Stability without growth

Economic stability has turned into stagnation as the government has been unable to resolve fundamental challenges faced by businesses and industry.

The reasons are manifold, both long-term and short-term; broadly the country’s inability to move forward boils down to flawed tax policy and institutional failures of the Federal Board of Revenue. Over the past few months, especially, it seems to have been turned into a security institution, taking a policing approach to matters left best to the market.

In fact, increasingly it seems that revenue calculations are based on static models ignoring economic linkages and market forces all together. How else could the tax authority consistently record revenue shortfalls with effective tax rates of 60 percent to 150 percent of income being faced by individuals and firms.

Take income tax on exporters, for example. For decades exporters were subject to a fixed tax regime where 1 percent of export proceeds were their full and final tax liability. In 2023, the IMF required withdrawal of all preferential tax regimes across the board, particularly for exporters, with a view that preferential regimes were distorting both fiscal revenues and productive incentives across the economy. The logic simply was to create a level playing field for all sectors across the economy.

The government of Pakistan, particularly the FBR, saw this as an opportunity to improve their cash flows, but at what cost. Instead of eliminating the fixed tax on exports and subjecting all businesses to the same normal tax regime, the FBR maintained the 1 percent tax on export proceeds, and brought income from exports under the Normal Tax Regime.

Now, exporters pay 1 percent advance tax on export proceeds (plus 0.25 percent export development surcharge) under the fixed tax regime plus 1.25 percent advance minimum turnover tax under the normal tax regime, and both are adjustable against the 29 percent income tax plus up to 10 percent super tax at the end of the year. Selling in the domestic market, on the other hand, attracts only the advance minimum turnover tax, adjustable against the same rates at the end of the financial year.

While at the end of the day both exporting and selling in the domestic market attracts a 29 percent income tax plus 10 percent super tax, exports face an advance income tax rate of nearly twice as much which, depending on profit margins, can go as high as 135 percent of turnover:

In the FBR’s static calculations, increasing the advance tax on exports of let’s say USD 30 billion from 1 percent to 2.25 percent increases revenue collection from USD 300 million to USD 675 million. Never mind that, assuming a profit rate of 1-5 percent, the 29 percent income tax applicable on these exports falls between USD 87 million to USD 435 million, meaning anywhere between USD 240-USD 588 million of the collection is refundable but never actually refunded. Accounting for the economic incentives created by such a policy, the picture changes entirely. Paying twice as much in advance tax creates a significant liquidity issue for exporters, and there is an implicit opportunity cost to the government holding that money in refunds—even if it were to refund it on time or at all, which rarely happens in Pakistan.

From a tax, liquidity, and profit perspective, the policy effectively makes domestic sales far more attractive than exports.

Once these economic linkages and behavioural responses are considered, the outcome reverses: depending on measurable elasticities, exports decline and with them the overall tax base, meaning that the initial USD 675 million revenue projection is never realized. In fact, not only does the expected tax revenue fail to materialize, but the consequent contraction in exports aggravates the current account deficit, worsening macroeconomic stability.

And this simplified example does not even account for the perverse incentives such policies create for tax evasion, under-reporting of income, or the withholding of export proceeds abroad—nor for the broader second- and third-order economic losses that stem from such distortions.

This approach is not limited to the FBR; the same static, accounting-based mindset runs through the power and gas sectors as well.

Take the example of the levy on captive power plants. Setting aside the fact that it has been deliberately and grossly miscalculated, it is difficult to understand how, when the stated policy objective was to shift captive units to the grid, the government expected to generate Rs 105 billion from a punitive levy that effectively eliminates demand altogether. With gas and RLNG tariffs reaching as high as USD 16 per MMBtu, no rational consumer would continue to use captive generation, and therefore no collection from the levy could realistically occur.

Yet elaborate fiscal plans were drawn up on the assumption of full recovery, with the projected revenue earmarked for transfer to the power sector to reduce electricity tariffs for all consumers.

A similar disconnect is evident in the design and implementation of the Competitive Trading Bilateral Contract Market (CTBCM). For months, the industrial sector has pointed out that the proposed Rs 12.55 per kWh plus premium wheeling charge renders bilateral power purchase agreements financially unviable, especially when coupled with the 800 MW cap and the pricing of hybrid consumption at the grid’s marginal cost. Despite repeated representations, the authorities have persisted with these terms. The result, once again, is a framework that appears coherent on paper but is infeasible on the ground.

Meanwhile, genuine reform that could deliver meaningful and sustained outcomes in exports, revenues, employment, and industrial growth continues to be constrained by the government’s fiscal position. Industrial electricity tariffs, for instance, range between 11 to 13 cents per kWh in Pakistan, compared to 5 to 9 cents in regional competitors.

