Customs duty is not the barrier, GST is

Industry admits 18% GST, not tariffs, hands the informal sector its edge, as import-based revenue falls below 40%

ISLAMABAD:

The National Tariff Policy 2025-30 has remained in the news for the right reasons recently, and it is time to offer a provisional assessment in the light of recent data. The good news first: the policy is working.

One of the underlying objectives of the policy was to stop treating customs tariff as a source of revenue and start treating it as a tool of industrial policy – to provide signals to industry and consumers. One year of experience indicates that the policy is succeeding, as the contribution of import-based revenue has come down from above 50% of overall tax revenue to less than 40%. This has happened despite an increase in import volume and customs revenue, while overall tariffs have gone down – exactly as the research had predicted.

Now the more difficult question is the impact of the tariff policy on industrial output, competitiveness and the overall trade balance. It is too early to comment on a policy that is designed for five years. However, some trends can be observed without necessarily establishing causal relationships. During the first quarter of fiscal year 2026-27 (1QFY27), Pakistan's provisional total goods exports reached $8.42 billion. This marks a 10.84% year-on-year growth compared with $7.59 billion during the first quarter of fiscal year 2025-26 (1QFY26). Agriculture and food rose by 23%, manufacturing, mining and energy by 17%, and textiles and apparel by 6%. This is broadly aligned with the goal of 14% growth due to tariff reforms by 2030.

However, there are strong headwinds against the National Tariff Policy. Pakistan's tariff debate is often framed as a choice between protecting domestic industry and exposing it to foreign competition. The real choice is different. It is whether the state should continue allocating resources through taxes, layers of customs duties, regulatory duties (RD) and additional customs duties (ACD), or establish a predictable, low and broadly uniform regime across industries and value chains.

If the state maintains different rates of taxes and tariffs, including ACD and RD, for different sectors of the economy, we are effectively selecting certain markets over others and obstructing competition. The durable principle is straightforward. Move towards low and uniform taxes and tariffs across industries and within value chains. Customs duties, regulatory duties and additional customs duties should cease to be instruments for selecting sectors, directing resources or shaping investment decisions. Firms should compete on productivity, quality and export capability rather than on their access to protection. A gradual transition may be necessary, but its destination must remain clear, and no sector should be treated as a favourite.

The discussion on whether we should include ACD or RD in our estimates of customs duty is peripheral at best. We should be discussing effective rates of tariffs in all cases. The argument from industry against tariff reduction can be summed up as follows. The local industry is at a cost disadvantage of around 20% to 30% against its foreign competitors on account of energy cost, bad infrastructure, expensive capital, deteriorating rule of law and other frictions like poor regulation. Therefore, to provide a level playing field, the state must provide a tariff protection wall to local firms by the same degree. Hence, some sectors get 10% protection, some get 20%. This is the underlying philosophy of all protectionists. The National Tariff Policy essentially puts a stop to this philosophy and provides a framework towards free and competitive markets.

For the sake of argument, let us consider this point of view sympathetically and extend the argument to include other problems of governance. The problem of corruption, for example, is very "taxing" and "tarrifying". We can add a few percentage points of tariff protection on its account. This is an unending debate. Also, no firm in the same market faces the same cost structure.

However, I want to acknowledge one point made recently at a seminar. The industry says customs duty is now less of a problem, and that they face a greater problem due to the high rate of General Sales Tax (GST), which is 18%, as it provides a huge advantage to the informal sector that does not pay any GST. The solution is not to seek protection from customs duty. The solution is to bring GST down to 5% across the board. This will wipe out the informal market as it will lose the incentive to stay undocumented.

The push for continuation of protective tariffs is not universal. Some sectors, like the steel industry, are adjusting well to the changing dynamics, where all other factors remain the same. A significant reduction in the cost of capital and the emergence of alternative sources of electricity are two major developments of the last two years. This can compensate for higher costs in other factors of production.

Another moot point is the cascading structure. Continuation of the existing cascading structure in tariffs is likely to preserve the existing inefficient structure of the economy. The new tariff policy is gradually reducing overall tariff rates, but it is broadly preserving the cascading. It retains tariff escalation by continuing to apply higher protection at later stages of processing. An overall reduction in tariff rates will reduce the impact of cascading but will not dismantle it.

The industrial policy idea that we should import components, assemble them locally and provide advantage to assemblers by erecting tariff walls on finished goods is deeply flawed. As the failure of the mobile phone device manufacturing policy has shown, a country cannot achieve competitive advantage through assembly and protection only. It must first establish an ecosystem around certain products where it has comparative advantage, and then establish value-chain linkages with leading global producers. This needs removal of tariff walls and investment in research and development (R&D), not support for the emergence of new classes of auto-assemblers.

THE WRITER IS CEO OF PRIME INSTITUTE, AN INDEPENDENT ECONOMIC POLICY THINK TANK