Why consumption-led growth is failing
Pakistan's economy is trapped in a structural bind: a consumption-led growth model drives up imports, suppresses exports, and widens tax revenue shortfalls, while an overreliance on regressive withholding taxes – deducted at source from salaries, imports, and production – burdens consumers and stifles progress.
In the first half of fiscal year 2024-25, the Federal Board of Revenue (FBR) missed its Rs6.009 trillion tax collection target by Rs386 billion, with the tax-to-GDP ratio stagnating at 10.8%, far below the Asia-Pacific average of 19.3% and the 15-20% achieved by fast-growing economies like India, Vietnam, and Malaysia. As a business expert, I argue that Pakistan's tax system, riddled with exemptions and propped up by high customs duties and withholding taxes, is fundamentally flawed.
The perceptions of many so-called tax experts – who defend exemptions and indirect taxes as necessary for equity or simplicity – are empirically unsound and detrimental to growth. This article quantifies the distortions of Pakistan's consumption-led economy, identifies key Statutory Regulatory Orders (SROs) granting exemptions that must be withdrawn and proposes a roadmap to align the tax-to-GDP ratio with dynamic economies.
Pakistan's economy is overwhelmingly consumption-driven, with private consumption accounting for 83% of GDP in 2022-23, compared to 65% in Vietnam and 60% in Malaysia (World Bank, 2022). This reliance fuels demand for imported goods, with Pakistan's import bill reaching $55.3 billion in FY23, while exports stagnated at $27.7 billion, resulting in a $27.6 billion trade deficit.
Rising consumption drives imports of luxury goods, electronics, and raw materials, depleting foreign exchange reserves to $9.4 billion by December 2024. Meanwhile, high production costs and tax distortions suppress exports, with Pakistan's export-to-GDP ratio at a mere 10%, compared to 25% in Vietnam.
When consumption is curtailed – through austerity or inflation (6% in FY25) – tax revenues collapse. Sales tax, heavily reliant on consumer spending, fell short by Rs286 billion in July-December 2024, as reduced consumption shrank taxable transactions. This volatility underscores the fragility of Pakistan's tax system, which depends on consumption rather than a stable, broad-based tax net.
Fast-growing economies like India balance consumption with investment-led growth, taxing income and production equitably. Pakistan's consumption-led model, exacerbated by tax exemptions, costs the exchequer over Rs1.7 trillion annually, equivalent to 27% of the FBR's total collection in FY23.
Regressive burden of WHT
Pakistan's tax system heavily relies on withholding taxes, which account for 65% of direct tax revenue (Rs1.98 trillion of Rs3.06 trillion in FY23). These taxes, deducted at source from salaries, imports, exports, and transactions, are passed on to consumers, inflating prices and eroding purchasing power.
The salaried class, just 2% of the workforce, contributes 18% of income tax, facing rates up to 35% (Finance Bill 2024), while sectors like agriculture (23% of GDP) contribute only 0.6% to revenue. Withholding taxes on imports (eg, 5.5% on raw materials) and factory-stage production (eg, 1-2% on manufacturing) are embedded in product prices, effectively taxing the poor and middle class indirectly.
For instance, a 5.5% withholding tax on imported edible oil increases retail prices by 8-10% after supply chain markups, contributing to a 30% rise in food prices in FY24. Similarly, a 1% withholding tax on exports (SRO 1125(I)/2011) raises production costs, making Pakistani textiles less competitive than Bangladesh's, where export taxes are minimal.
This regressive structure contradicts claims by tax experts that withholding taxes simplify collection. Instead, they burden consumers, discourage exports, and widen the tax shortfall, as evidenced by the Rs442 billion combined shortfall in indirect taxes in H1 FY25.
Exemptions: undermining tax base
Statutory Regulatory Orders (SROs) granting exemptions in income tax and sales tax are a primary driver of Pakistan's low tax-to-GDP ratio. These concessions, often justified as relief for essentials or incentives for growth, benefit entrenched interests and cost billions.
