The previous week’s article had highlighted the key features of the tax system of Pakistan, such that strengths and weaknesses could be identified.

The objective was to derive the tax reform agenda from the viewpoint of raising the level of revenues, improving equity in the tax system and enhancing the efficiency in tax collection.

The coverage of taxes is taken to include the petroleum levy, a large source of revenue. This is not the case with the Federal Ministry of Finance, which treats it as non-tax revenue. However, it was taken out of the sales tax on POL products. The IMF also categorises the petroleum levy as a tax.

The principal problem continues to be very low revenue mobilisation by the provinces. Consequently, the national tax-to-GDP ratio remains relatively low at close to 12 percent of the GDP.

Other Asian countries have ratios ranging from 14 percent to 18 percent of the GDP.

Regarding tax rates, the evidence is that these rates are relatively high in Pakistan, and the focus of tax reforms should be on expanding the tax bases and bringing down rates, especially on the corporate sector, large-scale manufacturing and salary incomes.

The scope of widening the tax base exists in several sectors, including retail trade, real estate and agricultural incomes.

Based on the above description of the required type of tax reforms at the federal and provincial levels, some proposals are presented below.

The first important step is the rationalisation of the petroleum levy. Following the shift from sales tax to the levy, the effective rate has gone up substantially, from 18 percent to between 30 percent and 35 percent.

The incidence of petroleum taxes is regressive because they increase the transport cost of all products, including food items.

The rise in petrol prices after the commencement of the Middle East war has led to a quantum jump in the rate of inflation from 5 percent to 11 percent.

Therefore, there should be a reduction by at least one-third initially in the petroleum levy, which is currently Rs 117.4 per litre on petrol and Rs 42.6 on HSD. This major step in the federal budget will constitute a big source of relief.

The government has apparently decided to impose a small fixed 1 percent tax on small retailers. There is also a need for more revenue from large retailers and outlets in supermarkets.

As such, the withholding of income tax on commercial consumers on their electricity bills should be made more progressive.

Given the gross under-taxation of property today, in the presence of six taxes on property at the federal and provincial levels, there is a need to focus on real estate.

Today, investment is being diverted in a big way from industry to real estate.

The first proposal is the levy of a capital value tax on property at the federal level as a substitute for the wealth tax. This will also increase the progressivity of the tax system.

The exemption limit may be Rs 10 million. Beyond this, there could be four slabs with rates ranging from 0.25 percent to 1 percent.

There is also a case for the enhancement of withholding taxes on commercial importers, given the extremely low incidence of taxes on the wholesale and retail trade sector. The current rates should be enhanced by 0.5 to 1 percentage points.

Turning to the personal income tax, there is a strong case for raising the exemption limit from Rs 600,000 to Rs 1,200,000. Also, the size of the slabs needs to be increased, especially on salary income.

There is need also for rationalisation of the super tax on profits of corporate entities. Currently, it is linked on a progressive basis to the absolute size of profits.

This penalises corporate entities which are large in size but have low rates of return on equity.

The structure could start with a tax rate of profits of 25 percent if the return on equity is less than 12 percent. Thereafter, there could be three more slabs.

The highest slab should have a tax rate on profits of 35 percent when the pre-tax return on equity exceeds 25 percent.

There is a dire need for the development of the provincial tax system in Pakistan.

This has also been highlighted by the IMF. Consequently, the IMF has asked for additional revenue mobilisation of Rs 400 billion by the four provincial governments combined in 2026-27.

There are a number of potential sources of additional tax revenues at the provincial level.

The first large tax base is the agricultural income tax. If collected at the same rate as other personal income, it has the potential to yield Rs 800 billion in revenues.

The IMF has pushed for reform of the agricultural income tax law. This has been done by the provincial governments.

However, this has not translated into additional revenues. For example, the Punjab government has targeted only Rs 10.5 billion from this tax in 2025-26.

The agricultural income tax will also contribute to increased progressivity of the tax system. The top 1 percent of the farmers own over 24 percent of the farm area in Pakistan, according to the Agricultural Census.

However, the rural elite has a dominant role in the provincial power structure and has prevented a move towards normal taxation of agricultural income like other incomes.

The solution lies in the introduction of a simple, presumptive tax system with the tax rate linked to the size of the land holding.

The exemption limit could be 12.5 acres equivalent irrigated area. Therefore, there could be several slabs starting with a tax rate of Rs 1000 per acre, going up on landholdings above 150 acres to Rs 10,000 per acre.

The tax audit system of FBR needs to be improved.

First, the percentage of returns audited should exceed 10 percent. Second, a risk-based audit policy should be developed based on the characteristics of the taxpayer. Third, a new taxpayer may be exempted from audit for the first three years. Fourth, a taxpayer may not be subject to audit if the income disclosed increases by more than 25 percent.

There is also a need to introduce some fiscal incentives for promoting savings and investment, which have fallen to exceptionally low levels in Pakistan in recent years.

First, the investment allowance for investment in particular types of savings instruments may be reintroduced in the personal income tax. Second, the enhancement of the tax credit for balancing and modernization and replacement (BMR) is to be raised from 10 percent to 20 percent. Third, a tax holiday may be given for new investment in industry anywhere in Pakistan for five years.

Finally, there is an urgent need to focus on the process of integrating the provincial sales tax on services with the federal sales tax on goods. The first step should be the replacement of the federal excise duty on services by the provincial sales tax. Second, harmonisation of tax rates should take place to facilitate the move to a proper VAT.

This implies an increase in the provincial tax rates. Third, move towards administration and harmonisation with the same tax return, a common IT system and common rules. The powers of audit to be shared by the federal and provincial governments.

Overall, the federal budget should focus on the reduction of the rate of the petroleum levy.

This can be made up at the national level by the above-mentioned reforms in federal and provincial taxes.

The year 2026-27 should focus more on the mobilisation of additional revenues from provincial taxes.

Copyright Business Recorder, 2026