Pakistan’s growth relies on untaxed areas: World Bank

ISLAMABAD: The World Bank (WB) has identified under-taxation as a key contributor to economic growth in Pakistan, according to its latest South Asia Development Update, titled ‘Taxing Times’, released on Wednesday.

WB Vice President for South Asia Martin Raiser remarked, “Multiple shocks over the past decade have left South Asian countries with limited buffers to withstand an increasingly challenging global environment.”

The report notes that in Pakistan, low tax buoyancy suggests that growth is being disproportionately driven by under-taxed sectors. From 2010 to 2019, the agriculture sector contributed nearly one-fifth of Pakistan’s cumulative growth, compared with less than one-tenth in average emerging markets and developing economies (EMDEs). Despite this contribution, agriculture remains subject to significantly lower income tax rates than non-agricultural sectors.

The report emphasises that increasing taxation on agriculture should be a priority for improving revenue mobilisation.Across South Asia, countries with tax buoyancies in line with the EMDE average but with low revenue-to-GDP ratios typically suffer from weak tax administration, excessive exemptions, and economic structures that favour undertaxed sectors. The report examines these structural issues in greater detail.

In the cases of Bangladesh, Bhutan, Pakistan and Sri Lanka -- all of which face above-average tax revenue shortfalls -- structural factors account for a significant portion of the gap. Specifically, widespread informality and limited financial development account for one-half, one-third, and one-quarter of the shortfall in personal income tax revenues in Bhutan, Pakistan and Sri Lanka, respectively.

A large agricultural sector and limited financial development together account for half of the shortfall in corporate income tax revenues in Bangladesh, Pakistan and Sri Lanka. These same factors also contribute to one-third of the shortfall in consumption tax revenues in Pakistan and Sri Lanka.

In terms of macroeconomic outlook, the World Bank notes that Pakistan is gradually recovering from a combination of natural disasters, external shocks and inflation.

Inflation has slowed more rapidly than expected, creating space for potential monetary easing. Although incoming economic data have been weaker than anticipated, a surge in imports of capital goods and strong consumer confidence point to growing private sector activity. Bank lending to the private sector has also increased as the government’s borrowing requirements have decreased.

The WB projects Pakistan’s economic growth to gradually strengthen, rising to 2.7 per cent in FY2024-25 and 3.1 per cent in FY2025-26. As part of its economic reform agenda, the Pakistan government has committed to raising tax revenues by 4-5 percentage points of GDP, restructuring the energy sector, and maintaining a flexible exchange rate.

Meanwhile, other South Asian nations are pursuing their own reform programmes. Bangladesh is aiming to strengthen its financial sector and modernise macroeconomic frameworks; Sri Lanka’s programme focuses on restoring debt sustainability and growth; and Nepal’s older programme, launched in response to the pandemic, is expected to conclude in 2025.

The report acknowledges that while the long-term impact of IMF-supported programmes on growth remains mixed, such programmes can offer crucial short-term protection against financial instability. South Asian countries in IMF programmes generally have lower credit ratings than other EMDEs, and rating agencies often cite the presence of IMF support as a stabilising factor.

Since 2020, Afghanistan, Bangladesh, Pakistan and Sri Lanka have all experienced substantial shortfalls in direct tax revenue, ranging from 1.4 to 2.6 percentage points of GDP -- compared with an average shortfall of 0.8 percentage point among all EMDEs. In these countries, the revenue shortfalls have been evenly divided between personal and corporate income taxes.