Withholdingisation: Weapon of destruction Huzaima Bukhari & Dr. Ikramul Haq "Taxes are increasingly collected through withholding and presumptive regimes rather than through proper assessment of income. This has weakened voluntary compliance and undermined the development of a modern tax administration"-Pakistan: Withholdingisation of the Economic System-A Source of Revenue, Civil Strife, or Dutch Disease, Muhammad Ashfaq Ahmad, Pakistan Development Review, Vol. 59, No. 4 (Winter 2020) Pakistan perhaps possesses one of the most destructive withholding-oriented tax systems in the world as majority of taxes withheld constitute minimum tax that are not adjustable. What originally began as a limited mechanism for advance collection gradually mutated into the central pillar of the entire revenue structure. The Federal Board of Revenue (FBR) collects the overwhelming income tax not through proper assessment of income but through advance deductions, minimum/presumptive levies and transactional taxation imposed at every conceivable stage of economic activity. This transformation did not strengthen tax administration. It utterly destroyed it. The tragedy of Pakistan's taxation system lies in the fact that while successive governments kept claiming "documentation" and "broadening of the tax base," the actual taxation machinery increasingly abandoned its core functions of assessment, investigation, audit and intelligent enforcement. Instead of building institutional capacity to identify taxable income, authorities found it easier to convert banks, electricity companies, telecom operators, exporters, importers and businesses into unpaid tax collectors. The result is what the above and other studies aptly described as the "withholdingization" of the tax system. This phenomenon has been extensively examined and documented in Tax Reforms in Pakistan: Historic & Critical View, Towards Broad, Flat, Low-rate, Predictable Taxes, various analyses of FBR performance and numerous articles published in Business Recorder, The Friday Times, The News and Minute Mirror. The figures [see Table] establish an undeniable reality: on average, over 95 percent of income tax collection during the last five fiscal years came automatically through withholding taxes, advance taxes and payments accompanying returns. Actual recovery through assessment, current demand and arrears constituted barely around 4-5 percent. This exposes the central contradiction of Pakistan's tax administration. FBR increasingly ceased functioning as an assessment-based taxation authority and evolved into a passive extraction machinery dependent almost entirely upon automatic collection streams. Banks, utility companies, telecom operators, exporters, importers and organised businesses became the real tax collectors while FBR itself progressively abandoned genuine investigative and assessment functions. The question, therefore, naturally arises: if nearly 95 percent taxes are collected automatically, what exactly is the present taxation machinery administratively accomplishing apart from coercive notices, disputed recoveries and procedural compliance burdens? The structural distortion can be seen from the composition of income tax collection itself. Data extracted from FBR/Revenue Division Year Books expose perhaps the greatest institutional failure of Pakistan's taxation system. Year Withholding Taxes Advance Tax Tax with Returns Collection out of Current & Arrear Demand FY2021 69% 23% 3% 4% FY2022 67% 25% 4% 5% FY2023 62% 29% 4% 5% FY2024 60% 34% 4% 4% FY2025 59% 33% 4% 5% Nearly every transaction today carries some form of advance or withholding tax. Banking transactions, electricity bills, mobile usage, cash withdrawals, imports, exports, contracts, property transfers, vehicle registration, airline tickets and even educational payments became avenues for tax collection regardless of actual taxable income. This fundamentally altered the philosophy of taxation itself. In a rational system, taxation follows determination of income. In Pakistan, taxation increasingly precedes income determination-or ignores it altogether. The state thus shifted from taxing income to taxing transactions. This distinction is crucial because transactional taxation does not necessarily correspond to actual ability to pay. It often taxes economic activity itself rather than net income or wealth. The consequence is distortion, cascading burdens and economic inefficiency. The salaried class provides perhaps the clearest example of this imbalance. Taxes are deducted at source with little possibility of concealment, making salaried individuals one of the most compliant segments of society. Meanwhile, large undocumented sectors continue operating substantially outside effective taxation despite visible wealth accumulation and conspicuous consumption. This is not documentation. It is selective extraction. The corporate sector similarly became an easy target because organised businesses leave documentary trails. Manufacturers, exporters and formal enterprises face dozens of withholding obligations not only as taxpayers but also as withholding agents responsible for collecting taxes from others. Thus, productive sectors became administrative extensions of FBR itself. The economic cost of this model is enormous. Businesses devote substantial resources merely to compliance and withholding procedures. Working capital gets blocked through advance taxes and delayed refunds. Multiple withholding provisions create cascading taxation effects. Litigation multiplies because many taxes deducted at source bear little relationship to actual liability. At the same time, genuine tax administration weakens further because authorities