Budget 2022-23 represents a continuation of a pattern seen in several past fiscal plans, where tax rates have consistently increased, and exemptions have been withdrawn, placing additional burdens on existing taxpayers. The main objective of this approach has been to reduce the fiscal deficit, which has remained persistently high at around 7 to 8 percent of the Gross Domestic Product over the past two decades. The strategy relies heavily on raising revenue through increased taxation, yet this approach has largely failed to achieve its intended outcomes. In real terms, revenue generation has not substantially improved, and fiscal deficits have continued to persist or even widen.
One significant and distinctive feature of the current budget is its proposal to eliminate rebates and allowances provided to individual investors who contribute to life and health insurance, voluntary pension schemes, and mutual funds. These tax incentives were previously available under sections 62 and 63 of the Income Tax Ordinance. The proposal to withdraw these tax credits, now up for vote in the National Assembly, effectively places an added tax burden on formal investment channels that encourage long-term savings. This policy direction risks being severely counterproductive, especially for sectors like capital markets, insurance, and mutual funds, which rely on retail investor participation for their growth and stability.
The Broader Economic Context of Savings and Investments in Pakistan
The Pakistani economy faces numerous deep-rooted and chronic problems. Among the most critical of these is the consistently low savings rate, which has remained under 15 percent of GDP. This is in stark contrast to comparable economies such as Bangladesh and India, where savings rates have typically ranged between 28 and 30 percent of GDP. Low domestic savings inherently limit the capacity for national investment, which has also remained below 15 percent. Without adequate internal savings, investments must be fueled through borrowing or foreign direct investment, both of which have become increasingly scarce. This is largely due to ongoing fiscal and current account deficits, as well as declining investor confidence.
Pakistan’s capital market reflects these challenges. Currently, the total market capitalization of all listed companies on the Pakistan Stock Exchange stands at just Rs. 7.1 trillion, or roughly $34.6 billion. This translates to less than 10 percent of the country’s GDP. Both in absolute terms and relative to GDP, this is the lowest level observed in the last two decades. The sharp decline in market capitalization illustrates the fragility of the capital market and the broader investment ecosystem.
Understanding the Implications of Tax Incentive Withdrawal
At present, sections 62 and 63 of the Income Tax Ordinance, 2001 allow individuals to receive tax credits for investing in mutual funds, life and health insurance policies, and voluntary pension schemes. These incentives effectively reduce their overall tax liability, within specific thresholds, encouraging formal savings and long-term financial planning. The Finance Bill 2022 proposes the removal of these benefits. The removal of even these modest incentives can have far-reaching negative consequences for the very sectors they support. This includes the mutual fund industry, the capital markets, insurance providers, and the broader formal economy.
The expected outcome is a decline in the already minimal levels of personal and institutional savings and investment. In a country where these rates are among the lowest globally, discouraging even modest participation in formal investment avenues is economically shortsighted. Additionally, the same budget introduces increased tax rates on salaried individuals, thereby escalating their financial burden. This dual impact — the removal of savings incentives and higher personal taxes — risks disincentivizing formal investment behavior altogether.
Life insurance and mutual funds are among the few instruments through which savings are mobilized from ordinary individuals and channeled into productive investments, particularly within the capital markets. The current number of retail investors in Pakistan’s capital market is estimated at under 300,000. For comparison, India has close to 50 million retail investors. This means Pakistan has just 0.6 percent of India’s investor base. The contrast is stark and highlights the significant underdevelopment of the investment landscape in Pakistan.
Comparative Global Investment Ecosystems
The negative implications of the proposed withdrawal of tax incentives become clearer when viewed against global benchmarks. Pakistan’s life and health insurance penetration rate is less than 0.6 percent, significantly lower than India’s 3 percent and a global average of 3.7 percent. Similarly, the market capitalization of Pakistan’s mutual fund industry stands at a meager 1.3 percent of GDP, compared to 15 percent in India and over 50 percent globally. Removing incentives from such a fragile foundation is not only regressive but also undermines decades of slow progress in formalizing financial practices in Pakistan.
The government’s strategy seems misaligned with its stated policy objectives of promoting financial inclusion, increasing formal savings, and deepening the capital markets. The decision to remove these tax incentives suggests a short-term revenue-maximization approach, with little regard for the long-term health of the economy. Not only does this hinder savings and investment growth, but it also affects broader macroeconomic stability by reducing capital availability for productive sectors.
