When taxes punish formal businesses

EDITORIAL: While the minister of state for finance has assured a traders’ delegation during recently held consultations that their demand for a simplified tax scheme would be given due consideration in the upcoming budget, the larger reality is that Pakistan’s taxation regime has grown increasingly convoluted, punitive and economically counterproductive.

Years of rising tax rates, coupled with complex compliance requirements and heavy-handed enforcement measures have imposed a disproportionate burden on the corporate sector, salaried individuals and compliant taxpayers, even as the tax base remains stubbornly narrow.

A simplified tax system as demanded by retailers and wholesalers is undeniably the need of the hour. Yet there is an unmistakable irony in such demands for relief emerging from a segment long mollycoddled by successive governments, while much of the documented economy continues to shoulder the weight of a dysfunctional and inequitable fiscal structure.

The distortions embedded within the existing taxation framework are best illustrated by the fact that nearly every formal sector economic activity is subjected to minimum taxation on turnover regardless of profitability. In any rational tax system, tax liability is linked to net income, allowing losses to be carried forward and offset against future earnings.

In Pakistan, however, turnover-based minimum taxes effectively penalise businesses simply for operating by taxing their gross incomes. The inevitable consequence is the erosion of profitability, and shrinking incentives for formal-sector expansion. This burden is further exacerbated by a withholding tax regime that extracts taxes at virtually every stage of commercial activity.

Enterprises operating across supply chains, from manufacturing and distribution to retail face repeated taxation at each transaction point, inflating operational costs of compliant businesses throughout the production cycle.

The economic consequences of such a regime are well established, with a World Bank Group study observing that higher effective corporate tax rates are directly associated with lower private investment and reduced business formation, noting that a 10 percent increase in effective corporate rates can reduce investment by as much as two percent of GDP while also suppressing new business entry.

On top of the highly punitive taxation that compliant businesses face, they also have to contend with relentless scrutiny through repeated audits, ever-expanding bureaucratic hurdles as well as delays in receiving tax refunds. Meanwhile, undocumented segments, particularly retail and wholesale, as well as agriculture continue to operate with far fewer obligations.

The result is a system that disproportionately squeezes documented businesses while incentivising large segments of the economy to remain outside the tax net.

The government has demonstrated little urgency to bring sectors like agriculture into the tax net, and the limited progress that has been made in recent times to tax this segment has largely been driven by IMF pressure rather than genuine political will.

The reason for that is not difficult to discern: the agriculture sector commands enormous political influence within the corridors of power. Similarly, the trading community has repeatedly demonstrated its nuisance value by resorting to shutter-down strikes and protests at the drop of a hat whenever even modest attempts are made to document or tax the sector more effectively.

In effect, political influence and the capacity to exert pressure have come to define the government’s approach to tax reform and expansion of the tax base.

The result is that the FBR has increasingly relied on targeting the lowest-hanging fruit, prioritising ease of collection over meaningful structural reform. While there is undoubtedly a pressing need for a simplified taxation framework, its benefits must extend across the economy rather than being tailored primarily towards politically influential constituencies.

More importantly, any simplification must go hand in hand with a serious, broad-based effort to expand the tax net, without which the inequities of the present system will continue to persist.

Copyright Business Recorder, 2026