Abstract:
This study investigates the impact of various fiscal policy instruments on
the income inequality of Pakistan using an Auto Regressive Distributed Lag
(ARDL) model on annual data. We find that direct taxes reduce income inequality,
measured using the Gini index, while indirect taxes increase disparities. As the
major portion of tax revenues are indirect taxes, the current tax regime of Pakistan
does not achieve income redistribution. Similarly, development expenditures have
significantly reduced income inequality, likely through the creation of employment
opportunities. On the other hand, the overall fiscal deficit increases income
inequality, due to a rising public debt financed by (regressive) indirect taxes. This
study suggests that in the case of Pakistan, where direct taxes are low, a large
shadow economy exists, and weak tax administration prevails, an increase in
development expenditures and broadening of the tax base of direct taxes should be
the main fiscal policy tools for income redistribution. Moreover, persistent high
fiscal deficits in the long run should be avoided. Finally, governments should
reduce educational inequalities and promote democratic values in the country in
order to promote greater fairness in distribution of income.
