A STUDY OF PAKISTAN’S FISCAL LANDSCAPE: EXAMINING THE INFLUENCE OF INSTITUTIONAL QUALITY AND TAX POLICY TRANSFORMATION

ABSTRACT


INTRODUCTION
Collection of Tax is an important source of revenue for a country.An equitable amount of revenue from tax share in GDP is obligatory for the smooth running of the government system and for raising the living standard (Olufemi et al., 2018).Tax reforms involve cautious changes to a country's tax system, amendments in rates of tax, administration, and improving efficiency and effectiveness.These reforms are carried out to produce an adequate amount of revenue for public expenditures, encourage economic growth, certify justifiable distribution of the tax load, make the collection techniques simple, increase limpidity, and develop overall competence (Brys et al., 2016).They frequently aim for important parts such as tax rates, administration of tax processes, and the overall tax structure for economic development while.Good tax reforms are measured by their effect on revenue generation, economic growth, and income distribution (Sang, 2019).However, the financial situation of Pakistan has undergone main transformations in recent years, moved by a sequence of tax reforms intended to reshape the nation's revenue organization plans.Since the inception of Pakistan (1947), every government has attempted to improve revenue collection, aiming at enhancing responsiveness, transparency, efficiency, and affordability.More specifically, over the past 32 years, the government has made nine attempts to boost revenue mobilization (Bukhari and Haq, 2020).To achieve this goal, various committees and commissions have been formed throughout the years, including the Tax Reforms Committee in 1990, the Resources Mobilization and Tax Reforms Commission in 1994, and the Commission of Tax Reforms in 1997.Furthermore, recent reforms initiated in 2001 with the help of the World Bank, as a part of the Poverty Reduction Program (PRP), linked financial assistance from International Financial Institutions (IFIs) to a broad range of structural, financial, and governance reforms (Iqbal, 2014).Indeed, these reforms covered civil service management, tax administration and compliance, financial management, and procurement, with the objective of poverty reduction (World Bank, 2002;Khan et al., 2023).Specifically, the World Bankfunded Tax Administration Reform Project in 2005 and the Tax Administration Reform Phase II in 2009 have made substantial impacts on revenue structure, equitable distribution of burden, increased transparency, and enhanced efficiency.Succeeding initiatives included the Tax Reform Commission in 2014 and the Revenue and Resource Mobilization Commission in 2022 to cope with the remaining flaws.Undeniably, Pakistan's average tax-to-GDP ratio during this period was reported at a lower 10 percent to the GDP share.This low contribution creates concerns about the capacity to finance crucial social welfare programs, potentially leading to increased debt-to-GDP share and heightened budgetary borrowing (KC, 2017).The higher tax-to-GDP ratios in developed countries not only signify a more effective revenue collection system but also provide them with greater fiscal space for social spending.Therefore, as the government is grappling with the dual objectives of boosting tax revenue and achieving fiscal sustainability, the tax-to-GDP ratio emerges as a pivotal element in evaluating the country's fiscal health.This ratio reflects the government's capacity to generate revenue proportionate to the overall economic output, and a higher tax-to-GDP ratio and robust revenue collection system to pace for sustained economic growth and development (Niaz, 2021).This key indicator of revenue collection has consistently remained below desirable levels, underscoring challenges in mobilizing sufficient revenue relative to the economy's size.Initiatives like the Tax Administration Reform Project and various commissions have been implemented, yet enduring issues such as tax evasion, a narrow tax base, and implementation challenges have held up significant enhancements of revenue collection (Iqbal, 2014).The persistent structural issue raises critical concern about the efficiency and impact of undertaken reforms, underlining the necessity for a broad and sustained strategy to find out the core reasons for Pakistan's tax revenue challenges.Addressing the said issue this study utilizes an extensive dataset, including multiple years, and incorporates various macroeconomic and institutional factors, such as good governance, Controlling Quality, Political Strength and absence of violence, government effectiveness, inflation, Rule of law and Tax to GDP ratio through advanced econometric techniques and statistical models.Despite, multiple reform attempts this study aims to aims to assess the overall changes in the tax-to-GDP ratio and provide valuable perceptions for policymakers and researchers alike.Figure 1 illustrates the total revenue, expenditure, and development fund allocations within the given financial period.Similarly, Figure 2 presents a breakdown of the 'total tax collection' categorized by various sources and Figure 3 depicts a comparative analysis of revenue and expenditure for the years 2022 and 2023.The study used the ADF test to assess the stationarity of the variables under consideration.The analysis utilizes the ARDL approach to check both short-run and long-run relationships in the variables.A significant adverse impact of tax reform on economic growth is indicated in both.Conversely, FDI exhibits a positive as well as a significant influence on economic growth.Import, while displaying a positive and insignificant effect in the short period, demonstrates a negative but significant impact on economic growth in the long run.Furthermore, the literacy rate is found to be an insignificant determinant of economic growth.
In contrast, Ahmed and Talpur (2016) noted that tax policy is a crucial determinant of inclusive growth, income distribution, and wealth redistribution.In the Pakistani context, the limited impact of taxes on income distribution, particularly for the poorest quintile, stems from a narrow tax base.This paper delves into a significant case where despite the private sector experiencing anticipated profits, the resulting income increase has failed to bring about progressive changes in tax contributions.The study also sheds light on the inadequate capabilities of the tax administrative machinery to combat evasion.projects.The research aims to understand why these reforms have had limited impact, addressing questions about their effects on PS organizations and exploring intended and unintended consequences.The study used a qualitative case study approach.
The research employs a social constructionist perspective and ethnographic methods for this analysis.The findings of the study reveal that prevalent corrupt practices, such as nepotism and favoritism, hindered the desired outcomes of efficiency and transparency in the field of revenue collection.In contrast, Hassan et al. (2021)

