Does Cutting the Tax Rate to Zero Induce Behavior Different from Other Tax Cuts? Evidence from Pakistan

Using a series of Pakistani tax reforms and administrative records, I document that taxable income responses induced by to-zero tax cuts are orders of magnitude larger than ones induced by similar-sized other cuts. This finding is remarkably robust to alternative specifications and holds for both the self-employed and wage earners. I explore salience, selective enforcement, and discontinuous evasion costs as explanations of the observed behavior. I find that the data favor the last explanation. The difference between the two sets of responses is primarily driven by a large, discrete tax evasion response, which is included in the former but not in the latter behavior. I estimate the difference as a lower bound on tax evasion, showing that at least 70% of the income of low- and middle-income self-employed and 1% of low-income wage earners goes unreported.