Quick to Fall, Slow to Rise: Asymmetric Effects of Sales Tax Decentralization on Revenue Collection in Pakistan

Abstract

Purpose: The purpose of this study is to test whether the relationship between Sales Tax on Services (STS) decentralization and provincial revenue collection in Pakistan is symmetric or asymmetric, challenging the implicit assumption in the fiscal decentralization literature that decentralization's effects on revenue collection are equal and opposite for increases and decreases.

Design/Methodology/Approach. This study employs monthly time-series data spanning fiscal years 2001 to 2024, comprising 288 monthly observations. The study decomposes the sales-tax-on-services decentralization (STSD) index into separate cumulative sums of its positive and negative monthly changes and estimates a Nonlinear Autoregressive Distributed Lag (NARDL) model of STS collection with respect to these two components. The bounds-testing approach confirms cointegration, and Wald tests are employed to formally test long-run and short-run symmetry.

Findings. The bounds-testing approach confirms strong cointegration between the decomposed decentralization measure and STS collection. In the long run, increases in decentralization intensity raise STS collection significantly, and decreases lower it significantly; a formal Wald test confirms that these two effects are statistically distinguishable from one another rather than mirror images of the same underlying relationship (p < 0.01). In the short run, a within-month decrease in decentralization intensity is associated with a significant, immediate fall in STS collection under conventional standard errors, whereas a within-month increase shows no corresponding immediate effect.

 Research Limitations. The study uses interpolated monthly data before 2011 due to unavailability of official monthly data. The model deliberately excludes GDP growth, debt growth, and population controls due to multicollinearity with decomposed decentralization variables. The marginal rejection of the Ramsey RESET test suggests potential functional-form nonlinearity beyond the positive-negative decomposition modeled.

Practical Implications. The findings suggest that Pakistan's sales-tax-on-services decentralization behaves less like a simple linear lever and more like a relationship with its own institutional memory: STS collection appears quicker to suffer when decentralization stalls or reverses than it is to gain when decentralization advances. Provincial revenue authorities and federal policymakers should treat the credibility and continuity of decentralization commitments as at least as important for revenue outcomes as the pace of further devolution itself.

Originality/Value. This study is the first to test whether the effect of sales tax on services decentralization on STS collection in Pakistan, or indeed the effect of fiscal decentralization on own-revenue collection in any comparable setting, is symmetric or asymmetric using the NARDL framework.

References

Bahmani-Oskooee, M., & Mohammadian, A. (2016). Asymmetry effects of exchange rate changes on domestic production: Evidence from nonlinear ARDL approach. Australian Economic Papers, 55(3), 181–191. https://doi.org/10.1111/1467-8454.12073

Bird, R. M., & Vaillancourt, F. (Eds.). (2008). Fiscal decentralization in developing countries. Cambridge University Press.

Engle, R. F., & Granger, C. W. J. (1987). Co-integration and error correction: Representation, estimation, and testing. Econometrica, 55(2), 251–276. https://doi.org/10.2307/1913236

Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263–291.

Kydland, F. E., & Prescott, E. C. (1977). Rules rather than discretion: The inconsistency of optimal plans. Journal of Political Economy, 85(3), 473–491. https://doi.org/10.1086/260580

Li, X.-L., Si, D.-K., & Ge, X. (2021). China's interest rate pass-through after the interest rate liberalization: Evidence from a nonlinear autoregressive distributed lag model. International Review of Economics & Finance, 73, 257–274. https://doi.org/10.1016/j.iref.2020.12.031

Martínez-Vázquez, J., Lago-Peñas, S., & Sacchi, A. (2017). The impact of fiscal decentralization: A survey. Journal of Economic Surveys, 31(4), 1095–1129.

Musgrave, R. A. (1959). The theory of public finance: A study in public economy. McGraw-Hill.

Oates, W. E. (1972). Fiscal federalism. Harcourt Brace Jovanovich.

Pesaran, M. H., Shin, Y., & Smith, R. J. (2001). Bounds testing approaches to the analysis of level relationships. Journal of Applied Econometrics, 16(3), 289–326. https://doi.org/10.1002/jae.616

Rodden, J. (2003). Reviving Leviathan: Fiscal federalism and the growth of government. International Organization, 57(4), 695–729.

Shin, Y., Yu, B., & Greenwood-Nimmo, M. (2014). Modelling asymmetric cointegration and dynamic multipliers in a nonlinear ARDL framework. In R. C. Sickles & W. C. Horrace (Eds.), Festschrift in honor of Peter Schmidt: Econometric methods and applications (pp. 281–314). Springer. https://doi.org/10.1007/978-1-4899-8008-3_9

Zhang, X., & Baek, J. (2022). The role of oil price shocks on exchange rates for the selected Asian countries: Asymmetric evidence from nonlinear ARDL and generalized IRFs approaches. Energy Economics, 112, Article 106178. https://doi.org/10.1016/j.eneco.2022.106178