Taxes and economic growth: an empirical analysis of Pakistan

The study investigates the empirical relationship between indirect taxes and economic growth in Pakistan. For estimation, the annual time series data (1974 to 2010) was used. The main purpose of the research is to find the long-run and short-run relationship between indirect taxes and economic growth. Philips Perron and Augmented Dickey fuller unit root tests were used to check the stationarity of every variable in the study. Auto Regressive Distributed Lag (ARDL) bounds testing approach for cointegrations (developed in 2001) was applied to estimate the long-run and short-run relationship among the variables. Indirect taxes have negative and significant effect on economic growth in long-run while its coefficents in short-run were insignificant. Due to one per cent increase in indirect taxes, economic growth would decrease by 1.68 per cent. ECM coefficient of indirect taxes shows 45 per cent speed of adjustment in a year. According to the research results it is imperative to decrease indirect taxes and increase the direct taxes, if we want to augment the economic growth. Currently, contribution of direct taxes out of total tax revenue is only 33 per cent and the share of indirect taxes is 63 per cent, while it should be reversed if economic growth has to increase.