Twin deficit is merely an indicator, not the root cause, of structural economic fragility
ISLAMABAD:
The recent Asian Development Bank (ADB) dialogue on fiscal sustainability brought together experts and policymakers to deliberate on Pakistan’s macroeconomic trajectory. While the narrative surrounding Pakistan’s fiscal and external imbalances remains dominated by overcoming the “twin deficit,” I would like to highlight a more fundamental truth: the twin deficit is merely an indicator, not the root cause, of structural economic fragility. Focusing solely on compressing deficits without addressing underlying market distortions risks further stifling productivity.
In the last decade, Pakistan’s twin deficit has come down from 12.2% of GDP to 2.6%, which is an indicator of fiscal consolidation. Yet, this macroeconomic stabilisation has not translated into sustained economic prosperity or industrial productivity. In Pakistan, however, demand contraction measures have repeatedly thrown the real economy into recession after modest tax-to-GDP gains.
A central topic at the dialogue was the misplaced focus on numerical tax-to-GDP targets. Pakistan has now crossed 10% of FBR tax-to-GDP, up from 8.3% two years ago. This can be considered remarkable. However, this is achieved by chasing an ambitious and extractive tax revenue collection target, which has superseded growth and productivity targets.
It is a realisation that is not totally lost on the FBR, as was demonstrated during the dialogue. It was acknowledged that higher taxation revenue has arrived at the cost of economic growth. Businesses are increasingly reluctant to invest in their expansion.
As a matter of fact, if petroleum development levy (PDL) is considered a tax, which constitutionally it is not, then the ratio will exceed 11%. If we include non-tax measures of government revenue, as well as provincial tax collection, the overall government revenue may be close to 15% of GDP already. It means that an achievement of these ratios will not automatically improve social service delivery or decrease our reliance on hand-outs.
Setting rigid, revenue-maximising targets is a practice rarely found in developed market economies, where the emphasis is on market neutrality, predictability and efficiency. Chasing an arbitrary target often leads to coercive enforcement and emergency surcharges, such as elevating corporate tax burdens to prohibitive levels. Instead, tax rationalisation must prioritise a broad-based, low-rate architecture that minimises distortions and aligns incentives for investment.
Structural tax reform must focus on fundamental valuation processes rather than rate hikes. Property tax revenue in Pakistan currently lingers at an abysmal 0.3% of GDP, compared to international benchmarks of 0.6% and a potential of 1.0%. Unlocking this potential requires transparent valuation reforms and fiscal federalism, giving local governments the autonomy and capacity to tap real estate value without overburdening transactions.
Simultaneously, the fragmented income tax and Value Added Tax (VAT) bases must be integrated to eliminate enforcement gaps and administrative frictions. It is a major friction for large businesses to grapple with conflicting demands from the federal and provincial governments to file multiple tax returns. The issue of whether GST should be charged at the point of production or on the point of sale is still not settled.
The tax system is still riddled with more than 60 withholding taxes, which means a major portion of both income and general sales tax is collected by withholding agents on behalf of the government, a free service that they are forced to perform.
The income tax rates, both on corporate and personal income, remain comparatively high, despite the welcome withdrawal of the super tax on many categories of income. These are some of the major issues that remain unaddressed, and until they are reformed, a claim of “sound or significant tax reforms” is just a platitude.
This serves as a stark warning – not merely to the government, but to international lenders like the World Bank and the ADB. Their continued influx of hundreds of millions of dollars in soft loans effectively subsidises a failing, extractive status quo rather than catalysing genuine systemic reform.
I do acknowledge that progress in digital transformation – such as digital invoicing reaching Rs2.5 trillion monthly transactions against an estimated Rs3.5 trillion potential per month – demonstrates the efficacy of technology in formalising transactions. However, technological tools must be deployed thoughtfully so as not to elevate the cost of doing business or ignore how real-market operations function. Digitalisation should facilitate compliance rather than serve as a mechanism for bureaucratic strangulation and extortion.
To break out of the perpetual cycle of stabilisation and stagnation, Pakistan must adopt home-grown, supply-side economic reforms. Rationalising distortions begins with phasing out distortionary tax-free zones, exemptions and discretionary withholding taxes that distort capital allocation. By prioritising deregulation, integrating tax bases and creating a level playing field for the private sector, Pakistan can shift its economic strategy away from short-term revenue extraction toward sustainable, market-led economic growth.
THE WRITER IS CHIEF EXECUTIVE OFFICER OF PRIME, AN INDEPENDENT ECONOMIC POLICY THINK TANK