Role of Tax Policy, Regulatory Quality, and Public Trust in Enhancing Tax Compliance: Evidence from Pakistan’s Informal Sector

Abstract

This study examines the impact of tax policy clarity, regulatory quality, and public trust in institutions on tax compliance behavior within Pakistan’s informal sector. A sample of 300 micro and small informal business owners was surveyed to explore how these institutional factors shape tax-related decisions. Partial Least Squares Structural Equation Modeling (PLS-SEM) was conducted using SmartPLS 4.0 to assess the reliability, validity, and predictive strength of the proposed model. The structural equation model analysis revealed that all three explanatory variables Public Trust, Regulatory Quality, and Tax Policy have a significant and positive effect on Tax Compliance. These relationships were statistically significant, as indicated by uniformly low p-values (all < 0.001), confirming the robustness of the model. The novelty of this study lies in its application of SmartPLS-SEM to investigate institutional drivers of tax compliance within the informal economy of a developing country—an area that has received limited empirical attention. By integrating governance-related variables into the tax compliance framework, this study provides empirical evidence that strengthening institutional trust and improving policy clarity can significantly boost voluntary compliance. The findings offer valuable insights for public economics and inform strategies for fiscal reform and informal sector integration.