Pakistan's tax-to-GDP ratio remains stagnant at 10% in 25 years: SBP

Pakistan’s tax-to-GDP ratio has stagnated close to 10% in the last two and a half decades which has the potential of around 22.3% percent of GDP.

According to the State Bank of Pakistan Annual Report the tax-to-GDP ratio in Pakistan is also one of the lowest compared to the emerging and developing economies, as well as the regional peers.

Given federal tax collections constitute about 90 percent of the total tax revenue, the State Bank prepared recommendations for federal tax reforms, drawing from the best international practices, with the goal of raising Pakistan's tax-to-GDP ratio.

Proper implementation of the value added tax (VAT)

VAT, one of the most widely implemented consumption-based taxes around the world, is not fully embedded in the tax system of Pakistan.

The environment of skepticism between the taxpayers and the tax authorities weighs on proper functioning of refund and input tax credit process, which is pivotal to VAT’s success. Moreover, the VAT tax base is narrow, necessitating rate increases every now and then, as well as delays in refunds by the tax authorities, to maintain or achieve higher revenue.

To optimize VAT, Pakistan should focus on streamlining the refund process through digital solutions that minimize human intervention and establish a broad-based, low, and uniform VAT on goods and services across all jurisdictions.

Rationalization of the corporate income tax (CIT)

At 29%, Pakistan is among the countries with high standard corporate income tax rates in the world, with certain sectors such as the banking sector subject to even higher rate. When additional taxes, such as super tax, are taken into account, the effective CIT rate turns out to be much higher.

Such kind of taxation distorts economic incentive structure, as well as fosters opportunities for tax fraud, tax evasion, and misreporting. In Pakistan, there are different effective rates for businesses that have led to the resource misallocation and the slowing down of economic growth.

Rationalizing tax expenditure

Tax expenditure is the tax forgone due to exemptions, concessional rates, tax credits, and tax holidays. Pakistan’s tax expenditure, estimated at 4.6%of GDP for FY23, is high compared to the average of 3.2% in low-middle income countries.

As international experiences suggest, preferential treatment does not usually yield intended results. Therefore, all tax expenditures, except those on account of exporters, need to be rationalized and gradually eliminated after carrying out cost-benefit analysis. Moreover, concessions and exemptions granted via statutory regulatory orders instill ad-hocism into tax policy, making it unreliable and unpredictable, with serious consequences for economic incentives.

Simplification of the entire tax system

The tax system is complex and fragmented in Pakistan. Complex tax laws tend to lead to multiple interpretations of tax statutes, giving way to appeals and litigation by taxpayers, as well as rent-seeking opportunities for tax administrators.

A promising step towards simplification includes the recent implementation of the Single Sales Tax Portal/Return system for the telecommunication sector by the FBR in collaboration with the World Bank. This has reduced the number of returns filed by the sector; however, the sales tax rates still vary across jurisdictions. A broader effort to simplify tax laws and harmonize tax rates across sectors and regions is critical for lowering costs and developing a more efficient revenue system.

Efficient use of federal excise taxes (FED)

To increase FED collection, the country should remove distortions caused by varied tax rates and implementation challenges.

Improving tax administration

SBP suggests there is a need to boost FBR’s spending on ICT as percent of total operational expenditure that is currently low.

Digital solutions applied so far, like Track and Trace System and FASTER Plus, are facing operational headwinds. There are issues of integration among these solutions as well, not to mention lack of data governance policies.