Domestic resource trap: When raising revenue shrinks the economy

For decades, a remarkably resilient idea has shaped economic policy across the developing world: before a government can invest, build infrastructure or expand public services, it must first “find the money”.

This logic lies at the heart of Domestic Resource Mobilisation (DRM). Governments are urged to raise tax-to-GDP ratios, broaden tax bases and improve enforcement so that more resources can be mobilised domestically for development.

There is an obvious truth here. Developing states need functioning tax systems. Pakistan cannot sustainably finance development while significant incomes, wealth and economic activity remain outside the tax net.

But there is another question that receives far less attention: What if the way a government raises revenue weakens the very economy from which that revenue must ultimately come?

Not every rupee of revenue is the same

An economy is not a reservoir of taxable cash. It is an interconnected system of production, investment, employment, consumption and credit. Raising revenue from different parts of that system produces very different economic consequences.

A rupee collected from speculative land gains is not economically equivalent to a rupee raised through an essential production input. A tax on cigarettes is not economically equivalent to a levy embedded in the fuel transporting vegetables from farm to market. Yet on the government’s revenue statement, each appears simply as another rupee collected.

In a recent IDEAs working paper, economist Nkosi challenges the conventional DRM paradigm. Drawing on endogenous-money, post-Keynesian and structuralist traditions, he proposes shifting the discussion from Domestic Resource Mobilisation to Domestic Resource Creation (DRC). The central idea is that finance should not be understood simply as a fixed stock of scarce savings that must first be mobilised before development can occur.

Applied to fiscal policy, that insight changes the question. Under a narrow resource-mobilisation approach, policymakers ask: How much revenue will this measure generate today? A resource-creation approach adds another question: What will this measure do to production, investment, employment and tomorrow’s revenue base?

That second question is critical because fiscal instruments do not merely collect money. They change prices, incentives and economic behaviour.

When inputs become the revenue base

Pakistan’s petroleum levy illustrates the dilemma. In FY2025-26, the federal government collected approximately Rs1.567 trillion through the petroleum levy, exceeding the original budget target of Rs1.468 trillion.

From a narrow revenue perspective, this is an impressive collection performance. But petroleum is not merely something motorists consume on Sunday drives. Fuel sits inside the costs of moving workers and goods, operating farms, transporting agricultural produce and distributing manufactured products.

This does not mean petroleum should never carry a levy. Fossil-fuel consumption creates environmental costs, and pricing those costs can serve a legitimate policy purpose. But timing and context matter. When global supply disruptions are already driving energy prices sharply higher, many economies work to cushion households and businesses from the shock and limit its transmission through domestic prices. In such circumstances, relying heavily on the same essential input as a convenient source of fiscal revenue raises a different question: Are we absorbing an external shock, or amplifying its effects through the domestic economy?

That brings us to a simple principle: fiscal policy should distinguish between what society wants to discourage and what the economy needs to expand.

Consider cigarettes. Their consumption imposes health costs, giving excise taxation a clear public-health rationale. The objective is partly behavioural: taxation is intended to discourage harmful consumption. Taxing speculative land gains can similarly discourage rent-seeking and unproductive asset accumulation.

But raising revenue through essential production inputs is different. Such measures can feed into costs across domestic value chains. On the government’s ledger, a rupee collected from cigarettes and a rupee collected through a petroleum levy both strengthen revenue. In the real economy, where that rupee comes from matters.

Tax rents, protect production

This is where Pakistan’s fiscal debate needs to move beyond the familiar argument over whether taxes should simply be higher or lower. That is the wrong binary.

Pakistan needs more revenue. But it also needs a larger, more productive and more formal economy from which sustainable revenues can be collected. The real question is therefore what to tax, what to levy, and with what consequences.

Activities that generate economic rents through speculative gains, privileged access or non-productive asset accumulation should not receive more favourable treatment than activities that create output, employment, technological capability and exports. Likewise, revenue measures imposed on intermediate inputs and formal production deserve much more scrutiny than conventional fiscal accounting encourages.

This is not an argument for another maze of exemptions, concessions and special treatments. It is an argument for recognising that the composition of revenue matters for economic development and the future tax base.

The objective should not simply be to collect the maximum possible amount from wherever collection is administratively easiest. It should be to raise necessary public revenue while minimising damage to productive capacity and shifting the burden toward rents, harmful consumption and undertaxed income and wealth.

Mind the denominator

This also changes how we should think about Pakistan’s obsession with the tax-to-GDP ratio. The ratio is useful. But it is an accounting indicator, not a development strategy.

The mainstream debate itself is becoming more sophisticated. The World Bank’s Raising Revenue Right, for example, argues that the challenge is not simply how much revenue emerging and developing economies collect. Efficiency and fairness also matter, and tax systems should support inclusive growth. Pakistan should take the argument one step further.

A fiscal reform cannot be judged solely by what happens to tax collection in the numerator. Policymakers must also ask what revenue measures are doing to investment, productivity, formalisation and GDP itself.

Imagine two policies raising exactly the same amount of revenue. An excise tax on cigarettes makes a harmful product more expensive and is intended to discourage its consumption. A petroleum levy, by contrast, raises revenue from an input used to transport almost everything, including fresh vegetables and fruits from farms to markets. One can therefore discourage harmful consumption; the other can add to the cost of consuming goods we actually want households to afford. Both may look equally successful against a revenue target. They are not equivalent fiscal policies, nor are their development consequences the same.

Creating resources, not just collecting them

This is the deeper significance of the shift from Domestic Resource Mobilisation to Domestic Resource Creation. It should not be interpreted as an argument that governments can simply create unlimited money. Pakistan’s constraints are painfully real: energy, productivity, technology, skills, infrastructure, logistics and foreign exchange cannot be printed into existence.

Indeed, this is precisely the point. The purpose of development policy should be to expand these real productive capabilities, while fiscal policy should support rather than undermine that objective.

Finance and credit can be directed toward removing productive bottlenecks. Public investment can expand infrastructure and human capabilities. Taxation can discourage harmful consumption and rent-seeking, redistribute income and wealth, and help manage aggregate demand. These instruments should work together rather than against one another.

If credit pours into speculative assets while fiscal policy falls disproportionately on formal production and essential inputs, the financial system is encouraging one kind of economy while the fiscal system is squeezing another. That is not resource creation.

An economy worth taxing

Pakistan’s fiscal predicament is real. Debt servicing, public services and development expenditure have to be financed. Better tax administration and enforcement are essential. Those with the greatest capacity to pay should not remain outside the tax system.

But continually asking “where can we find another trillion rupees?” is not enough.

For every major revenue measure, policymakers should also ask: Where will this money come from in the real economy? What behaviour will the measure discourage? What activity will it make more expensive? And will today’s revenue measure enlarge or diminish tomorrow’s productive base?

Those questions transform fiscal policy from a bookkeeping exercise into an instrument of economic development.

The choice is therefore not between taxation and no taxation, nor between fiscal responsibility and monetary expansion. It is between extracting from the economy we have and helping create the economy we need.

A government cannot indefinitely strengthen its fiscal balance sheet by weakening the productive economy beneath it.

Pakistan certainly needs to collect more effectively. But, ultimately, it needs something even more fundamental: an economy worth taxing.