Income tax contributes 3.7% of GDP (Rs3.06 trillion in FY23), but only 2.74 million individuals — 1.3% of the population — file returns. Exemptions shrink the tax base, costing Rs1.2 trillion annually. Key SROs include:
SRO 1062(I)/2013: Exempts agricultural income. In FY23, agriculture contributed Rs36 billion, costing an estimated Rs1.2 trillion in forgone revenue at a 10% effective rate. This benefits large landowners, not small farmers. SRO 947(I)/2008: Grants exemptions to export-oriented industries, notably textiles, costing Rs150 billion annually.
SRO 1125(I)/2011: Reduces withholding tax rates for distributors and retailers, costing Rs80 billion annually. Retail tax evasion persists despite POS integration initiatives.
Sales tax, at 41% of FBR revenue, is undermined by exemptions. Key SROs include: SRO 190(I)/2002: Exempts foodstuffs, costing Rs200 billion annually. A 5% GST, as in India, could yield Rs100-150 billion.
SRO 837(I)/2021: Zero-rated pharmaceutical inputs and equipment, costing Rs50 billion. Over-invoicing abuses this.
SRO 563(I)/2022: Exempts plant and machinery, costing Rs120 billion. This favours large firms, while SMEs are taxed fully.
Exemptions cost Rs1.7 trillion annually. Agriculture's exemption has not boosted productivity, and food exemptions fail to curb price hikes. Withdrawing these could add Rs1 trillion, narrowing the fiscal deficit (6.7% of GDP in FY25).
To offset exemption losses, Pakistan relies on customs duties (17% of FBR revenue). High duties (20% average) distort the economy. Duties on raw materials raise production costs and reduce export competitiveness. High tariffs fuel smuggling, costing Rs300 billion annually in electronics and textiles.
Duties also inflate prices, contributing to inflation. For example, a 20% duty on hats was reduced to 5%, but selective relief creates inequities. Fast-growing economies use moderate tariffs and broad-based VATs to balance revenue and trade. Pakistan's reliance on customs is unsustainable.
Many tax experts defend exemptions and withholding taxes as necessary. These claims are flawed. Agricultural exemptions benefit large landowners, not small farmers. Food exemptions don't reduce prices. Withholding taxes inflate costs and reduce competitiveness. High duties disincentivise exports and fuel smuggling. FBR data shows direct taxes outperformed targets in H1 FY25, while indirect taxes missed, proving that broadening direct taxes is more effective.
To achieve a 15-20% tax-to-GDP ratio, Pakistan must implement bold reforms: Withdraw SROs – SRO 1062: Tax agricultural income above Rs600,000; SRO 190: Apply 5% GST on food; SROs 947 and 1125: End export and retail exemptions; SROs 837 and 563: Phase out pharmaceutical and machinery exemptions.
Reduce withholding taxes: Lower rates on salaried class and exports to 10-15%. Broaden the tax base: enforce Section 114B to penalise non-filers and expand the filer base; integrate all retailers into the POS system. Lower customs duties: Reduce tariffs to 10%, boosting trade. Digitalise and reform: Automate FBR processes and restructure it into an autonomous body.
Withdrawing SROs could generate Rs1 trillion. Tax base expansion could add Rs380 billion. Customs reform could add Rs100 billion. Combined with the current Rs6.15 trillion baseline, Pakistan could collect Rs7.63 trillion, raising the tax-to-GDP ratio to 14.5%. With sustained reform, it could reach 16-18% by 2030.
The current strategy – raising taxes on the salaried class while preserving exemptions – fuels inflation, emigration, and inequality. Instead, the government must shift from indirect taxes to direct taxes, eliminate discretionary SROs, and invest in digitalisation to streamline collection and reduce evasion.
THE WRITER IS A TRADE EXPERT WITH OVER 35 YEARS OF EXPERIENCE IN INTERNATIONAL TRADE, A COMMODITIES CONNOISSEUR & FORMER VICE PRESIDENT OF KCCI