Economic Ramifications of Discouraging Formal Savings
The primary instruments for formal savings — life insurance, mutual funds, and pension schemes — rely heavily on small but consistent contributions from salaried individuals. The proposed withdrawal of tax credits jeopardizes this stream of investment. The insurance and mutual fund sectors, already under pressure, may see reduced participation and slower growth. This stagnation can also lead to reduced investment in key sectors of the economy, as these institutions often invest in government securities, corporate bonds, and equities.
A reduction in the profitability of these companies is another significant consequence. Insurance companies and mutual funds generate returns that are taxed. In addition, dividends distributed by these entities are also taxed in the hands of the recipients. Therefore, any reduction in investment inflow and profitability directly impacts government tax revenue. The immediate gain of Rs. 3.9 billion projected from the removal of tax incentives may be vastly overstated when weighed against the broader loss in tax revenues from reduced business profits and dividends.
The proposal also risks reversing the modest gains made in promoting financial literacy and formal savings. Individuals who previously invested to avail tax rebates may now reconsider their decisions, potentially withdrawing their investments or discontinuing their insurance policies. This behavior will not only hurt the respective financial sectors but also expose individuals to greater financial insecurity.
Evaluating the Impact on Tax Revenues
The Federal Board of Revenue’s estimated gain of Rs. 3.9 billion from the withdrawal of tax incentives may not hold up under scrutiny. A closer examination reveals that the potential losses could far exceed the projected benefits. Insurance companies, mutual funds, and other financial entities affected by these proposals are taxed at standard corporate rates. They also contribute to government revenue through dividend distributions and capital gains taxes. If these entities experience a decline in investment and profitability due to the loss of retail investor interest, the resulting reduction in tax payments could outweigh the initial revenue gains.
Moreover, retail investors currently account for a significant share of the mutual fund and insurance industries. Open-end mutual fund schemes have over Rs. 340 billion invested by retail participants, while pension schemes hold over Rs. 39 billion. The majority of these investments come from salaried individuals seeking tax benefits. Insurance premiums paid by individuals toward life and health coverage are also substantial, with most qualifying for current tax credits.
Should the incentives be withdrawn, these investments may not only stagnate but even shrink. The consequence would be reduced earnings for companies, smaller taxable profits, and lower dividend payouts. In such a scenario, the net tax impact could be negative rather than positive. The assumption that revenue can be increased merely by withdrawing incentives does not take into account the full scope of behavioral and economic reactions from affected sectors and individuals.
The Role of Institutional Investment in Capital Market Stability
The capital market depends heavily on institutional investment to maintain stability and growth. A large portion of institutional funds comes from insurance companies and mutual funds. The Insurance Association of Pakistan estimates that the total investment by the insurance sector stands at Rs. 2 trillion. Of this, approximately 60 percent, or Rs. 1.2 trillion is attributed to life and health insurance. Mutual funds contribute another Rs. 200 billion to the equity market out of their total asset base of around Rs. 1.2 trillion.
If incentives for retail participation are removed, these institutions will face stagnation in their inflows, leading to reduced investments in capital markets and money markets. This contraction would likely cause a decline in market capitalization, increased volatility, and capital losses. Capital losses reduce capital gains, which in turn shrink the tax base for capital gains taxes. Again, this indicates a potentially negative effect on overall government revenue — exactly the opposite of what the budget aims to achieve.
Beyond revenue implications, the broader impact on market confidence cannot be overlooked. With Pakistan’s capital market already at a historical low, any further deterioration would make recovery even more difficult. The loss of retail investor trust, coupled with declining institutional investment, could send adverse signals to foreign investors and rating agencies, compounding economic challenges.
The Disconnect Between Policy Goals and Budget Proposals
There appears to be a clear contradiction between the government’s broader economic goals and the actual proposals in the budget. On one hand, there is emphasis on formalizing the economy, promoting financial inclusion, and encouraging long-term savings and investments. On the other hand, the removal of key tax incentives undermines these objectives.
Rather than introducing new instruments or expanding existing incentives to increase participation in formal investment vehicles, the current budget seeks to do the opposite. This disconnect raises questions about the coherence and direction of fiscal policymaking. Policy decisions must be rooted in a clear understanding of the dynamics between taxation, investment behavior, and economic growth.
