Pakistan’s Weak Tax Collection System: Causes, Consequences and the Way Forward
Outline
Introduction
Taxation as the foundation of a functioning developmental state
Pakistan’s persistent revenue problem despite recent improvements
Narrow and unevenly distributed tax base
Large informal economy and widespread undocumented transactions
Tax exemptions, concessions and preferential treatment
Under-taxation of agriculture, retail, property and other sectors
Complexity of the tax system and high compliance costs
Weak enforcement, tax evasion and administrative shortcomings
Fragmented federal-provincial fiscal structure
Low public trust, weak tax morale and perception of unfairness
Consequences: fiscal deficits, borrowing and mounting debt burden
Debt servicing and crowding out of development expenditure
Distortion of economic incentives and burden on compliant taxpayers
Broadening the tax base rather than repeatedly raising tax rates
Rationalizing exemptions and ensuring horizontal equity
Digitization, data integration and risk-based enforcement
Simplifying compliance and rebuilding the taxpayer-state relationship
Reforming fiscal federalism and strengthening provincial revenues
Conclusion
Essay
No modern state can sustainably provide education, healthcare, infrastructure, security and social protection without mobilizing adequate domestic revenue. Development projects may be announced through ambitious budgets, yet their implementation ultimately depends upon the state’s ability to raise resources from its own economy. Pakistan has struggled with this basic fiscal requirement for decades. Although tax collection has improved recently, the country still taxes a relatively narrow section of its economy while large areas of income, wealth and commercial activity either remain lightly taxed or outside effective enforcement. Consequently, fiscal pressures repeatedly compel governments to borrow, compress development expenditure or impose additional taxes on already documented taxpayers. Pakistan’s weak tax system therefore represents not merely an accounting problem but a fundamental obstacle to sustainable economic development. Its remedy requires broadening the base, eliminating unjustified exemptions, simplifying taxation, strengthening technology-based enforcement, improving federal-provincial coordination and restoring taxpayers’ confidence that taxation is both fair and productive.
Pakistan has made measurable progress in revenue collection, but the starting point remains weak. The Federal Board of Revenue collected about Rs 11.74 trillion in FY2024–25, while the FBR tax-to-GDP ratio increased from 8.8 percent to 10.3 percent. The number of income-tax return filers also rose from around four million to about seven million over three years. [1] These improvements demonstrate that reform is possible, yet they should not obscure Pakistan’s underlying fiscal weakness. The IMF estimated that even after recent gains, total tax revenue including provincial taxes and the petroleum development levy reached only 12.3 percent of GDP in FY2025, remaining below the 25th percentile of comparable emerging and middle-income economies. [2]
The first structural problem is the narrowness of the tax base. Pakistan has historically relied disproportionately upon a relatively limited group of salaried individuals, formal corporations, importers and documented businesses. Large segments of agriculture, property, wholesale and retail trade and parts of the services economy have contributed less than their economic weight would suggest. The IMF’s 2026 assessment found agriculture to be the largest undertaxed sector: it accounted for about 24.6 percent of value added in the underlying analysis while facing an effective tax rate of only 0.3 percent. [2] Such imbalance undermines both revenue and the principle that citizens with comparable ability to pay should face comparable taxation.
The large informal economy makes this imbalance harder to correct. Many commercial transactions remain cash-based and poorly documented, allowing incomes and sales to remain invisible to tax authorities. Earlier PIDE research on Pakistan’s underground economy identified unreported economic activity, weak documentation and cash transactions as important facilitators of tax evasion. [3] Informality creates a vicious cycle: businesses that pay taxes face higher effective costs than competitors that evade them, encouraging otherwise compliant firms to remain small, conceal activity or resist formalization. The consequence is an economy in which remaining outside the formal system may appear commercially advantageous.
Tax exemptions and preferential treatments further narrow the base. Pakistan’s Tax Expenditure Report 2026 estimated tax expenditures of approximately Rs 2.353 trillion for FY2025 through income-tax, sales-tax and customs concessions. [4] Not every exemption is undesirable: certain concessions may protect low-income households, encourage investment or serve legitimate public policy objectives. The difficulty arises when exemptions survive without transparent cost-benefit evaluation, favour particular sectors or create opportunities for avoidance. A tax system riddled with exceptions eventually forces the government to compensate by imposing higher rates elsewhere.