METHODOLOGY Data
Every government relies on revenues to fund various essential expenditures such as defense, healthiness, learning, structure, transfer payments, and grants.A well-organized taxation system is crucial for revenue generation and to finance these expenditures.In this study, an efficient taxation system is assessed through institutional factors like tax regulatory quality, political stability, government effectiveness, tax GDP ratio, rule of law, and inflation for the data period 1996 to 2022.The data for this study is sourced from reputable outlets such as the Economic Survey of Pakistan and World Development Indicators.

Justification of Variables
The data for tax to GDP is a dependent variable in the model that can explain an increase in the tax/GDP ratio pointing out that the government is collecting a higher proportion of its revenue relative to the overall economic output or Gross Domestic Product (GDP).On the other hand, independent variables can be explained as Tax Reforms are all the struggles and efforts taken for the improvement of tax income collection of a state is tax reforms.Controlling quality examines the efficiency of rules.Political stability is another independent variable, that measures the level of political discontent and political issues on tax collection.Government efficiency is an important sign that measures the competence of community management, reflecting the government's capacity to implement and enforce tax policies.The rule of law, as an independent variable, evaluates the strength of legal frameworks, playing a significant role in shaping the business environment and influencing tax compliance.Lastly, Inflation (GDP deflator annual %) takes the average change in the prices of all goods and services produced within a country, reflecting the inflationary or deflationary trends in the economy relative to its Gross Domestic Product (GDP).This set of independent variables collectively offers a distinction and multifaceted examination of governance, economic stability, and fiscal policies, contributing to a comprehensive understanding of their potential interconnectedness with the tax/GDP ratio.

