Reforming Taxes to Rebuild Pakistan’s Economy

You know that feeling when you look at your paycheck and see how much the government deducted in taxes? In Pakistan, that frustration is all too common. The tax system is broken, and it’s holding the country back. Pakistan has one of the lowest tax collection rates in the world. Most people don’t pay what they owe, and the government can’t fund important programs. But that could all change if Pakistan reforms its tax laws. New policies that make the system fairer and easier to understand could transform the economy. With more tax revenue, Pakistan could invest in healthcare, education, infrastructure, and more. Tax reform won’t solve all of Pakistan’s problems overnight, but it would put the country on the path to a more prosperous future. The potential benefits are huge. Pakistan’s leaders have a chance to make history by rebuilding the tax system from the ground up. The time for real reform is now.

Tax-to- GDP Ratio in Pakistan

Pakistan’s tax-to-GDP ratio is among the lowest in the world at just 6.7% in 2023. This means the government collects very little in taxes compared to the size of the economy. For comparison, the average tax-to-GDP ratio for emerging economies is 15% and for OECD countries it’s over 34%.

Clearly, Pakistan’s low tax collection hinders its ability to fund important things like infrastructure, healthcare, and education. The main reasons for Pakistan’s poor tax performance are:

  • A narrow tax base. Only about 1% of Pakistanis actually pay income tax. The government needs to make it easier for more people to pay taxes, especially small businesses and the self-employed.
  • Rampant tax evasion. Billions are lost each year due to under-reporting of incomes, non-filing of tax returns, and other shady practices. The tax authorities must clamp down on tax evasion through audits, penalties, and a simplified tax code.
  • Overreliance on indirect taxes. About 60-70% of tax revenue comes from indirect taxes like sales tax and customs duties. The government should focus more on direct taxes like income and corporate tax. Direct taxes are fairer and more sustainable.
  • Generous tax incentives. The government gives away billions in tax breaks and incentives each year to attract investment. But many of these incentives are unnecessary and mainly benefit large companies and wealthy individuals. It’s time to review the tax incentive regime.

By broadening the tax base, curbing evasion, rebalancing direct and indirect taxes, and rationalizing tax incentives, Pakistan can significantly improve its tax-to-GDP ratio. And a fairer, more efficient tax system will provide the funds to build a stronger, more prosperous Pakistan.

The IMF Recommendations on Taxation

The International Monetary Fund (IMF) recently evaluated Pakistan’s tax system and provided recommendations to improve revenue collection and support economic growth. Their suggestions aim to broaden the tax base, reduce exemptions, and improve administration.

For starters, the IMF proposed increasing the number of people actually paying taxes in Pakistan. Only about 1% of the population files income tax returns. By comparison, the average for emerging economies is over 15%. The IMF suggested lowering personal income tax thresholds to bring more people into the system and increase the number of registered businesses paying corporate tax.

The IMF also recommended reducing the large number of tax exemptions and loopholes that currently exist. By eliminating special tax treatments for certain sectors or groups, the government could increase revenue. For example, the agricultural sector is largely exempt from income taxes, representing a major lost opportunity. Removing some of these exemptions could make the system fairer and more efficient.

Finally, the IMF pointed out the need to strengthen tax administration by improving audit processes, enhancing penalties for non-compliance, and increasing the use of technology. Modernizing systems and compliance monitoring could help reduce tax evasion and increase the reliability of revenue forecasts.

While politically difficult, implementing the IMF’s recommendations on broadening the tax base, reducing exemptions, and improving administration could significantly impact Pakistan’s economy. By increasing government revenue, these reforms would provide funding for essential services and infrastructure to support growth and prosperity over the long run. Overall, a fair, efficient and transparent tax system is vital for Pakistan’s sustainable development.

Impact of Low Tax Revenues on Economic Growth in Pakistan

Low tax revenues have severely hampered Pakistan’s economic growth and development. When a government doesn’t collect enough taxes, it struggles to fund important programs and infrastructure that fuel a nation’s economy.

Lack of Funding for Essential Programs

Without sufficient tax income, Pakistan can’t adequately fund healthcare, education, infrastructure, and other public services that drive economic growth. Pakistan only spends about 2% of its GDP on healthcare and education, well below the global average. This lack of funding for essential programs and social services hinders human development and economic mobility.

Reliance on Foreign Aid and Debt

Pakistan has had to rely heavily on foreign aid and loans to fund its budget, racking up substantial debt. The country owes over $100 billion in external debt, spending a large portion of its budget on interest payments. This dependence on other nations and international lenders weakens Pakistan’s economy.

Weak Infrastructure

Pakistan’s infrastructure—including transportation, energy, and digital networks—requires major improvements to sustain a growing economy. But low tax revenues mean little funding is available for infrastructure investments. Traffic congestion, power outages, and lack of access to technology all make it difficult for businesses to thrive.

