Overcoming fiscal deficit

On June 10, 2026, the federal government will unveil budget for fiscal year (FY) 2026-27 amidst familiar warnings about fiscal deficits, rising debt, IMF conditionalities and the alleged necessity of imposing additional taxes.

Once again, citizens are expected to believe that Pakistan suffers from a shortage of revenue. The official narrative suggests that fiscal stability requires higher taxation, stricter enforcement and continued sacrifices by already overtaxed segments of society but facts tell an entirely different story.

For nearly three decades, articles in these pages and elsewhere have highlighted the phenomenon of “foregone taxes in trillions”. Shockingly, the issue attracted little policy attention. Of late, official reports of the Federal Board of Revenue (FBR), Economic Surveys of Pakistan and even studies by the Pakistan Institute of Development Economics (PIDE) confirm that concerns were neither exaggerated nor misplaced.

Pakistan’s fiscal deficit is not merely the result of inadequate taxation. It is substantially a consequence of trillions of rupees voluntarily surrendered through tax expenditures. The following official figures, extracted from annual Economic Surveys and FBR’s website, illustrate the magnitude of the issue:

===========================================Table: Tax Expenditure (2010-11 to 2024-25)===========================================Fiscal Year    Tax Expenditure (Rs billion)===========================================2010-11                               150.32011-12                               185.52012-13                               239.52013-14                               477.12014-15                               415.82015-16                               394.62016-17                               415.82017-18                               541.02018-19                               972.42019-20                                11502020-21                              1314.32021-22                   1482.3 GST on POL                       waived in March 20222022-23         2239.6 Excluding GST on POL2023-24         3879.2 Excluding GST on POL2024-25         2434.7 Excluding GST on POL===========================================

The Table exposes a startling reality. Federal tax expenditure increased almost sixteen-fold between FY2010-11 and FY2024-25. The latest figure of Rs. 2.435 trillion (not including forgone sales tax on petroleum products) exceeds the annual budgets of several provinces and is significantly larger than the revenue shortfalls repeatedly cited by the government to justify new taxation measures. Had even a portion of these concessions been rationalised, Pakistan’s fiscal deficit could have been substantially reduced and, in certain years, transformed into a surplus.

Tax expenditure represents revenue forgone through exemptions, concessions, exclusions, tax credits, preferential rates, special regimes and other departures from the normal tax structure. Economically, it is no different from direct budgetary spending. The only difference is that it escapes the scrutiny ordinarily applied to expenditure shown in the budget.

Every rupee of federal tax expenditure granted in divisible-pool taxes affects not only the federal government but also the provinces. The 1973 Constitution guarantees provinces a share in federal tax revenues through the National Finance Commission (NFC) Award.

When federal authorities forego trillions through exemptions and concessions, provinces are simultaneously deprived of resources for education, health, local government, infrastructure and social protection. This raises a fundamental question. By what constitutional logic should selected beneficiaries receive preferential tax treatment while provinces lose resources constitutionally intended for their citizens?

The debate on tax expenditure is not merely fiscal. It concerns the distribution of power, resources and opportunities within the federation itself. PIDE’s recent study on tax expenditures reaches an equally troubling conclusion. It notes the absence of rigorous cost-benefit analysis, lack of meaningful evaluation and weak institutional scrutiny regarding the effectiveness of tax concessions.

Exemptions are frequently granted in the name of industrial development, investment promotion or social objectives, yet little evidence is produced to demonstrate whether these objectives are actually achieved. Many concessions survive long after their original rationale has disappeared. Others effectively operate as hidden subsidies benefiting narrow groups at public expense.

In this peculiar milieu, the first and most immediate reform should be a comprehensive review of all tax expenditures. Every concession should be subjected to annual scrutiny, accompanied by a sunset clause and automatic lapse unless justified by measurable economic and social benefits. Even a reduction of one-third of existing tax expenditures could generate hundreds of billions of rupees, substantially reducing dependence on regressive taxation and borrowing.

The second reform concerns one of Pakistan’s most protected sources of untaxed wealth: agricultural land rent.

For decades, public debate has conflated the interests of small farmers with those of large landowners. These are entirely different questions. Small cultivators facing climate shocks, rising input costs and declining productivity deserve protection and support. Large agricultural rentiers enjoying substantial income from ownership of land do not.

