How do political institutions affect fiscal capacity? Explaining taxation in developing economies

Abstract

A central aspect of institutional development in developing economies is building tax systems capable of raising revenues from broad tax bases, i.e. fiscal capacity. While it is recognised that fiscal capacity is pivotal for state building and economic development, it is less clear what its origins are and what explains its cross-country differences. We focus on political institutions, seen as stronger systems of checks and balances on the executive. Exploiting a recent database on public sector performance in developing economies and an IV strategy, we estimate their long-run impact, distinguishing between the accountability and transparency of fiscal institutions (impartiality) and their effectiveness in extracting revenues. We find that stronger constraints on the executive foster the impartiality of tax systems. However, there is no robust evidence that they also improve its effectiveness. Our findings also suggest that the overall impact on both total tax revenues and income tax is economically relevant.

Is tax morale culturally driven?

“…However, the tax collection process is often complex, and can be perceived by citizens to lack transparency. Recent institutional studies show that tax systems perceived as transparent and accountable by taxpayers increase their tax compliance (Ricciuti et al 2019). On the contrary, the moral cost of rent-seeking behaviour such as corruption and tax evasion reduces when citizens perceive that the tax administration lacks of transparent procedures and when laws are too complex for citizens to understand without legal advice (Torgler 2005).…”

Is there a fiscal resource curse? Resource rents, fiscal capacity, and political institutions in developing economies

“…However, we have not yet identified which specific tax institutions are affected, an exercise that might deliver insights on the mechanisms. Following Ricciuti et al (2019), we unbundle fiscal capacity and distinguish between two aspects of tax systems: the accountability and transparency of such institutions, which we call impartiality; and their effectiveness in extracting revenues.…”

The impact of tropical storms on tax revenue

“…In this regard, developing countries are particularly vulnerable as they are often characterised by a narrow tax base combined with an excessive reliance on limited low value exports, which amplify their risk of increased revenue volatility and, ultimately, lower tax collection (Morrissey et al, 2016). Additionally, many developing countries have limited fiscal capacity and fail to tap into their full revenue potential because of inefficient tax collection and a large informal sector (Besley & Persson, 2014; Ricciuti et al, 2019). 1 Developing nations also tend to rely heavily on sales taxes, which are easier to administrate than personal taxes, but entail lower revenues (Ricciuti et al, 2019).…”

“…Additionally, many developing countries have limited fiscal capacity and fail to tap into their full revenue potential because of inefficient tax collection and a large informal sector (Besley & Persson, 2014; Ricciuti et al, 2019). 1 Developing nations also tend to rely heavily on sales taxes, which are easier to administrate than personal taxes, but entail lower revenues (Ricciuti et al, 2019). Nonetheless, until recently, the relationship between tax revenue and external shocks in developing countries has only been scantily explored, where conclusions from existing studies have been limited by a large heterogeneity of cases and consistent data on tax capacity and tax performance (Dawkins & Whalley, 1997; McNabb, 2018).…”