Removing incentives that support financial products such as insurance and mutual funds discourages long-term financial planning and pushes people back toward informal or non-transparent means of saving. It also removes one of the few advantages enjoyed by salaried individuals who are already overburdened by tax obligations. This may further deepen the informal economy and widen the gap between taxpaying and non-taxpaying segments.
Long-Term Implications of Disincentivizing Savings
Savings play a fundamental role in the economic development of any country. They provide the capital required for investment in infrastructure, industry, and innovation. When savings rates decline, economies become more dependent on external borrowing and foreign direct investment, both of which carry their risks and uncertainties. Pakistan, with its already limited internal savings, is especially vulnerable to external financial shocks. Any measure that further discourages personal savings will deepen the country’s financial instability.
The removal of tax incentives from life insurance, mutual funds, and pension schemes effectively reduces the attractiveness of formal saving mechanisms. Without tax benefits, individuals may opt for informal saving methods, such as hoarding cash or investing in non-productive assets like gold or real estate. These alternatives do not contribute to the formal economy, and they fail to generate the economic multiplier effects that come from investments in productive sectors.
Undermining the Insurance and Mutual Fund Industries
Life and health insurance companies and mutual funds play a dual role in the economy. On one hand, they offer financial security and investment opportunities to individuals. On the other hand, they act as institutional investors that contribute significantly to the capital and money markets. Their role in financial intermediation cannot be overstated.
The proposed removal of tax credits will make these products less attractive to new investors and may even lead current investors to exit. Insurance companies depend on a continuous stream of premium inflows to manage risk and maintain reserves. A slowdown in premium collection affects their solvency, investment capacity, and profitability. Mutual funds face similar risks. A reduction in retail participation would result in lower Assets Under Management, which directly affects their operational revenue and market influence.
This weakening of insurance and mutual fund industries would be felt across the financial ecosystem. Institutional investments in bonds, equities, and government securities would decline, reducing liquidity in capital markets and increasing volatility. Moreover, companies that rely on institutional investors to raise capital would face difficulties in securing funds, slowing business expansion and job creation.
Impact on Capital Market Development
Pakistan’s capital markets are already underdeveloped relative to global and regional peers. A vibrant capital market is crucial for channeling savings into productive investments, improving resource allocation, and supporting economic growth. The erosion of investor confidence through regressive fiscal policies only exacerbates the market’s fragility.
Capital markets in developed economies thrive because of deep participation from both retail and institutional investors. Tax incentives serve as an important tool in encouraging such participation. They help align individual financial planning with broader economic goals. The elimination of such incentives in Pakistan represents a significant step backward for market development.
At present, Pakistan’s stock market capitalization is less than 10 percent of its GDP. This figure reflects the limited trust and engagement from the population in financial markets. Removing one of the few remaining incentives to invest in capital markets could push this ratio even lower. The long-term consequences would include a reduction in innovation, capital formation, and economic diversification.
Shrinking the Pool of Long-Term Capital
Long-term capital is essential for infrastructure development, energy projects, and industrial expansion. It is usually sourced from institutional investors who have predictable cash flows and long investment horizons. Insurance companies and pension funds are among the most reliable providers of long-term capital.
When these institutions face a decline in inflows due to unfavorable tax policies, their capacity to invest in long-term projects is diminished. This creates a funding gap that cannot easily be filled by short-term lenders or external investors. As a result, vital infrastructure and industrial projects may be delayed, scaled down, or cancelled altogether.
Moreover, in the absence of adequate long-term capital, the government may be forced to increase its reliance on commercial banks for domestic borrowing. This crowds out private sector borrowing, raises interest rates, and reduces access to credit for small and medium enterprises. Ultimately, this chain reaction restricts economic growth and employment generation.
Risks to Financial Inclusion and Literacy
Over the past decade, modest progress has been made in improving financial inclusion and literacy in Pakistan. Initiatives by the State Bank and financial institutions have helped to introduce more people to formal banking, insurance, and investment products. Tax incentives have played a supportive role in this progress by making it financially advantageous to participate in formal financial systems.
The reversal of these incentives sends a contradictory message. It suggests that participation in formal savings and investment schemes is no longer valued or rewarded. This could lead to a decline in financial inclusion and a reversion to cash-based, informal saving methods that offer no long-term protection or growth.
