Public Finance & Taxation

In this post we will discuss the basic introduction to public finance including the concepts of budget, various types of budgets, sources of public revenue, types of public expenditure. Moreover, we pass through definitions of fiscal policy and its objective along with tools of fiscal policy.

Public finance is the field of economics that studies government spending and taxation. Public finance is divided into four branches

• Public expenditure
• Public revenue
• Public debt
• Financial administration

What is budget?

Budget is an annual financial statement of the revenue and heads of expenditure of the government in the coming fiscal year.

• There are three sources of government revenue.
  • Tax revenues
  • Non-tax revenues
  • Government debt
• Tax revenues include
  • Direct taxes
  • Indirect taxes
• Non-tax revenues include fines and fees, prices, grants and gifts, deficit financing etc.
• Government debt includes
  • Internal debt
  • External debt

Types of Budgets

There are two types of budgets

• Revenue Budget
• Capital Budget

Revenue Budget

Revenue budget is a statement of the government’s estimated revenue receipts and revenue expenditure for a period of one financial year.

• Revenue receipts: These are the receipts that neither create liability nor decrease any asset for the govt. It includes both tax revenue like direct and indirect taxes and non-tax revenue like interest receipts, dividends, profits, fee and fines, and grants etc.
• Revenue Expenditure: Revenue expenditure is that expenditure of the government which does not cause increase in government assets and does not cause any reduction in liability. Such as salaries of government employees, subsides, transfer payments.

Capital Budget

Capital budget is a statement of the government’s estimated capital receipts and capital expenditure.

• Capital Receipts: Capital receipts are receipts which create liabilities or reduce assets of the government. It consists of (i) selling public assets like enterprises (ii) Money received from borrowing etc.
• Capital Expenditure: Capital expenditure is the expenditure of the government which either creates assets or reduces liability. It consists of (i) long-term investment by govt. such as creation of an asset, investment on infrastructure, (ii) funds to local and state governments by central government, (iii) repayment of its own loan, etc.

To understand quickly see Revenue & Capital Budget Table

Tax Revenue

Tax revenues are the revenues collected by government through various forms of taxes such as direct taxes, and indirect taxes.

What is Tax?

The word tax comes from Latin word “Taxare” which means “to estimate or to value”. Tax is a compulsory payment made by the households or firms to the government. In economic terms tax is the flow of income or wealth from households and firms to the government. Or Tax is a compulsory financial charge or levy imposed by the government on households or firms to raise revenue. Taxes can be divided into direct and indirect taxes.

Direct Taxes

Direct tax is a tax that is imposed directly on the income or profits of individuals and businesses, and their burden cannot be shifted to others. It is borne by those on whom they are levied. Examples are income tax, wealth tax, property tax, corporate tax, capital gain tax.

Types of Direct Taxes

Income Tax: Income tax is imposed on the income that is being earned in a financial year. The tax is paid based on income tax slabs.

Property Tax: Property tax is a tax levied on the value of immovable property, such as land and buildings. In Pakistan, property tax is charged by the local government authorities.

Capital Gains Tax: Capital gains tax is a tax levied on the profit earned from the sale of an asset. In Pakistan, capital gains tax is charged on the sale of immovable property, shares, securities, and other assets.

Corporate Tax: Corporate income tax is levied on income earned by organizations and various business entities.

Miscellaneous: Land Revenue, Agriculture-Income tax, urban immovable property tax etc.

Indirect Taxes

Indirect taxe is a tax those whose burden can be shifted to others so that those who pay these taxes do not bear the whole burden but pass it on wholly or partly to others. These taxes are levied on goods and services, and producers or sellers include the tax in the price of the product.

Types of indirect Taxes

Federal Excise Duty: Federal Excise Duty (FED) is a tax levied on specific goods and services produced and consumed in Pakistan. FED is charged on a wide range of items, including cigarettes, cement, sugar, beverages, and petroleum products.

Custom duty: Customs Duty is a tax levied on imported or exported goods. It is charged by the Federal Board of Revenue (FBR) at the time of import or export.

Sales tax Sales tax is a tax levied on the sale of goods and services. This tax is added in the price of a good thus consumers pay the taxes at the time of purchase of goods. In Pakistan it is levied at federal and provincial levels. 

Miscellaneous: Gas and Petroleum Surcharge, Foreign Travel Tax, Sales Tax on Services, Stamp duty, electricity duty, Motor Vehicle tax, cotton fee etc.

