Taxation, Fiscal Deficit and Inflation in Pakistan

Fiscal policy has more controversial debate regarding its effectiveness on different macroeconomic activities of an economy. Taxation and government expenditure are two main instruments of fiscal policy. This paper is aimed to analyze and update the effects of different instruments of fiscal policy on inflation in Pakistan economy. The data time span for this study is 1979-2013. The impact of fiscal policy on inflation is analyzed by utilizing the Bounds testing procedure and ARDL approach of co-integration which is a better estimation technique for small sample size. It is found that investment negatively and significantly affect the inflation rate. The outcomes of the study show that both types of taxes (direct and indirect) are causing to increase the inflation level while fiscal deficit is also one of the reasons to increase the inflation in the country. The study proposed that government should decrease the level of expenditure to reduce the level of fiscal deficit and investment have to be promoted to decrease the inflation in the country. Furthermore, it is also suggested to decrease the level of taxation for controlling inflation.