Theme/Relevant Ministry:

TAX POLICY/ ADMINISTRATION:
M/o Finance; FBR

Project Brief:

Tax is an important tool of fiscal policy which generates revenue and enable governments to finance current and development expenditures. However, taxes leave individuals and firms with less income and therefore, they have to compromise their consumption. Thus, tax system of a country affects its economic growth and welfare of the people. A good tax system should generate sufficient resources for the government without overburdening the households and firms. Since change in tax policy has long reaching impacts on various interconnected economic agents, therefore, the impact of tax reforms is analyzed using general equilibrium approach, considering the interrelationships between all the sectors of economy. This study uses computable general equilibrium model to quantify the impact of changes in direct and indirect tax rate policies on various economic indicators including economic growth, consumption, investment, exports, sectoral shifts and income. For this, we first develop social accounting matrix based on 2017 data and then run simulations. The results show that in the long run under the unbalanced budget condition, reducing personal income tax rates results in increasing consumption expenditures, government expenditures and income of various types of labour but decreasing economic growth and exports. However, introducing flat and low-income tax rate along with decreasing corporate tax, sales tax and custom duty results in increasing economic growth, exports, consumption expenditures and household income. Whereas the balanced budget condition produces better economic results. Therefore, we recommend simplifying tax regime by abolishing inefficient and distortionary taxes and reducing rates of all types of taxes and controlling government expenditures to keep budget in balance even in short run as a suitable policy for economic growth and household welfare.

Public Policy Relevance:

This study identifies and quantifies the direction and magnitude of impacts of proposed changes in direct and indirect tax rates and tax structure on various sectors of the economy, economic growth, employment level, government revenue and income distribution, etc., using a general equilibrium framework. This analysis provides government and policymakers with a comprehensive comparative analysis of various tax rate proposals. Given the low tax to GDP ratio and economic growth in Pakistan, this study helps to choose a better tax rate structure.

Unedited Working Paper and Policy Brief prepared for the Second RASTA Conference can be downloaded from the link: https://pide.org.pk/rasta/2nd-rasta-conference/