The original definition of “agricultural income” in the Income-tax Act, 1922 was rooted in agricultural operations and cultivation. It was never intended to create a blanket fiscal immunity for large landowners. The exemption recognised income arising from land used for agricultural purposes and from agricultural operations performed on that land. What emerged over subsequent decades was a political distortion whereby constitutional protection of agriculture gradually evolved into protection of agricultural rent and landed privilege.

The Finance Bill 2026 should distinguish between income from cultivation and income from ownership of agricultural land. Small cultivators deserve support, not taxation. Agricultural rent accruing to absentee owners and large landholders is a different economic category altogether and should be brought within the tax net. Such a distinction is entirely consistent with both classical public finance and the original scheme of the Income-tax Act, 1922.

The third reform concerns the fragmented structure of Pakistan’s income tax system. The current regime has abandoned the foundational principle of comprehensive income taxation. Separate tax blocks, final taxation regimes, minimum taxes, presumptive taxes and countless special provisions have created a system characterised by complexity, inequity and litigation.

Every source of income after computation as per respective head of income should be aggregated into a single taxable base ending all kinds of separate treatments. Additionally, artificial distinctions between different categories of income need to be removed.

After computing taxable income as suggested above, under a simplified structure, annual income up to Rs. 1.2 million should remain below taxable threshold. Income exceeding Rs. 1.2 million up to Rs. 3.6 million should be taxed at 5 percent. Income exceeding Rs. 3.6 million up to Rs. 6 million should be taxed at 15 percent. Income exceeding Rs. 6 million should be taxed at 25 percent. The corporate tax rate should simultaneously be reduced to 25 percent.

Excess profit tax or business profit tax, if necessary, for persons earning income beyond Rs. 200 million may be imposed through separate laws, as was done historically.

A broad tax base coupled with moderate rates will always outperform a narrow base burdened by excessive taxation. Pakistan’s fiscal challenges also require addressing another long-neglected constitutional anomaly: fragmented sales taxation.

The division between federal sales tax on goods and provincial sales tax on services has generated overlapping jurisdictions, multiple compliance regimes, cascading taxation and substantial administrative inefficiencies.

Trans-provincial services and entities operating across provincial boundaries require harmonised treatment. Their inclusion within a unified federal framework would significantly enhance efficiency and revenue mobilisation. Studies undertaken earlier suggest that comprehensive taxation of trans-provincial services could generate approximately Rs. 3 to 4 trillion in additional revenue over time through integrated administration and elimination of leakages.

Such potential alone is sufficient to alter Pakistan’s fiscal landscape fundamentally. At the same time, provincial governments must abandon their excessive dependence on federal transfers.

Pakistan’s provinces possess substantial taxation powers over agricultural income, agricultural land, urban immovable property, services and local economic activities. Yet provincial tax collection remains exceptionally low by international standards.

In successful federations, sub-national governments mobilise significant resources independently. Indian states collectively raise revenues approaching 8 percent of GDP through their own taxation powers. Pakistani provinces should be aiming for revenue mobilisation of at least 5 to 8 percent of GDP.

If provinces effectively utilised their constitutional powers while the federation rationalised tax expenditures, taxed agricultural rent, integrated trans-provincial taxation and implemented comprehensive income taxation, Pakistan’s chronic fiscal deficit would largely disappear.

The country would no longer require excessive petroleum levies to compensate for weak tax policy. Dependence on borrowing would decline. Corporate taxation could become internationally competitive. Personal taxation could become simpler, fairer and more predictable.

The debate surrounding annual federal budgets, unfortunately, begins on a false premise. Pakistan does not suffer from a shortage of taxable capacity. It suffers from policy choices that favour exemptions over equity, fragmentation over simplicity and privilege over constitutional fiscal justice. The challenge is not only to discover new taxpayers. The real challenge is to stop subsidising powerful interests through the tax system while claiming insufficient resources for governance.

Fiscal sovereignty will remain elusive so long as trillions continue to be surrendered through tax expenditures, large sources of economic rent remain untaxed and constitutional taxing powers remain underutilised.

The choice before policymakers is straightforward. Continue managing deficits through higher taxation of the compliant and greater dependence on debt or dismantle the structural distortions that create those deficits in the first place. The first path perpetuates debtocracy. The second offers a route towards genuine fiscal sustainability and constitutional federalism.

Copyright Business Recorder, 2026