Reforming Pakistan’s tax policy

A system at odds with growth

Pakistan’s tax system is increasingly at odds with the country’s core economic objectives: attracting investment, creating jobs, expanding exports, and achieving inclusive growth. While fiscal consolidation under the IMF-supported programme has helped stabilise macroeconomic indicators, the tax regime itself remains distortionary, unpredictable, and excessively punitive for documented economic activity.

The result is a paradox. Stability has improved, but the incentives required for growth remain weak. Fiscal policy, instead of enabling expansion, has become a binding constraint on it.

The cost of complexity and burden

For businesses, the cumulative effect of high tax rates, cascading indirect taxes, an expansive withholding regime, and proxy taxation of turnover rather than profit has been to raise the cost of doing business materially. Frequent and discretionary policy changes further erode confidence.

These distortions have predictable consequences: formal employment is discouraged, reinvestment of profits is constrained, export competitiveness is weakened, and informality is incentivised. In effect, the system penalises compliance while rewarding those who remain outside it.

An opportunity in institutional reform

The establishment of the Tax Policy Office—separating tax policy from tax administration—is an important and welcome step. It creates the possibility of designing tax policy around long-term economic objectives rather than short-term revenue imperatives.

However, institutional change alone will not suffice. For this reform to succeed, tax policy must be anchored in predictability, credibility, and a clearly articulated medium-term direction. Without this, the separation risks becoming cosmetic.

There is also a tension that must be managed carefully. Assigning the Tax Policy Office responsibility for drafting the annual budget—balancing revenues against expenditure—could dilute its objectivity. The integrity of policy design must not be compromised by short-term fiscal pressures.

The case for a medium-term tax framework

Pakistan needs a clearly defined, medium-term destination tax regime benchmarked against regional competitors such as India, Bangladesh, and Vietnam. This framework should signal a phased rationalisation of rates, a broadening of the tax base, and the removal of the most growth-distorting measures.

In the short term, such reforms may entail revenue trade-offs. However, these can be mitigated through higher economic activity, base expansion, and complementary fiscal measures: rationalisation of expenditure, privatisation and restructuring of state-owned enterprises, reduced borrowing costs, and better-targeted subsidies.

Without such a framework, Pakistan risks remaining trapped in a low-investment, low-productivity equilibrium—where macro stability is preserved, but growth, employment, and export dynamism remain subdued.

Structural weaknesses that must be addressed

Pakistan’s tax system has evolved primarily as a revenue-maximisation tool rather than an instrument of economic policy. This has resulted in several structural distortions:

Penal taxation of compliant firms and salaried individuals

Excessive reliance on advance and withholding taxes functioning as minimum taxes

Turnover-based minimum taxes that disproportionately hurt low-margin sectors and exporters

Cascading indirect taxes that inflate domestic production costs

High GST rates in an undocumented economy, encouraging evasion and burdening lower-income consumers

Uncompetitive taxation of exports

Multiple taxation of dividends within group structures, discouraging scale and diversification

Frequent, discretionary policy changes that undermine investor confidence

Addressing these weaknesses is central to restoring both fairness and efficiency.

A phased reform agenda

Given fiscal constraints, reform must be sequenced. A credible roadmap, rather than a one-off adjustment, is key to rebuilding confidence.

First, personal taxation must be rationalised to stem brain drain and incentivise formal sector participation. This requires inflation-indexed tax slabs and a reduction in top marginal rates to 25 percent for salaried and 30 percent for non-salaried individuals.

Second, capital formation must be encouraged and flight of capital arrested by withdrawing the Capital Value Tax and eliminating distortive measures such as deemed rental income taxation under Clause 7E.

Third, corporate taxation should be aligned with regional benchmarks through a phased reduction from 29 percent to 25 percent, with a 1 percent lower tax incentive for listed companies to promote transparency and governance. Where immediate rate cuts are constrained, relief on incremental profits can reduce the effective burden without sacrificing revenues.

Fourth, export taxation should be simplified through a low, final tax regime—providing certainty and improving competitiveness.

Fifth, the phased elimination of the Super Tax—earlier on export income and subsequently on non-export income—would reduce uncertainty and signal policy consistency.

Sixth, capital market development must be supported by restoring tax neutrality for inter-corporate dividends within eligible group structures, subject to minimum public float requirements to prevent excessive concentration.

Seventh, capital gains taxation should revert to a holding-period-based system to encourage long-term investment and facilitate foreign direct investment, especially in private companies.

Eighth, liquidity pressures on businesses must be eased by allowing the offset of pending tax refunds against current liabilities.

Ninth, distortions in minimum taxation should be addressed by aligning them more closely with actual profitability, with differentiation across sectors based on asset intensity.

Tenth, the tax arbitrage between formal and informal sectors must be reduced through better alignment of withholding and sales tax regimes, alongside greater reliance on documented supply chains.

Finally, expanding the scope of the Third Schedule can improve sales tax collection efficiency through upstream enforcement.

The cost of delay

Not all reforms can—or should—be implemented in a single budget. But the absence of a clearly articulated, time-bound roadmap is itself costly. Investment decisions are shaped as much by expectations as by current conditions.

Pakistan does not suffer from a lack of entrepreneurial capacity or opportunity. What it lacks is a tax system that rewards investment, scale, and formalisation.

Reform, therefore, is not simply about raising revenue more efficiently. It is about redefining the role of taxation as an enabler of growth.

The choice is clear: persist with a system that constrains the economy or adopt one that allows it to expand.

Copyright Business Recorder, 2026