Taxes and Economy

You are currently viewing Taxes and Economy

Taxes and Economy

Consumption expenditure is one of the determinants of economic growth. Two components of expenditure include household or private expenditure and government expenditure. Household expenditure has inverse relationship with tax rate. Householders tend to spend less when tax rate increases. In case of indirect tax, e.g. sales tax, higher prices erode purchasing power of householders and they buy fewer goods and services if taxes are too much on expenditure. The direct taxes have reducing impact on disposal income, which also negatively affects household consumption expenditure. Steindel (2001) concludes that whenever a tax policy of tax cuts is announced, consumers will await to increase spending until such policy of tax change is implemented. Reduced consumption expenditure due to taxes may reduce economic growth as higher the consumption expenditure, the higher will be gross domestic product (GDP), provided other factors influencing GDP are kept constant.
Level of investment is an important determinant of economic growth. Higher investment boosts real-time economic activity and generates a lot of employment, which, in turn, will have increasing impact on consumption expenditure. So, directly and indirectly, increase in investment will improve economic growth. The effects of tax policy on attracting foreign and domestic investment have been studied in a number of empirical studies. In a panel gravity-model setting to analyze the role of taxation as a determinant of foreign direct investment (FDI) in Central and East European Countries, Bellak & Leibrecht (2005) conclude that lowering tax rates has been successful in attracting FDI in the region, which is evident from -2.93 semi-elasticity tax rates on capital movement between trading countries. Likewise, using dynamic panel data econometrics, Klemm & Parys (2009) empirically investigated how effective are incentives in attracting investment and found evidence that lower corporate income tax rates and longer tax holidays are effective in attracting FDI.
Kransdorff (2010) examines the competitiveness of South Africa’s tax regime in order to determine whether it is a potential cause of the country’s relative FDI dearth, and concludes that taxation is important in attracting efficiency-seeking FDI.
Gebremedhin & Saporna (2016) empirically investigated the impact of tax holiday on investment in Ethiopia and found a positive impact on attracting additional investment, creation of new employment opportunity, and enhancing long-term revenue of the government.
In a comparative study on the contribution of tax incentives towards FDI inflow in three (3) African countries (Nigeria, Ghana and South Africa) using data for the period from 1999 to 2015, Ugwu (2018) found a positive association between tax incentives and FDI.
While investigating the impact of specific tax-based policy incentives on inflows of FDI in Nigeria using secondary data of 23 years for the period 1994 to 2016, Olaniyi, et al. (2018) conclude that tax incentive policy plays a significant role in attracting FDI.
Exports promote economic growth and are a principal source of foreign exchange earnings for balancing trade and current accounts (Weiss, 2005). In fact, exports accelerate economic growth by facilitating exploitation of economies of scale, allowing efficient resource-allocation, improving foreign exchange earnings, increasing efficiency and productivity through competition, providing more jobs and encouraging domestic innovation through knowledge spill-overs (Malik, Ghani and Musleh ud Din, 2017). This could be the reason why the government adopts several measures for boosting exports. For example, in order to boost exports, the government introduced zero-rating/reduced rates regime for manufacturers, exporters, importers and wholesalers of five export-oriented sectors textile, leather, sports goods, surgical goods and carpets. The special sales tax regime for the designated sectors remained in enforce during the period from 1 January 2012 to 30 June 2019, albeit in different forms and shapes.
From 1 January 2012, the supplies of goods in the designated sectors were declared zero-rated but supplies of certain goods were taxable at a uniform rate of 5%. However, supplies made to persons outside the designated sectors were taxable at the standard rate of 17%.
From 1 March 2013, zero-rating regime was withdrawn and instead 2% sales tax was imposed on supplies of the designated sectors. On 19 March 2013, the FBR exempted import and supply of raw cotton and ginned cotton from sales tax. Effective from 26 July 2013, tax rates 2%, 5% and 7% were introduced on imports and supplies of the designated sectors.
From 1 July 2015, tax rates 3% and 5% with 1% value-addition tax on commercial imports were imposed. Effective from 1 July 2016, tax rates of 0% and 5% with 2% value addition tax on commercial imports were imposed but commercial import of finished fabric subjected to 6% rate with additional 2% value addition tax.
Thereafter, the 17% standard sales tax rate along with additional 2% value addition tax on imported finished goods of carpets, sports and surgical sectors was introduced. However, the domestic supplies of such goods subjected to 17% standard rate.
In addition to applicable rates, further tax at the rate of 1% or 2% was also charged on the supply of goods made to unregistered persons by persons registered of the designated sectors. The FBR eventually abolished the special sales tax regime for the designated sectors from 1 July 2019 through the Finance Act, 2020.
Alternatively, revenue raised through taxes could be useful in promoting socio-economic development. Tax revenue collected from wealthy people could be distributed to low-income households directly in the form of cash transfers as well as indirectly in the form of public goods and services in different sectors of economy such as healthy education, etc. Effective use of tax revenue will boost economic activity, generate employment and improve overall living standards of people. Efficient collection and utilization of tax revenue will help to improve all components associated with GDP.

The author is serving as Additional Commissioner Inland Revenue at Federal Board of Revenue, Pakistan. He can be contacted at

Muhammad Ali Asghar

This is the Admin of this website

Leave a Reply