Karachi, October 18, 2024 – In a striking revelation, the State Bank of Pakistan (SBP) has shed light on the alarming state of Pakistan’s C-Efficiency Ratio (CER) and the effective General Sales Tax (GST) rate during the fiscal year 2023-24. The SBP’s findings underscore critical challenges in the country’s tax enforcement and base expansion, painting a concerning picture for policymakers.
The C-efficiency ratio, or CER, is a crucial metric in determining a country’s tax efficiency. It measures the ratio of actual sales tax revenues to the product of the standard GST rate and final consumption. A higher CER indicates a well-enforced, broad-based VAT system with few exemptions, while a lower CER signals base erosion due to exemptions, concessions, or poor enforcement. A CER of 100% would suggest a perfectly enforced VAT with no loopholes, exemptions, or concessions. However, most countries fall short of this ideal due to various factors, such as policy choices aimed at protecting lower-income households or enforcement difficulties.
The SBP revealed that Pakistan’s CER stood at a meager 20.7% in FY24, down from an already low 22.6% in FY23. This sharp decline illustrates a further erosion of Pakistan’s GST revenue base, signaling worsening compliance and enforcement. In contrast, countries like New Zealand boast one of the highest CERs globally, at around 90%, with minimal exemptions limited to areas like donated goods, financial services, penalty interest, and fine metals.
The implications of Pakistan’s low CER are stark. As the SBP report highlights, Pakistan’s effective GST rate is now merely one-fifth of its actual weighted GST rate on goods and services. This signifies that GST is being applied to an ever-narrowing tax base, with significant gaps in compliance and enforcement, resulting in lost revenue. While the government introduced corrective measures in the Finance Act 2023 to broaden the tax base, these efforts have yet to yield the desired results, the SBP added.
The SBP further stated that the Finance Act 2024 aimed to further rationalize sales tax expenditures, marking a positive step towards broadening the base. However, elevated GST rates on goods and services remain a pressing concern. High GST rates can exacerbate compliance challenges, as taxpayers face increased burdens, leading to potential evasion or avoidance. Thus, the current situation presents a dual challenge: balancing tax efficiency with the need to alleviate the tax burden on citizens.
International best practices emphasize that a broad-based, uniformly enforced, and relatively low sales tax rate is more likely to generate higher revenue yields. Cross-country comparisons consistently show an inverse relationship between CER and GST rates, meaning that lower rates paired with better enforcement can lead to more effective revenue collection.
SBP’s sensitivity analysis underscores the immense potential for revenue gains if Pakistan improves its CER. The report suggests that by broadening the tax base and enhancing enforcement, revenue collection could increase significantly. Even if the GST rate were lowered to 13-15%, the CER could rise, resulting in a potential 1.5-fold increase in collections to Rs 5.4 trillion. In a scenario where CER and GST rates align with international medians (52% CER and 15% GST), Pakistan could witness a 2.1-fold rise in collections, reaching Rs 7.7 trillion.
These findings highlight that improved tax efficiency, combined with better compliance and enforcement, could lead to substantial revenue gains, potentially allowing the government to reduce the standard GST rate without jeopardizing revenue targets.