As the unelected technocrats in charge of managing Pakistan’s economy prepare a new budget chasing an IMF decreed tax-to-GDP ratio of 13%, the most financially marginalized segments of the population can expect a new onslaught of regressive levies, from higher taxes on cash transactions to additional transaction charges for non-filers. The Finance Minister’s “war on cash” will disproportionately hit the estimated 80% of adults in Pakistan who do not have a debit card from a financial institution or an account with a mobile money service provider.  Meanwhile those speculating in much higher risk—and, at present, illegal—cryptocurrencies stand to benefit from the minister’s chairmanship of the newly minted Pakistan Crypto Council. Pakistan’s tax-to-GDP target—arbitrary, flawed, and contradicted by the experiences of its neighboring countries—obscures the areas where real reform efforts are urgently needed.

The tax-to-GDP ratio is a frequently referenced indicator of Pakistan’s fiscal travails, and one that is widely used as a benchmark by institutions such as the IMF and the World Bank. It allows policy makers to make comparisons of tax revenue relative to economic scale across countries and regions, and shows, for example, that developed countries tend to have higher tax-to-GDP ratios than developing countries. Higher tax revenues enable a country to invest more in essential areas such as infrastructure, healthcare, and education. This, in turn, leads to substantial growth and long-term prosperity dividends.

At 10%, the narrative goes, Pakistan’s tax-to-GDP ratio is too low to allow for investment in developing human capital and infrastructure. The World Bank advises that tax revenue must be increased, and cites research that indicates a tax-to-GDP ratio of at least 15% is necessary to reach the tipping point to sustained economic growth and development. Pakistan’s economic managers have quite literally taken this figure to the bank.

Except that some of these are questionable conclusions drawn from flawed assumptions. The World Bank’s purported 15% tax-to-GDP threshold for economic growth is derived from a 2016 IMF Working Paper titled “Tax Capacity and Growth: Is there a Tipping Point?” This paper analyzed the historical tax-to-GDP ratios of 30 advanced economies and found that countries tended to experience higher GDP per capita growth once their tax-to-GDP ratio passed 12.5%.

Regrettably, this paper falls apart under scrutiny. One of the first questions that comes to mind is why the World Bank arbitrarily added 2.5 percentage points to the threshold level identified in the paper, rounding it up to 15% without any econometric justification. As a creditor, the World Bank benefits from additional repayment security if its client states increase their tax revenue. This does not appear to be as much about investing in schools and healthcare as much as it is about Pakistan’s debt servicing capacity.

The actual findings reported in the paper are not particularly compelling. The “tipping point” described by the authors, is a GDP per capita that is about 6% higher—cumulatively—after 10 years. This is statistical noise masquerading as an insight. Half a percent per year is barely a noticeable level of growth, let alone one that should dictate long-term tax policy.

While the paper carries the IMF’s admittedly powerful brand credentials, it is not exactly a peer-reviewed academic paper that should be accepted unreservedly. IMF Working Papers, in fact, are known to have variable quality standards. In a review of IMF research produced between 1999 and 2008, the Independent Evaluation Office of the IMF found that the quality of Working Papers, which are not subject to a rigorous quality review, was considerably lower than publications external to the IMF. One such external publication, an IMF study conducted on emerging market economies, explicitly contradicts this paper, finding that a 1% increase in tax-to-GDP actually decreases GDP growth by 0.6%.

The experience of Pakistan’s neighbors supports this. India’s ratio of 11.7% is not much higher than Pakistan’s, and Bangladesh at 7.5% is substantially lower. Both economies are much healthier than Pakistan, having grown at an average rate of 6% for much of the past decade compared to Pakistan’s 3%.

Wagging the dog

Many developed countries do have high tax-to-GDP ratios, but the direction of causality most likely points in the other direction. Economic development and increasing corporatization of commercial activities tends to yield increased tax collection, even without a change in tax rates, as businesses formalize, scale, and add depth. High tax-to-GDP is the result of a country being economically developed rather than a cause of it.

Pakistan’s tax-to-GDP ratio may be on the low side relative to countries such as Vietnam, Indonesia, and Mexico, which could be considered comparable economies. But these countries have materially different—and far more progressive—tax structures, generating substantially more from corporate income tax and social security contributions as a percentage of tax revenue than what Pakistan does. Vietnam attracts businesses with a 20% corporate tax rate, and generates USD 15 billion in tax revenue from them. Pakistan chases them away with periodic supertaxes on top of a 35% base rate. It is not about taxing more, but taxing more wisely.

Instead of squeezing the weakest among its citizens, Pakistan should consider taking on those with resources to spare. Additional revenue does not necessarily need to come from taxes. Government’s non-tax revenue is approximately a quarter of total revenue at present. This does not include any of the earnings from the numerous commercial investments of the military establishment. Even if sacred cows are left untouched, non-tax revenue could be substantially increased through improvements in the way state-owned enterprises are run and government assets are monetized.

But it must be acknowledged that there is nothing to indicate that more revenue will automatically translate into increased investment in healthcare and education. Nor will the availability of funds miraculously change Pakistan’s spending priorities. If anything, Pakistan’s propensity for quixotic and strategically incoherent pursuits suggests that wastefulness would only increase. Consider the insanity: Pakistan’s power sector faces a crippling Rs. 2.4 trillion circular debt crisis. Yet the Ministry of Finance this month announced a proposal to establish bitcoin mining and AI data centers powered by 2 GW of subsidized electricity. Never mind that crypto-currency is currently illegal in Pakistan, and the IMF’s AI Preparedness Index ranks Pakistan 119 out of 165 countries.

Pakistan’s quest for 15% tax-to-GDP serves its creditors and elites, not the daily wagers working in brick kilns. The incoherent initiatives meant to usher in prosperity deflect from the more unfortunate reality of a state that is beholden to vested interests—domestic and foreign—and unaccountable to the public. If Pakistan continues to pass budgets that extract rents from those most in need of government support and exploits its poorest citizens to pay for loans that fund vanity projects, it is simply an elaborate pretense that it is in pursuit of prosperity for all.