DO CORPORATE TAXES EFFECT SECTORAL

GROWTH; EVEIDENCE FROM TEXTILE SECTOR OF

PAKISTAN
BY
Muhammad Faheem

Roll No: 189

A research assignment submitted in partial fulfillment

Of

The requirements for the degree of

BS (HONS)

IN

ECONOMICS

Government College University Faisalabad, Pakistan.

Supervisor signature: _________________

 June 2016

ABSTRACT

Tax policy has been core determinant of investment. We think more tax cut accelerate
economic growth but the thing is; is it happening now? In this paper you will study
either taxes effect growth or not. Core purpose of this paper is establishing a relation
between corporate tax rate and growth of textile sector. Results indicate that tax has
negative effects on textile sector’s growth with high degree.

Key words: Corporate Tax, Textile Sector Growth, Unemployment

INTRODUCTION

One of the central predictions of growth theory is that income taxes have a negative
effect on the pace of economic expansion. People think it is true, more taxes decline
economic growth. Objective of this study is to find out the relation between tax and
growth variables. In conventional model, cut in corporate tax without a corresponding
reduction in federal expenditures will encourage consumption expenditures and interest
earnings due to increase in corporate profit. Contrarily, according to Ricardian
Equivalence Theorem (RET), the same change in fiscal policy will not result in any
macroeconomic changes. Similarly, a reduction in deficit-financed federal tax cut will
not affect macroeconomic indicators [Saxton (1999)].

Recognizing the textile industry’s importance for Pakistan, current study explores the
link between corporate and growth of textile sector for the period of 1993-2014. The
study examines the corporate tax effectiveness in same time period. By using simple
econometrics techniques this study tests the significance of relation among variables.
This study is first empirical analysis of tax growth relation by using tome series data. It
is also first study in which you’ll sectorial growth and corporate tax relation.
RESEARCH QUESTION

Is there any relation between corporate tax and growth?

Does corporate tax really effect textile sector growth in Pakistan?

RESEARCH OBJECTIVE

To find out the relationship between corporate tax and growth of textile sector in
Pakistan.

To do a empirical analysis of tax and growth relation for two decades

CORPORATE TAX

It is elite business sector of Pakistan. It is also a part of Pakistan Inc. It was started after
Bhutto’s privatization policy when General Zia-ul-Haq came to rule. Companies act
1984 allow to corporations to generate mix businesses. It formation started in 1984 to
promote business and private ownership. Now corporate sector with more than 100,000
registered companies is working in Pakistan according to board of investment. Security
exchange commission of Pakistan is an institution who is the supervisor of this sector.

TEXTILE SECTOR OF PAKISTAN

It is the largest manufacturing sector of Pakistan. It generates large number of

employment opportunities after agriculture sector. This sector contributes 8.5% of the
GDP and provides employment to about 15 million people or roughly 30% of the 49
million workforce of the country.

UNEMPLOYMENT

In Pakistan labor force include all persons who are of ten years and above, and during
the period are without work, currently available for work and seeking for work. On the
basis of the existing population of 142.87 million with Labor force participation rate of
34.50 percent, the total labor force comes to 49 million. Out of 49 million 2.29 million
are unemployed. Unemployment rate is 6% of total population (2014).
LITERATURE REVIEW

One of the most famous perception is taxes have adverse effect on economic growth.
Studies almost explain the same results but differ in magnitude. Robert Barros fond that
there is relation between tax and growth; taxes affect economic growth negatively. We
start our literature that is examining the cause and effect relation among corporate taxes
and economic growth Hall and Jorgenson (1967), and Jorgenson (1963), has tried to
assess the relevant tax distortions. There is a large selection of studies including
Summers (1981), Feldstein, Dicks-Mireaux, and Poterba (1983), Auer Bach (1983,
2002), King and Fullerton (1984), Auerbach and Hassett (1992, 2002), Cummins,
Hassett, and Hubbard (1996), Djankov, Ganser, McLiesh, Ramalho and Shleifer
(2010), Chirinko (2002), Hassett and Hubbard (2002), and Hines (2001, 2007). Fazzari,
Hubbard, and Petersen (1988) and Devereux and Griffith (2003) find out that corporate
taxes affect adversely growth by reducing current cash flow. Jones and Manuelli (1990)
and Rebel0 (1991), increase in income taxes lead to permanent declines in the rate of
economic expansion. In the Lucas (1988) model, a higher income tax rate reduces the
ratios of physical capital to effective labor and leads to a temporary decline in the rate
of growth. These studies conclude that, based on both historical and cross-sectional
empirical analysis, the share of indirect taxes to total tax revenues fell while that of
direct taxes rose with economic development, leading to the transformation of the
economic structure Chelliah, (1989). The relationship between tax structure and the
economic structure as related to the level of economic development Abizadeh (1979).
MATERIAL AND METHODOLOGY

Data and source:

For this study, annual time series data from 1993 to 2014 is used. The data has
been collected from Economic surveys of Pakistan and data bank of All Pakistan
Textile Manufacturers Association (APTMA).

