A new fiscal compact

PAKISTAN’S forthcoming budget confronts a difficult reality. The formal economy is overtaxed, investment remains weak, exports struggle to compete regionally, and salaried individuals face rising tax burdens even as inflation erodes purchasing power. Yet meaningful tax relief appears fiscally difficult at a time when economic growth is slowing, debt servicing costs remain elevated and IMF discipline continues to constrain policy choices.

This dilemma has triggered an important national debate. If Pakistan wishes to reduce the burden on documented businesses and taxpayers, how can it compensate for the resulting loss in revenue? The answer lies in recognising that Pakistan’s fiscal challenge is no longer simply one of raising taxes. It is increasingly about how all parts of the state can share responsibility for reviving industry, employment and economic growth. This responsibility includes the provinces in which employment is potentially created.

If the government were to fully align Pakistan’s tax regime with more competitive regional structures in a single year — reducing corporate tax from 29 per cent to 25pc, withdrawing super tax, eliminating capital value tax and restoring exporters to a lower presumptive regime — the estimated fiscal cost could exceed Rs1.3 trillion annually. Pakistan’s finances cannot absorb such a shock immediately.

Borrowing is not a realistic solution. Interest rates are likely to remain elevated amid renewed inflationary pressures following the Iran conflict and energy market disruptions. Debt servicing already consumes a dangerously large share of federal revenues. Public sector development expenditure has already been repeatedly compressed, leaving little room for further cuts without undermining infrastructure and long-term productivity.

Pakistan’s fiscal challenge is no longer simply one of raising taxes.

Compounding matters further is the likelihood of slower economic activity in FY26/27, which could weaken tax collection even before any relief measures are introduced.

Yet the status quo is equally unsustainable. Pakistan’s tax structure increasingly penalises documentation, formal employment and investment. Exporters compete internationally against firms operating under lower and more predictable tax regimes in countries such as India, Bangladesh and Vietnam. Formal companies bear corporate taxes, super tax, cascading indirect taxes and multiple withholding levies while much of the informal economy remains outside the effective tax net.

The salaried class faces similar inequities. Inflation and stagnant tax thresholds have steadily pushed middle and upper-middle income professionals into disproportionately high tax brackets. Pakistan’s salaried employees — among the easiest taxpayers to document and collect from — now shoulder a growing share of the direct tax burden while large segments of agriculture, retail and real estate remain lightly taxed.

This is not merely unfair; it is economically counterproductive. Excessive taxation of documented income discourages formalisation, weakens consumption, accelerates migration of skilled professionals and undermines confidence in the system itself.

The forthcoming budget should therefore begin a phased rationalisation of salaried taxation. Tax slabs and thresholds should better reflect inflation and cost-of-living realities, while marginal rates on middle-income earners should be moderated over time. Such reform is not simply relief; it is necessary to sustain the formal economy and preserve Pakistan’s skilled workforce.

But meaningful reform cannot be financed through federal measures alone. If the country wishes to revive industry and employment, the burden of adjustment must be shared more broadly between the centre and the provinces. Sectors and activities that have historically remained undertaxed must contribute more meaningfully so that the documented sector is no longer expected to carry a disproportionate share of the fiscal load.

Agriculture income taxation is the clearest example. Large-scale agriculture cannot indefinitely remain outside effective taxation. Better land records, withholding mechanisms at commodity markets, realistic valuation of commercial farming and stronger enforcement can gradually improve both revenue mobilisation and fairness.

Urban property taxation also remains severely underdeveloped relative to regional norms. Improved valuation systems, GIS mapping and better collection mechanisms could expand revenues while discouraging speculative holding of urban land.

The retail and wholesale sectors likewise require a more pragmatic approach. Repeated attempts to fully document retailers have produced only limited success. Pakistan’s fragmented retail economy remains difficult to tax effectively through conventional sales tax administration. In this context, greater use of the Third Schedule mechanism — under which sales tax responsibility shifts upstream to manufacturers and importers at fixed retail values — may become necessary for selected sectors.

However, Third Schedule expansion should not become a substitute for broader documentation. Overreliance on upstream taxation risks placing an even greater burden on the formal manufacturing sector while downstream informality persists. The longer-term objective must remain gradual documentation of retail and wholesale activity through digital invoicing, electronic payments, simplified turnover-based taxation and point-of-sale integration.

At the same time, expenditure rationalisation remains essential. Pakistan can no longer afford low-return projects, administrative excesses or continued energy-sector inefficiencies that crowd out productive investment. Better targeting of subsidies, lower transmission losses, improved recoveries and reform of costly capacity payment structures could generate substantial medium-term fiscal savings.

Non-tax revenues must also become part of the adjustment strategy. Privatisation proceeds, land sales, stronger dividends from profitable state enterprises and better recovery of government receivables can help cushion the transition towards a more competitive fiscal regime.

The IMF, too, should recognise that durable fiscal stability cannot come indefinitely from extracting more from a shrinking pool of compliant taxpayers. Stability without growth eventually becomes self-defeating.

Pakistan now needs a broader economic compact — one in which the responsibility for rebuilding growth, employment and competitiveness is shared across sectors of the economy rather than borne disproportionately by the formal industrial and salaried classes or slowly by the federal government. Without such a shift, every future budget may continue to stabilise the present but weaken the future.

The writer is a former CEO of Unilever Pakistan and of the Pakistan Business Council.

Published in Dawn, May 16th, 2026