Narrative of large tax gap

PAKISTAN’S fiscal debate has settled into a familiar rhythm. The World Bank, IMF, tax consultants and commentators frequently assert that the country suffers from a ‘tax gap’ of seven to nine per cent of GDP — a shortfall between what is collected and what the law, ideally enforced, would yield. The metric implies that this shortfall is a result of cheating taxpayers. It is a powerful narrative that favours the tax collector and policymaker to deflect their mistakes or venality to focus on increased coercion to ensure compliance.

Consultants insist that the gap is a hard, objective, measurable headline number. It is anything but. Different studies measure different things. Some estimate what could be collected if all economic activity were fully captured and perfectly enforced. Others focus on exemptions built into the system. Still others compare Pakistan’s tax-to-GDP ratio with peer countries and conclude there is ‘room’ to collect more. Though these approaches are analytically distinct, public debate often merges them into an erroneous conclusion: citizens are not paying what they owe.

The verdict is mistaken, or at least incomplete. Treating the tax gap as the central problem confuses symptoms with deeper structural issues. A large share of the gap is not evasion but policy. By lumping together evasion, avoidance and policy-driven exclusions, the narrative shifts attention away from a warped tax policy and weak state legitimacy. At best, the gap is a rough indicator of a bad tax policy and administration; at worst, it destroys trust.

A large share of the tax gap is not evasion but policy.

Pakistan possesses a distorted, fragmented tax system due to separate federal and provincial jurisdictions. This system is riddled with exemptions, concessions and preferential regimes (for example, the IPPs) as well as excessive and often multiple taxes. Excessive taxation and several exemptions, with a complicated and confused policy, force even good citizens to game the system for survival. In addition, most working adults earn below the income tax threshold. What looks like non-compliance is part poverty, part deliberate exclusion.

The design of the system is also inefficient, exemplified by a host of convoluted taxes, high rates, heavy reliance on over 230 distortive withholding taxes and unpredictability (frequent changes in laws and procedures). Moreover, compliance processes are complex and the paperwork so burdensome that even willing taxpayers struggle to comply. It is revealing that much of the gap is actually documented policy. Official tax expenditure reports list the vast exemptions across the system. Similarly, the sales tax system is weakened by exemptions that break the value-added chain. What appears as a gap is often just a system not designed to function cleanly.

Cross-country comparisons are problematic. There is no single ‘correct’ tax-to-GDP ratio; it depends on the role of the state and the specific political and economic choices a country makes. In Pakistan, this nuance is lost and invoking such a ratio to indict taxpayers is a rhetorical move, not an analytical one since it shifts the focus to aggressive enforcement of a bad system rather than fixing it. The US has a tax-to-GDP ratio of about 26pc, Germany 38pc, Sweden 42pc and the UK 35pc — a large dispersion contrary to the consultant claim.

Treating the full gap as ‘recoverable’ leads to direct bad policy, poor outcomes, unrealistic IMF-imposed targets, and excessive pressure on the FBR, leading to harassment of those already documented. This ‘squeezing of the squeezed’ targets captive salaried individuals and a small number of firms, which also bear a heavy compliance burden as collection agents for the FBR. They get punished simply because they are visible in the data. The consequences are predictable. Fear of the system discourages registration. Firms fragment to stay below thresholds. Transactions move off the books. Cash use increases (cash in circulation today is Rs.12.1 trillion, having increased by Rs.1.5tr this year). The effective tax base shrinks even as enforcement intensifies.

There is a deeper point that the gap framework misses. Taxation is not the only way the state extracts resources. Regulations carry real economic costs. Trade restrictions and non-tariff barriers raise consumer prices and undercut exporters — implicit taxes embedded in trade policy. Energy pricing distortions shift costs across sectors in non-transparent and unpredictably ways. Urban land use restrictions, anti-high-rise zoning and administrative delays suppress productivity and raise costs. The judiciary’s inability to resolve disputes quickly locks up capital for years.

None of these burdens appear in tax gap estimates. Yet they shape the economy profoundly and raise the true cost of government far beyond what fiscal accounts reveal. When compliance is expensive, outcomes are uncertain and hidden costs are high, rational economic actors adjust their behaviour to avoid onerous government policy. The informal economy is, in part, a rational response to an irrational system. Internationally, countries that publish tax gap estimates use them as diagnostic tools — signals to simplify procedures, reduce compliance costs and build trust. In Pakistan, the gap is cited as a mandate for enforcement. But enforcement without structural reform only squeezes the already visible. It does not bring the invisible into the net.

Our tax problem is not a mystery; the outcomes are a result of deliberate design. Addressing the gap requires political consensus to confront powerful, protected lobbies. The path forward is not more pressure but a simpler tax structure with fewer exemptions, a coherent sales tax system, lower compliance costs through reduction in financial, time and effort costs linked with compliance, predictable policy and timely dispute resolution. These require confronting powerful organised lobbies that have shaped the current system to their advantage. That is a political challenge, not a technical one. No gap estimate will make it easier to face.

The tax gap is a symptom, not a cause. Treating it as a compliance alone divorced from policy design flaws and administration creates conflict to disrupt investment and growth. Pakistan does not need harder enforcement of a broken system. Ultimately, the goal is not just to close a numerical gap but to have a system people can actually participate in, one built on simplicity, fairness and trust rather than coercion and complexity.

Nadeem ul Haque is former VC PIDE and deputy chair of the Planning Commission.

Shahid Kardar is a former governor of the State Bank of Pakistan.

Published in Dawn, April 11th, 2026

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