Even after accounting for stranded generation costs and grid inefficiencies, the actual cost of service for industrial consumers remains around 9 cents per kWh. Yet a cross-subsidy of roughly Rs 130 billion for protected and lifeline consumers inflates industrial tariffs by as much as double what industries in comparable economies are paying. The result is a power tariff that is both uncompetitive and regressive, eroding Pakistan’s export base, industrial employment, and ultimately tax revenues.

It is also widely acknowledged that the cross-subsidy regime is being systematically abused. The only eligibility criterion is consumption below 200 kWh per month, with no mechanism to verify income or need. As a result, many consumers who are not low-income—including those with rooftop solar systems that reduce their recorded grid usage—qualify for heavily subsidized electricity.

The government has already committed to reforming the system by routing targeted subsidies through the Benazir Income Support Programme (BISP) and removing the cross-subsidy burden from end-consumer power tariffs. Such a shift would immediately restore regional competitiveness, stimulating new industrial load on the grid and improving capacity utilization across the sector. But with fiscal space eroded by inefficient taxation and weak revenue administration, the state is unable to absorb the transition cost of rationalizing tariffs, even though doing so would generate far greater economic and fiscal returns in the medium term.

The government’s inability to bring untaxed or undertaxed segments, such as agriculture and retail, into the tax net has further compounded the problem. As a result, the burden of sustaining public finances falls disproportionately on a narrow base of already overtaxed sectors.

The formal industry, particularly the export-oriented segment, has been stretched to its limits, with little to no breathing space left after the punitive fiscal measures introduced over the past one to two years. The outcome is paradoxical: sectors that are most visible, documented, and compliant are also those most penalized, while large portions of the economy remain effectively outside the tax system.

In addition to double advance taxation and prohibitive energy prices, two of the most pressing challenges, industrial and export-oriented firms face an array of overlapping taxes and surcharges that cumulatively erode profitability and competitiveness:

Exporting textile units, for instance, are subject to a complex combination of federal and provincial taxes that, when aggregated, amount to between 7 percent-11 percent of turnover based on profit margins of 6-15 percent. These include not only income and sales taxes, but also a range of levies with no direct connection to export activity: petroleum levies, social security contributions, provincial infrastructure cess, property tax, and stamp duties, among others. Many of these charges are designed for domestic consumption or general fiscal purposes but are effectively imposed on firms competing in global markets, where prices are determined internationally and cost increases cannot always be passed on to buyers.

Export competitiveness fundamentally depends on minimizing domestic cost distortions. When taxes unrelated to production or export activity are imposed, they act as a deadweight loss on the economy—reducing the incentive to produce, discouraging reinvestment, and misallocating resources toward less productive sectors. Placing the entire financial burden of the state on a narrow economic base and expecting it to carry that weight into the international marketplace, is simply untenable.

Competing countries such as India and Bangladesh, especially following the imposition of the US tariffs, are doing the opposite: rationalizing their tax structures, streamlining compliance, and using targeted fiscal incentives to promote export growth. Pakistan’s approach, by contrast, continues to treat its most productive and internationally competitive sectors as the primary source of fiscal extraction rather than as the engine of recovery and growth.

All these distortions ultimately feed into the macroeconomy characterized by nominal indicators like the exchange rate, interest rate, and inflation that are inexplicably linked to the real economy, particularly industry. When the real side of the economy remains constrained, macro indicators inevitably deteriorate. These pressures are now visible with renewed talk of exchange rate devaluation, inflationary pressures and limited space to lower interest rates, all direct consequences of the structural weaknesses in productive sectors. Essentially, they are all symptoms of an economy where the industrial base is overtaxed, overcharged, and deprived of liquidity.

Stopgap measures like devaluing the rupee to Rs. 300/USD or introducing temporary power tariff subsidies are not viable solutions. In fact, episodes of sharp devaluation never yield sustained export gains; it is consistent, gradual and predictable depreciation that supports exports by maintaining domestic input costs lower in foreign-currency terms and allowing firms to plan production competitively, for which a stable macroeconomy with predictable and low inflation and interest rates itself is an essential prerequisite.

Pakistan is now more than halfway through the IMF programme, with feeble stability in nominal macro indicators and very little if any improvement on the real side of the economy. Policymakers must decide whether this is to be Pakistan’s last IMF programme or whether the country will continue to depend on them indefinitely.

If the objective is to exit the cycle, the industry must be empowered and allowed to compete. The government must address the core of the problem: energy and tax distortions that cripple industrial competitiveness, sustain structural inflation, and block investment.

Copyright Business Recorder, 2025