Functional and econometric model
The function of the variables takes the following form: Where, GTR represents the dependent variable, and f () denotes the functional form, representing the connection between GDP and the independent variables.The goal is to estimate the coefficients of the said variables on tax to GDP share; we need an econometrics model, which can be written as follows: Where, Tax-GDP-ration shows the dependent variable and the other independent variables, including RQ are regulatory quality, PS is political stability, GE is government effectiveness, RL is rule of law and finally, Inf is inflation.While β0 to β6 are the coefficients to be estimated in this study and the εt represents the error term capturing unobserved factors' influence.Additionally, in time series data analysis the first step is to pursue stationary of the data, to choose an appropriate estimation technique for a data set.
For this purpose, a unit root test is used.

The Autoregressive Distributed Lag (ARDL) model
The ARDL co-integration technique is used to study the short-term and long-run connection amid the concerned variables by including lagged values of the dependent variable to assess the impact of past values of the dependent variable, thereby capturing any long-run relationship that may exist (Gul et al., 2023).The ARDL model is written as follows: Where: Δ ln Tax-GDP-t represents the first difference of the log of GDP at time t, showing the short-run changes in GDP.While Δ ln RQ t-i, Δ ln PS t-i, Δ ln GE t-i, Δ ln RL t-i, and Δ ln INF t-i, revealed the first differences of the log.Whereas β0 is the intercept, and βᵢ (for i = 1 to n) are the coefficients representing the short-run impacts of the changes in the independent variables on Tax-GDP.Moreover, the study pursues the Error Correction Term to know the long-run adjustment.

Error Correction Model (ECM)
It is an econometric technique used to estimate the link between two or more variables that share a long-term equilibrium association.The term "error correction" pertains to the extent to which the current point corrects the past disequilibrium, aiming to restore balance (Khan et al., 2023).The ECT value must exhibit both statistical significance and a negative sign.The ECM model includes the first differences of the variables to assess the short-run change toward the long-run equilibrium adjustment.The ECM model is as follows: (4) Where: ECM t-1 is the lag value of ECT, which captures the deviation from the long-term equilibrium and γ is the coefficient of the ECT, indicating how quickly the variables adjust.The ECM provides insights into both short-term dynamics and long-term associations between Tax-GDP and independent variables in the model.Moreover, to validate the model's results, it is essential to conduct some diagnostic tests.

Unit Root Test
A unit root implies a trend in the time series, where the variance and mean are not constant over time.It assesses whether the series exhibits stationary (unit root) or not.There are many tests such as ADF, KPSS, and ERS, to be used for this purpose but the most widely used is the unit root test.Based on the Unit root test, it is justified that our variables are in mixed order hence ARDL estimation method is appropriate in this data analysis (Khan et al., 2023).

Diagnostic Tests
Diagnostic tests are an important part of econometric analysis.They help to know the validity of the model assumptions and evaluate the reliability of the estimated model.Here are some commonly used diagnostic tests for analysis, as given below: Normality Test: For the normality of residuals often use the Jarque-Bera test.This test observes whether the residuals follow a normal distribution or not.Departures from normality may indicate model misspecification of the assumptions.Heteroscedasticity test: Heteroscedasticity refers to the presence of non-constant variance in the residuals.This can be assessed using the Breusch-Pagan test.Autocorrelation: Autocorrelation occurs when the residuals are correlated with each other over time.This issue is being detected by using the Breusch-Godfrey test in this study.Stability Test: To test for stability, the study employs the CUSUM test to examine whether there are structural breaks in the model parameters.These are a few diagnostic tests commonly used in econometrics.The specific tests to be applied may depend on the features of the data and the assumptions of the specific model.
As shown in The Breusch-Pagan-Godfrey test (Table 6) is conducted to check heteroskedasticity in the regression model.Hence the results show that there is no significant evidence revealed of finding heteroskedasticity in the model.The F-statistic value 1.261658 with a probability value (Prob.Chi-Square) of 0.2860 both exceeds typical significance levels.These findings show that the variability of errors across observations is not statistically significant.More specifically, it means that there is no evidence of heteroskedasticity.In Table 7, the results of the Breusch-Godfrey test are presented, which show the presence of serial correlation within the regression model.The Fstatistic and chi-square value (Prob.χ2) is greater than 0.05 hence it provides evidence that there is no autocorrelation in the regression model.
In Figure 4, normality test using the Jarque-Bera statistic, which examines whether the data pursue normal distribution.In this case, the calculated value is 1.482489 and the corresponding p-value of 0.476521 indicates a measure of normal distribution.
For instance, with a p-value of 0.476521, which is greater than the typical significance level of 0.05, there is insufficient evidence to reject the null hypothesis that the data is normally distributed.The CUSUM and CUSUM square (Figure 5) are statistical techniques used to assess stability in the regression model.The CUSUM test examines cumulative changes, while the CUSUM Square test reveals sensitivity by integrating squared deviations.When the blue line consistently falls within the red lines and can't touch the critical line, it shows an absence of significant structural alterations.This stability shows that in the observed values, no substantial deviation or shift is detected throughout the analyzed timeframe.Additionally, the QUSUM Square test provides further insights into the variance changes over time, emphasizing the overall understanding of process stability.

