Like many developing countries, Pakistan also has very low tax – GDP ratio and mostly relies on consumption taxes. Large majority remain out of tax net because of overall low average incomes. Low revenue collection then results in inflation tax as an alternative to raise revenues. Various programs with IMF has special focus on tax reforms including improved tax governance, increasing share of direct taxes, expanding the tax net, imposition of sales tax on wider scales and improving the tax elasticity and buoyancy. Tax reforms efforts since 1990s are quite visible from significant increase of the share of direct tax in total tax revenues (17.3 percent in 1990-91 and 29.4 percent in 2005-06) and share of sales tax in total tax revenues (15.4 percent in 1990-91 and 41.3 percent in 2005-06). Despite visible changes in tax structure of Pakistan, total tax – GDP ratio is little above 12 percent.
Share of indirect taxes in total tax revenues is more than direct taxes, however, since 1990-91 this trend is moving in opposite direction, i.e., share of indirect taxes in total tax revenue was 82 percent in 1990-91 which is now reduced to 68.5 percent. Direct tax is comprised of income tax mainly. Share of direct taxes in total tax revenues has been substantially increasing from under 20 percent to 31.5 percent since 1990-91. The sole contribution is through income taxes, i.e., 93 percent of the total direct taxes in 2005-06. Indirect taxes are comprised of sales tax, custom duties and federal excise tax. After the structural adjustment program in 1987-88 Pakistan has started reducing custom duties (50.4 percent in 1987-88 and 19.4 percent in 2005-06). Custom duties were replaced by sales tax, which increased from 11.6 percent of total tax revenues in 1987-99 to 41.3 percent of total tax revenues in 2005-06. Share of excise tax has also declined to 7.7 percent of total tax revenues in 2005-06 from 22.3 percent of total tax revenues in 1987-88.
It is generally believe that sales tax is a regressive tax but a rigorous study by Sadia Refaqat in 2005 published in Pakistan Development Review concluded that sales tax in Pakistan is not clearly a regressive tax, however 1990s reforms are slightly welfare reducing because sales tax on items such as vegetable ghee, sugar and basic fuels are hurting poor. This is also stated in a study by Faiz Bilquees in 2004 published in the Pakistan Developmetn Review that introduction of sales tax on the petroleum products, gas and electricity directly affects the consumption of poor because they lowered the consumption of other goods. Contrary to this it is theoretically proved that sales tax is difficult to avoid/evade thus to improve efficiency and equity sales tax/VAT is better tax than other.
In my recent study on the long run determinants of tax efforts, I concluded that per capita income and sectoral share of value added sectors are the main determinants of long run tax efforts in Pakistan. However, increase in revenues from sales tax is due to inclusion of new products under the sales tax net. It is also concluded that indirect taxes are difficult to evade.