Taxation Reforms: A CGE-Microsimulation Analysis for Pakistan

This paper provides an ex ante assessment of 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 VAT and agricultural direct taxes seem more attractive. The former has the highest share in indirect taxes and is also easier to collect, and the later is intended to bring the presently exempted agricultural incomes in to the tax net. In the first step we study the general equilibrium effects of existing taxes by removing them one at a time from the system. In the second step we study the micro-macro impacts of 4 policy experiments: a) non-uniform VAT, b) changing direct-indirect tax mix in favour of VAT and ensuring revenue neutrality, c) doubling of existing VAT rate, and d) introduction of a 7 percent agricultural income tax. In the third step we try to decompose the personal income tax system in order to obtain the contribution of rate, allowances, deductions, exemptions and credits towards progressivity. Results from experiments indicate that a non-uniform VAT deteriorates investment, distorts consumption, and increases wage inequality. Doubling of VAT rates has similar results except that the decline in investment is greater. A flat agriculture income tax proves regressive as consumption levels of farmers, rural workers and urban poor declines.