Macroeconomic Determinants of Tax Morale, Institutional Development and Optimal Government Spending in Pakistan

Abstract

The effectiveness of fiscal policy for economic activities has long been a subject on the applied research agenda and theoretical front for policy makers and academicians since the emergence of macro-economics. Over the years, developing economies failed to finance their public spending through collected revenues. This dissertation is focused to explore the four different facets of fiscal policy for a developing economy, Pakistan. Firstly, tax to GDP ratio of country is not sufficient to meet the public spending for welfare of society and improvement of human resource. Comprehending the importance to increase the tax revenues for economy, the determinants of tax morale in Pakistan are explored, acquiring data from the World Values Survey for the wave of 2010-2014. The estimation is carried out by using weighted ordered probit model that is a more appropriate technique to estimate such type of data. The estimated results demonstrate that confidence in parliament, confidence in civil services and confidence in government affect the tax morale positively and significantly. Moreover, religiosity has impact on people’s behavior and it may be a restriction in the way of tax evasion. The estimated results reveal that population having age of 30-49 years have higher level of tax morale contrary to other groups. It is also disclosed that Pakistani women and married people have higher level of tax morale as compared with man and unmarried people respectively. Institutions play a vital role to explain the varying economic performance across the nations and the impact of fiscal policy to improve institutional quality is still an explored dimension in literature. To find the impact of fiscal policy on institutions, annual time series data covering the time span from 1984-2015 was used and ARDL technique was applied. A new index for twelve institutional indicators taken from International Country Risk Guide was constructed by Principal Component Analysis. The estimated results draw attention that government spending 11 are contributing to improve the quality of institutions at little extent while education and equitable income distribution are also promoting the institutional quality in the country. The impact of institutions and fiscal policy on economic growth is examined using the data from 1984-2015 by applying the ARDL technique. The estimated results signify that government spending and institutions have momentous impact on economic growth of the country. In the same way, education and private investment are boosting the economic growth while trade openness has not significant impact on growth. Finally, the growth maximizing level of government spending for different categories like current expenditure, development expenditures, defense expenditures and overall government expenditures is determined. The data for this section consists of annual time series data for the period of 1984-2015. The Scully Model is used to estimate the optimal level of different categories of government spending that augment real economic growth. The empirical results illustrate that optimal sizes of government expenditures, current expenditures, development expenditures and defense expenditures are 20.66%, 13.18%, 6.75% and 3% of GDP respectively. It is suggested that government has to take serious steps to restore the confidence of people on public institutions to improve the tax morale, which will enhance the tax to GDP ratio of the country. The collected revenues should be spending on welfare oriented projects and free from resource crunch in form of corruption. It will improve the quality of institutions along with boosting economic growth. To attain the potential economic growth, government should have to rethink about different categories of public spending because the estimated optimal points of spending are different from existing trend of expenditures by the government.