Reducing the appeal of formal financial instruments also threatens the momentum behind recent awareness campaigns. People who were beginning to understand and adopt formal savings practices may now feel discouraged. The resulting apathy could take years to overcome and may hinder efforts to build a financially literate society.
Harm to Middle-Class and Salaried Individuals
Salaried individuals form the backbone of the tax-paying population in Pakistan. Unlike business owners or those in the informal economy, their income is fully documented, and taxes are deducted at source. For this reason, they often bear a disproportionate share of the tax burden.
The removal of tax rebates on insurance premiums, pension contributions, and mutual fund investments directly impacts this segment. These incentives were among the few tools available to salaried individuals to manage their tax liabilities while planning for future financial security. Their removal increases the effective tax rate on this class and reduces disposable income.
This increase in financial pressure could lead to lower consumption, reduced ability to invest in education or healthcare, and even the postponement of major life decisions such as buying a home or starting a business. Over time, this could erode the economic resilience of the middle class and widen the gap between the formal and informal sectors.
Diminishing Returns from Revenue Collection Efforts
From a purely fiscal perspective, the estimated additional revenue of Rs. 3.9 billion appears modest when weighed against the potential economic damage. The government’s aim of raising revenue through the removal of tax credits fails to consider the broader revenue losses that may result from slower economic growth, reduced corporate profitability, and weaker capital markets.
If businesses in the insurance and mutual fund sectors report lower earnings, they will pay less in corporate taxes. If retail investors withdraw from capital markets, dividend payouts will fall, reducing personal income tax collections. If the stock market declines, capital gains tax revenues will decrease. All these outcomes would offset the initial gain and could even lead to a net reduction in tax revenue.
Moreover, the administrative cost of enforcing these new rules and addressing potential disputes or appeals may also eat into the projected gains. The policy could end up being a bureaucratic burden with little to show in terms of real fiscal improvement.
Misalignment with Global Best Practices
Globally, governments use tax incentives to encourage behavior that benefits society and the economy. These include deductions for education, health care, retirement savings, and investment in small businesses. The underlying principle is to reward forward-looking financial behavior and reduce reliance on public welfare systems.
In developed countries, tax-advantaged retirement accounts and insurance policies are standard tools for building financial security. They reduce the long-term burden on the state and increase individual financial independence. By contrast, Pakistan’s move to eliminate such incentives runs counter to international trends and best practices.
This divergence not only undermines the credibility of fiscal policy but also sends confusing signals to foreign investors and international financial institutions. It suggests a lack of commitment to building a modern, resilient financial system that supports personal savings and long-term capital formation.
The Regressive Nature of the Policy
The withdrawal of tax credits disproportionately affects those who are already compliant with the tax system. People who contribute to formal insurance and investment products tend to be tax filers, salaried workers, and middle-class professionals. Punishing this group through higher taxes while leaving the informal sector untouched is inherently regressive.
Instead of broadening the tax base by bringing informal earners into the fold, the policy penalizes those already participating. This could lead to greater tax evasion, reduced trust in the system, and a weakening of the social contract between citizens and the state.
A more equitable approach would be to maintain incentives for formal financial behavior while strengthening enforcement mechanisms to widen the tax base. This would support both revenue growth and economic development.
Missed Opportunity for Structural Reform
Rather than removing incentives that promote savings and investment, the government could have used the budget to initiate structural reforms. These might include enhancing the reach and quality of financial products, expanding coverage of tax-advantaged savings plans, or introducing matching contributions for low-income investors.
Such reforms would align short-term fiscal goals with long-term economic development. They would also promote financial discipline, reduce dependency on external financing, and improve the country’s creditworthiness. Unfortunately, the current proposals fall short of this vision and represent a missed opportunity to lay the groundwork for sustainable growth.
Structural Weaknesses in Pakistan’s Fiscal Framework
Pakistan’s repeated fiscal challenges have exposed critical weaknesses in its revenue generation model. The state has consistently relied on a narrow tax base, with a significant portion of the burden falling on salaried individuals and documented businesses. Meanwhile, the vast informal economy, which comprises a large share of national economic activity, remains largely untaxed and unregulated.
This imbalance has created a fiscal framework that is both inefficient and unjust. Rather than working to broaden the tax net and integrate the informal sector, successive governments have turned to regressive measures such as withdrawing tax credits and increasing tax rates on existing payers. These moves have failed to generate meaningful, sustainable revenue and have further weakened public trust in the tax system.
