Linkage between Tax Burden and Demand for Currency in Pakistan

Abstract

The purpose of this study is to examine the effect of tax burden on the demand for currency in Pakistan and the examination is delimited to total tax revenue only. High formal tax burdens drive individuals toward cash transactions to evade documentation. The study follows quantitative methodology and uses ARDL approach on time series data from 1979-2023. Variables used are currency ratio, tax-to-GDP ratio, interest rates, domestic credit to private sector, inflation and a dummy variable to capture structural shocks from Covid 19. The resulting model is tested with diagnostic tests to confirm its stability and robustness. The study reveals a highly significant and positive relationship of tax burden with the currency demand; and a negative and significant relationship between interest rate and currency in short and long run. Private sector growth and inflation both have significant and negative impact on demand for currency in the short run but not in the long run. Authorities should expand the tax base, reduce tax rates, and encourage digital payments to control high cash transaction.