Pakistan’s fiscal challenges are mounting as revenue shortfalls and increasing taxes strain both businesses and consumers. While inflation has eased and international commodity prices, especially oil, have fallen, these temporary reprieves are not enough to address the deeper structural issues.

The government faces tough choices—raising taxes in ways that burden the public or finding alternative solutions to close the fiscal gap. However, the path forward is fraught with obstacles, including the Federal Board of Revenue’s failure to collect taxes efficiently, creating distortions across the economy.

The government’s resolve to trim its fiscal excess appears absent. Without such a course of action, hopes for fiscal tightening and the broadening of the tax base remain an elusive fantasy. In the meantime, fresh taxes continue to emerge, though they struggle to deliver any meaningful results in generating revenue, merely striving to meet monthly, quarterly, and annual collection benchmarks.

The disheartening reality is that all efforts have been directed toward amplifying the tax load, which disproportionately falls on sectors already contributing to the tax system, mostly in indirect forms that disproportionately afflict the impoverished. Simultaneously, there is scant attention given to trimming expenditures, where ample opportunity for savings exists.

As the International Monetary Fund’s executive board deliberates over Pakistan’s program, this seemingly positive development is unfortunately paired with the looming threat of additional tax burdens. This is largely due to the Federal Board of Revenue’s failure to meet the anticipated tax revenue targets.

The FBR is expected to fall short by approximately Rs200 billion in the first fiscal quarter. The data from the first two months of the current fiscal year point to this shortfall, triggering the contingencies laid out in the yet-to-be-released Memorandum of Economic and Financial Policies (MEFP).

This suggests that a mini-budget is imminent, potentially introduced or negotiated with the IMF before Pakistan’s case reaches the IMF board. The fiscal year 2025 budget has already imposed a significant strain on nearly all economic participants, thanks to stringent taxation measures. The tax rates for salaried individuals have been substantially hiked, the corporate super tax remains in place, exporters are now subjected to the regular tax regime, and various sales tax exemptions—including those on essentials like infant formula, food, and children’s stationery—have been rescinded. Moreover, within three months, it’s likely that even more taxes will be introduced, exacerbating the frustration of businesses and consumers alike.

The government has managed to find some respite due to a dip in inflation and the decline of international commodity prices—particularly in oil. In response, the State Bank of Pakistan has cut the policy rate by an additional 2 percent, bringing it down to 17.5 percent, which is aimed at reducing the cost of debt servicing. These developments provide the government with a temporary buffer to mitigate the fiscal deficit exacerbated by the revenue shortfall.

One potential avenue for the government is to raise the petroleum levy, leveraging the drop in global oil prices without affecting consumer prices. Ideally, this should have been done earlier, but the volatile political climate has made it challenging. However, as time progresses, the government’s range of options to address the issue will inevitably shrink.

That said, this action alone will not suffice. The government must do more. At this point, certain contingency measures will come into effect. One such measure is to increase withholding tax rates across various sectors. The withholding tax system is inherently indirect, and in some cases, the revenue collected surpasses the actual tax owed. Refunds, when due, are often delayed, contributing to an inflated effective tax rate.

Withholding taxes are inherently inflationary, as businesses often pass the burden on to consumers. This creates a regressive tax system, further driving up the cost of business operations. A similar dynamic exists with sales tax, where recipients of services or goods are required to withhold 20 percent of the supplier’s sales tax to ensure proper payment to the treasury. This process adds layers of complexity, increasing the cost of doing business—a situation exacerbated by the Federal Board of Revenue’s (FBR) inability to collect taxes directly.

Additionally, the government plans to eliminate sales tax exemptions or reduced rates on specific items—like tractors. This will only worsen the situation for farmers, who are already dissatisfied due to the lack of support prices, leading to higher costs and stifling growth in the agricultural sector, which is expected to remain sluggish in this fiscal year.

There is no denying that the FBR has struggled to collect its due taxes, especially on income, increasingly turning to transaction-based taxes through the withholding mechanism. This shift has effectively morphed what should be a direct income tax into a sales tax—an indirect tax—thus distorting the entire tax framework.

Not only has this dramatically increased the cost of doing business, but it has also contributed to inflation and further complicated the economic landscape, creating significant gaps for tax leakages.

The government’s current approach, heavily reliant on indirect taxes and withholding mechanisms, has led to a skewed tax system that burdens consumers and businesses alike. While recent economic developments, such as reduced inflation and lower oil prices, provide some relief, they are far from solving the core fiscal issues. The failure of the FBR to directly collect income taxes has only compounded the problem, pushing the economy towards inefficiencies and price hikes. Moving forward, the government must consider comprehensive reforms to stabilize its fiscal strategy and prevent further economic fallout.