The decision to eliminate tax incentives for savings and investment is yet another example of targeting the limited, compliant portion of the economy. Such policies discourage compliance and reward informality. Over time, this can lead to greater tax evasion, underreporting of income, and reduced transparency across economic transactions.
Behavioral Responses to Tax Policy Changes
One of the most critical, yet often overlooked, aspects of tax policy is its influence on behavior. People respond to incentives and disincentives in ways that can significantly alter economic outcomes. The decision to remove tax incentives for life and health insurance, mutual funds, and pension schemes may result in a decline in participation, not just from new investors but also from existing ones.
Individuals who initially chose these formal instruments to reduce their tax liability may reassess their financial strategies and shift to options that offer better short-term returns or no reporting obligations. For instance, real estate and foreign currency holdings may appear more attractive. These assets are less productive for the economy but may be perceived as safer or more profitable by individuals in the absence of tax benefits on financial instruments.
Moreover, when formal saving options become less rewarding, the perceived value of financial planning also declines. People may become more inclined to spend rather than save, undermining the long-term pool of capital available for investment in public and private sector projects. These behavioral changes have long-term ramifications that go beyond the immediate fiscal cycle.
Decline in Institutional Confidence
Policy reversals like the proposed withdrawal of tax incentives contribute to a climate of policy uncertainty. Investors, both domestic and international, look for stable and predictable regulatory environments. When governments make sudden or inconsistent changes to fiscal policy, it undermines investor confidence and makes long-term planning difficult.
In Pakistan’s case, such policy instability is a recurring issue. Businesses and financial institutions must frequently adjust to shifting regulations, tax codes, and compliance standards. The cumulative effect is a weakening of institutional trust, which then leads to capital flight, reduced foreign direct investment, and slow development of financial infrastructure.
When savings instruments such as life insurance and mutual funds become less viable, the institutions offering them suffer in credibility. Consumers may begin to doubt the reliability or future performance of these financial products. Once trust is eroded, it becomes incredibly difficult to rebuild, even with future incentives or reforms.
Reducing the Role of Financial Intermediaries
Financial intermediaries like mutual funds and insurance companies serve as vital channels between savers and borrowers. They collect savings from the public and allocate these funds to productive ventures, including industrial development, infrastructure projects, and government securities. These institutions reduce the transaction costs of financial intermediation and contribute to the overall efficiency of the economy.
The withdrawal of tax incentives curtails their ability to attract capital from individual investors. As a result, the volume of funds they manage may decline, limiting their capacity to invest in broader economic activities. This diminishes their relevance in the financial system and reduces their ability to influence long-term interest rates, liquidity, and market dynamics.
Furthermore, weakened intermediaries cannot fulfill their secondary role of financial education. Institutions often serve as the first point of financial literacy for retail investors. By engaging with mutual fund representatives or insurance agents, individuals learn about budgeting, investing, and planning for retirement. Reduced demand for these services will likely shrink the outreach of such educational initiatives, further worsening financial literacy.
Impact on Demographic Segments with Special Needs
Tax-advantaged savings instruments serve not just the general public but also specific demographic groups who have limited earning windows or greater financial vulnerabilities. For instance, younger professionals often rely on pension schemes to accumulate wealth gradually for retirement. Similarly, families with dependents use life and health insurance policies to protect themselves from unforeseen financial shocks.
The elimination of tax benefits associated with these instruments disproportionately affects these vulnerable groups. They lose both the incentive and the means to secure their future. Young people, in particular, may become more financially insecure if they are discouraged from long-term savings early in their careers.
Women, who often save on behalf of their families and children, may also be adversely impacted. In many households, women manage household budgets and make decisions about health insurance or children’s education funds. Discouraging formal savings limits their financial agency and increases economic vulnerability, especially in single-income households.
Threat to Retirement Security
One of the main justifications for tax credits on pension schemes is to promote retirement security. In the absence of a robust public pension system, individuals must rely on personal savings to ensure a dignified retirement. Tax-advantaged retirement accounts are widely recognized globally as a tool to encourage disciplined long-term savings.
The proposed budget changes threaten the viability of this system. Without the lure of tax savings, many salaried individuals may no longer contribute to voluntary pension schemes. Over time, this will reduce the overall pool of retirement capital, potentially increasing dependency on government transfers or informal family support systems in old age.
