Pakistan's Budget 2025-26: Fiscal Consolidation Over Reform
The budget's focus on fiscal consolidation and reliance on non-tax revenues may not address the underlying issues of tax evasion and a regressive tax system, which could have long-term implications for Pakistan's economic growth and stability. The government must find a balance between meeting the IMF's requirements and providing relief to the middle class, while also addressing the structural issues in the tax system.
Pakistan's upcoming budget for FY26 is expected to prioritize fiscal consolidation, aiming for a third consecutive year of primary fiscal surplus, but may persist economic strangulation due to reliance on higher direct taxes and non-tax revenues, without offering relief to salaried individuals or the corporate sector.
The tax system in Pakistan is plagued by evasion, with a significant portion of the population opting out of filing taxes, leading to a parallel economy and undermining compliance. The non-filer category, introduced in 2013, allows individuals to legally avoid paying taxes, creating a two-tier structure where filers face audits, penalties, and complex filing requirements, while non-filers are exempt from scrutiny. To address the budget deficit, the government must scrap the non-filer category, enhance enforcement capacity, and accelerate digitization.
The International Monetary Fund (IMF) is pushing for the implementation of the National Tariff Policy (NTP), but the government is hesitating due to concerns about lower customs duty collections. The Federal Excise Duty (FED) on certain items is expected to be increased, including on cigarettes and ultra-processed foods, but this may only push more activity into the informal economy. The government has reportedly secured IMF approval for a significant increase in defense spending, but negotiations are ongoing regarding the size of the development budget.
The federal government in Pakistan is planning to provide tax relief to middle-class salaried individuals and businesses, particularly the real estate lobby, in the upcoming budget. However, the IMF has expressed concerns over the government's proposals, citing the need to maintain a primary budget surplus target of 1.6% of GDP. The IMF is concerned that the government's expenditure and tax relief proposals will hit this target, and has asked the authorities to come up with alternative sources of revenue to offset the impact of the increase in defence and other expenditures.
The upcoming budget reflects a cautious, IMF-driven approach that prioritizes fiscal consolidation over transformative change, which may provide some macroeconomic stability, but the continued reliance on existing taxpayers and indirect taxes risks stifling growth and further entrenching informality. The government has a formidable challenge ahead of it in balancing the IMF's programme goals with its desire to provide relief to middle-class voters.