Practise analysing how income and indirect tax changes affect incentives, revenue, inequality, output, prices, trade and investment.
Sources for use with Section B
The economy of Pakistan
Figure 1 National debt, $ billions, 2018–2022
Figure 2 Rupee–US dollar exchange rate, January 2022 to June 2022
Extract A Economic outlook Between January and June 2022 Pakistan’s currency, the rupee, depreciated against the US dollar. This was mainly as a result of rising global inflation rates and the strong appreciation of the US dollar. However, economists expected the external value of the rupee to increase against the US dollar in the third quarter of 2022. They anticipated 5 that the dollars earned by Pakistan from its exports would be greater than the dollars paid for its imports and debt servicing. Pakistan experienced a significant decline in foreign currency reserves from $16 billion in June 2021 to $10 billion in June 2022. Many economists believed that the economy could be on the verge of an economic collapse in the third quarter of 10 2022. In June 2022, Pakistan’s central bank, the State Bank of Pakistan (SBP), informed Pakistan’s Government that the country’s rising foreign currency gap would have a negative impact on its ability to import. The SBP claimed that the rising foreign currency gap was likely to increase further because of higher debt servicing 15 payments. To prevent these reserves from running out, the SBP suggested a temporary ban on the import of non‑essential goods. Pakistan’s Government borrowed $1.2 billion from the IMF to prevent a further fall in foreign currency reserves. This financial support enabled the Government to reduce its current account deficit of the balance of payments and to help finance the 20 country’s national debt. The loan from the IMF required the Government of Pakistan to meet certain conditions. These included a reduction in the fiscal deficit, partly by the removal of fuel and energy subsidies. The IMF also required Pakistan’s central bank to raise its base rate of interest to stabilise the rupee. 25 Previous governments of Pakistan have not always met the terms of their loan agreements with the IMF. For example, the fiscal deficit has not been reduced significantly because the government collects very little revenue from direct taxes, especially from the booming property market. Large houses cost anywhere between $500 000 and $2 million to purchase but the owners only pay a small proportion as 30 tax. The IMF proposed that high‑income households should pay significantly more income tax than low‑income and middle‑income households.
With reference to the information provided and your own knowledge, discuss the likely macroeconomic effects of an increase in income tax rates, aimed at high-income households, on the economy of Pakistan.
Indicative content guidance
Answers must be credited by using the level descriptors (below) in line with the general marking guidance. The indicative content below exemplifies some of the points that candidates may make, but this does not imply that any of these must be included. Other relevant points must also be credited.
QS9: Interpret, apply and analyse information in written, graphical, tabular and numerical forms.
Knowledge, Application and Analysis ( 8 marks) - indicative content
- Definition/understanding of income tax
- "IMF proposed that high-income households should pay significantly more income tax than the low-income and middle-income households."
- Impact on incentives to work: it could act as a disincentive for Pakistan's citizens to take higher paid jobs; less overtime hours worked and/or less promotion opportunities sought by high income earners
- Tax revenues: these might be expected to increase (reference to Laffer curve analysis); improve Pakistan's public finances and "help reduce its fiscal deficit"
- Could cause an increase in tax evasion (illegal) and tax avoidance (legal); could also lead to an increase in the number of tax exiles
- Increased income equality: the tax system is more progressive; if taxes collected are used to redistribute incomes to the low-income households, then income distribution will become more equal
- Impact on AD and economic growth, unemployment, and inflation: this can be represented by an AD/AS diagram; reference to the multiplier
- Improvement of trade balance: increase in top rate of income tax would cause a fall in disposable income for top earners and this reduces their consumption and imports
- Fall in FDI flows: entrepreneurs and senior managers from TNCs would see a fall in their disposable income, assuming they would be based in the country for which the FDI was destined
N.B. Positive effects may be awarded as KAA and negative effects as evaluation (or vice versa)
Level
Mark Descriptor
0 No rewardable material.
Level 1
1-3
Level 2
4-6
Displays elements of knowledge and understanding of economic terms, principles, concepts, theories and models. Ability to apply knowledge and understanding to some elements of the question. Some evidence and contextual references are evident in the answer. Chains of reasoning in terms of cause and/or consequence are evident but they
may not be developed fully or some stages are omitted.
Level 3
7-8
Demonstrates accurate and precise knowledge and understanding of economic terms, principles, concepts, theories and models.
Ability to link knowledge and understanding in context using relevant examples that are fully integrated to address the broad elements of the question. Analysis is clear, coherent, relevant and focused. The answer demonstrates logical and multi-stage chains of reasoning in terms of cause and/or consequence.
Evaluation (6 marks) - indicative content
- Depends on the extent of the disincentive effects of the income tax; high income earners in Pakistan might continue to work hard to maintain their standard of living
- Tax revenues may fall if the tax rate is increased beyond the optimal rate; reference to the Laffer curve analysis; also depends on the overall impact on AD and on economic growth
- Depends on powers of Pakistan's tax authorities to collect taxes; extent of tax evasion and tax avoidance; income tax is not the only factor influencing a person's decision on where to live
- Depends on how the tax revenues are used by Pakistan's Government and whether other fiscal changes offset the impact of this increase in income tax rates
- Depends on the elasticity of the LRAS/level of spare capacity; impact could depend on the changes in other components of AD; if savings are reduced to pay for the higher income tax, then the effects will be minimal
- Depends on taxpayer's marginal propensity to consume/marginal propensity to import; depends on the PED of Pakistan's imports
- Other factors also affect FDI flows and are not just dependent on changes in income tax, e.g. business confidence, rate of economic growth, interest rate
- Overall impact would depend on how many people in Pakistan are affected by the top rate of income tax
- Impact depends on magnitude of the increase in the top rate of income tax
- Pakistan's Government should focus on increasing property taxes as only a small proportion of tax is currently raised from this source; opportunity for significant increases in tax revenue if the proportion of property tax is raised
Level
Mark
Descriptor
0
No rewardable material.
Level 1
1-2
Identification of generic evaluative comments.
No supporting evidence/reference to context.
No evidence of a logical chain of reasoning.
Level 2
3-4
Evidence of evaluation of alternative approaches
Some supporting evidence/reference to context.
Evaluation is supported by a partially-developed chain of reasoning.
Level 3
5-6
Evaluation recognises different viewpoints and/or is critical of the evidence. Appropriate reference to evidence/context.
Evaluation is supported by a logical chain of reasoning.
Question
Between 2000 and 2020, Gibraltar's terms of trade worsened by 44.6\% and Greece's terms of trade worsened by 14.3\%.
Evaluate factors that might cause a country's terms of trade to worsen.
Indicative content