The Macroeconomic Benefits of Tax Enforcement in Pakistan

The benefits of improved tax enforcement in Pakistan through simulations of a model of the Pakistani economy is studied. We begin by documenting that the effective tax rate facing firms is increasing in firm size, with firms in the modern sector facing tax rates nearly ten percentage points higher than in the traditional sector. In addition, larger firms face substantially higher tax rates than small firms. Effective tax rates range from 5% for smaller firms to 10% for middle-sized firms and 15% for the largest firms. We then build a two-sector (modern and traditional) model of the Pakistani economy. Simulations of the model show that improvements in tax enforcement could increase revenues (by 8% in our middle scenario) but also reduce informality (by 3.3 percentage points) and increase GDP (by nearly 2%). We contrast this with a one percentage point increase in the tax rate, which increases tax revenues, but reduces GDP and increases the rate of informality