Fuel levy poses bigger inflation risks

The inflationary impact of fuel prices extends well beyond their relatively small direct weight in Pakistan's Consumer Price Index (CPI), as higher petroleum costs feed into transport, logistics, agriculture and business operations before eventually reaching consumers, economists said.

Motor fuel accounts for 2.91% of the urban CPI basket, according to the Pakistan Bureau of Statistics (PBS) data. But the broader transport group has a 6.14% weight, while transport services alone carry a 1.75% weight. In August, motor fuel prices were 24.43% higher year-on-year, while the transport group rose 21.79%. Economist and IBA Assistant Professor Adil Nakhoda said motor fuel's direct contribution to the CPI could appear limited, but its multiplier effect could have a much wider impact on the economy.

"Transport and logistics, energy costs and second-round effects, where businesses pass on the costs to consumers," can significantly amplify the initial impact of higher fuel prices, Nakhoda said. "Fuel is a double-edged sword," said former FPCCI secretary-general and former ICMA senior director research Shahid Anwar. "It is wise as a short-term revenue instrument, but is risky if overused; the real problem begins when an easy-to-collect tax becomes a substitute for difficult tax reforms."

Nakhoda argued that the impact of the petroleum levy on diesel was particularly important because diesel was more closely connected with economic activity than petrol. The levy on diesel should be reconsidered as it had a more direct adverse impact on the economy, he said. Higher fuel prices eventually feed into prices of food and other goods and services through higher distribution and operating costs, said Anwar. He cautioned, however, against attributing all current inflation to petroleum taxation, saying food, energy and other supply-side factors also contributed to price pressures.

Pakistan's national CPI inflation reached 11.15% year-on-year in August 2026, putting cost implications of fuel and transport under greater scrutiny. Despite its inflationary and distributional costs, economists acknowledged that the petroleum levy remained an effective fiscal instrument because it was relatively easy for the government to collect. Nakhoda said the levy was an indirect consumption-based tax that could be collected efficiently at fuel stations. He said it had played an important role in improving Pakistan's fiscal position, contributing to the narrowing of fiscal deficit to below 2.6% of GDP and helping achieve a primary surplus of 2.9% of GDP.

Anwar similarly described petroleum taxation as fiscally justified because of its relatively efficient collection mechanism. But both experts warned that the fiscal convenience of the levy could become problematic if the government began relying on it instead of pursuing structural tax reforms. The government collected a record Rs1.567 trillion from the petroleum levy in FY2025-26, according to Anwar, while the FY2026-27 budget has set a target of Rs1.68 trillion.

Nakhoda warned that the regressive nature of petroleum taxation could eventually undermine economic activity and "crowd out direct taxation as the government takes the easier route to raise revenues". Anwar argued that petroleum taxation should remain predictable and within legal limits, but Pakistan should gradually reduce its dependence on fuel as a major revenue source. The issue is particularly significant because petroleum products already carry a high effective tax burden. The IMF said petroleum products had an effective tax rate of 166%, leaving Pakistan's revenue system heavily reliant on fuel taxation and vulnerable to shocks. The IMF has also noted that Pakistan's tax base remains concentrated in a few sectors, with agriculture, real estate and business services contributing significant economic value relative to their tax collections.

The economists suggest the alternative to a lower petroleum levy should be a broader and more effective tax base rather than simply imposing another tax on existing documented taxpayers. Nakhoda called for greater taxation of currently untapped sectors, a shift towards direct taxation, digitisation and restructuring of the FBR, and stronger action against tax evasion by high-net-worth individuals. The IMF's latest assessment identifies broader taxation of under-taxed sectors, digital invoicing, improved compliance and stronger agricultural income tax enforcement as avenues for revenue mobilisation. It estimates that improving GST efficiency alone could potentially generate around Rs2.1 trillion, equivalent to 1.8% of GDP, based on the FY2024-25 tax base. Nakhoda suggested tax credits for EV adopters and subsidies for poorer motorcycle owners to support the transition, while warning that petroleum taxation should not undermine policies aimed at shifting consumers towards alternative energy.