As life expectancy increases and healthcare costs rise, the burden on public systems and families will grow unless private retirement savings are encouraged. The decision to remove incentives for such savings contradicts this demographic reality and fails to address the long-term needs of an aging population.
Erosion of Public Trust in Government Policy
Public trust is a critical yet intangible asset for any government. When people believe that policy decisions are made in their best interest, they are more likely to comply with regulations, pay taxes, and invest in formal institutions. However, when policies appear short-sighted or inconsistent, public trust begins to erode.
The removal of incentives for formal savings not only affects economic behavior but also the relationship between the state and its citizens. People may interpret this policy move as a sign that the government is more interested in short-term revenue collection than in long-term economic development or financial empowerment.
Rebuilding trust after such a policy misstep can be a lengthy process. It would require not only the reversal of the current proposal but also a broader commitment to policies that prioritize sustainable economic development and equitable tax structures. Until such a shift occurs, skepticism and disengagement from formal financial systems may persist.
Failure to Align Fiscal and Monetary Policies
Sound economic management requires coordination between fiscal and monetary authorities. While the central bank may pursue monetary policies aimed at reducing inflation and stabilizing the currency, fiscal policies should complement these efforts by promoting savings and investment.
In Pakistan, the recent fiscal proposals are misaligned with broader monetary objectives. While the State Bank may encourage financial inclusion and capital market development, the removal of tax incentives undercuts these goals. It creates conflicting signals in the market, which can lead to confusion and inefficiencies.
Such a disconnect between fiscal and monetary policy can reduce the effectiveness of both. For instance, lower interest rates intended to stimulate investment may not yield the desired results if individuals are simultaneously discouraged from saving through unfavorable tax policies. Coordination and consistency across government agencies are essential to achieving macroeconomic stability.
Short-Termism in Economic Planning
A recurring theme in Pakistan’s fiscal management is the focus on short-term fixes at the expense of long-term stability. Policymakers often prioritize immediate revenue generation over structural reforms that would yield sustainable growth. The removal of tax credits for savings and investment instruments is a textbook example of such short-term thinking.
While it may plug a small fiscal gap in the current budget, it does so by undermining sectors that contribute to long-term economic resilience. The cost of rebuilding these sectors in the future—both in financial and institutional terms—will far exceed the savings realized today.
Sustainable economic planning requires a forward-looking approach that balances current needs with future obligations. Instead of weakening savings institutions, efforts should be directed at strengthening them through regulatory support, public awareness campaigns, and integration with social welfare policies.
Missed Fiscal Opportunities through Reform
The current policy direction also ignores several low-hanging fruits for reform. For example, better enforcement of existing tax laws, digitization of the informal economy, and rationalization of tax exemptions for powerful interest groups could generate far more revenue than the removal of savings incentives.
The informal economy, which remains largely untaxed, offers enormous potential for revenue expansion. Investments in data analytics, tax audits, and cross-institutional data sharing could bring more people into the tax net. This would allow the government to maintain or even expand incentives for formal savings while still improving fiscal health.
In addition, a tiered system of tax incentives could be introduced, where individuals with lower income receive higher tax credits for savings. This would ensure that the policy remains progressive and targeted, benefiting those who need it most while maintaining economic incentives for all income levels.
Strategic Missteps in Economic Prioritization
By targeting sectors that have historically received little government support but play an outsized role in economic stability, the budget proposals send the wrong message about the country’s priorities. Instead of encouraging institutional development and private savings, the government appears to be signaling that these are expendable in the face of fiscal pressure.
This misalignment can have long-term strategic consequences. Future governments may find it more difficult to reintroduce incentives or rebuild weakened institutions. The erosion of trust, participation, and capital in these sectors could take years to recover, delaying the country’s progress toward financial modernization.
Such decisions also affect Pakistan’s image on the international stage. Investors, donors, and multilateral institutions assess a country’s policy coherence and commitment to reform before making long-term engagements. Regressive fiscal measures signal weakness and indecision, potentially reducing international goodwill and financial assistance.
Revisiting the Economic Role of Incentives in Formal Savings
Incentives in the form of tax credits and rebates play a pivotal role in encouraging individuals to shift from informal and often unproductive savings mechanisms to formal, structured financial instruments. Life insurance policies, mutual funds, and voluntary pension schemes are not just products; they are essential building blocks of a resilient financial ecosystem. These instruments mobilize idle funds, enhance financial security, and contribute to economic growth by supporting productive investment.
