Taxation, Informal Economy and Economic Development in Pakistan

Abstract

Taxation is one of the key instruments through which domestic resource mobilization, provision of public goods, inequality, and sustainable economic development can be achieved. However, despite everything, Pakistan still suffers from the longstanding problem of underdeveloped tax base along with the existence of a significant level of informality. The interaction between taxation and informality creates an unattractive political economy scenario, since on the one hand, large taxes can induce firms and households to operate informally, while on the other hand, low taxes decrease the government’s capacity to provide public goods. According to recent research, despite certain progress, the ratio of tax revenue to GDP in Pakistan remains relatively low compared to its peers. According to IMF, the gross general government tax was estimated at 12.3% of GDP in FY2025 and there is much untapped potential of revenue generation in the country (IMF, 2026). The paper examines the relationship between taxation, informality and economic development in Pakistan. The paper notes that the revenue mobilization through sustainability depends on a number of factors such as broader tax base, simplification, tax administration through digital technology, improved tax morale, exemption, formalization of informal activities, and improved quality of government expenditure. According to the paper, formalization must be undertaken through institutional trust rather than by coercion only.