CONCLUSIONS AND RECOMMENDATIONS
The central aim of this analysis is to assess the effect of tax improvements on tax to GDP ratio in the context of Pakistan.The result of the unit root test suggests that the ARDL estimation technique is appropriate for this data analysis.Additionally, the bound test revealed that all the independent variables collectively impact tax to GDP share in Pakistan.Similarly, the long-run results depicted that, regulatory quality and government effectiveness show a positive effect on tax to GDP share, which suggests that improvements in this area lead to a substantial increase in the dependent variable (Tax to GDP).Similarly, political stability and the rule of law represent positive and significant on tax to GDP share, underscoring their important roles in increasing revenue collection.In contrast, inflation depicts a negative effect on tax to GDP share that highlights the decrease in revenue mobilization in total revenue collection.
Based on the empirical findings, a few recommendations can be suggested: The positive influence of regulatory quality and government effectiveness on the tax to GDP share shows that improving this area can lead to an enhancement in revenue collection.Measures such as streamlining rules, improving governance, and lessening bureaucratic problems can contribute to producing a more attractive environment for tax compliance and revenue mobilization.Political stability and the rule of law have revealed a positive effect on tax to GDP share in the case of Pakistan.Researchers and policymakers must prioritize efforts to retain political stability and improve the rule of law to foster tax compliance.Additionally, strengthening institutions' responsibilities for enforcing tax laws and guaranteeing a fair and transparent tax structure can further boost revenue mobilization efforts.

Figure 1 .
Figure 1.Total revenue, expenditure, and development fund; Source: Economic Survey of Pakistan.

