Tax collection: a system designed to fail

EDITORIAL: Clearly, Pakistan’s repeated failure to meet tax collection targets is not merely a fiscal problem; it reflects a tax structure that continues rewarding informality while overburdening the shrinking segment of the economy that actually complies.

The latest debate surrounding the expansion of the Third Schedule under the Sales Tax Act has once again exposed the deeper flaw at the heart of the system: policymakers remain trapped in a cycle of squeezing documented businesses harder while the black economy continues operating largely beyond reach.

That imbalance has persisted for years. Retailers remain overwhelmingly undocumented despite repeated enforcement campaigns, additional taxes on non-filers and increasingly punitive measures aimed at forcing compliance. Yet every failed drive produces the same outcome.

The state misses its revenue targets, the informal economy adapts and the compliant sector absorbs more pressure.

The result is a distorted arrangement where manufacturers and organised businesses effectively subsidise widespread non-compliance elsewhere in the system. Companies already registered within the formal economy face audits, withholding requirements, advance taxes and regulatory scrutiny, while vast sections of retail commerce continue functioning outside meaningful documentation.

The burden therefore falls disproportionately on those easiest to monitor rather than those most responsible for leakage.

That is why the discussion around the Third Schedule deserves serious attention. The proposal to collect GST earlier in the supply chain, based on printed retail prices, reflects an acknowledgment that the current downstream collection model is failing in practice.

In sectors where retail informality remains deeply entrenched, collecting tax at the manufacturing or import stage may offer a cleaner and more enforceable mechanism.

There is practical logic behind this approach. Pakistan’s retail economy remains fragmented, cash-based and weakly documented, particularly outside major urban centres.

Attempting to enforce full invoice-based compliance across such a system has repeatedly produced administrative complexity without commensurate gains in documentation. Meanwhile, compliant manufacturers continue absorbing costs linked to leakage and non-payment further down the chain.

Consumers could also benefit from greater price visibility. Printed retail pricing reduces space for arbitrary mark-ups and improves transparency in markets where enforcement capacity remains weak. For essential packaged goods such as cooking oil, dairy products and flour, clearer pricing mechanisms can offer some protection to households already struggling under persistent inflationary pressure.

Still, the Third Schedule should not be mistaken for comprehensive reform. At best, it is a transitional corrective measure within a much larger structural problem. Pakistan’s tax system remains excessively dependent on indirect taxation while documentation incentives remain weak and enforcement uneven. A durable solution requires broader redesign rather than another patch layered onto an already distorted framework.

The deeper issue is that the present system actively discourages formality. Businesses operating transparently often face higher effective costs, more intrusive oversight and greater compliance burdens than those functioning informally. Under such conditions, the incentive structure itself becomes counterproductive. Informality is rewarded while documentation becomes commercially punitive.

This also explains why the tax net remains persistently narrow despite years of reform rhetoric. Governments repeatedly respond to shortfalls by targeting already visible taxpayers because expanding genuine documentation requires institutional capacity, political resolve and long-term consistency. Raising rates, imposing surcharges or intensifying audits is administratively easier than restructuring the system itself.

The economic consequences are substantial. A narrow and distorted tax base weakens state capacity, increases dependence on borrowing and pushes policymakers toward repeated reliance on indirect taxation and petroleum levies. These measures then feed inflationary pressures that ultimately fall hardest on salaried and lower-income households already carrying much of the formal tax burden.

The immediate case for expanding the Third Schedule may well be valid for certain sectors. But the broader lesson is more important.

Pakistan cannot continue operating a tax regime where compliance becomes economically disadvantageous while informality remains commercially survivable.

At some stage, policymakers must stop treating tax collection as an exercise in extracting more from the documented minority and begin designing a framework that genuinely broadens participation fairly and sustainably.

Until then, revenue targets will continue being missed, distortions will deepen and the black economy will continue thriving alongside a formal sector carrying an increasingly unsustainable burden.

Copyright Business Recorder, 2026