Pakistan’s General Sales Tax illustrates the problem clearly. The standard GST rate is already 18 percent, yet the IMF estimated that the system’s C-efficiency had declined to about 22.8 percent, meaning that only a relatively small proportion of the theoretical consumption-tax base is effectively captured. The Fund attributed this partly to exemptions, concessionary treatment, zero-rating and fragmented taxation of services. [2] Thus, Pakistan does not simply suffer from taxes being too low; in many cases rates are relatively high while the base is too narrow and compliance too uneven.
Complexity itself encourages non-compliance. Multiple taxes, withholding provisions, documentation requirements and differences between federal and provincial systems make taxation intimidating for ordinary citizens and costly for businesses. Academic research based on Pakistani taxpayers found that simplicity of tax compliance had a particularly strong association with voluntary compliance, while perceptions of fairness and government spending also influenced behaviour. [5] A person willing to pay taxes may still rely upon professional intermediaries merely to understand filing requirements. When legal compliance is complicated and evasion appears relatively easy, the system unintentionally rewards informality.
Weak enforcement compounds the problem. Pakistan has traditionally depended heavily upon withholding mechanisms because taxing income directly at source is administratively easier than identifying millions of individuals and enterprises through effective assessment. Yet enforcement that concentrates repeatedly on documented taxpayers cannot substitute for genuine base expansion. Research published in the Journal of Public Economics, using evidence from a Pakistani tax reform, found that under conditions of weak enforcement and high informality, higher taxation caused some firms to under-report earnings, shift legal form or move towards informality; the behavioural response was large enough in the studied reform to reduce revenue. [6] The lesson is important: Pakistan cannot solve weak collection merely by increasing rates on those whom the state already knows how to tax.
Fiscal federalism presents another structural difficulty. Following devolution, provinces have major expenditure responsibilities, particularly in education, healthcare and local service delivery, while significant revenue mobilization remains concentrated at the federal level. A 2026 World Bank assessment found that the division of the tax base across multiple jurisdictions increases compliance costs and constrains revenue mobilization, while provincial own-source revenue remains insufficient relative to expenditure responsibilities. [7] PIDE has similarly argued that heavy provincial dependence upon federal transfers can weaken incentives to undertake politically difficult own-source revenue reforms. [8]
Yet taxation is not simply a matter of legislation and enforcement; it is also a social contract. Citizens are more willing to contribute when they believe others are paying fairly and when taxation produces visible public services. Pakistani research has found government trust and perceptions of tax justice to be significant determinants of compliance behaviour. [9] When taxpayers see poor schools, inadequate hospitals, deteriorating infrastructure or perceived privileges for influential groups, taxation may be viewed less as civic contribution and more as compulsory extraction. Enforcement is necessary, but sustainable tax compliance requires legitimacy as well.
The consequences of weak revenue mobilization extend across the economy. When recurring expenditure and development needs exceed sustainable domestic resources, governments must borrow or reduce expenditure. Pakistan’s total public debt stood at approximately Rs 83.3 trillion by the end of March 2026, including around US$92.2 billion in external public debt. [10] It would be incorrect to attribute this debt entirely to tax weakness, because exchange-rate movements, interest rates, development financing and expenditure choices also matter. Nevertheless, persistent revenue inadequacy is an important contributor to repeated fiscal deficits and financing requirements.
Heavy borrowing then generates another burden: debt servicing. The State Bank of Pakistan reported that mark-up payments in FY2025 were equivalent to 49.4 percent of total government revenue and 7.8 percent of GDP. [11] When such a large portion of public resources goes towards servicing existing debt, fewer resources remain available for schools, hospitals, water systems, universities, transport and other development priorities. The fiscal problem becomes self-reinforcing: weak taxation leads to borrowing, borrowing creates debt-service obligations, and debt service further reduces the resources available for productive investment.
A weak tax system also damages fairness and economic competitiveness. When agriculture, property, retail or informal enterprises escape effective taxation, governments often rely more heavily upon indirect taxes and deductions from easily identifiable taxpayers. This creates resentment among compliant citizens and encourages further evasion. Businesses that honestly document transactions can be placed at a competitive disadvantage against firms operating outside the system. Thus, tax evasion is not a victimless act; it transfers the burden towards those who comply and weakens the state’s capacity to provide services to everyone.
The first major reform must therefore be broadening the tax base rather than repeatedly raising rates. Agriculture income, retail trade, property transactions and professional services should be taxed according to actual income and capacity to pay, while genuinely low-income households and subsistence farmers remain protected. Provinces have already amended agricultural income-tax regimes, but the IMF has reported implementation delays and enforcement challenges. [2] Effective implementation requires land and income databases, digital filing, data sharing with FBR and politically neutral enforcement.
