The Pakistan system of taxing enterprises has undergone some major changes in recent years. Nevertheless, the corporate tax system remains plagued by a number of problems, problems that relate to the neutrality, the yield, and the simplicity of the tax system. The existence of numerous exemption programs has greatly distorted the allocation of investment across sectors and asset types, and has also significantly reduced tax revenues. There also seem to exist significant amounts of tax evasion, evasion that also distorts resource allocation, reduces tax revenues, and compromises the distributional objectives of the system. In part as a result of tax avoidance and tax evasion, the tax base has shrunkn over time, further reducing revenues and leaving many taxpayers out of the tax net. The extensive use of tax incentives is seldom tracked, quantified, and evaluated, and the intended effects on economic growth are uncertain. The incentives are only one feature of the tax system that contributes to an overly complicated system, complications that illustrate the limitations of the tax administration. The tax system was designed for times and circumstances that are long past, and the system has evolved over time in a piecemeal, ad hoc manner with little apparent thought given to the ways in which the pieces of the system need to fit together.

 This chapter discusses these issues. The next section briefly describes some recent global trends in taxing enterprises in a globalized world. The basic structure of the Pakistan corporate tax structure is then discussed, followed by a discussion of the system of incentives. The distorting effects of the tax incentives and tax system on investment are demonstrated by calculating both average effective tax rates (AETRs) from tax return information, and also marginal effective tax rates (METRs) from analytical models. The following sections compare Pakistan tax practice to international practices, examine the overall investment “climate” in Pakistan by drawing upon several recent surveys of business practices in Pakistan and elsewhere, and then identify some of the other core issues in the “system” of corporate taxation. The final section presents some issues that need to be considered in any possible reforms, including some possible reform options.

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