The embrace of Nessus

Pakistan's upcoming budget for FY27 is expected to follow a familiar pattern of incremental changes rather than substantial reform, a trend that has persisted for over a decade. Successive governments have relied on various measures, such as amnesty schemes and point-of-sale machines, to document the economy, particularly the burgeoning services sector. However, these efforts are often likened to trying to measure the ocean with a teacup, suggesting their inadequacy.

The services sector has been the fastest-growing segment of Pakistan's economy since the 1980s, now accounting for nearly 60% of GDP, while industry and agriculture have seen their shares shrink. Despite this growth, the services sector contributes less than 40% of total revenues, a stark contrast to the manufacturing sector, which can contribute as much as 55%. This imbalance is a central issue, as the most dynamic part of the economy makes a minimal contribution to state revenue.

Several factors contribute to this revenue shortfall. Primarily, governments have failed to enact the necessary tax reforms to keep pace with economic shifts. Currently, the bulk of revenue from the services sector comes from banking and telecommunications, considered the easiest targets. The article suggests that documenting transactions within this sector is the crucial first step toward capturing more revenue.

For decades, a Value Added Tax (VAT) was considered the primary solution for documenting the economy and distributing the tax burden more equitably. VAT was a recurring feature in IMF reform agendas for Pakistan between 1988 and 2008. Although legislation for VAT was passed in 1992 and updated in 1996, it was never fully implemented in its value-added capacity across the board. A significant attempt to modernize it in 2008 failed spectacularly, leading the IMF to remove it from future reform plans. Since then, the VAT has been abandoned, leaving a critical question unanswered: how will Pakistan document its economy if not through VAT?