Islamabad: Despite numerous reforms, Pakistan's tax-GDP ratio is below the regional average, hampered by the limited scope of its tax system and the widespread adoption of informal economic activity, the Asian Development Bank (ADB) said.
The bank said its latest report, “Taxing policy guides on informal and tax-hard sectors,” and said Pakistan's experience shows that focusing solely on expanding the tax base without ensuring meaningful compliance among existing taxpayers results in minimal revenue growth and increased management costs. Nominal income tax revenue is rising, but there is no growth in practical terms.
The banks recommended that policymakers should consider that simply increasing the number of registered taxpayers is not comparable to a more robust tax system.
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Instead, it may be necessary to focus on targeted approaches that simplify the tax process and promote real participation while enhancing compliance among existing taxpayers. Revenue Authorities operate with limited enforcement resources and require strategic decisions on where they will have the greatest impact on where these efforts should be allocated.
The increase in registered filers has not been translated into meaningful revenue growth, and there is no substantial evidence of non-debt benefits, such as improved economic formalization or increased financial transparency. These policies appear to be less than optimal from a policy perspective. These measures impose compliance costs on taxpayers, and harm government management costs and economic activity.
The lack of measurable benefits against these important costs suggests that current approaches may require reassessment to better fit with sustainable fiscal goals.
Proactive measures to increase tax returns may not necessarily lead to higher income collection or broader economic benefits. To this extent, Pakistan's experience is consistent with that of Rwanda, South Africa, Uganda and other economies. In Pakistan, these policies expanded the nominal tax base, but were unable to generate significant revenue growth as many new filers either reported minimal revenue or remained violated actual tax contributions.
The steady increase in nominal income tax revenues has increased from less than Rs 5,000 crore in 2007 to nearly Rs 1.5 crore in 2021. This upward trend could convince policymakers and the public that reforms aimed at expanding the tax base and improving compliance are working.
However, in effect, tax revenues as a share of GDP have stagnated, fluctuating 3-4% for most periods. This discrepancy suggests that little progress has been made in strengthening compliance and effectively gaining income from the informal, tax-hard (HTT) sector while more revenue is being collected. This lack of real revenue growth indicates that new tax filers contribute little to the overall tax collection, raising questions about the effectiveness of these costly compliance measures.
The report noted that while the total number of tax returners is generally increasing over time, a significant portion of tax returners each year consists of individuals reporting zero tax payments. This highlights key challenges in expanding the tax base.
If income authorities focus too much attention on individuals and businesses who do not fail to file their tax returns, these taxpayers register as filers, but declare taxable income or declare minimal taxable income. Violations within the registered sector are central themes of the report, highlighting that simply increasing the number of filers is unlikely to expand the state's financial capacity.
Existing evidence shows that the tax benefits of formalizing a company are often insignificant. Between 2014 and 2021, Pakistan tripled the size of its formal sector. However, the expansion of the tax base did not lead to corresponding increases in revenue. By 2021, the country had collected roughly the same tax revenue as in 2007.
Pakistan has 7.6% of the minimum stake in the labour force in the PIT register, and Vietnam has more registered taxpayers than individuals in the labour force. In Pakistan, the income tax gap for 2022 was estimated to be about 30% of the total tax collected, and the sales tax gap was estimated to be about 24% of the tax collected.
In recent years, Pakistan has implemented a variety of invasive and costly measures to expand its tax base. These measures aim to increase the costs of operating outside the registration tax system by penalizing non-filing. These measures include the following withholding tax rates:
The distinction between tax returners and non-filer was introduced through the discriminatory withholding laws through the 2014 Financial Act. The law marked the first case where non-filers received a higher withholding tax rate compared to filers. The main purpose of this policy was to encourage tax compliance by imposing higher tax rates on individuals and entities that did not file income tax returns.
Over the years, the government has continued to adjust these fees, introducing new categories for additional withholding.
The bank also said that generally the withholding tax rate applied to non-filers is twice that of filers. However, in some cases, this rate is significantly higher (for example, 20 times more sales to distributors and wholesalers).
Limitations to engage in high value transactions: To further prevent violations of compliance, the government imposes full restrictions on non-filers to purchase property and engage in other transactions. Since 2018, non-filers have been banned from purchasing properties valued at over 5 million rupees.
Additionally, these restrictions apply to the transfer of property ownership, requiring both the buyer and the seller to be registered with the taxpayer for transactions exceeding the specified threshold. In addition to property restrictions, Pakistan has implemented a prohibition on the purchase of vehicles and registration of non-filerers.
Mandatory evidence of professional licenses and tax returns for contracts: To implement compliance within the specialist sector, the government requires that individuals provide proof of tax returns when applying for a specific professional license and government contract.
Consultants, contractors and suppliers who want to work with government agencies must be tax returners, which are often a requirement that aim to formalize contract work with freelances, which are part of the informal economy. Additionally, certain specialized bodies, such as the Bar Council, require that members be registered with taxpayers.
Measures against non-filing are becoming increasingly strict over time. The new proposals currently being conceived include: Exceptions include travel for religious or educational purposes. The proposed annual cash withdrawal limit of Rs 30 million will be charged to non-filers. Non-filers are prohibited from purchasing immovable real estate and vehicles.
Copyright Business Recorder, 2025
