Taxation is the lifeblood of a state, shaping not only revenues but also the social contract between citizens and the government. In Pakistan, this lifeblood runs thin. Despite decades of reforms, the tax system remains narrow, regressive, and inefficient — symptomatic of weak institutions, elite capture, and eroding public trust, as evident from the FBR missing its FY26 first-quarter target by Rs199 billion, despite the IMF’s vigilant oversight.
The facts are sobering. Pakistan’s tax-to-GDP ratio hovers around 10 per cent, among the lowest in the region and well below the global average and MLDA’s tipping point. Only 1.5 per cent of Pakistanis file income tax returns, and among those who do, more than 40 per cent declared nil income in their returns filed for the tax year 2025, as reported in the media — leaving the system heavily reliant on indirect taxation. At the same time, more than half of the economy, with some estimates placing the informal sector as high as 64%, operates outside the tax net altogether. Elites manage to evade or exploit exemptions, while ordinary citizens shoulder the burden through sales taxes and levies on consumption. The result is a system that exacerbates inequality rather than correcting it.
The recent fiscal performance illustrates this imbalance starkly. Salaried individuals, a segment easiest to tax, paid Rs85 billion in the first two months of FY2025-26, 21 per cent more than last year’s Rs70 billion. This amount came despite nominal reductions in tax rates announced in the budget, with the government claiming Rs56 billion in relief for those earning up to Rs3.2 million annually. In reality, the relief was negligible. Last fiscal year, salaried individuals contributed Rs555 billion — 51 per cent more than the previous year. Meanwhile, sectors with far greater earning potential, such as agriculture and real estate, continue to under-contribute. For instance, Punjab set a target of Rs 10 billion from agriculture income tax, even though the sector’s potential is estimated between Rs 450 and 500 billion. Showcasing the entrenched political economy in the fiscal machinery.
Tax systems are judged not only by how much revenue they collect but also by their elasticity and buoyancy — their ability to respond automatically to changes in economic activity. In Pakistan’s early decades, elasticity and buoyancy were impressively high. Choudhry (1962), examining data from 1949–1960, found income tax elasticity at 3.81 and overall tax buoyancy at 5.1 — indicators of a responsive system capable of stabilising the economy. But by the early 2000s, elasticity for overall taxes had declined below unity, meaning that revenues no longer kept pace with growth. The IMF’s 2017 assessment covering 1960–2015 confirmed the trend: while overall buoyancy appeared modestly above one, income tax elasticity had fallen to 0.95, showing a system unable to adapt to structural shifts.
This long-run decline tells a story of governance failure. Frequent ad hoc policy changes, overlapping jurisdictions, and an administrative machinery marred by inefficiency and corruption have eroded resilience. Instead of serving as an automatic stabiliser, the tax system has become a source of instability, forcing governments into repeated borrowing from the IMF, World Bank, and commercial banks.
Yet the governance challenge is not only institutional — it is also behavioural. As CDPR’s recent Insights for Change brief highlights, deep-rooted mistrust of government institutions and cultural attitudes toward evasion shape compliance. Many citizens believe taxes will be misused due to corruption, while observing others evade without consequence normalises avoidance. Even when individuals intend to comply, they face barriers: opaque rules, confusing processes, and liquidity constraints. This reinforces the perception of taxation as a burden rather than a civic duty.
The reliance on regressive indirect taxes is perhaps the most visible sign of this governance deficit. Studies over four decades have shown that Pakistan’s General Sales Tax (GST), once progressive in the early 1990s, has since turned regressive. The burden falls disproportionately on lower- and middle-income households, while wealthier groups exploit exemptions or underreport incomes. Waseem (2023) estimates that fake invoices and over-claimed refunds alone cost the country nearly 40 per cent of potential tax revenues. Meanwhile, restrictive monetary and fiscal controls, high tariffs, and protectionist measures — often introduced in the name of stability — end up widening trade imbalances, encouraging smuggling, and costing the exchequer billions in lost revenue each year.
Governance in taxation is about more than plugging leaks; it is about building legitimacy. Citizens comply when taxation feels fair and delivers value, yet in Pakistan, both are missing. Perceptions of misuse, high compliance costs, bureaucratic hurdles, and opaque rules undermine trust. The governance challenge also extends to the federal-provincial divide: the 18th Amendment expanded provincial roles without matching revenue capacity. The consequences are stark: debt servicing consumes most revenues, squeezing health, education, and infrastructure spending, and perpetuating a cycle of weak services, eroded legitimacy, and low compliance. As Pakistan pursues ambitious growth under the URAAN initiative, aiming for 6–7% GDP growth, 10% annual export expansion, and an increase in women’s labour force participation from 22% to 35%, the challenge lies in aligning fiscal governance with this vision.
What then is the way forward? From a governance perspective, three shifts are critical.
First, the state must commit to equity in taxation. This means reducing reliance on indirect taxes and expanding the direct base to include professionals, traders, and large landholders long exempted. Those with higher capacity must contribute proportionately more. Without this, the system will remain regressive and politically unsustainable.
Second, administrative reforms are indispensable. Digitalisation of records, transparent refund systems, and simplified filing can reduce evasion and compliance costs. Lessons can be drawn from countries like India, where digitisation and AI tools reduced tax evasion by double digits. For Pakistan, integrating AI into audits, fraud detection, and revenue forecasting could help formalise the vast informal sector and rebuild trust.
Third, rebuilding the fiscal social contract is essential. Taxpayers need to see visible returns: investments in local infrastructure, education, and healthcare financed transparently through tax revenues. Citizens are more likely to comply voluntarily when they believe taxes fund collective goods rather than elite consumption. Behavioural interventions — such as participatory budgeting, social recognition of compliant taxpayers, and well-designed digital tools can support this shift, but only if rigorously tested and adapted to Pakistan’s realities.
Ultimately, taxation in Pakistan is a mirror of governance. A regressive, ineffective tax system reflects a state captured by narrow interests and unable to enforce rules fairly. Conversely, a fair, broad-based, and efficient system would signal a state capable of governing inclusively. For now, Pakistan remains stuck in the former.