Taxes and Informality: Evidence from a recent Pakistani Tax Reform

Using a tax reform implemented in Pakistan in 2009, I investigate intensive and extensive margin behavioral responses to taxes. The reform creates large tax rate variations between very similar taxpayers and thus generates compelling quasi-experimental variation, which is used to identify structural parameters important for tax policy.

Relying on administrative records for universe of income tax filers for the years 2006-2010, I characterize a host of responses triggered by the reform, which include reduction in earnings, shifting of income across bases, switching of business organization and movements in and out of the formal economy.

Structural elasticities governing these responses are large, and reflect the considerable welfare costs the reform imposes on the treated taxpayers. I also find evidence that the reform had signicant negative spillover effects on VAT.