But when tax design is reduced to meeting prior actions and quarterly revenue numbers, local realities disappear from the frame. Pakistan has a galaxy of economists, tax practitioners, accountants, industrialists, exporters, technologists and administrators who understand its markets, informality, poverty, provincial complexities and productive sectors far better than any visiting mission can. Their expertise should not be summoned after policy has already been drafted elsewhere; it should shape the policy from the start.

One reason this debate remains so thin is fear. Too few people speak openly about FBR policy, administration and enforcement, not because they agree with it, but because they worry about what may follow: punitive scrutiny, selective notices, delayed refunds, aggressive audits or other forms of administrative retaliation. Silence should not be mistaken for consent. A tax authority that can frighten people into silence may meet a quarterly target, but it cannot build legitimacy.

The proposed cotton-bale camera system is a revealing example. FBR procurement material envisaged video analytics to monitor and count cotton bales at spinning facilities. But a cotton bale is an input, not taxable income. Bales differ in weight, moisture, grade, staple and wastage; mills produce different counts and blends. A camera may count an object perfectly while measuring taxable value added very badly.

This is twenty-first-century technology enforcing a nineteenth-century excise instinct.

The compliant mill must install equipment, maintain connectivity, reconcile discrepancies and answer queries. Its managers spend more time explaining cotton bales than improving output. Meanwhile, evasion may simply migrate to undocumented trading, false invoicing, unregistered production or collusion elsewhere in the chain. Cameras may have a limited role as a risk indicator, but universal physical surveillance is no substitute for intelligent tax administration.

The Export Facilitation Scheme exposes the opposite weakness. EFS was introduced for good reason: exporters should not finance duties and taxes on inputs that will ultimately leave the country in exported goods. Abolishing the scheme would punish genuine exporters and restore the very liquidity burden it was meant to remove.

But duty-free access creates an obvious arbitrage opportunity. Inputs imported for export production acquire an immediate domestic-market advantage if they are misdeclared, over-reported or diverted. That risk demands rigorous reconciliation. Recent official reports and proceedings have alleged significant misuse, including shortages of duty-free imported cotton and disputed treatment across large numbers of export declarations. Other inquiries have examined alleged misdeclaration and possible official involvement. These remain matters for due process, but they expose vulnerabilities that no serious reform agenda can ignore.

The contradiction is stark. The state is prepared to count every bale entering a documented spinning mill, yet still struggles to reconcile tax-free imports with inventories, production, exports and foreign-exchange proceeds. It watches what is easy to watch, not always what most needs watching.

Nor is FBR the only culprit. Many businesses and industries have learned to game the system they publicly condemn. Some remain deliberately below the radar; others use exemptions, misclassification, influence, litigation and delay as part of their commercial strategy. In a system where an underhand payment can work wonders, honest compliance becomes a disadvantage, and manipulation becomes routine. Reform must therefore confront both sides: official discretion and weakness on one side, and private incentives for evasion, privilege and negotiated compliance on the other.

The answer is not more indiscriminate policing. It is better targeting. Every tax-free input should be digitally matched with inventory, realistic input-output ratios, export quantities, customs declarations and repatriated proceeds. Algorithms should identify abnormal patterns. High-risk users should face intensive post-clearance audit; consistently compliant exporters should receive faster and simpler treatment. Where collusion is proved, penalties must apply to both the beneficiary and the official. Otherwise the honest exporter pays twice: once through taxes and again through unfair competition.

The same principle should govern domestic taxation. FBR already sits amid data from NADRA, banks, utilities, property registries, customs, companies and provincial authorities. The purpose of integration should be to identify undeclared income and serious inconsistencies, not to spray notices across the economy and call it enforcement. Technology should reduce discretion, contact and compliance costs. A bad process does not become good merely because it acquires a dashboard.

FBR’s scorecard must therefore change. Gross collection should remain important, but it cannot be the only measure. The agency should also report growth in the tax base, voluntary compliance, separate stocks and ageing of unpaid sales-tax and income-tax refunds, the share of assessments sustained on appeal, audit yield actually collected, litigation duration, taxpayer compliance cost and the contribution of newly documented sectors.

Pakistan should also measure the cost and quality of tax administration, not just the cash collected. Mature revenue bodies increasingly look at digital service quality, voluntary compliance, audit targeting, dispute resolution, arrears management and the administrative cost of collection. But even that ratio can mislead. A low official cost of collection is no achievement if the real cost is simply pushed onto taxpayers through withholding, delayed refunds, excessive notices and duplicated reporting. Expensive technology is no better if it does not reduce contact, discretion and compliance hours. The test should be practical: how much sustainable, legally sound revenue is collected for every rupee spent by the state and every rupee of compliance cost imposed on citizens and firms?

It should also disclose the composition of so-called direct taxation more honestly: how much comes from assessed income and profits; how much is collected in advance; how much operates as minimum or final tax; how much is refundable; and how much is ultimately retained. Without that information, a rising direct-tax share can be more accounting presentation than structural progress.

Pakistan needs more revenue; chronic deficits leave no room for fantasies about a tax-free state. But it needs better taxation even more urgently. A narrow base carrying high, distortive rates is not a foundation for fiscal strength. It is a slow transfer of pressure onto the very people and firms expected to build the future revenue base.

The objective is simple: tax comparable incomes comparably; widen the base; reduce reliance on gross-transaction taxation; end unjustified exemptions; protect working capital; make enforcement impersonal and risk-based; and stop treating formality as an invitation to be squeezed.

A system that rewards invisibility will produce more invisibility. A system that punishes documentation will produce less documentation. And a system in which honest businesses watch competitors prosper through evasion, misdeclaration or privileged treatment will not merely lose revenue. It will lose consent.

FBR should not be merely an extraction machine, designed to take the most from those easiest to reach. It must finance the state, but it must also account for what its choices do to society and the economy: who carries the burden, which sectors are pushed back, how many jobs are put at risk, how much investment is delayed and whether compliance is being rewarded or punished. If Pakistan keeps ignoring these questions, each new reform will look depressingly familiar: better software, sharper cameras and a heavier load on the people still willing to comply.