  • Improving tax collection should be a top priority. By broadening the tax base and making the system fairer and more efficient, Pakistan can generate much-needed revenue to invest in its economy and people. More funding for healthcare, education, infrastructure, and other public services will help Pakistan unlock its economic potential. While increasing taxes may be unpopular, the economic benefits of a stronger, self-sustaining economy would be substantial. With more tax revenue, Pakistan can break free of foreign aid dependence and take control of its economic destiny.

Evaluating Recent Tax Amendments in Pakistan

As a leading financial advisory firm in Pakistan, Usman Rasheed & Co Chartered Accountants closely monitors new tax policies and amendments to determine their potential impact on businesses and the overall economy. Recent changes aim to broaden the tax base, reduce evasion, and generate higher revenues to fund government operations and public services.

Evaluating the Impact of Recent Reforms

The government has taken steps to simplify tax filing and payment for small businesses and salaried individuals. Digital tax portals make it easier to submit returns, pay dues, and track payments. While increasing convenience, these portals also improve transparency and compliance.

  • Reduced tax rates for small businesses encourage formalization of the economy. More businesses registering and paying taxes boosts government revenues in the long run.
  • An amnesty program allowed individuals and businesses to declare previously unreported assets and income without penalty. By legalizing hidden wealth, the government gained one-time revenues and those assets are now taxable going forward.
  • Reforms aim to reduce over-reliance on indirect taxes like sales tax and customs duties which disproportionately impact lower-income groups. Shifting to direct income and corporate taxes is fairer and more progressive.
  • Anti-evasion efforts like biometric verification, third-party data sharing, and penalties aim to curb under-reporting of income and non-filing of returns. Improved enforcement and a broader tax base will generate higher revenues to fund public services and economic growth initiatives.

While still a work in progress, recent tax reforms and amendments in Pakistan are steps in the right direction. By simplifying compliance, broadening the tax base, and improving enforcement, the government can generate higher revenues to invest in healthcare, education, infrastructure, and other building blocks of economic development. Continued progress on tax policy and administration reform will be key to rebuilding Pakistan’s economy in a post-pandemic world.

The Way Forward: Recommendations for Improving Tax Policy

To improve tax policy and rebuild Pakistan’s economy, several recommendations should be considered:

Simplify the Tax Code

The current tax code is overly complex with too many exemptions and loopholes. Simplifying the code by reducing exemptions and special treatments will make the system fairer and easier to comply with. This could significantly expand the tax base as more people and businesses pay what they owe.

Increase Transparency

There is a lack of transparency in how tax revenue is collected and spent. Providing citizens with more details on tax rates, what their taxes fund, and how funds are allocated can build trust in the system and willingness to pay. Annual reports on how funds were used and the impacts they had may encourage higher voluntary compliance.

Improve Tax Administration

The tax administration system needs an overhaul to reduce corruption, increase efficiency, and take advantage of technology. Investing in an advanced IT infrastructure and providing regular training for tax officials can help reduce errors, limit personal interactions, and decrease opportunities for bribery. Stronger enforcement of existing tax laws will also boost revenue collection.

Incentivize Formalization

Pakistan’s large informal sector pays little in taxes. Incentives like tax holidays, subsidies, and simplified registration processes can encourage small businesses and individuals to formalize. Once in the system, they can be brought into full tax compliance over time. Expanding the tax base by accessing this sector has huge potential.

Broaden the GST

Pakistan’s GST covers only about 60% of the potential tax base. Expanding the GST to more goods and services will spread the tax burden more evenly and raise substantial revenue. While politically difficult, a broader GST at a lower single rate is an efficient way to increase tax intake in a fair manner.

With a combination of policy reforms and administrative improvements, Pakistan can build a tax system that funds economic growth and prosperity. By making the system simpler, fairer and more transparent, people and businesses will be more willing to pay their fair share. With technology and training, collection can become more efficient. And expanding the tax base through formalization and a broader GST can unlock much-needed revenue to invest in Pakistan’s future.

Conclusion

So there you have it, some ideas on how Pakistan can reform its tax policies to boost economic growth. It won’t be easy, but with political will and public support, a fairer and more effective tax system can be put in place. You’ve seen how other countries were able to turn things around by simplifying tax filing, closing loopholes, and making people actually want to pay what they owe. Pakistan has so much potential, with a young, entrepreneurial population and strategic location. By making smart changes to tax laws and administration, the government can unlock that potential and finally give the economy the jolt it needs. The path forward is clear, now it’s just a matter of mustering the courage to take that first step. Here’s hoping policymakers choose to walk down that path sooner rather than later. The future of Pakistan’s economy depends on it.

About Us

Usman Rasheed & Co Chartered Accountants is a leading financial advisory and audit firm in Pakistan, having offices in Islamabad, Quetta, Lahore, Karachi, Peshawar & Gilgit. The firm is providing Audit, Tax, Corporate, Financial, Business, Legal & Secretarial Advisory services and other related assistance to local and foreign private, public and other organizations working in Pakistan

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