World Bank Suggests Tax Reforms for Higher Income Groups in Pakistan

The World Bank has advised Pakistan to implement higher effective tax rates for the uppermost income brackets. According to the bank, the nation’s income tax system could achieve greater progressivity by eliminating exemptions for high-income earners and adjusting the highest tax rate’s income threshold.

In its recent “South Asia Development Update, Taxing Times” report, the World Bank highlighted that industrial production has diminished due to elevated input expenses, increased taxation, and reduced government spending on development. The expansion of services was also hindered by the repercussions of weakened agricultural and industrial sectors.

Among emerging market and developing countries, Pakistan exhibits one of the broadest spectrums of tax rates and income thresholds across its personal income tax brackets, contributing to a relatively progressive income tax structure.

The government has declared its intention to enhance tax revenues by an amount equivalent to 4–5% of GDP, overhaul the energy sector, and permit a flexible exchange rate, the report stated.

The report suggests that Pakistan’s practice of guaranteeing prices for sugarcane production while subsidizing water consumption promotes inefficient resource utilization. These subsidies could be replaced with direct, targeted financial assistance, particularly for farmers adopting sustainable land management practices.

Data indicates that Pakistan’s tax responsiveness ranks in the lowest quartile among EMDEs, reflecting a reliance on taxing slower-growing economic activities. Consumption taxes, such as sales tax, excise taxes, and VAT, along with trade taxes, account for a larger share of tax revenues in all South Asian countries except Bhutan and Pakistan, compared to the average EMDE, with a smaller proportion derived from income taxes. In 2024, Pakistan and Sri Lanka had consumption tax rates significantly above the EMDE average.

The report further observed that Pakistan, Sri Lanka, and Bangladesh, which have the lowest overall revenue-to-GDP ratios in South Asia, also demonstrate considerably lower tax revenue-to-GDP ratios compared to other EMDEs with comparable tax rates across all tax categories.

Since 2020, Afghanistan, Bangladesh, Pakistan, and Sri Lanka have experienced substantial deficits in direct tax revenue, ranging from 1.4 to 2.6 percentage points of GDP, compared to an average shortfall of 0.8 percentage point among all EMDEs. These revenue shortfalls have been almost equally distributed between personal and corporate income tax revenues.

Among Bangladesh, Bhutan, Pakistan, and Sri Lanka, which face above-average tax revenue deficits, domestic factors account for a quarter of the deficits in Bangladesh and Bhutan, and one-third in Pakistan and Sri Lanka. Specifically, widespread informality and underdeveloped financial sectors account for half, one-third, and a quarter of the deficits in personal income tax revenues in Bhutan, Pakistan, and Sri Lanka, respectively.

A substantial agricultural sector and a lack of financial development contribute to half of the shortfall in corporate income tax revenues in Bangladesh, Pakistan, and Sri Lanka, and one-third of the shortfall in consumption tax revenues in Pakistan and Sri Lanka. However, even after considering these country-specific factors, these four nations still exhibit larger tax gaps than the EMDE average.

An evaluation for Pakistan identifies key areas for improvement, including compliance risk management, timely tax declaration filings, tax dispute resolutions, tax payments, and the monitoring of inaccurate reporting.

The implementation of electronic VAT filing and computerized risk analysis in Pakistan has halved refund claims and enabled the detection of a significantly higher number of fraudulent claims compared to manual assessments.

The responsiveness of revenues to changes in tax bases in Bangladesh and India is similar to that in other EMDEs, while Nepal’s responsiveness is in the top quartile, and Pakistan’s is in the bottom quartile.

Tax buoyancy in Bangladesh and India aligns with other EMDEs, whereas Nepal’s tax buoyancy ranks in the top quartile and Pakistan’s in the bottom quartile.

Below-average tax buoyancy, as seen in Pakistan, suggests that economic growth is disproportionately driven by under-taxed economic activities. The agricultural sector in Pakistan accounted for approximately one-fifth of cumulative growth from 2010–19, compared to less than one-tenth in the average EMDE. Given the considerably lower income tax rates in the agricultural sector compared to non-agricultural sectors in many parts of Pakistan, enhancing taxation of agricultural activity is a priority for increasing tax revenues.

The report also noted that Pakistan’s economy is recovering from natural disasters, external pressures, and inflation, with projected growth of 2.7% in fiscal year 2024-25 and 3.1% in fiscal year 2025-26.

Pakistan’s GDP grew by 2.5% in fiscal year 2023-24, following a slight contraction in fiscal year 2022-23. Strong remittance inflows supported private consumption, but private investment growth remained weak due to high real interest rates and political instability. Favorable weather conditions led to a 19-year high in agricultural growth, while industrial activity contracted and services growth remained subdued. This weak growth has continued into the first half of fiscal year 2024-25, with output increasing by an average of 1.5% year-on-year, slower than the 2.1% expansion in the first half of the previous year.

Agriculture experienced muted growth in the first half of fiscal year 2024-25 due to drought-like conditions and pest infestations, following last year’s surge.

The government achieved a primary surplus in the first half of fiscal year 2024-25, with fiscal consolidation efforts supported by an IMF program. The current account was in surplus at the end of 2024, driven by higher remittances resulting from reduced political uncertainty and exchange rate stability, which more than compensated for the wider trade and primary income deficits.

As depreciation pressures on the currency eased, a strong agricultural harvest and stabilizing administrative prices contributed to a steady decline in inflation, reaching 0.7% in March 2025 from a peak of nearly 40% in mid-2023. This allowed the central bank to reduce its policy rate by 10 percentage points since June 2024, bringing it to 12% in January.