90% inflation trap that resets no tax bracket

Here is a policy question worth asking before the next budget: if a worker today earns exactly what it takes to live the way someone on Rs100,000 a month lived in 2021, why are they being taxed as though they got a raise?

They did not. Prices did. Between 2021 and 2024, Pakistan’s cumulative inflation crossed 90%. A hundred rupees from 2021 buys less than 55 rupees of goods and services today. Yet the income thresholds that determine who pays 15%, 25% or 35% in tax have barely moved. The result is a stealth tax increase, one that required no legislation, no announcement and no debate. Economists have a name for it: bracket creep. In Pakistan’s case, it might more honestly be called a structural squeeze on the only people the tax system can actually reach.

Take a concrete example. In 2021-22, a monthly salary of Rs100,000 placed a worker in the lowest marginal bracket. That income covered a modest urban household in major cities: rent, school fees, groceries, utilities and a thin margin for savings. Fast forward to 2024-25. That same basket of goods now costs around Rs200,000 a month. A worker lucky enough to have received some cost-of-living adjustments might now earn Rs150,000 to Rs175,000. And here is where the double jeopardy kicks in.

First, their salary has not kept up with inflation, so they are poorer in real terms. Second, their nominal income has risen enough to push them into a higher tax bracket, where a 15% marginal rate applies on income exceeding Rs1.2 million annually. They have lost on both fronts simultaneously – squeezed by rising prices and then taxed more heavily on the insufficient compensation they received for it. The tax system, indifferent to all of this, treats them as though they climbed the income ladder.

They did not climb. The ladder was pulled up. The 35% marginal rate, Pakistan’s highest, kicks in at Rs4.1 million annually, or roughly Rs342,000 a month. In 2021, that income marked a comfortable upper-middle-class life. Today, it describes a mid-career professional in any major Pakistani city: a senior engineer, an experienced banker, a corporate manager in their late thirties. These are not the people a top marginal rate of 35% was designed to target. These are the backbone of the formal economy, the most compliant taxpayers in the country, and the group with the least ability to restructure their income to reduce their exposure.

A mid-level executive earning Rs350,000 a month is paying the same marginal rate as someone bringing home Rs1.5 million a month. The tax code has quietly decided these two people are in the same bracket. They are not. The standard critique of bracket creep focuses on fairness, and rightly so. But there is a second, more insidious consequence that gets less attention. When a marginal salary increase is taxed at 25% to 35%, the worker in the formal economy retains only 65% to 75% of every additional rupee earned, on a salary that is already losing ground to inflation. At that point, the financial return to working harder, taking on more responsibility or investing in one’s own skills approaches negligibility. Ambition, in other words, is being taxed.

This matters beyond individual fairness. Pakistan has roughly 7.5 to 8 million active tax filers in a workforce of over 80 million. The informal economy remains vast, and a meaningful part of it stays informal precisely because the cost of formalisation is high relative to the benefit. A tax structure that simultaneously raises the real burden on compliant earners and destroys the incentive to earn more is not just inequitable. It is economically self-defeating. The textbook solution is automatic indexation: tax brackets adjusted each year in line with the consumer price index, so that inflation does not silently do what a ministry of finance would never dare to announce. Several OECD countries have done this for decades. The principle is simple: if prices rise 20%, the thresholds at which higher rates apply rise by 20% too. The real burden stays constant.

Applied to Pakistan’s situation, had the 2021-22 slabs been fully indexed to cumulative CPI through 2024-25, the 35% bracket would begin at around Rs7.5 to Rs8 million annually, not Rs4.1 million. The 25% bracket would open at roughly Rs4 million, not Rs2.2 million. That is not a tax cut for the rich. That is the tax system correctly identifying who the rich actually are. If automatic indexation feels too ambitious, and given Pakistan’s fiscal constraints, that concern is not unreasonable, there is a more immediate and politically achievable alternative: a one-off rationalisation of the tax brackets to account for the extraordinary inflation of the past years.

No tax policy designer in 2021 anticipated a cumulative 90% price shock. The slab structure was calibrated for a different economy. A targeted, one-time reset of the thresholds to reflect today’s real purchasing power would restore the original distributional logic of the tax code without requiring a permanent indexation mechanism. It would be an acknowledgment that the government has been collecting an unlegislated inflation surcharge from the salaried class for four consecutive years, and that it is time to stop.

The government’s instinctive objection to any bracket reform is revenue. Pakistan’s tax-to-GDP ratio sits at around 10% to 11%, among the lowest in the region, and fiscal space is genuinely tight. But the response to that challenge cannot indefinitely be to squeeze harder the small population of people who are already in the net. The withholding regime captures the salaried class with near-total efficiency. The challenge was never extracting more from them. The challenge is extending the net to the informal economy, the agricultural sector and the retail trade, sectors that remain largely untouched while the salaried middle class bears a growing real burden through a mechanism that nobody voted for. Bracket creep is a symptom of a system that finds it easier to tighten existing traps than to build new ones. At some point, that strategy runs out of road. A tax system that silently raises its take every time prices rise is not merely inefficient. It is, in a quiet but consequential way, a betrayal of the people who play by the rules.

THE WRITER IS AN ASSISTANT PROFESSOR OF ECONOMICS AND DIRECTOR OF THE ECONOMIC GROWTH AND FORECASTING LAB AT IBA