Figure 3 .
Figure 3.Comparison of Revenue and Expenditure; Source: Economic Survey of Pakistan (2023).This section of the study has observed the existing literature and finds divergent perspectives on the connection between factors of institutional quality and revenue mobilization.The study conducted by Chaudhry and Munir (2010) on Pakistan's tax revenue determinants from 1973 to 2009, utilized an autoregressive model to capture dynamic changes.Resultsindicate that the agriculture sector negatively impacts the tax and GDP ratio, while factors like openness, overseas support, external liability, broad money and stability positively influence tax income.Similarly,Addison and Levin (2012) analyzed 39 countries from 1980 to 2005 to inspect the causes of total tax revenue and tax organization using using two-step GMM regression estimation technique.The study found that the agriculture sector adversely affects the total tax income-GDP segment.While GDP PC and urbanization are positively connected to the tax revenue-to-GDP share for indirect tax income collection.However, the scale of foreign support adversely impacts the direct tax collection to the GDP share.Recently,Shakeel et al. (2023) studied the effect of Tax Reform on development in the context of Pakistan, utilizing the data spanning from 1978 to 2011.The study used the ADF test to assess the stationarity of the variables under consideration.The analysis utilizes the ARDL approach to check both short-run and long-run relationships in the variables.A significant adverse impact of tax reform on economic growth is indicated in both.Conversely, FDI exhibits a positive as well as a significant influence on economic growth.Import, while displaying a positive and insignificant effect in the short period, demonstrates a negative but significant impact on economic growth in the long run.Furthermore, the literacy rate is found to be an insignificant determinant of economic growth.In contrast,Ahmed and Talpur (2016) noted that tax policy is a crucial determinant of inclusive growth, income distribution, and wealth redistribution.In the Pakistani context, the limited impact of taxes on income distribution, particularly for the poorest quintile, stems from a narrow tax base.This paper delves into a significant case where despite the private sector experiencing anticipated profits, the resulting income increase has failed to bring about progressive changes in tax contributions.The study also sheds light on the inadequate capabilities of the tax administrative machinery to combat evasion.Furthermore, it Furthermore, it explores how a distortion tax policy acts as a barrier to the entry of new firms and investments, impeding competition and hindering the enhancement of consumer surplus.Examining the economic landscape since 2007, the research uncovers challenges such as low investment levels, sluggish private sector credit growth, and declining exports, despite preferential market access.The study suggests that the corporate tax structure may contribute to cartel, a view supported by insights from the tax directory and discussions with key stakeholders.Drawing on these findings, the paper puts forth recommendations for corporate taxation reform in Pakistan.Similarly,Castanheira et al. (2012) provide a comprehensive exploration of the political economics writings about individual income tax reforms.The study examines the part of political restrictions and inducements as the primary source of tax reforms.The study identified labor tax reforms in the European Union between 2000 and 2007; the findings focus on the main effect of political variables over economic attention in driving tax reforms.This literature provides important practical evidence for the understanding of the complicated interaction between political dynamics, economic factors, and tax reform consequences.In contrast,Audi et al. (2021) find that a tax system is important for economic well-being and development.The evaluation emphasizes on tax importance of South Asian countries, taking the data from 1990 to 2019.The findings include significant buoyancy for income tax, sales tax, and total tax revenue, indicating a positive association with economic progress.Excise duty and customs duty display positive but insignificant coefficients, proposing the need for policy adjustments.The study suggests improving the overall tax system and emphasizes the encouragement of customs duties and excise duties by international institutions.In summary, the paper highlights the significance of a balanced tax structure for economic development in the SAARC region.On the other hand, Milwood (2011) assessed Jamaica's tax system for the data period March 1998 to December 2010 by estimating the impact of discretionary changes on elasticity and buoyancy.The findings indicate a total tax progression rate of 3.39.Iqbal (2014) investigated the major flaws in Pakistan's public sector (PS) despite a series of reforms initiated under various studied the connection between governance and revenue from tax in Pakistan taking the period from 1976 to 2019.The governance, described by stability, law and order, and conflict resolution, is explored as a vital determinant of tax revenue collection.This article used the Autoregressive Distributive Lag technique.The findings revealed the significant as well as a positive influence of governance factors on tax revenue suggesting that better-quality governance adds to improved revenue collection in Pakistan.activities as strategic measures for fostering improved tax revenue collection in Pakistan.The study suggests valuable intuitions for policymakers to reinforce the fiscal landscape and improve economic activities and revenue mobilization Another study done by Mughal (2012) on tax evasion poses important challenges to the government.This paper focuses on separating the complexities of tax avoidance and evasion in the context of Pakistan.The results confirm the strength of all study variables related to the reasons for tax evasion in Pakistan.

Table 5 ,
The F-test evaluates the overall fit of a regression model.The Value of the F-statistic value is 10.57263 which is greater than the lower and upper bound values at all levels of significance at 10%, 5%, 2.5%, and 1% respectively.It suggested that the overall model is fit and eligible for further estimation.If the F-statistic Therefore, the study rejects the null hypothesis.

Table 4 .
Short run and long run results.