The Rate Structure of Indirect Taxes in Pakistan

The purpose of this paper is to examine the rate structure of indirect taxes in Pakistan with particular emphasis on the incentive aspects of the tax structure. It is a part of a series of studies to evaluate the impact of the fiscal system in Pakistan, which is being undertaken by the Fiscal and Monetary Section of the Pakistan Institute of Development Economics. The rate structure of indirect taxes, however, is only one of the many factors that influence the relative prices and relative profitabilities of industries. Direct controls, like the import-licensing system, exchange-rate policy, the export-bonus scheme, etc., may in fact have greater impact on relative prices and on the pattern of investment than indirect tax rates. However, this paper examines the differential incentives provided by the rate structure of indirect taxes alone, assuming that the market is allowed to operate freely and that rate structure is the major factor influencing relative prices of industrial goods. The traditional objectives of taxation policy have been confined largely to diverting sufficient resources to the government sector to match its expenditures. However, recent developments in fiscal thought have come to assign a more positive role to taxation policy in economic development, and the impact of the tax structure on the rate and direction of saving and investment is widely recognized. In Pakistan and other underdeveloped countries, in view of the inadequate coverage and administrative complexities of direct taxes, indirect taxes assume a particular significance.