Tax design, not rates, is Pakistan's real problem

Pakistan's tax debate often starts in the wrong place. We argue over rates, targets and quarterly shortfalls, but avoid the central problem: the design of the tax system itself.

A tax regime that depends on a largely undocumented retail economy to collect revenue will keep producing distortion, leakage and resentment. That is exactly what has happened under the current General Sales Tax framework. The result is a system that is formally broad, administratively heavy and practically porous. It burdens those who are visible, compliant and documented, while allowing large parts of the market to stay outside the net.

This is why Pakistan needs to stop pretending that more punitive taxation at the retail end will somehow produce mass documentation. The evidence points the other way. Unregistered retailers face a 4% further tax, and non-filers face an additional advance income tax burden, yet the share of undocumented retail activity remains overwhelmingly high.

If years of higher penalties, schemes, notices and enforcement drives have not altered this reality, then policymakers must admit that the problem is not weak resolve. It is poor architecture. In practice, these taxes do not discipline the informal economy as intended. They often shift the burden upwards to the formal sector, especially manufacturers in fast-moving consumer goods. Producers that are already registered, audited and exposed to enforcement pressure end up absorbing costs to preserve shelf space and market access.

The informal retailer stays largely untouched, the state still struggles to capture full revenue, and the compliant business pays the price for everybody else's non-compliance. This is not tax reform. It is a policy arrangement that penalises formality.

A more realistic alternative already exists within Pakistan's own legal framework. The Third Schedule of the Sales Tax Act offers a structurally cleaner route for certain categories of consumer goods. Under this method, tax is charged on the printed retail price and collected upfront at the manufacturing or import stage.

The rate does not need to rise. What changes are the collection point and the visibility of the tax base. In a market where downstream informality is entrenched, this matters far more than another round of threats or another registration campaign.

There is another reason this matters: consumers. Printed retail prices do more than simplify tax administration. They create transparency in everyday markets where arbitrary pricing is common and weak enforcement is the norm. For essential household items, especially in smaller towns and low-information markets, a visible price on the pack is a modest but meaningful form of consumer protection. It reduces room for unjustified markups, improves enforcement by provincial authorities and gives households a reference point in an inflationary environment where every rupee counts.

The current debate around expanding the Third Schedule to products such as cooking oil, milk, dairy items, flour, frozen foods and condiments is therefore worth taking seriously. Recent reporting in The Express Tribune has highlighted industry concerns that the existing GST chain is too complex, too vulnerable to leakages and too unfair to firms already inside the tax net.

It has also pointed to the practical value of collecting the same 18% tax earlier in the supply chain, rather than trying and failing to squeeze compliance from the last, weakest and least documented point in the market. Still, the Third Schedule should not be romanticised as a complete answer. It is best seen as a transitional correction, not a substitute for deeper reform. Pakistan ultimately needs a GST system that encourages invoice-based compliance, aligns incentives across the chain and uses digital tools to make formal participation worthwhile.

A durable tax system cannot rely forever on coercion at one end and exemptions at the other. It must reward documentation for producers, retailers and consumers alike.

The immediate policy choice, however, is clear. If the government wants to protect revenue, reduce distortions and support the formal economy before the next budget cycle, it should expand the Third Schedule for carefully selected packaged essentials and begin phasing out instruments that merely punish compliant businesses for selling into an informal market. Pakistan does not need a harsher GST regime. It needs a smarter one – one that recognises economic reality and builds compliance around it rather than against it.

Third Schedule expansion serves as an immediate, technically viable solution to protect formal manufacturers. However, it cannot be presented as a long-term reform and can also be counter-productive for the purpose of value chain documentation. Additionally, the structural flaws that limit the self-enforcing mechanisms need to be addressed to increase formalisation and minimise revenue leakages.

THE WRITERS ARE AFFILIATED WITH PRIME INSTITUTE, AN INDEPENDENT ECONOMIC POLICY THINK TANK