The drastic shift from being a ‘geostrategic asset’ to a ‘pauper Frankenstein,’ coupled with the pursuit of inordinate adventures, has frequently pushed Pakistan to the brink of insolvency.
According to Budget 2024-2025 (B-25), the country’s chronic reliance on external receipts is set to reach Rs. 5.6 trillion in the coming year. Despite the external debt stock standing at Rs. 36 trillion (34% of GDP) out of the total debt & liabilities of Rs. 77 trillion (73% of GDP). With high-interest debt payments accounting for more than half of the proposed expenditure in B-25—the bizarre situation casts an ominous shadow on the state’s sovereignty.
Adding insult to injury, at the expense side, the B-25 has posited a staggering 28% growth in non-productive expenditure, and ergo, a federal fiscal deficit of Rs. 8.5 trillion. This highlights the urgent need to boost domestic revenue mobilization and curb fiscal expenditure simultaneously.
Our focus today is on the revenue side of the equation.
Federal Board of Revenue (FBR) has the foremost responsibility as the revenue mobilizer of the country— fomenting inflows to enable the country to smoothly perform its functions and appropriate resources for the provision of public good.
It requires no esoteric awakenings to acknowledge that the FBR has failed as a revenue mobilizer, let alone address sundry subtleties of non-revenue objectives.
Pakistan has been a loyal recipient of MLDA’s aid, which seems to be becoming less charitable with each help, as it arguably should. IMF, for instance, recommends a tax-to-GDP ratio (a symptom rather than a cause) of 15% as the tipping point for developing economies. Unfortunately, Pakistan’s current ratio hovers around 9 percent, and it is proposed to inflate to 13 percent in the coming three years.
Despite having a gargantuan revenue potential, as highlighted by the World Bank (WB), of up to 26% of the GDP, there is a significant gap between potential and actual revenue collection.
FBR’s primary collection method remains the excessive withholding tax (WHT) regime or what can be referred to as withholding-isation. This means that instead of taxing the “income” of a taxpayer, a presumptive approach of taxing the “transaction” itself at the instance of emergence has been adopted. In other words, tax collection is preponed by subtracting chunks of revenue at each step of the transaction.
Interestingly, the WHT regime, like many other prevailing quagmires, is a colonial legacy. Initially, it was exploited solely to capture income from salaries, interest on securities, dividends, and super-tax on bonus shares. However, its implementation expanded notably post-90s, following diminished US interest after the ousting of the Soviet Union. To address revenue challenges, the state adopted this egregious methodology to address challenges of meagre revenue conflation.
While the withholding regime itself is not the problem—it is recognized worldwide as a legitimate and important source of fast-forwarding revenue collection—the issue lies in the frenzied manner in which it was and is being applied.
WHT has been applied to all manner of transactions such as utility bills, school fees, bank transactions, telephone bills, etc. Sardonically, despite many of these being full and final liabilities or minimum tax (de facto final, as mostly the amount withheld attunes to tax liability anyway), the FBR classifies them as direct taxes.
Albeit, the number of withholding provisions has plummeted from 58 in 2020 to 31 in 2023. Yet tax collection in WHT mode as a percentage of income tax has stayed at an average of 67% during the same period. Studies suggest that more than 80% of Pakistanis are paying income tax via this regime.
B-25 has set an exorbitant target of Rs. 12.9 trillion in tax revenue (couched within enormous withholding-isation), representing a 40.2% growth from the previous period. To exacerbate collections, the run-of-the-mill approach of taxing the taxed is conspicuous.
Salaried individuals are to be taxed up to approximately 48.5% (including the normal tax regime, surcharge, and super tax), while non-salaried individuals/AOPs are to be taxed up to approximately 59.5% (including the normal tax regime, surcharge, and super tax)—one of the most vibrant tax rates. worldwide. In other words, a person may end up working for 6-7 months just to pay taxes. And not to mention, the exorbitant corporate tax rate of 29% (compared to the worldwide average of 23%), plus additional super tax and tax on dividend distribution.
Prima facie, the government is simultaneously warding off corporatization and dissuading the urban high-income and upper middle-income segments from remaining within the documented economy.
Like any mania, withholding-isation leads to more and more withholding-isation, given the comfort and face-saving benefits the FBR can claim under the guise of huge collections. The addition of WHT at each transaction chain becomes embedded in the price tag, thereby increasing the final prices of goods and services produced in the economy.
In addition to chunks of the transaction being taken away, it is no secret that “refunds” are deliberately deferred and deterred as much as possible: this is vouched by the fact that FBR does not reveal the details of refunds sought, and hence the overall collection is always inflated anyway.
All of this ultimately leads to supply-side inflation, a.k.a “taxflation,” proliferation of the undocumented economy (estimated at Rs. 126 trillion), and foments the phenomenon that Dr. Nadeem Ul Haq calls “killing the transactions” and so consequently “killing the economic growth.”
Additionally, withholding-isation has unburdened FBR from its responsibilities. FBR has literally abdicated its own job to the withholding agents, which have negative ramifications on the economic environment as a whole. It leads to a hostile climate for thriving businesses. For instance, the World Bank’s Ease of Doing Business ranking places Pakistan at 108, whereas India is ranked at 62, which signifies how less conducive our government’s policy is towards business entrepreneurs vis-à-vis our neighbouring counterpart.
It is estimated that it takes 594 hours to comply with provisions of tax law (withholding tax compliance time is not included) in Pakistan, while in India it takes 243 hours only.
Furthermore, study calibrates Pakistan’s tax collection cost to be 0.73 percent compared to the world average of 2.5 percent. Ex-facie, this looks good, but when we factor in the costs incurred by businesses due to the delegation of duty, Pakistan’s national tax collection cost gallops to 3.5 to 4 percent—probably the highest in the world. The delta is paid by the Pakistani entrepreneurs.
And to yoke them (withholding agents) to the imposed responsibilities, provisions like Section 161 of the Income Tax Ordinance, 2001, are legitimized: where the withholding agent is held responsible and susceptible to paying the tax that should have been withheld from the witholdee.
In other words, this provision, along with penalties stipulated in Section 182 of the Ordinance, equates the failure to deduct tax with tax evasion!!. One may wonder how any sensible mind could consider this treatment as cogent at all.
Simply, the withholding agents themselves are mandated to work as the de facto FBR.
Pakistan’s overreliance on withholding-isation is a self-defeating cycle as evident from the inability the original target of B-24. It is extractive, stifles economic growth, kills documented transactions, and burdens businesses.
Instead of conferring this albatross on the already weakened shoulders of the taxed. It’s time to break free from this “malady”. The path forward requires a complete overhaul of the tax system, prioritizing simplicity, efficiency, and a fair distribution of the tax burden.
Only by rationalizing the revenue side—abandoning all-out reliance on this extractive engagement and implementing cogent measures such as broadening the tax base (BTB), promoting the use of technology and documenting the undocumented, and disciplining the expenditure side—can Pakistan unlock its true economic potential.
Perhaps, it is time to dilute withholding-isation!
Furqan Ali & Abdullah Ahmed
Furqan Ali is a Policy Fellow at Learner’s Republic and presently serves as an advisory associate at a firm based in Peshawar. Abdullah Ahmed is a Policy Fellow at Learner’s Republic and a Data Science & AI trainee at Atomcamp.