Pakistan under strong pressure to reform 'dysfunctional' tax system

Pakistan's plea for billions of dollars to recover from this summer's floods has sparked pressure on the country to reform its dysfunctional tax system, which collects very little money, even from the rich.

The country's biggest donor, the United States, has issued one of the strongest warnings, saying the world will only be able to fund a quarter of the tens of billions of dollars it will take to rebuild - and it will be difficult to get American taxpayers to help if Pakistanis aren't footing their share of the bill.

But many economists fear the threats are hollow and the US and others will once again bail out Pakistan without insisting on necessary economic reforms because the nuclear-armed country is so important in the war against al-Qaeda and the Taleban.

"Pakistan can say, 'If you don't help us, the economy crumbles, the Taleban takes over and there goes your war on terror,"' said Akbar Zaidi, an economist who recently published a report on Pakistan's tax system for the Carnegie Endowment for International Peace. "They don't want to alienate the government, so they will let them off the hook."

Pakistan has one of the lowest effective tax rates in the world, equal to about 9 per cent of the value of the country's economy, according to the Carnegie report. In contrast, the US equivalent is about 28 per cent. One of the reasons Pakistan's rate is so low is because many people avoid paying taxes. Fewer than 2 per cent of the country's 175 million citizens pay any income tax, according to the report.

Ishrat Hussain, former head of the Pakistan central bank, estimated that better enforcement of tax policies and the elimination of exemptions should produce an effective tax rate of 15 per cent - generating nearly $10 billion in revenue per year.