The Poverty Implications of Alternative Tax Reforms: Some Countries Intuitive Results In an Application to Pakistan

This paper presents results from four simulations of the impact of potential tax reforms in Pakistan on poverty, shared prosperity, and inequality. The simulations are carried out in the context of a dynamic computational general equilibrium (CGE) model that incorporates endogenous evasion of the corporate income tax. The simulations are: a forward looking benchmark case, an increase in the corporate income tax from 35 to 45 percent, a rise in the General Sales Tax (GST) from 16 to 17 percent, and an increase in the tariff rate from 14 percent to 19 percent. The simulations link the CGE model to household survey data that is incorporated in a micro simulation model. This “top down” approach permits a disaggregated estimation of the poverty implications of alternative tax and tariff policies. The results indicate, counterintuitively, that the increase in the sales tax leads to milder average increases in poverty than an equal-yield corporate income tax, because the fall in capital investment resulting from the corporate tax increase lowers the marginal product of labor. The simulated tariff increase raises poverty slightly more than the sales tax increase and slightly less than the corporate tax increase. The difference in simulated poverty impacts is small, as the average headcount rate increases by half a percentage point more under the corporate income tax than the sales tax, confirming the limits of indirect taxation as a tool for redistributing income.