Inefficient by design

PAKISTAN has entered IMF programmes roughly two dozen times. More than any other country. Each programme lands with the same diagnosis: the tax base is too narrow, distortions are too many, and institutions are too weak. The IMF prescribes, Pakistan implements, and the programme ends. And then, after a brief interval, another programme begins with the same diagnosis and the same prescription. If this were simply a story of poor implementation or weak state capacity, one would expect at least incremental improvement over these many decades. Instead, the patient presents the same symptoms at every admission.

This demands a different kind of explanation, one that asks not why reform has failed, but whether what we call reform was ever designed to succeed. In the theory of inefficient institutions, economist Daron Acemoglu offers the clearest framework for this sort of question. In his theory, the puzzle of persistent underdevelopment dissolves once you accept the premise that groups holding political power choose policies, not to maximise aggregate welfare, but to transfer resources from the rest of society to themselves. Crucially, these choices are not accidental; they are equilibria. The set of rules that emerge are inefficient by design, because the groups that benefit from inefficiency are precisely the groups with the power to shape these rules. Pakistan, examined through this lens, is a classic case study.

Acemoglu’s framework identifies three mechanisms through which elites extract rents at the expense of broader welfare. The first is revenue extraction: taxing productive groups to fund transfers to the powerful. The second is factor price manipulation: impoverishing competing producers in order to reduce their demand for labour and other inputs, thus benefiting elite producers indirectly. The third is political consolidation: deliberately weakening the economic base of groups that might challenge elite dominance. All three are visible in Pakistan’s current fiscal architecture.

Consider the petroleum levy. Over the past few years, it has quietly become the federal government’s main revenue instrument, with the IMF now targeting Rs1.7 trillion for the 2026 budget. To give you the context of its size, in the 2025 budget, three smaller provinces, Sindh, KPK and Balochistan received Rs2.04tr, Rs1.34tr and Rs0.743tr respectively as their share from the NFC award. More alarmingly, this target is in the year when the IMF itself reports the effective tax rate on petroleum products in Pakistan is 166 per cent. Two things about this levy deserve more attention than they receive. First, unlike income tax or sales tax, the petroleum levy does not enter the divisible pool, meaning provinces and the populations they serve receive no share of its proceeds. This is a structural choice that concentrates fiscal resources at the federal centre while the costs are borne by everyone who buys fuel, which is everyone.

The question isn’t why reform failed but whether it was ever designed to succeed.

Second, energy is an essential input. The levy raises the cost of production across all productive sectors, functioning as a tax on economic activity itself. In Acemoglu’s terms, this is factor price manipulation operating at national scale.

Now consider what has happened to the salaried class over the same period. Withholding tax from salaries rose sharply, reaching Rs605.6 billion in 2024–25. The traders, the landlords, and the large retailers remain largely outside the effective tax net. This is not because the state lacks the administrative capacity to reach them, but because they are sufficiently proximate to those who are the decision-makers. The salaried professionals are taxed because they can be.

What makes this architecture particularly legible through Acemoglu’s framework is what has happened simultaneously on the other side of the ledger. In the same fiscal year when the petroleum levy target was breaking records and the salaried class was squeezed further, the banking sector recorded historic profits exceeding Rs600bn, earned primarily on government securities.

In plain words, the fiscal crisis that justifies the levy and excessive tax on salaried class also compels the government to borrow at high rates. Banks lend to the government rather than the productive economy. Take another example, SUV and pickup sales rose sharply in 2025, and it is not the salaried middle class who can afford it. When a crisis concentrates its costs on the salaried middle class while generating record returns for asset holders and the financial sector, it has ceased to be a crisis and has become policy.

After all these IMF programmes, each one individually and collectively selling us the reform agenda, Pakistan ranks 168th on the Human Development Index, below countries with a fraction of its economic history, endowment and potential. This cannot be classified as the residue of bad luck or insufficient effort. It is the arithmetic of a system — a system in which the institutions designed to fund public goods are instead calibrated to extract from those least able to resist extraction and shelter those who are most able to shape the rules.

The micro-mechanisms through which ordinary citizens end up bearing more than their due share of the burden is captured with clarity in my model on rent-seeking published in 2018. The state sets a statutory rate, call it the intended transfer. How much any individual actually pays depends not on that rate but on something else entirely — the stock of political capital they have accumulated. Those who accumulate sufficient political capital can resist the transfer away from themselves.

An individual’s effective contribution to the exchequer depends on the strength of his relative political capital and the institutional controls designed to prevent evasion. Where political capital exceeds the threshold set by those controls, he ends up paying less than the statutory rate. Where it falls short, because he has neither the resources nor the connections to accumulate it, he pays the full rate. And when institutional controls are weak enough that evasion is widespread, those who cannot evade are made to compensate for the leakages created by those who do.

The writer is an associate professor of economics at the Lahore School of Economics.

Published in Dawn, June 20th, 2026 ...