Pakistan’s chronic fiscal deficit, hovering around 7% of GDP in 2023-24, underscores an urgent need to broaden the tax base. Yet, the government’s reliance on tax expenditures—exemptions, deductions, and reduced rates—continues to erode revenue potential. These incentives, designed to spur sectors like agriculture, exports, and SMEs, cost the exchequer an estimated ₨1.2 trillion annually, equivalent to 2.5% of GDP. While proponents argue they drive growth, critics warn of distorted markets and a culture of dependency. A 2023 World Bank study revealed Pakistan forgoes 40% more revenue via tax breaks than regional peers, raising questions about their efficacy in achieving policy goals.
The Scale and Sectors Driving Tax Expenditures
Tax expenditures permeate federal and provincial statutes, with 85% concentrated in three areas:
- Export-Oriented Industries: Zero-rated sales tax for textiles (costing ₨287 billion/year).
- Energy Sector: Reduced duties on imported LNG (₨190 billion/year).
- Agriculture: Income tax exemptions (₨360 billion/year) despite contributing 23% to GDP.
Revenue Impact of Major Exemptions (FY2023-24)
| Sector | Revenue Foregone (₨ billion) | % of Total Tax Expenditures |
|---|---|---|
| Exporters | 498 | 41.5% |
| Agriculture | 360 | 30.0% |
| Corporate Tax Holidays | 185 | 15.4% |
Economic Distortions and Equity Concerns
While tax incentives aim to stimulate priority sectors, they often create market imbalances. For instance:
- Textile Dominance: 60% of export incentives benefit large textile firms, stifling diversification into higher-value sectors like IT.
- Informality Incentives: Agriculture’s blanket exemption discourages 78% of farmers from formalizing operations.
- Elite Capture: Corporate tax holidays in Special Economic Zones (SEZs) primarily aid conglomerates, with 70% of SEZ benefits accruing to top 10 business groups.
These distortions are compounded by weak sunset clauses. The 2012 Tax Exemption Law for power projects, meant to expire in 2022, was extended indefinitely, costing ₨45 billion annually despite sectoral recovery.
The Cost-Benefit Mismatch
Evaluations reveal scant evidence that tax expenditures achieve intended outcomes:
- Export Growth vs. Incentives: Despite ₨2.1 trillion in export subsidies since 2016, Pakistan’s export-to-GDP ratio remains stagnant at 10%, compared to Bangladesh’s 15%.
- Agricultural Productivity: Tax-free status hasn’t boosted yields; wheat productivity lags 40% behind India’s.
- SEZ Underperformance: Only 12 of 46 SEZs are operational, with 80% of beneficiaries rerouting profits instead of reinvesting.
Toward Rationalization: Policy Levers
Reforming tax expenditures without destabilizing sectors requires phased, evidence-based measures:
- Sunset Clause Enforcement: Automatically expire exemptions after 3-5 years unless rigorous cost-benefit analyses justify extensions.
- Targeted Incentives: Replace blanket exemptions with performance-linked tax credits (e.g., export incentives tied to value-added products).
- Transparency Mechanisms: Publish an annual Tax Expenditure Statement, as mandated (but never implemented) under the 2019 Public Financial Management Act.
The 2024 shift to taxing retailers illustrates progress, but deeper structural reforms are vital. By redirecting even 25% of forgone revenue toward social safety nets or infrastructure, Pakistan could offset subsidy cuts while enhancing equity.
Tax expenditures need not be abolished—but their role as a default policy tool must end. As the IMF presses for rationalization under the 2023 Stand-By Arrangement, Pakistan has a window to rebalance its fiscal toolkit toward transparency and results-based governance.
This article was published on PublicFinance.pk.
