The Tax Gap Problem in Pakistan: Broadening The Taxation Base

Pakistan is facing a serious problem in collecting enough taxes to fulfill its development and public service needs. Taxes are basically collected to benefit its public by building roads, providing healthcare, infrastructure, and fulfilling necessities. However, Pakistan is collecting this amount much less than what is required, and this gap between the required taxes and the collected taxes is called the tax gap. According to a recent report of the Federal Board of Revenue (FBR), the tax-to-GDP ratio for the year 2023-2024 is only 9%. This low collection rate after looking into the economic size of the country signals a major shortfall, creating challenges for the government to provide sufficient resources to the public.

Causes of Pakistan’s Tax Gap

There are several reasons leading to the tax gap in Pakistan. The most crucial one is that only a small fraction of people pay taxes; millions of businesses in the country are operating without even registering for taxes, especially in the case of small businesses, and the ones registered, not even they as a whole are paying taxes. According to a report, registered taxpayers recently reached nearly 10 million, but only 4.4 million filed annual returns, and of those, only about 2.3 million actually paid any tax. 

Secondly, tax evasion is a common ongoing problem in countries where wealthier individuals are manipulating the system by paying less than they should. Moreover, if we see that many people are earning without an official record, like freelancers or daily wage earners, it leads to an informal economic system in Pakistan. If we see Pakistan’s tax administration system is also weak, corruption and outdated processes are making the proper collection of taxes difficult. Lastly, Pakistan is heavily relying on indirect taxes such as sales tax, which is affecting the poor more than the rich, making the system less fair, as seen in the ratio demonstrated in the Pakistan Economic Survey 2023-2024.

Why Raising Taxes Alone Doesn’t Work in Pakistan

The easiest solution that comes into one’s mind is to increase tax rates, but actually, this is the most ineffective way and often fails in Pakistan. It can be seen that already several people and businesses are using ways to avoid taxes, so increasing the taxes would provide them with a more solid reason, and they will try much harder to avoid taxes. Meanwhile, the smaller ratio of people who are already paying the taxes will be more burdened, which is unfair and might make them unwilling to pay. 

Also, because Pakistan more heavily relies on indirect taxes and these taxes mostly affect ordinary consumers, normally the lower and middle class families, instead of rich people, who actually should be targeted, but they often find ways to avoid taxes. Although the government has tried to increase direct taxes but still a huge part of it still relies on indirect taxes. So simply raising the taxes won’t solve the problem, but can make it even worse by burdening the wrong group.

Why Broadening the Tax Base Is More Effective

A long-term solution for this problem is to broaden the tax system instead of increasing it, which means to include more people in this tax net. When more individuals and businesses pay the taxes, there will be no need to increase the amount, as that will be automatically collected due to a wider tax base. This will lead to a shift towards a fairer system as the burden will be shared by more instead of a few.  Bringing small businesses and freelancers, basically the informal sector, under a formal setting will allow them to pay reasonable taxes as well as benefit them by providing legal recognition, certain protections, and access to financial services. 

This method will also lead to stability, as when lots of people pay small amounts, the government would not need to rely on large resources. It will also make cheating on tax paying harder and ensure compliance. Primarily, the government would need to depend on indirect taxes and can smoothly shift to direct taxes such as income tax, which will culminate in an unbiased system where everyone will pay according to their ability to pay.

Practical Recommendations

Pakistan can adopt various practical steps to expand its tax net and improve revenue collection, such as

1. Many small businesses and freelancers don’t register due to the process being complicated and expensive, so the government can take steps to provide a simplified process easier for everyone to adopt, and give temporary incentives so more people can join, and taxes can be collected without any pressure.
2. FBR should work more efficiently. This refers to hiring more trained staff, simplifying the process, and also keeping a check on people who should pay the taxes but are not. Stronger enforcement will make it harder for people to avoid taxes.
3. Include digital tools in the process so tracking income can be easy. Digital tax filing, online invoices, and connecting tax records with banks will prevent people from hiding their earnings. It can also be seen in recent plans of FBR, where they emphasized digitisation to help increase the tax‑to‑GDP ratio.
4. At the moment, Pakistan collects a lot of money via indirect taxes, so it is shifting towards the system of direct taxes, which will create proportionality and a balance between rich and poor, ensuring a justified system of taxation.
5. The government should run campaigns to educate people on how their taxes are being utilized, i.e, in the education sector, healthcare sector, etc. This will build a bridge of trust between the government and its people.
6. Wealthier individuals should pay a fair share of taxes based on their income or profit instead of burdening lower-income groups.
7. Tax reforms should not be a one-time exercise. The government should continuously keep a check on tax collection, compliance rates, and the effectiveness of policies, regularly adjusting strategies based on changing economic conditions.

Conclusion

Pakistan’s tax gap is a structural problem that can not be solved only by increasing taxes but requires a more practical approach, which is broadening the tax system. Including more people in the taxation system will ensure fair revenue collection, lead to a reduction in inequality, and provide sufficient resources to the government required to fund public services like education, infrastructure, healthcare, etc. An inclusive tax system will prove to play a key role in reducing Pakistan’s tax gap and supporting sustainable growth. Broadening the tax base will be far more effective than increasing taxes and will soon be at the heart of Pakistan’s tax reform strategy.

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