FBR’s Performance FY 2024-25 (Part IV)

Tariff distortions, under-invoicing & structural trade imbalances

Dr. Ikramul Haq

If income tax has become largely indirect taxation, through pass-on withholdingisation, and sales tax structurally narrow and distortionary, customs duties represent the most consequential component of Pakistan’s faulty tax policy in terms of long-term economic damage. Fiscal year (FY) 2025 once again demonstrates that tariff policy, rather than facilitating trade and industrialisation, continues to function primarily as a tool of revenue extraction, creating distortions that undermine competitiveness, encourage evasion and weaken the integrity of the entire tax system.

According to the Revenue Division Year Book 2025, customs duties contributed around one-tenth of total federal tax revenues. However, this relatively modest share conceals their wider economic impact. Unlike income tax and sales tax, customs duties directly influence the cost structure of production, the competitiveness of exports and the incentives for formal versus informal economic activity. The structure of customs duties, therefore, has implications far beyond revenue.

In FY 2025, net customs duty collection of Rs. 1284 billion was about 21.6% of indirect taxes and roughly 10.9% of total tax revenue. Collection grew by around 16.4% compared to the FY 2024. The five-year collection data (Figure 17 of Revenue Division Year Book 2025 ) shows that it has nearly doubled from Rs. 748 billion in FY2021 to Rs. 1284 billion in FY2025.

The most striking feature of customs performance in FY 2025 is the extreme concentration of revenue in a limited number of import categories. Official tables in the Revenue Division Year Book 2025 and FBR Year Book 2024-25 (customs sections) show that a handful of commodities dominate collection, reflecting both structural dependence and policy distortions.

Top 10 Customs Duty Revenue Spinners—FY 2024-25—FBR Year Book 2024-25

These ten heads together account for nearly 66 percent of total customs duties, confirming an extremely narrow and concentrated revenue base as reflected in Table 13, Page 24 of FBR Year Book 2024-25.

This concentration reveals three critical structural realities. First, Pakistan’s fiscal system remains heavily dependent on petroleum imports. With POL products alone contributing over 22 percent of customs duties, revenue performance is directly tied to global oil prices and import volumes. This creates inherent fiscal vulnerability, exposing the budget to external shocks beyond domestic control.

Second, a substantial portion of customs revenue is derived from industrial inputs. Machinery, electrical equipment, iron and steel, plastics and chemicals together account for a significant share. This indicates that Pakistan continues to tax production rather than income. Instead of encouraging industrial growth, tariff policy raises the cost of doing business and undermines competitiveness.

Third, consumption-related imports such as vehicles and edible oil contribute a sizeable portion of revenue, reflecting a consumption-oriented rather than production-oriented tax structure. This reinforces structural imbalances in the economy.

The implications of this tariff structure are far-reaching. High tariffs on machinery and intermediate goods act as implicit taxes on exports. Export sectors are forced to operate with higher input costs compared to regional competitors, reducing their ability to compete in global markets. This is one of the key reasons why Pakistan’s export performance remains stagnant despite repeated policy interventions.

Empirical work by international institutions and local think tanks, particularly PRIME Institute, consistently supports this conclusion. Research supported by the World Bank shows that high and dispersed tariff structures discourage industrial upgrading and reduce productivity growth.

Similarly, studies by Dr. Manzoor Ahmad and others highlight how Pakistan’s tariff regime has historically protected inefficient sectors while penalising competitive ones. Shahid Kardar’s seminal work also emphasises that tariff distortions have long been a major impediment to industrial efficiency and fiscal rationality.

Customs duty collection is predominantly made up of import duties, accounting for approximately 98.4% of the total, with the remaining portion coming from export duties and the export development surcharge.

The distortions created by high tariffs are further amplified by under-invoicing. When tariff rates are high, importers have strong incentives to declare lower values. Under-invoicing reduces customs duties and also depresses sales tax collected at import stage. This creates a cascading effect across the tax system. Under-invoicing also contributes to the growth of the informal economy. Goods imported at undervalued prices enter domestic markets and are sold through undocumented channels. Retailers and distributors remain outside the tax net, weakening both sales tax documentation and income tax enforcement. This reinforces the structural weaknesses identified in Parts II and III.

Closely linked to under-invoicing is the problem of smuggling. High tariff differentials between formal imports and informal channels create strong incentives for cross-border smuggling. Goods entering through informal routes bypass customs duties entirely, distorting markets and undermining domestic industry.

The combined effect of high tariffs, under-invoicing and smuggling is the emergence of a dual economy. Formal sector businesses face high costs and regulatory burdens, while informal operators benefit from lower costs and weak enforcement. This discourages documentation and perpetuates the cycle of informality.

Another important dimension is import compression. Under IMF stabilisation programmes, Pakistan often restricts imports to manage external imbalances. While this may temporarily reduce current account deficits, it also reduces industrial activity by limiting access to raw materials and intermediate goods. As a result, production declines, exports suffer and economic growth slows.

Import compression also affects revenue. Lower imports reduce customs duties and import-stage sales tax, forcing the government to rely more heavily on domestic taxation. This shifts the burden onto already documented sectors, particularly through higher sales tax and withholding taxes.

The tariff structure itself adds to complexity. Multiple layers of customs duty, additional customs duty and regulatory duties create a highly fragmented system. Different rates on similar products encourage misclassification and rent-seeking. Businesses manipulate tariff codes to reduce liability, increasing disputes and administrative inefficiencies.

International experience shows that simpler and lower tariff regimes are more effective. Countries that have rationalised tariffs, reduced dispersion and eliminated non-tariff barriers have achieved higher growth and stronger export performance. Pakistan’s continued reliance on complex and high tariffs has produced the opposite outcome.

The structural link between customs duties and other taxes is particularly important. High tariffs encourage under-invoicing, which reduces sales tax collection at import stage. Weak sales tax documentation undermines income tax enforcement. The result is a cascading effect across the entire tax system, reinforcing reliance on withholding taxation.

Energy imports further complicate this dynamic. Petroleum products remain a major source of customs revenue as well as sales tax and petroleum levy. Fluctuations in global oil prices directly affect fiscal performance. This dependence highlights the need for aligning tariff policy with energy policy, including reducing duties on renewable energy equipment and improving energy efficiency.

The fundamental issue is one of policy direction. Pakistan’s customs regime continues to prioritise short-term revenue over long-term growth. High tariffs generate immediate revenue but undermine competitiveness, encourage evasion and distort economic incentives. A shift toward a simplified, transparent and growth-oriented tariff regime is essential.

Such a regime would involve reducing tariff dispersion, lowering rates on intermediate goods, eliminating regulatory duties and strengthening enforcement through data integration. These reforms must be coordinated with changes in sales tax and income tax to create a coherent fiscal framework.

Official data for FY 2025 confirms that the current approach is unsustainable. Customs duties remain volatile, enforcement challenges persist and structural distortions continue to undermine economic performance. Without comprehensive reform, Pakistan’s tax system will continue to penalise production, reward informality and erode fiscal credibility.

The analysis now turns to the final component of federal taxation. The next part will examine federal excise duty, exploring its role as a policy instrument, its distortionary effects and its place within Pakistan’s complex and evolving tax structure.

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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 an 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.