Effect of Poverty Volatility on Tax Revenue Instability in Developing Countries

Abstract

This paper complements the relatively few existing studies on the macroeconomic effects of poverty in developing countries, by investigating the effect of poverty volatility on tax revenue instability. The empirical analysis has been conducted using an unbalanced panel dataset of 112 developing countries covering the period 1980-2017, and primarily the two-step system Generalized Method of Moments technique. Findings have revealed that, on average, over the full sample, poverty volatility is associated with lower tax revenue instability. However, this reflects differentiated effect across countries, as low-income countries tend to experience a positive tax revenue instability effect of poverty volatility, while poverty volatility results in lower tax revenue instability in relatively advanced countries (among developing countries). Additionally, these outcomes hide the fact that poverty volatility exerts a higher positive effect on tax revenue instability in the context of increasing poverty rates. From a policy perspective, this analysis shows that it is essential for policymakers to dampen the volatility of poverty rates (notably in countries with high poverty rates) if they were to ensure the stability of tax revenue or reduce its instability, given the adverse effect of tax revenue instability on economic growth.