EDITORIAL: The Asian Development Bank’s recent report, “Taxing informal and hard-to-tax sectors — a policy guide” casts a spotlight on Pakistan’s long-standing struggles with undertaking effective tax reforms. Despite years of repeated efforts aimed at meaningfully expanding the tax base and boosting revenue collection, the country has continued to chronically underperform on both counts.
The report further underscores broader structural issues that have long plagued Pakistan’s fiscal landscape: a narrow and inequitable tax base, a burdensome, complicated compliance regime and a vast informal economy that remains outside the tax ambit.
These systemic shortcomings have meant that despite nominal gains, revenue collection has seen little growth in real terms over the past decade. The tax-to-GDP ratio continues to lag well behind other regional economies, falling short of the 10.6 percent target for FY2024-25.
Research also shows that the tax bureaucracy’s disproportionate focus on identifying non-filers of tax returns and expanding the number of registered filers has produced limited dividends.
While formal registrations have increased on paper since 2014, they have not been matched by a commensurate rise in actual revenue, as many filers declare negligible or no taxable income, resulting in little meaningful addition to overall revenue and clearly indicating that too many registrants continue to under-report or evade their obligations.
In fact, non-compliance within the registered segment has become as serious a challenge as the vast informal economy outside the tax net, underscoring that simply expanding the roster of filers without addressing under-reporting and enforcement gaps will do little to strengthen the country’s fiscal capacity.
Beyond weakening compliance among existing taxpayers, the structural inefficiencies plaguing the tax system have also incentivised businesses to remain informal.
A key driver of widespread tax evasion and the reluctance of many enterprises to formalise is the prohibitively high cost of compliance to the tax regime. In recent years, not only have tax rates surged steeply, but the procedural burdens, regulatory uncertainty and the overall convoluted nature of the tax structure — dominated by indirect taxes, a tortuous withholding tax regime where multiple tax rates apply at different stages of business transactions, and minimum taxation on turnover regardless of profitability — have collectively deterred participation in the formal economy.
An apt example of how the above factors combine to discourage businesses from entering the formal sector, and even jeopardise the viability of those part of the tax net is the recent hike in the general withholding tax rate for services rendered from 11 percent to a hefty 15 percent of turnover in the latest budget.
Such taxation on gross turnover, especially when applied at high rates, is particularly punitive for businesses with slim profit margins. Because it applies regardless of actual earnings, it places an outsized burden on smaller firms and new entrants, many of which lack the financial resilience to absorb such costs.
The resulting pressure on cash flows and profitability can undermine business sustainability, driving some to exit the formal sector, or cease operations altogether.
It is essential, then, that policies targeting informality and compliance with the tax regime are carefully crafted. As the ADB report notes, steep hikes in tax rates can push formal businesses underground, while lowering rates alone may achieve little without effective enforcement measures, administrative reform of the tax bureaucracy and a broader tax base.
Adjustments to tax rates must be accompanied by simplified compliance procedures, targeted enforcement strategies and meaningful support for businesses transitioning into the formal sector.
The FBR must also move beyond the flawed notion that more filers automatically mean more revenue. Its habitual reliance on elevated tax rates and aggressive enforcement measures has done little to address underlying inefficiencies. Only a shift towards meaningful structural reform of the taxation framework will deliver lasting results.
Copyright Business Recorder, 2025