One tenet of taxation is its distorting effect on economic behaviour. Despite the economic inefficiencies resulting from taxation, it is widely believed that taxes impact minimally on the economy's growth rate. Evidence in developing countries generally supports this view. In this paper, we present evidence that tax distortions in South Africa may be much more severe. Using tax and economic data from 1960 to 2002 and a two-stage modelling technique to control for unobservable business cycle variables, we examine the relationship between total taxation, the mix of taxation and economic growth. We find that decreased tax burdens are strongly associated with increased economic growth potential; in addition, contrary to most theoretical research, decreased indirect taxation relative to direct taxation is strongly correlated with increased economic growth potential. J.E.L.

This paper is the joint product of a think tank, initiated in the public sector and extended to a group of academics. It may be seen as the executive summary of a rather voluminous report for internal use in the Department of Finance on fiscal federalism, one of the large economic issues facing the New South Africa. Debate on the subject continues.