Model specification:

The dynamic modelling is used to observe the impact of corporate tax on growth
of textile sector in Pakistan.
TG= β0 + β1LNCT + β2UNE + µ
TG= GROWTH OF TEXTILE SECTOR
LNCT= NATURAL LOG OF CORPORATE TAX
UNE= UNEMPLOYMENT RATE
µ= Error Correction
Unit root test:
Unit root test is used to check the data is stationary or non-stationary. To test
the unit root most used test is Augmented Dickey Fuller test.
ADF TEST:
The order of integration of the variable determined by using ADF test, ADF test
has been used to find the stationary of data. It is a test of time series sample in
a unit root test.

ΔYt = β1 + β2t + δYt − 1 + + ∑ αiΔYt − i + εt

𝑖=1

Where ε t is a pure White noise error term and where ΔYt-1= (Yt-1-Yt-2), ΔYt-2=
(Yt-2-Yt-3)
J. J co integration Model:

J.J co integration is a procedure used for testing co integration of several time

series. This test allow more than one co integrating relationship so it is more
generally significant than the Engle-Granger test which is based on the Dickey-
Fuller test for unit root in the residuals from a single co integrating relationship.
Vector errors correction model:
Short run and long run
Changes between variables are use through vector error correction model. The
variables that are integrated of order one they have long run relationship. The
main purpose of ECM is to show the speed of adjustment from short run
equilibrium to long run equilibrium Johansen S. and juselius K (1990).
RESULTS AND DISCUSSIONS

Results of ADF for Unit Root Test. TG is dependent variable Data used 1993-2014

Value of T statistics of all variables is less than Tabulated value at 10% 5% and 1%
level. All variables are stationary at 1st difference. So we use J.J co integration model.

Stationary Result Stationary Result

(At level) (At 1st Difference)

Variables
With Intercept With trend With Intercept With trend &
&Intercept Intercept

Ln(CT)(Natural Log of -9.294388 -8.868672 -9.183207 -8.720467

Corporate Tax)

TG(Annual Growth of -3.483792 -3.436901 -6.484729 -6.281931

Textile Sector)

UNE(Rate of -2.459054 -3.230094 -2.874024 -2.772372

Unemployment)
Long-run Results and interpretation:

Normalized co-integrating coefficients;

Variables Normalize integrating T-Statistics

coefficients

Ln(CT) -1078.278 212.563

UNE -5.220160 212.563

The results show the negative relationship between TG and CT, which means one unit
change in CT, will bring about 1078.278 percent decrease in TG (growth of textile).
And it is significant at 10% 5% and 1% level of significance. TG has negative
relationship with UNE (Unemployment) that shows one unit change in UNE will bring
about -5.220160 percentage decrease in TG (Textile sector growth).
Short-run results and interpretation:

Vector error correction estimates:

Cointegrating Eq. Coefficient Standard error T-statistic

Ln(CT)(-1) 1.541458 0.78789 1.95643

UNE(-1) 154.0252 54.4518 2.82865

On the basis of (-) sign the long-run equilibrium is converging from short-run. In case
of co integrating equation Ln CT (-1), the results indicate that long-run equilibrium is
converging from short-run by speed of 1.541458%. The results of UNE (-1) indicate
that long-run equilibrium is converging from short-run by the speed of 154.0252%.
Table: Unrestricted Co-integration Rank Test (Trace):

Hypothesized Trace
Eigenvalue
No. of CE(s) Statistic Critical Value

None * 0.685834 39.06981 29.79707

At most 1 * 0.453026 15.91314 15.49471

At most 2 * 0.174943 3.846065 3.841466

Trace test indicates 3 co-integrating equation(s) at the 0.05 level

Table: Unrestricted Co-integration Rank Test (Maximum Eigen value):

Hypothesized Max-Eigen
Eigenvalue
No. of CE(s) Value Critical Value

None * 0.685834 23.15667 21.13162

At most 1 0.453026 12.06707 14.26460

At most 2 * 0.174943 3.846065 3.841466

Max-Eigen value test indicates 1 co integrating equation(s) at the 0.05 level

Conclusions and suggestions

Corporate tax has significant effects on textile’s sector growth but more than social
perception. There is negative relation between corporate tax and textile sector growth.
Less Increase in corporate tax cause more effect on growth. While holding other
determinants of growth constant low tax rates were associated with higher growth but
it happens rapidly in case of Pakistan Inc.

Now what government should do?

 Government should decrease corporate tax rate it will be first step toward
organised business expansion
 Corporations increase economic activities but Government should promote
enterprises as well
 Major source of government tax revenue should be more corporate tax with
less corporate tax rate.
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