Pakistan Institute of Development Economics

Pakistan: Withholdingisation of the Economic System—A Source of Revenue, Civil Strife, or Dutch Disease+?
QR Code

Pakistan: Withholdingisation of the Economic System—A Source of Revenue, Civil Strife, or Dutch Disease+? (PIDE Working Papers No. 2020:7)

Publication Year : 2020
Explore More : Working Paper
JEL Classification : H1

The paper takes an incisive shot at the systemic inadequacies that have tiptoed into the economic order of the state over time via the apparently innocuous mechanism of withholding taxes. Withholding tax—a legitimate instrument of preponing the state revenues on clearly identifiable chunks of incomes—has historically been resorted to by most states, and to that extent it should be normal with Pakistan, too. However, what has happened in Pakistan is that the tool of withholding taxation has been used as a source of revenues way too large in scale, size, scope and intensity. In addition to the pulling forward of tax collection on clearly demarcated chunks of incomes, a large number of transactions have also been roped into its nexus and then charged to tax by presumptivising gross receipts as income—a withholdingisation of the sorts not only of the tax system but of the entire economic system as a weighty portion of ubiquitous withholding taxes gets stuck into the pricing structure of the final goods and services produced in the economy rendering them price-incompetitive in the international market. This overwhelming withholdingisation of the economic system, it is argued, has been brought about by a numb state continually operating under, using a Freudian framework, the “pleasure principle” instead of the “reality principle” with political governments complacently choosing to continue harvesting quick bucks into the exchequer, pushing the extractive system into a total disarray, the society into burgeoning civil strife, and the economy to the Dutch Disease effect.


“The central dilemmas of collective life are embodied in the question of taxation.”1

Historically, the state has raised extractive structures, inter alia, to meet its expenditure needs with taxes availing centrality and forming foundational pillars of most public finance systems. Tax defined as “a compulsory contribution to the government, imposed in the common interest of all, for the purpose of defraying the expenses incurred in carrying out the public functions…without reference to the special benefits conferred on the one making the payment,”2 manifests itself in multiple forms and models. In order to achieve cardinal objectives, that is, equity, neutrality, and certainty, states have experimented with differing taxing models. Since different taxes have varying yield times—Income Tax, Wealth Tax, and Capital Gains Tax being annual levies; Value Added Tax including its variants like Sales Tax, General Sales Tax, and Excise duties being monthly or activity-based levies; Gift Tax and Inheritance Tax (Estate Duty) being occurrence-dependent charges—governments are always striving to find ways and means to reduce the lag between the point at which revenues become due, and the point at which those can actually be collected—that is, by advance payment of taxes.

This objective is generally achieved through two modes i.e. advance taxes3and withholding taxes.4 In the sub-continental context, the fiction of advance tax was introduced during 1940s purely as a war measure to harvest quick bucks into the exchequer, “combat inflation and to withdraw a part of the unprecedented amount of currency in circulation.”5 To be exact, “‘advance tax’ popularly styled as ‘pay as you earn’ scheme was introduced in 1944,” and it covered “all types of taxable income (except salaries and interest on securities where provision already existed for deduction at source) exceeding twenty-five thousand rupees.”6 It was observed that though “like many other innovations in taxation legislation, this innovation also has outlived its used by date which gave it birth,”7 over time, the payment of advance tax in instalments has become a necessity; an important ingredient of most public finance systems across the globe.


1 Evan S. Lieberman, Race and regionalism in the politics of taxation in Brazil and South Africa, Cambridge studies in comparative politics (Cambridge; New York: Cambridge University Press, 2003).
2 R.W. McGee, The Philosophy of Taxation and Public Finance (Springer US, 2011). 16. 3 “Advance tax” implies approximation and payment by a person in monthly or quarterly instalments of his total annual tax liability worked out on the basis of estaimated total annual taxable income.
4 “Withholding tax” refers to deduction of certain percentage of various types of incomes at the very payment or release stage.
5 This observation was made in Prushottamdas vs. Commissioner Income Tax, 48 ITR 206(2011).
6 GOP, “The Taxation Enquiry Committee Report (Volume 1) “ (Karachi: Ministry of Finance, 1960),
150. 7 Prushottamdas vs. Commissioner Income Tax.


Withholding tax, on the other hand, has rather deeper roots in time. Not only that its origins can be traced as far back in history as 1512, but also that “most forms of direct taxation during the 16th, 17th and 18th centuries contained taxation at source, and that its use increased with the passage of time.”8 The importance of withholding taxation continued to increase throughout “the nineteenth century as the income tax evolved into a major form of direct taxation.”9 During the British period, the mechanism of withholding tax, for the first time, was introduced in 1861, and salary income of government employees was brought under its scope.10 It was argued that due to the application of withholding tax, the contribution of government employees “to the fisc rose from 14 per cent in 1860, to 21 per cent in 1864.”11 Over the past one and a half century since, the withholding regime has considerably expanded in most countries eliciting arguments both for and against its application, and expansion.

In Pakistan’s context, justifying the need and efficacy of withholding regime, Khan posits that “since withholding taxes are transaction related, they are easy to collect.”12 He also asserts that “in a country like Pakistan where the economy is predominantly un-documented and outreach of the department is limited,” withholding “taxes easily cover some otherwise difficult sources of income.”13 He goes on to maintain that taxpayers also “find it convenient as their annual tax burden is spread over the year, helping them discharge their tax liability in instalments,” and that “withholding tax regime provides considerable documentation to the economy and effective control to…escapement of income being all pervasive in the economy.”14 Withholding taxes have also been credited as being able to “provide a clear picture to the other economic partners and prospective investors about the taxation regime and serves as important source of policy initiatives of a country.”15 It is logical that, given its wide-going merits, at-source withholding is worldwide recognised as a legitimate tool of fast-forwarding of revenue collection.