The removal of tax incentives from these products disincentivizes their use, particularly among retail investors. When the tangible benefit of lower tax liability is withdrawn, many individuals no longer see the advantage of engaging with formal financial systems. This undermines efforts to deepen the reach of structured financial tools and promotes a return to cash savings and real estate speculation, which offer limited benefit to the broader economy.
Long-term economic resilience requires consistent and forward-thinking policies that promote savings across all strata of society. Tax benefits serve as a behavioral nudge for individuals to plan for the future. Eliminating such incentives disrupts this behavior and reverses years of effort spent building awareness, trust, and participation in formal finance.
Broader Impact on the Economy’s Formalization
Pakistan has struggled with a largely undocumented economy. A significant portion of transactions, employment, and assets remain outside the purview of government regulation, taxation, and oversight. Policymakers have consistently emphasized the need to formalize the economy to increase revenue, improve regulation, and enhance productivity.
Savings instruments such as insurance and mutual funds serve as entry points for individuals and small businesses into the formal economy. They require disclosure of identity, income, and transaction history, which naturally generates documentation and visibility. As more people adopt these instruments, the state benefits from improved data collection and more accurate economic forecasting.
Removing incentives for such products, however, undermines these gains. Individuals are more likely to opt out of formal mechanisms and revert to informal practices. This weakens the government’s ability to track economic activity, enforce compliance, and design effective policy interventions. It also constrains the development of a tax culture, as people lose confidence that their transparency is rewarded with fair treatment.
Undermining Social Equity and Financial Protection
The tax credits proposed for withdrawal primarily benefit middle-class, salaried individuals who often lack access to other forms of wealth-building or tax avoidance. These individuals are already fully visible to the tax system, with income deductions occurring directly through payroll. By eliminating their access to savings-related tax incentives, the state further burdens a segment of the population that has little room for tax planning or wealth shielding.
In contrast, many higher-income earners and those in the informal economy continue to benefit from loopholes, underreporting, and limited oversight. The result is a regressive system where the compliant bear a disproportionate burden. This inequality damages public perception and reduces the incentive for voluntary compliance.
Moreover, without formal financial protection tools, individuals are more vulnerable to personal financial shocks. Life and health insurance serve as safety nets against emergencies. Pension schemes protect individuals from poverty in old age. When access to these tools is discouraged through fiscal policy, people are forced to rely on personal networks or public welfare systems, neither of which may be reliable or sufficient.
Potential for Capital Flight and Investment Diversion
Investors, particularly those with significant capital, are highly responsive to changes in taxation policy. When they perceive a reduction in after-tax returns or an increase in compliance burden, they often look for alternative jurisdictions or investment vehicles. In a world where capital is mobile and financial options are global, local policies must be carefully calibrated to retain investor confidence.
The withdrawal of savings-related tax credits may not only affect local retail investors but also institutional and high-net-worth investors. As profitability declines for mutual funds and insurance companies, and as investor sentiment weakens, the resulting capital outflows may accelerate. This could manifest as reduced inflows into the stock market, weaker demand for government bonds, and greater interest in offshore investments.
This scenario not only weakens the domestic financial system but also creates exchange rate pressure. Reduced demand for local currency instruments can lead to depreciation, inflation, and increased borrowing costs. The broader macroeconomic impact would far outweigh the modest fiscal gains expected from the policy change.
Opportunity Cost of Policy Reversal
Opportunity cost is a fundamental concept in economics. By removing tax incentives for formal savings, the government forgoes the long-term economic benefits associated with capital accumulation, market development, and financial inclusion. These include higher productivity, more efficient resource allocation, and reduced reliance on public welfare systems.
The fiscal savings from eliminating tax credits must be weighed against these foregone benefits. If the result is lower overall investment, reduced profitability for financial institutions, and weaker economic growth, then the net effect of the policy is negative. Policymakers must assess not just what is gained today, but what is lost in the years to come.
In addition, the cost of restoring confidence once it is lost can be extremely high. Future governments may need to offer even more generous incentives to reverse the damage, or they may find that people are simply unwilling to return to formal financial systems. These indirect and often unquantifiable costs must be part of any serious policy analysis.
