Burden of Regressive Taxation

Around the world, there is a trend toward lowering consum-ption taxes, yet Pakistan stands out with its significant dependence on indirect taxes.

The International Monetary Fund (IMF) has recommended that Pakistan’s Federal Board of Revenue (FBR) adopt a flat General Sales Tax (GST) rate of 18% across a broad range of goods, from essentials like food and medicine to everyday items like stationery. This strategy could significantly enhance Pakistan’s financial reserves, potentially increasing the nation’s GDP revenue by approximately 1.3%, translating to about Rs1,300 billion. There is also talk of raising the GST to 19% to boost the FBR’s revenue collection efforts further.

Pakistan’s tax-to-GDP ratio hovers around 10%, markedly below the OECD’s 34% average. Generally, a tax-to-GDP ratio exceeding 15% is crucial for economic growth and poverty reduction. This figure is a pivotal benchmark, signifying a nation’s capability to fund crucial public services and infrastructure that spur development and elevate societal well-being.

Around the world, there is a trend toward lowering consumption taxes, yet Pakistan stands out with its significant dependence on indirect taxes, which account for 60% of its total tax revenue. This is markedly different from OECD countries, where consumption taxes average only 32.1% of the total. With a heavy lean on sales, excise, and customs duties, Pakistan’s fiscal approach underscores a fiscal strategy deeply influenced by its economic challenges and administrative preferences, setting it apart globally.

Pakistan proceeds with its proposed GST hike and shift to a uniform tax rate, which could significantly impact its economy. Notably, the regressive nature of this indirect taxation could heighten, hitting the lower-income groups hardest by increasing their tax burden disproportionately. Additionally, such a shift is likely to exert inflationary pressures, amplifying the cost of living and potentially curbing consumer spending—a scenario that could stymie economic growth.

In general, GST highlights a stark fiscal injustice: whether earning 10,000 PKR or a million, everyone pays the same rate, making this regressive tax fundamentally unfair. A recent empirical analysis found that the top 10% of the richest of Pakistan only contributed 5.9% of total indirect taxes in the same year vis-à-vis 9.3% of the poorest 10%. With an average GST rate of 12% across Asia, Pakistan’s 18% is exceptionally high among developing nations. This rate was increased by 1% by the PMLN government in June 2013, a move that the Supreme Court of Pakistan later annulled, citing its disproportionate impact on lower-income groups. Despite the court’s ruling, the decision was not fully implemented.

Due to the unjust and ridiculous nature of GST, in a bold move aligned with his campaign promises, Malaysia’s former Prime Minister Mahathir Mohammad abolished the 6% GST in 2027, constituting 18% of the government’s revenue. This decision aimed to alleviate the burden of rising inflation and stimulate consumer spending, thereby boosting the Malaysian economy.

It is important to note that with an increase in GST, the cost of both the finished product and the materials used to produce it will go up. The rising cost of raw materials has a multiplicative effect that drives up the cost of finished goods. This is compounded by the current economic environment, where energy price surges, currency fluctuations, and global commodity trends, influenced by events like the COVID-19 pandemic, the Russia-Ukraine conflict, and tensions in the Middle East, are already driving prices higher.

The price will dampen the purchasing power and decelerate economic activity, compounding the effects of an already contractionary monetary policy. It is crucial to note that economic growth above 5% in Pakistan can potentially cut unemployment rates. Conversely, an economic downturn heightens the risk of stagflation, marked by rising unemployment coupled with escalating inflation.

To reduce reliance on indirect taxes, Pakistan should broaden its tax base, enhance tax compliance with modern systems, simplify tax codes, and strengthen the FBR. It should also formalize the informal sector, promote public awareness about tax responsibilities, implement legislative reforms, and increase international cooperation to prevent tax evasion. These strategies aim to create a fairer and more balanced tax system. By implementing these measures, Pakistan can work towards a more balanced and equitable tax system, reducing dependency on indirect taxes that disproportionately affect lower-income groups.

Waqas Shair
The writer is a research associate at the Center of Economic Planning and Development (CEPD), Minhaj University Lahore. He is pursuing his Doctor of Philosophy degree at the University of the Punjab. He can be reached at waqas.eco@mul.edu.pk; waqasshair689

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