Provincial revenue mobilisation

The previous article had focused on the overall fiscal performance of Provincial governments in the first six months of 2024-25. The objective of this article is to look more closely on the process of revenue mobilization by the four Provincial governments.

There is need first to highlight some of the key provincial revenue magnitudes like the overall revenues-to-GDP ratio of these governments combined. It was 0.9% of the GDP in 2023-24. The tax-to-GDP ratio was 0.7% of the GDP, while the non-tax to GDP ratio was only 0.2% of the GDP. The overall revenue-to-GDP ratio was significantly higher in 2017-18 at 1.4% of the GDP.

There is a wide variation in the tax-to-GDP ratio of the individual provinces. It is the highest in Sindh at 1.4% of the provincial GDP, followed by Punjab at 0.8% of the GDP. It is very low in the two smaller provinces: Khyber-Pakhtunkhwa and Baluchistan. The two larger provinces generate almost 89% of the total provincial revenues.

Within provincial taxes, there is a wide variation in the level of revenues mobilized. By far the biggest tax is the sales tax on services, which generates almost 65% of total tax revenues. Next is other sources, with a share of 13%.

The issue is what are the other sources? Perhaps it will be a revelation that the biggest other source of tax revenue is a unique levy by the Sindh government. This is the Sindh development maintenance of infrastructure levy. This yielded Rs110 billion in 2023-24, equivalent to over 14% of the total provincial revenues in Pakistan.

There is need to identify the precise nature of this source of revenue. It was levied in 2017 on goods that are removed, transported or shipped for entering into or leaving the province from or for outside the country.

Consequently, this levy is controversial in nature. If it is charged on goods destined for a location within the province, then it is effectively a sales tax. If it is levied on goods leaving the province, then it is tantamount to a customs duty on the province which it is being transported to. Either way, this tax appears to be in violation of the principles underlying the federal structure of Pakistan.

This levy is largely responsible for the relatively fast growth of provincial taxes in the four provinces combined of 21.3% in the first half of 2024-25. This has enabled achievement of the indicative target of provincial tax revenues for December 2024 in the IMF Programme.

The performance in particular of the sales tax on services, the largest provincial tax, has been disappointing. The national growth rate has been 13.6% in the first six months of 2024-25. In fact, the growth rate has been only 8% in Punjab. Here again, Sindh has performed better with a growth rate of over 22%, following escalation in the rate from 13% to 16%. It is surprising that Sindh collects more revenue from this tax than Punjab. The size of the services sector in Punjab is twice the size of the services sector in Sindh.

One of the features of the present IMF Programme is that is attaching high priority also to the development of provincial taxes. In particular, one of the tax reforms to be implemented is the transition from a positive list to a negative list of services in the levy of the sales tax on services.

However, the Sales tax on Services act of Sindh has the first schedule under Chapter 98 of the Pakistan Customs Tariff as the tax base. This contains a very comprehensive list with hardly any services outside the list. It is not clear as to what is the merit of a transition to a negative list.

One problem is the encroachment into the services tax base by the Federal government through the levy of excise duty. Currently, travel by air, a transport service, is subject to excise duty. This yields almost 10% of the revenues from the excise duty.

The 2024-25 Federal budget has now introduced an excise duty on property sales. There is need to withdraw excise duties on services in order to prevent double taxation.

Turning to the revenue potential and the ‘tax gap’ in provincial taxes, a recent study by this author has quantified this magnitude in a project recently completed for the Pakistan Institute of Development Economics.

The first tax which has been studied is the agricultural income tax. This is a tax which has been lying moribund since its introduction in 1997, with revenues of only a few billion rupees. The IMF Programme has laid emphasis on the development of this tax from the viewpoint of significantly broadening the tax base and generating significant revenues in a very progressive manner.

The farm area distribution is very skewed, with 5% of the largest farmers owning 36% of the farm area. The IMF Programme requires agricultural incomes to be taxed like other personal incomes at the same tax rates. Accordingly, the revenue potential is substantial and has been estimated on the tax base of 2023-24 at Rs880 billion, equivalent to 0.8% of the GDP. However, there will inevitably be strong resistance from the large politically influential agricultural landowners.

The other areas of gross under-taxation at the provincial level are taxes on property and real estate. The provincial fiscal powers, as per the Constitution, include the urban immoveable property tax and the capital value tax on property. The other existing tax on property transactions is the stamp duty.

The total estimated revenue nationally from these taxes is not even approaching 0.1% of the GDP. The combined ‘tax gap’ is estimated at over Rs275 billion on the 2023-24 tax base. Sindh has a large tax base also in commercial properties but there is hardly any collection in the province of the urban immoveable property tax.

The capital value tax on property is likely to be a very progressive tax, and act as a partial proxy for the wealth tax. However, none of the provinces is currently collecting revenues from this tax. The estimated revenue potential of property-related taxes in the four provinces combined is close to 0.3% of the GDP.

Overall, the ‘tax gap’ currently in provincial taxes is large. As highlighted above it is 0.8% of the GDP in the agricultural income tax and 0.3% of the GDP in property-related taxes. Further, expanding the coverage of the sales tax on services to other services could generate an additional 0.6% of the GDP.

Therefore, continued focus in the IMF Programme up to 2026-27 on tax reforms for development of provincial taxes, combined with improved tax administration, could yield an additional 1.7% of the GDP. It will lead to a more than trebling of the provincial tax-to-GDP ratio from 0.7% currently to 2.4% of the GDP. This will enable substantially larger expenditure allocations for education, health, irrigation and social protection.

However, it needs to be emphasized finally that even after accomplishing a greater fiscal effort, the combined tax-to-GDP ratio of the provinces of Pakistan will remain much lower than the current revenue mobilization by the States of India of over 6% of the GDP.

Copyright Business Recorder, 2025