Taxing savings – a recipe for stagnation

EDITORIAL: The tax bureaucracy’s propensity of coming up with measures that purportedly aim to enhance revenue collection, but instead end up producing crippling economic outcomes reveals a dangerous cycle of incompetence, where basic economic principles are routinely ignored.

There is an entire history of the FBR resorting to knee-jerk taxation measures that squeeze the compliant, reward the untaxed and sabotage economic growth with depressing consistency. The latest in a long line of self-defeating proposals under consideration is to hike the tax rate by two percent on interest income from commercial bank deposits and savings schemes in the upcoming budget.

This proposal risks further weakening of a key pillar of economic stability that is already the weakest in the region, i.e., national savings. By discouraging savings, the FBR will be essentially starving the economy of vital capital, reducing investment levels and crippling long-term economic growth, all while doing very little to widen the tax net.

It is pertinent to note that the current tax rate on interest income for filers of tax returns is already a pretty hefty 15 percent. For non-filers, the rate is even higher at 35 percent. Moreover, for filers, the 15 percent rate applies only to interest income of up to Rs 5 million annually.

Any income beyond this threshold is taxed at the applicable slab rate on the individual’s total income, including interest earnings, further squeezing those who are already part of the tax net. A further two percent hike in the tax rate would only deepen this distortion.

Pakistan already has one of the lowest savings rates in the region — a structural weakness that has severely undermined the country’s economic uplift. With insufficient domestic savings, the economy relies heavily on external borrowing to meet its needs, creating a dangerous cycle of debt dependency.

Increasing the tax rate on interest incomes from bank deposits and savings schemes effectively amounts to penalising the act of saving, as people will think twice before parking their money in formal financial instruments, and will instead opt for untaxed or low-tax alternatives, further shrinking the formal savings pool.

The result will be an even greater reliance on borrowing and an even more urgent need to raise additional revenue just to service the growing debt. Far from strengthening public finances, this policy would be profoundly counterproductive.

The fundamental challenge confronting the economy is the glaring gap between expenditures and earnings, and addressing this deficit should be the government’s singular focus. While curbing expenditure is one way forward, however, options on this front are limited.

Debt servicing, by far the largest outlay, is a pass-through item of expenditure, while cuts in defence spending are also unlikely in the near term, given regional tensions, and the turmoil in Balochistan and parts of Khyber-Pakhtunkhwa. Still, the government can trim its substantial current expenditure levels in other areas.

At the very least, a leaner cabinet, with fewer ministers and advisors is both fiscally prudent and symbolically necessary. The authorities can’t credibly preach austerity to the public while maintaining the glaring optics of an indulgent state apparatus.

On the revenue side, Pakistan needs a tax system that effectively taxes incomes and consumption and not assets and savings. Instead, we have a regime that disproportionately taxes transactions. Businesses are forced to navigate a labyrinthine withholding tax structure, where multiple tax rates apply at different stages of business transactions. On top of that, virtually every economic activity faces a minimum tax on turnover regardless of profit or loss.

The convoluted tax system, therefore, actively discourages compliance while punishing law-abiding taxpayers, with this dysfunction starving public coffers and leaving critical areas of the economy underfunded. The proposed tax on savings if implemented would simply double down on this same flawed approach. The finance minister’s stated goal of bringing a budget of structural reforms cannot be met through a measure that is fundamentally at odds with economic vitality. Government policy must encourage savings, not drive them underground.

Copyright Business Recorder, 2025