Reforming indirect taxation in Pakistan: A macro-micro analysis

This paper provides an ex ante economy-wide assessment of some contentious taxation reforms being considered in Pakistan, in order to widen the tax base and rationalise the rate structure of different taxes. Amongst the main proposals, those focusing on value added tax (VAT) and agricultural direct taxes seem relatively more attractive. The former has the highest share in indirect taxes and is also easier to collect, while the latter is intended to bring the presently exempted agricultural incomes into the tax net. Our results indicate the tough choices for policy makers in trying to improve the dismal tax to GDP ratio in Pakistan. All simulations result in a decrease in investment and consumption levels, and an increase in poverty. However government income increases sharply which in turn also increases spending by public sector and wages of skilled labour. A key benefit of such reforms is also to document the vast economic activity that currently lies out of the tax net. We thus recommend a gradual approach to tax reform that can make the adjustment process less painful.