Impact of Tax and Transfers on Income Inequality and Budget Deficit: A CGE Analysis for Pakistan

Abstract

This paper analyzes the impact of tax and transfers on income distribution. We use a simple Computable General Equilibrium model for Pakistan (CGEP) adapted from Lofgren et al. (2001). Our CGE model takes into account the market interactions, that is, the effects of pricing outcomes of one market in other markets; which in turn create ripples throughout the whole economy, even to the extent of affecting the price-quantity equilibrium in the original market. We use Social Accounting Matrix (SAM) 2008 as developed by Debowicz et al (2012). To explore the impact of tax and transfers on income inequality, two sets of simulation exercises are performed. Further, we examine the inequality effects using Theil T, Theil L, Theil S and Hoover’s Indexes. Our results show that a policy mix of sales tax, income tax and government expenditures helps in reducing income inequality; while, at the same time it lessens the economy’s financial dependency.