The steady increase in the petroleum levy has once again highlighted one of the most persistent weaknesses in Pakistan’s tax system: the government’s growing dependence on easily collected indirect taxes to finance an overwhelmingly current-expense-driven budget. While the levy provides a convenient and predictable source of revenue for the government, its impact is anything but convenient for ordinary citizens, particularly lower-income households already struggling with high living costs.
The petroleum levy has been budgeted to generate Rs1.676 trillion during the current fiscal year. Although the government temporarily reduced the levy in the early weeks following the US-Israel invasion of Iran to provide some relief to consumers amid rising fuel prices, it has subsequently restored the levy in phases. The increases have been broadly aligned with the revenue target approved in the federal budget.
The restoration of the levy has also been linked to commitments made under Pakistan’s ongoing Extended Fund Facility programme with the International Monetary Fund. Under the programme, the authorities are expected to ensure that the revenue targets incorporated into the budget are achieved. The government is also required to avoid approving unbudgeted expenditures, including additional subsidies, and where unforeseen costs arise, these are expected to be passed on to consumers rather than absorbed by the exchequer.
From the government’s perspective, the petroleum levy is therefore an attractive fiscal instrument. It provides a relatively reliable stream of revenue without requiring the state to undertake a complicated process of identifying taxpayers, assessing incomes or enforcing compliance across large sections of the economy. The consumer pays the levy at the pump, and the money can be collected with comparatively little administrative effort.
However, the latest increase in fuel prices has not been driven by the levy alone. Another factor was the agreement reached with the Pakistan Petroleum Dealers Association after the association launched a nationwide strike. The settlement resulted in an adjustment in the margins and contributed to the increase ultimately faced by consumers at filling stations. The growing dependence on the petroleum levy has become increasingly visible in successive federal budgets. There are two fundamental reasons for its appeal to the government. The first relates to the way the levy is classified for fiscal purposes. It is placed among taxes outside the divisible pool, meaning that the revenue does not have to be shared with the provinces under the National Finance Commission mechanism.
This classification has long been a subject of debate because, in practical terms, the levy is imposed on petroleum consumption by the general public and has characteristics similar to a sales tax. Sales tax revenues, however, are part of the divisible pool and are consequently shared with the provinces under the NFC arrangements. The classification of the petroleum levy as a non-divisible tax therefore gives the federal government greater control over the revenue it generates.
The second reason is even simpler: the levy is extraordinarily easy to collect. Unlike income tax, which requires taxpayers to declare earnings and the Federal Board of Revenue to monitor compliance, the petroleum levy is collected at the point of sale. Petrol stations effectively perform the role of collection agents, while the FBR has relatively limited involvement in determining whether an individual consumer has paid the correct amount. The tax is embedded in the price of fuel and collected before the consumer drives away from the filling station. This makes the petroleum levy an extremely efficient source of revenue from the government’s perspective. But administrative efficiency should not be confused with economic fairness.
For a country where poverty remains exceptionally high, repeatedly increasing the cost of fuel through taxation has consequences extending far beyond vehicle owners. Pakistan’s poverty level is estimated at around 44 percent, an extraordinarily high figure for a country seeking to achieve sustainable economic growth. Any additional burden on petroleum consumers reduces the purchasing power of households already operating under severe financial constraints.
The impact is particularly pronounced because petrol is not merely a product consumed by private motorists. Fuel costs are embedded throughout the economy. Public transport operators face higher operating expenses, which are eventually passed on to passengers. Transport costs influence the prices of food and other essential goods because almost everything consumed in Pakistan has to be moved from farms, factories, warehouses or ports to markets.
A rise in petroleum prices can therefore function as a tax on virtually the entire economy. A worker who does not own a car may still pay the price through more expensive bus or motorcycle fares and higher prices for food and household necessities. In this sense, the petroleum levy reaches considerably further than the filling station.
The deeper problem, however, is not the existence of the petroleum levy itself but the extent to which the government has come to rely on it. A government whose expenditure is dominated by current spending will naturally seek revenue sources that can be collected quickly and predictably. Yet this approach creates a vicious cycle. Instead of reforming the tax system and broadening the direct-tax base, the state repeatedly turns to consumption taxes because they are easier to collect. Around 93 percent of total federal expenditure is consumed by current, non-development spending. This leaves relatively limited fiscal space for investment in infrastructure, human capital, education, healthcare and other areas capable of raising long-term productivity.
The result is a tax structure that places a disproportionate burden on consumption rather than income and wealth. Indirect taxes such as sales taxes and petroleum levies affect poorer households more severely because lower-income families spend a larger proportion of their earnings on basic necessities. Wealthier households, by contrast, have greater capacity to save and invest and can therefore absorb consumption taxes more easily.
The solution is not simply to abolish the petroleum levy overnight, particularly when the government faces substantial financing requirements and has committed itself to fiscal targets under the IMF programme. The more important task is to reduce dependence on such taxes over time by fundamentally reforming the tax structure.
Pakistan needs a stronger system of direct taxation based on the ability-to-pay principle. Those with higher incomes, greater property holdings and larger economic gains should contribute proportionately more to the national exchequer. At the same time, tax administration must become more effective so that income and wealth that currently escape taxation are brought into the formal system.
Such reforms would not be easy. They would inevitably encounter resistance from powerful economic groups and require political determination. But continuing to extract more revenue from fuel consumption is hardly a sustainable alternative.
The government needs revenue, and the country needs fiscal discipline. But the question is not simply how much revenue can be collected; it is also who bears the burden. A tax system that repeatedly turns to petrol pumps because they offer an easy collection mechanism may balance the books in the short term, but it does little to create a fairer or more productive economy.
The petroleum levy may be an efficient tax collector’s dream, but for millions of Pakistanis it is another deduction from an already shrinking household budget. If the government is serious about reducing poverty and creating sustainable growth, it must gradually move away from taxing consumption and towards taxing the ability to pay. Fiscal stability achieved by making everyday necessities increasingly expensive is not a durable economic solution. Pakistan needs a tax system that raises revenue without continually squeezing those least able to bear the burden.