Tax vs Fee

It is important to distinguish between tax and fee. Fee is a compulsory payment made by a person who receives in return a particular benefit or service from the Government. For example, students pay educational fee for public schools or colleges and in return receive benefits of teaching. While tax is also a compulsory payment, but the proceeds of tax are utilized for common benefits or general purposes of the State not for specific purpose.

Forms of Taxes

Proportional tax: Proportional tax or flat tax is a tax whose rate remains uniform at all income levels. If for example, tax rate is 10%, then everyone (poor or rich) will pay 10%.

Progressive tax: Progressive or graduated tax is a tax whose rate increases with the increase in income levels. For example, income tax. It is levied on the basis of income tax slabs.

Regressive tax: A tax whose rate falls along with the increase in income.

Digressive tax: This tax is a combination of progressive and proportional tax whose rate increase up to a specific income level afterwards its rate is constant.

Value Added Tax (VAT): It is levied on the value added to goods and services at each stage of production or distribution.

Specific tax: A specific tax is a fixed amount changed pee unit on a good or service sold regardless of its price or value. It is also known as per-unit tax. Example, a tax of RS. 20 per pack of cigarette.

Ad valorem tax: The term “ad valorem” is a Latin word meaning “according to value”. This tax is levied on the commodities on the basis of their value. Examples are sales tax, property tax, import duty, value-added tax.

Income Tax Slab of Pakistan for Fiscal Year 2025-26

Income tax is a direct tax levied on the taxable income. Of individuals and businesses. Taxable income is the total income earned during a tax year, minus any deductions and exemptions. See Income Tax Slabs Table to view the details on income tax rate for each income bracket.

Source: Federal Board of Revenue (FBR), Circular No. 01 of 2025-26 (Income Tax), dated 2 August 2025, p. 4. URL: Circular No 01 of 2025-26 Income Tax.

Non-Tax Revenue

Non-tax revenue is the revenue collected by the government from sources other than taxes. These include:

• Profits on state owned enterprises
• Fees for providing specific services by the govt. such as education fee, registration fee etc.
• Fines and penalties imposed by govt. on violation of laws such as traffic challan.
• Gants, gifts and aid received from people and other govts of other countries.
• Prices of public goods and services such as airline fare, metro fares etc.
• Dividends and interest
• Royalties
• Income from selling govt. assets

Debt Revenue

Debt revenue is the revenue collected by the government from internal and external borrowing to finance its budget deficit.

• The money borrowed by the government from lenders inside the country like individuals, public or private organizations, central banks, commercial banks, and non-bank financial institutions is called internal debt.
• The loan borrowed by the government from lenders outside the country like foreign individuals, foreign government, and international financial institutions like world bank, IMF, ADB etc is called external debt.

Government Expenditure

Broadly, government expenditures are divided into current, and development expenditure.

Expenditure made for normal day to day working of the government departments and services provided by it are current or non-development expenditures. They are recurring in nature. Such as expenses on defense, law and order, civil administration, salaries of govt. employees, subsidies, transfer payments etc.

Those expenditures that increase the productive capacity of the economy are called development expenditure. They are non-recurring in nature such as expenses on health, education, transportation, and other Public Sector Development Programe.

Fiscal Policy

Fiscal policy is a policy which is concerned with the government revenues and government expenditure.

In the words of Michael Parkin

• The use of the federal budget to achieve macroeconomic objectives such as full employment, sustained economic growth, and price level stability is called fiscal policy.

According to Paul A Samuelson

• Fiscal policy is concerned with all those arrangements which are adopted by the government to collect the revenue and make expenditures so that economic stability can be attained without inflation or deflation.

Tools or instruments of Fiscal policy

• Government expenditure
• Taxes (direct and indirect taxes)
• Deficit financing (government borrowing and printing of new notes)
• Subsidies
• Transfer payments

Objectives of Fiscal Policy

• Price Stability
• Raising employment level
• Redistribution of Income
• Economic development

Deficit Financing

Deficit financing is a policy where the government finances its expenditure via borrowing. The purpose of deficit financing is to raise revenue and meet budget deficit.

According to Mahboob ul Haq “Deficit financing represents the gap between estimated revenues and estimated government expenditure”. To meet such deficit government borrows from various sources such as.

• Borrowing from banks (Central and commercial banks)
• Borrowing from non-bank institutes such as insurance companies and saving institutes.
• Printing of new notes

Public Debt

Public debt is the sum total of the borrowings of the federal government of a country. It is also called Sovereign debt or national debt. It includes both internal and external debt. It is the sum of past budget deficits minus the sum of past budget surpluses. A government budget deficit increases government debt. A persistent budget deficit feeds itself: It leads to increased borrowing, which leads to larger interest payments, which in turn lead to a larger deficit.