Does Cutting the Tax Rate to Zero Induce Behavior Different from Other Tax Cuts? Evidence from Pakistan

Using a series of Pakistani tax reforms and administrative records, I document that taxable
income responses induced by to-zero tax cuts are orders of magnitude larger than ones induced by similar-sized other cuts. This finding is remarkably robust to alternative specifications and holds for both self-employed and wage-earners. I explore salience, selective enforcement, and discontinuous evasion costs as explanations of the observed behavior. I find that the data favor the last explanation. The difference between the two sets of responses is primarily driven by large, discrete tax evasion response, which is included in the former but not in the latter behavior. I estimate the difference as a lower bound on tax evasion, showing that at least 70% of income of low- and middle-income self-employed and and 1% of low-income wage-earners goes unreported.