Second, exemptions should be subjected to transparent periodic review. Every concession should have a clearly stated policy purpose, estimated fiscal cost and expiry or review date. Exemptions that mainly benefit narrow interests without producing measurable economic or social benefits should be withdrawn gradually. The objective is not simply to collect more revenue but to create horizontal equity: similar incomes and economic activities should face similar tax treatment.
Third, Pakistan must accelerate digitalization. Bank information where legally permissible, property records, vehicle registrations, utility consumption, customs data, company records and provincial databases can be integrated to identify large discrepancies between declared income and economic activity. The World Bank’s Pakistan Raises Revenue project has already supported expanded IT infrastructure, data tools and a broader taxpayer base, including about 1.5 million new taxpayers under project-supported reforms. [12] Digital invoicing and electronic payments can further reduce the space for unrecorded transactions while limiting discretionary contact between taxpayers and officials.
Fourth, enforcement should become intelligence-based rather than harassment-based. Modern tax administrations cannot audit everybody; they use data analytics to identify high-risk cases. Serious evasion should carry predictable penalties, but compliant taxpayers should experience minimum unnecessary interaction with tax officials. Faster dispute resolution is equally important because tax demands locked in years of litigation do not strengthen the treasury and damage business confidence.
Fifth, compliance must become dramatically simpler. Small enterprises should have straightforward return forms, clear thresholds and easily understandable rules. Federal and provincial authorities should harmonize definitions, registration and payment procedures wherever constitutionally possible. Research on Pakistani taxpayers indicates that simplicity, fairness and perceptions about government spending materially influence voluntary compliance. [5] A taxpayer should not need to become a tax-law specialist merely to fulfil an ordinary civic obligation.
Sixth, fiscal federalism must reward revenue effort. Provinces should strengthen taxation of property, agriculture and services while gradually becoming less dependent upon federal transfers for every fiscal need. The federation and provinces require interoperable tax systems and systematic data sharing rather than competing bureaucracies. At the same time, any reform of the NFC architecture should preserve provincial autonomy while creating stronger incentives for own-source revenue mobilization and improved service delivery. [8]
Finally, greater taxation must be accompanied by greater accountability. Citizens should be able to see how revenue is spent through transparent budgets, procurement systems and easily accessible public expenditure dashboards. Better schools, reliable hospitals and functional infrastructure are themselves instruments of tax reform because they demonstrate the value of contributing to the state. Pakistan must therefore move from a coercive conception of taxation towards a reciprocal social contract: citizens pay fairly, and the state spends fairly.
Conclusion
Pakistan’s weak tax collection system is neither the result of a single administrative failure nor something that can be repaired through occasional increases in tax rates. It reflects a deeper combination of a narrow tax base, informality, exemptions, complexity, uneven enforcement, fragmented fiscal federalism and weak public trust.
Recent increases in FBR collection and the tax-to-GDP ratio demonstrate that improvement is possible, but Pakistan still collects substantially less than its economic and developmental requirements demand. As long as large sectors remain undertaxed while compliant taxpayers carry an excessive burden, the tax system will struggle to generate both revenue and legitimacy.
The consequences reach far beyond FBR’s annual collection target. Weak domestic revenue contributes to fiscal deficits and borrowing, while growing debt-service obligations restrict the resources available for education, healthcare, infrastructure and social protection. A state that repeatedly borrows to meet recurring needs eventually compromises both economic sovereignty and future development.
The solution is therefore not simply more taxation, but better taxation. Pakistan must broaden the base, tax comparable incomes equitably, rationalize exemptions, document economic activity, integrate federal and provincial databases, expand digital invoicing, strengthen risk-based enforcement and make compliance easier for honest taxpayers.
Equally important, government must demonstrate that taxes are translated into visible and efficient public services. Compliance cannot rest permanently upon fear of penalties; it must eventually be supported by trust that the system is fair and that public money is used responsibly.
Pakistan’s development ambitions will remain vulnerable as long as they depend excessively upon borrowed resources. Sustainable development requires a sustainable fiscal state. A country that wishes to finance its own schools, hospitals and infrastructure must ultimately build a tax system in which those capable of contributing are brought fairly into the net, evasion becomes difficult, compliance becomes simple, and citizens can see the public value created by the taxes they pay.
References
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