How tax evasion undermines Pakistan’s progress

Amidst Pakistan’s vibrant bazaars, expanding industrial corridors, and booming digital economy lies an invisible fault line — the widespread evasion of taxes through fraudulent business practices. It is often treated as a minor white-collar transgression, but tax evasion is anything but victimless.

Every forged invoice, undeclared sale, and under-the-table deal chips away at the country’s economic foundation, undermining essential services, deterring foreign investment, and deepening inequality. This silent erosion of state capacity robs the nation of the very revenues that could transform lives, finance education, power hospitals, and build infrastructure that connects people and markets. In essence, tax fraud not only steals money from the treasury but also deprives people of opportunities.

Pakistan faces a crisis not only of insufficient tax rates but of systemic noncompliance. The numbers are stark: while there are over 300,000 industrial electricity connections in the country, only around 87,900 companies filed tax returns in 2024–25. With just 5.8 million total filers — a decline from previous years — the gap between potential and actual compliance remains wide, as estimates suggest that over 15 million should be in the tax net. The resulting tax compliance gap is estimated at a staggering PKR 5.8 trillion annually, around 6.9% of the GDP. This is not a shortfall in digits — it is a deficit in roads, schools, clean water, and social protection.

At the heart of this problem are numerous fraudulent practices that continue unabated. One of the most damaging is the use of flying invoices — fictitious purchase records used to claim undue input tax credits or inflate costs. These invoices are often circulated through a web of shelf companies — entities created only to facilitate ghost transactions — that vanish before audits can catch up. This manipulation is not confined to the shadows; it penetrates mainstream sectors where compliance is critical. In manufacturing, trade, and even services, tax returns often reflect a fraction of the real economic activity, and undeclared sales or stock misreporting remain rampant.

Businesses also frequently misclassify goods and services to fall under lower tax brackets or avoid duties altogether. High-value imports are labeled under irrelevant HS codes, and services that are taxable are hidden under exempt categories. This kind of misclassification is both deliberate and strategic, designed to exploit the limited cross-verification capacity of revenue authorities.

Making matters worse is the country's still-prevalent cash-based economy. Without digital integration and traceable transactions, entire chains of commerce operate off the books. Many businesses, particularly in retail and construction, do not use point-of-sale systems or digital ledgers, making evasion all too easy and detection nearly impossible.

While fraudulent intent is a core issue, structural disincentives for compliance also play a part. Pakistan has one of the highest corporate tax rates in the region — 29% for non-banking public and other companies, 39% for banking companies, with additional super tax rates ranging from 1% to 10% for high-income firms. Although small companies benefit from a 20% rate, the burden of complex filing processes, inconsistent audit practices, and steep compliance costs discourages smaller firms from entering the formal economy.

This situation is compounded by the chronic non-issuance of legitimate refunds, particularly in export-oriented sectors. Even tax-compliant companies face significant liquidity problems when billions of rupees in refunds remain stuck for months or years. This erodes trust and pushes businesses to recoup lost funds by underreporting their liabilities in the future.

Adding to the frustration is the lack of transparency in regulatory proceedings. Tax audits and enforcement actions remain opaque, inconsistent, and vulnerable to discretion or manipulation. There is no real-time visibility for taxpayers to track their cases or contest unfair assessments without long delays and legal costs. This absence of predictability not only invites corruption but also deters foreign investors who view institutional opacity as a major risk.

Weak enforcement compounds these problems. Despite the scale of evasion, criminal prosecutions are rare, and penalties are too low to deter serious fraud. Most investigations rely on outdated paperwork, not data-driven systems, and the pace of reform within enforcement agencies has been sluggish at best. While the private sector adapts rapidly to technology, tax authorities continue to rely on manual procedures that leave them several steps behind the fraudsters.

A deeper structural flaw lies in the fragmented nature of Pakistan’s tax administration. The federal revenue body, FBR, operates largely in isolation from provincial authorities like Punjab Revenue Authority, Sindh Revenue Board, Khyber Pakhtunkhwa Revenue Authority, and Balochistan Revenue Authority. This lack of integration allows businesses to exploit jurisdictional loopholes — shifting income between regions, misreporting figures to different tax bodies, and selectively filing based on enforcement risk. There is no unified taxpayer record or cross-agency data matching, allowing leakages to persist even when non-compliance is evident.

These practices and systemic failures create a destructive economic cycle. Honest businesses that pay their taxes find themselves at a competitive disadvantage, unable to match the prices of tax-evading peers. The incentive to cheat becomes systemic, forcing more companies into the grey economy just to survive. As the base of honest taxpayers shrinks, governments resort to raising rates on the few who remain compliant, pushing them to evade, too. The cycle perpetuates itself, draining both economic potential and moral credibility.

The consequences reach beyond domestic borders. Weak tax enforcement signals poor governance to global investors and credit rating agencies, limiting Foreign Direct Investment (FDI) and raising borrowing costs. Meanwhile, multinational corporations exploit regulatory gaps to shift profits offshore, depriving the country of taxes on its most successful businesses. But perhaps the most corrosive effect is on public trust. When ordinary citizens see large firms operate with impunity while they face deductions on every paycheck, the social contract fractures. People lose faith in the system, and voluntary compliance — the bedrock of any modern tax regime — begins to collapse.

The solutions are neither unattainable nor untested. Countries like Rwanda, Mexico, and Estonia have shown that digital transformation, institutional reforms, and clear enforcement can radically improve tax compliance and public revenue. Pakistan, a country challenged for FDI, needs to embrace a similar path: implementing mandatory digital invoicing, automating audits, integrating federal and provincial tax systems, simplifying compliance for SMEs, and cracking down on repeat offenders with real penalties. These foundational changes are necessary to rebuild trust, stimulate growth, and reclaim public resources.

Every day that tax fraud goes unchallenged, is another day for the country to drift further from prosperity.

*Anwar Kashif Mumtaz is a Supreme Court advocate and president of Pakistan Tax Bar Association with 25+ years in corporate and tax law