Introduction

Pakistan's taxation system has come under intense scrutiny in recent years. The country's low and declining revenue yield has been attributed to wide-ranging concessions and exemptions, large-scale tax evasion, and a slack and corrupt tax administration. This has led to the perception of a virtual breakdown of tax compliance in the country.

Improving the tax effort has now become the lynchpin of any future economic reform process. Experience shows that this will require political determination to overcome the resistance from powerful vested interests. In addition, tax collecting agencies such as the Federal Board of Revenue (FBR), will need to undergo fundamental improvements to successfully implement the required changes in tax policy.

The objective of this chapter is to describe Pakistan's taxation system both at the federal and provincial levels, followed by an in-depth diagnosis of the factors contributing to the exceptionally low tax-to-GDP ratio. We also assess the level of tax rates, the magnitude of tax expenditures (revenue losses due to concessions and exemptions in the tax code), and the extent of tax evasion.

Based on this diagnosis, we identify the key elements of a reform package in the areas of tax policy and administration. This set of reforms will promote transparency of the tax system, improve the progressivity of the tax burden, and remove distortions in the allocation of resources in the economy. Importantly, the various measures proposed will help in significantly raising the tax-to GDP ratio.

The taxation system

Allocation of fiscal powers

The major taxes that can be levied at the federal level are given in Part I of the Federal Legislative List (FLL) in the Constitution of Pakistan. As shown in Table 7.1, this includes customs duties (including export duties), excise duties, taxes on income and corporations, sales tax, capital value tax, taxes on natural resources, capacity taxes, and terminal taxes on goods and passengers carried by different modes of transport.