Pakistan has undergone a significant change in tax structure over the last
fifteen years. However, this change is not apparent on the surface, as there has not
been much change in the tax to GDP ratio over the last fifteen years. But if we look
beyond the surface we can see changes, for example in (1990-91), indirect taxes
contributed 82 percent of total tax revenue with Customs, Excise and Sales tax each
contributing around 55, 28 and 18 percent respectively, while in (2001-02), indirect
tax share within the total tax revenue fell slightly to 68 percent with Customs,
Excises and Sales tax each now contributing around 18, 18 and 64 percent
respectively.
Thus, it may not be wrong to say that there has been a significant change
in the tax mix in the span of less than ten years and this development is
important from the perspective of efficiency, effectiveness and equity with which
revenues have and will be raised. Although, Value Added Tax (VAT) is likely to
be more efficient in raising revenue than both the ordinary Sales Tax and Trade
Taxes that it has replaced see e.g. [Nellor (1987); Liam Ebrill (2001)], the same
cannot be said as far as the fairness issue is concerned. This in no way implies
that the trade taxes replaced by VAT were more fair. However in most
developing countries they operate with strict import licensing schemes, binding
quotas and foreign exchange restrictions that make them more a kin to lump sum
tax. Therefore in most cases they have no flow through effect to the consumers
[for example see Clarete (1986); Shah (1991)]. But in contrast to this VAT being
a consumption tax has the capacity to directly affect each and every household.
Thus equity becomes much more of a real concern and this concern is heightened
given that governments of most of the developing countries lack the capacity to
carry out significant redistribution. This paper will begin with a brief introduction of Value Added Tax (VAT).
Section II describes and compares major incidence methodologies as well as explains
the methodology used in this study. Section III presents (1) estimates the incidence
of VAT at national, provincial and regional level and a comparison of progressivity
of VAT to the progressivity of sales tax it replaced, (2) an examination of VAT
(2001-02) at individual commodity level is carried out to better comprehend VAT
incidence on the poor, (3) distributional characteristics of goods to rank good and
services consumed by the poor in order to propose pro-poor VAT reforms.