become addicted to passive collection. The irony is painful. A system originally justified as a temporary enforcement tool became the permanent substitute for administrative reform itself. Successive governments preferred this model because it generated short-term revenues without confronting politically powerful untaxed sectors. Rather than documenting wholesale trade, speculative real estate, large agricultural incomes and informal services, authorities simply intensified taxation on documented sectors already within reach. This policy choice had profound economic consequences. Formalisation became costly. Businesses increasingly shifted toward informality to avoid excessive compliance burdens. Cash transactions expanded. Smaller enterprises preferred remaining undocumented rather than entering a punitive regulatory environment. Banking penetration periodically weakened due to irrational transactional taxes. The state therefore unintentionally incentivised the very informality it claimed to combat. The 0.6 percent withholding tax on banking transactions by so-called non-filers represented one of the clearest examples of this contradiction. Earlier experience already demonstrated that such measures discourage banking habits and increase cash circulation, yet policymakers repeatedly relied upon coercive transactional taxes instead of meaningful reform. The obsession with withholding also undermined voluntary compliance culture. In functioning tax systems, citizens file returns because taxation is linked with civic legitimacy, predictable administration and fair enforcement. In Pakistan, however, many taxpayers increasingly perceive filing merely as a gateway to harassment, notices and arbitrary demands. The tax administration itself inadvertently weakened trust in formalisation. The constitutional dimension of withholdingization is equally important. Majority of withholding provisions operate effectively as minimum or final taxes disconnected from actual income determination. In substance, this converts presumptive collection into substantive taxation without proper assessment. Such practices raise serious questions regarding equity, due process and the constitutional principle that taxation must correspond with lawful determination of taxable capacity. This distortion becomes especially dangerous when inflation accelerates. In inflationary conditions, nominal transactions rise automatically, increasing withholding collections without reflecting real income growth. Governments then celebrate "record revenues" even though much of the increase merely reflects inflation and transactional taxation rather than expansion of genuine taxable capacity. The illusion of revenue growth thus masks structural stagnation. The same phenomenon is visible in customs and sales tax collection as well. A substantial portion of sales tax is effectively collected at import stage rather than through a properly functioning value-added chain. This weakens domestic documentation and shifts the burden onto organised sectors while encouraging under-invoicing, smuggling and informal trade networks. The latest fiscal trends demonstrate precisely this problem. FBR collections continue rising nominally, yet the economy remains burdened by low investment, shrinking industrial competitiveness and widening informality. The documented sector carries a disproportionate burden while untaxed and undertaxed sectors continue escaping meaningful scrutiny. The system therefore produces economic contraction alongside nominal revenue expansion. This is unsustainable. A modern economy cannot function through perpetual extraction from compliant sectors alone. Sustainable taxation requires broadening of the actual base rather than intensifying burdens upon existing taxpayers. Pakistan must therefore reverse withholdingization gradually but decisively. The future lies not in multiplying transactional taxes but in rebuilding genuine tax administration. Risk-based audits, integrated databases, digital invoicing, sectoral intelligence and intelligent enforcement must replace indiscriminate withholding mechanisms. Transactional taxes should remain limited tools of advance collection rather than substitutes for assessment. At the same time, untaxed sectors must finally enter the formal framework through rational, low-rate and predictable taxation. Documentation cannot occur through fear alone. It requires reduction of compliance costs, simplification of procedures and restoration of institutional trust. Most importantly, policymakers must recognise that excessive withholding is itself evidence of administrative weakness. A state confident in its tax administration does not need to tax every transaction blindly. It develops the institutional capacity to determine actual income and taxable wealth. Pakistan today stands at a critical crossroads. The country can continue the present cycle of withholding-based extraction, shrinking formalisation and economic suffocation, or it can rebuild taxation around growth, fairness and institutional competence. Withholdingisation has effectively replaced taxation itself, while extraction has replaced growth-oriented fiscal policy. Without dismantling this structure, every future tax reform will merely deepen the crisis it claims to solve. _____________________________________________ Huzaima Bukhari, lawyer and author, is an Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Senior Visiting Fellow of Pakistan Institute of Development Economics (PIDE) Dr. Ikramul Haq, Advocate Supreme Court, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also served Civil Services of Pakistan from 1984 to 1996.
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