The Impact of Tax Policies on Economic Growth: Evidence from South-Asian Economies

The public policy instruments, such as tax rate changes, have different implications in exogenous (neoclassical) and endogenous growth theories. The neoclassical theory predicts that changes in a country’s tax structure should have only transitory impact on its long-run economic growth while endogenous growth theory argues that such changes may have an effect impact on the growth. This study tests whether tax policies conducted by Pakistan, India and Sri Lanka have transitory or permanent effect on their economic growth. The study finds transitory and negative effect of tax rate on the growth only for short-term but has no effect in the long-term. The tax rates in all these countries are low as compared to developed countries. Due to low tax rates these countries heavily depend on bond financing and foreign debt. In view of the findings of this study most important policy implication of the study is that to finance the budget and most of their revenue requirements should be financed with tax increases and if necessary bond financing should be contingent providing a guard against transitory shocks to the budget.