Pakistan’s economy stands at a critical juncture, with a substantial portion of its economic activity residing in the shadows of the informal sector. This predominantly undocumented sector poses a myriad of problems, ranging from inaccuracies in estimating the Gross Domestic Product (GDP) to meager tax collections and a lack of data to effectively allocate targeted subsidies.
Recent statements by prominent figures in the business community, such as the Chairman of the National Business Group Pakistan and the President of the Pakistan Businessmen and Intellectuals Forum, have urged the government to shift its focus towards the formal and documented economy and to bolster tax collection efforts.
One of the glaring issues in Pakistan’s tax system is the heavy reliance on indirect taxes, with a staggering 64% of tax revenues being derived from sales tax, customs duty and federal excise duty. In contrast, only 36% is collected in the form of direct taxes, which is insufficient for a balanced and equitable tax system. This skewed approach to taxation has exacerbated income inequality, pushing 40% of the population below the poverty line.
It is abundantly clear that without a substantial increase in the share of direct taxes in the tax system, Pakistan’s economy will struggle to stabilize. This viewpoint is echoed not only by the local business community but also by international organizations such as the International Monetary Fund (IMF) and the World Bank. The repeated calls from these organizations to reform Pakistan’s tax system and promote documentation should not be ignored.
The crux of Pakistan’s fiscal issues, including a persistent fiscal deficit, inflation, balance of payments problems and a dearth of investment and savings, can be traced back to its faulty tax system. This system disproportionately burdens the poor and hinders economic growth.
The IMF has underscored the importance of collecting taxes from the affluent while safeguarding the welfare of the less privileged through subsidies and other support measures. Achieving this balance necessitates a shift towards a formal, documented economy where everyone contributes to tax collection.
While the government may claim to be expanding the tax base, the reality paints a different picture. Pakistan’s tax-to-GDP ratio languishes at a mere 8.6%, and the fiscal deficit has persisted at 7% for many years, largely due to the fact that over half of the economy remains undocumented. This dire situation has led the business community and regular taxpayers to sound the alarm, warning of the consequences of not collecting taxes from crucial sectors and underperforming in tax collection efforts.
To avert this crisis, Pakistan must prioritize economic reforms, particularly in its tax system. Transitioning towards a formal, documented economy, increasing the share of direct taxes and heeding the counsel of international organizations are crucial steps toward a brighter economic future. Failure to act now will only deepen the economic woes and exacerbate the plight of the country’s most vulnerable citizens.
