When tax rates defeat their purpose

There is a point beyond which higher tax rates do not produce higher revenue. In fact, they can do the opposite: shrink the tax base, encourage avoidance, push activity into informal channels, and reduce the very revenue the state hopes to collect. This is not merely a textbook proposition from the Laffer Curve. Pakistan's recent tax experience provides concrete evidence that excessive taxation can defeat its own purpose.

Consider the hefty federal excise duty imposed on business class air tickets in 2025-26. The assumption was simple: affluent travellers would pay more, and the Federal Board of Revenue (FBR) would collect billions from those perceived to have a greater capacity to pay. The result was quite different. As acknowledged by an FBR official during proceedings of the National Assembly Standing Committee on Finance and Revenue, these business class passengers simply stopped buying such tickets from Pakistan. They purchased international tickets from other jurisdictions, upgraded after departure, or found other legal ways to avoid the charge.

The outcome was predictable: Pakistan lost business, airlines and travel agents lost transactions, and the FBR failed to collect the expected revenue. After a year, the authorities effectively conceded that the measure had not worked. The lesson is straightforward. Tax policy should be based on evidence, behavioural analysis and market realities, not on assumptions about who can be made to pay more.

The opposite experience is equally instructive. When the government reduced customs duties, additional customs duties and regulatory duties under the National Tariff Policy last year, critics feared that lower rates would undermine revenue targets. Yet the reduction in tariff rates encouraged more formal imports and widened the base on which taxes could be collected. Instead of depressing customs revenue, the move contributed to a substantial increase in receipts under that head.

This is the essential insight Pakistan repeatedly ignores. Lower, more rational rates can bring activity into the documented economy. Higher rates, especially when they are poorly designed, can drive activity away from Pakistan, into informality, or into other jurisdictions. Revenue is not generated by rates alone; it is generated by economic activity that remains visible, viable and willing to comply.

Real estate taxation offers another example. The Capital Value Tax on Pakistanis owning property abroad required payment on assets already acquired outside the country, often through income that had already been taxed. Similarly, the tax on deemed rental income attempted to tax an imaginary return rather than actual income. Both measures were viewed as unfair by many taxpayers, and neither appears to have generated enough revenue to justify the damage they caused to confidence.

More importantly, such measures contributed to capital flight. Investors compare jurisdictions. If investing in Pakistani real estate entails a tax burden approaching 15%, while comparable investment in Dubai may carry a much lower transaction cost of around 5%, capital will move. Once that happens, Pakistan loses not only immediate revenue but also investment, construction activity, documentation, jobs and future taxable income. The state may win a legal power to tax but lose the market it intended to tax. Thankfully, these taxes have been withdrawn now, but they have done damage.

These examples point to a broader conclusion. Pakistan should seriously consider reducing excessive rates of corporate income tax, personal income tax and general sales tax. A simpler and lower-rate regime can improve compliance, reduce incentives for evasion, encourage savings and investment, and ultimately increase revenue by expanding the tax base. This is not a call for abandoning revenue mobilisation. It is a call for smarter revenue mobilisation.

Pakistan's fiscal debate remains trapped in a narrow framework: if the state needs more money, it must raise rates or keep them high. But recent history shows that this approach often backfires. The Ministry of Finance, the FBR and the IMF should pay closer attention to how taxpayers behave. Supply-side economics may be unfashionable in some policy circles, but Pakistan's own experience shows that incentives matter.

The country does not need more arbitrary taxes designed to punish visible economic activity. It needs a tax system that is predictable, moderate and broad-based. If policymakers are willing to learn from Pakistan's own tax history, they may discover that the path to higher revenue does not always run through higher rates. Sometimes, the surest way to collect more is to tax less, but tax better.

THE WRITER IS FOUNDER AND CEO OF POLICY RESEARCH INSTITUTE OF MARKET ECONOMY (PRIME)