Recommendations for Policy Redirection
A more constructive approach to fiscal management would involve expanding the tax base rather than deepening the burden on those already compliant. This could include integrating the informal economy through digital payment systems, incentivizing documentation, and enhancing audit capacity. These measures would help improve revenue collection without undermining economic growth.
Policymakers should also consider the design of more targeted tax incentives. For example, tax credits could be tied to income levels, offering greater benefits to low- and middle-income individuals while phasing out for higher-income earners. Such a progressive approach ensures equity while maintaining the incentive structure.
Additionally, efforts should be made to simplify access to savings instruments. Financial institutions can be encouraged to reduce administrative hurdles and improve customer service. The state can also support public awareness campaigns that explain the value of long-term savings and how individuals can benefit from formal financial products.
Importance of Stakeholder Consultation
Another significant shortcoming of the proposed changes is the apparent lack of stakeholder engagement. Financial policies, especially those affecting savings and investments, should be developed in consultation with affected parties, including financial institutions, economists, industry experts, and representatives of the salaried class.
Inclusive policy development not only ensures better outcomes but also builds public support. When stakeholders are consulted, they can provide critical insights into the real-world impact of policy changes and offer alternative solutions. This helps avoid unintended consequences and improves the credibility of governance institutions.
In the case of tax credits for savings, consultation with mutual fund associations, insurance companies, pension administrators, and salaried individuals could have revealed the likely behavioral and financial effects. Instead, the policy appears to have been introduced without a thorough understanding of its implications or broader economic context.
Aligning Policy with Development Goals
Pakistan’s long-term development goals include poverty reduction, financial inclusion, increased domestic investment, and sustainable economic growth. Achieving these goals requires consistent and supportive policies across sectors. Tax policy should be aligned with development goals, not in conflict with them.
Encouraging savings contributes to poverty alleviation by providing individuals with a buffer against economic shocks. Promoting pension schemes reduces future public welfare liabilities. Supporting the growth of capital markets increases investment in industries and infrastructure. These are all goals that tax incentives help to support.
The proposed policy shift, however, undermines these objectives. By making savings less attractive, it increases financial insecurity, weakens private sector investment, and raises future fiscal liabilities. Reinstating these incentives and expanding them where appropriate would be a more strategic move for long-term development.
Learning from Global Examples
Countries around the world have developed sophisticated systems to promote savings among their populations. In the United States, 401(k) and IRA plans allow individuals to save for retirement with tax advantages. In the United Kingdom, ISAs provide tax-free interest and returns on investments. In India, schemes like the Public Provident Fund and National Pension Scheme offer both tax savings and financial protection.
These policies are not viewed as revenue losses but as investments in human capital and economic stability. They are supported by rigorous oversight, robust regulatory frameworks, and extensive public education campaigns. Pakistan can learn from these examples by designing locally appropriate systems that encourage savings without creating distortions.
A well-designed incentive system tailored to Pakistan’s demographic and economic context could significantly improve financial security and economic performance. It would also send a clear message to both domestic and international stakeholders that the country is committed to sustainable and inclusive growth.
Reaffirming the Importance of Economic Vision
Policy decisions must be guided by a coherent economic vision that prioritizes national well-being over short-term accounting gains. Taxation should be a tool to promote investment, equity, and stability not a blunt instrument to close fiscal gaps at any cost.
Reversing the proposed withdrawal of savings-related tax incentives would represent a step toward reaffirming such a vision. It would indicate that the government values long-term economic health, trusts its citizens to invest wisely, and recognizes the vital role of financial institutions in development.
The decision would also restore confidence among the investing public and provide a foundation for future reforms. It would demonstrate a willingness to listen, adapt, and align policies with the real needs of the people and the economy.
Conclusion
The policy to eliminate tax incentives for investments in life and health insurance, mutual funds, and pension schemes represents a short-sighted and counterproductive move. While it may offer limited fiscal relief in the immediate term, its long-term consequences are detrimental to savings, investment, financial inclusion, and economic growth. The expected gains in revenue are likely to be outweighed by the losses in profitability, capital market participation, and public trust.
Instead of punishing those who participate in formal financial systems, the government should be rewarding and expanding their participation. Incentives for savings are not just tax breaks, they are essential tools for economic development, social equity, and institutional strength. The decision to withdraw them should be reconsidered in light of their far-reaching impact on the economy and society.