Tax-financing of Budget Deficits in LDCs: Re-validation of Laffer Curve Theory

Abstract

Urgent need for quick action to put Nigeria and other developing economies back to the path of economic recovery has almost imposed state of emergency on these economies. Most LDCs are faced with acute shortage of development funds due to recessions accompanying incessant crashes in international financial market. Raising existing tax rates to finance budget deficit in LDCs often generates public debate on pros and cons of such policy option. Study considered Nigeria as typical case of LDCs. Study focused on establishing the effectiveness of tax-financing of budget deficit under Laffer curve theory. Study spanned across 1970-2015. Data were analyzed using ADF, CUSUM, heteroskedasticity, multiple regression, Johansen cointegration and ECM. Results indicate that: (1) Custom and exercise duties, petroleum profit tax and value-added tax contributed significantly to the reduction in budget deficit while company income tax had nonsignificant impact(2)Total government revenue constituted major chunk of planned income for budget deficit financing(3) Deficit financing of capital health expenditure yielded high returns while that of recurrent education expenditure and capital education expenditure was accompanied by low returns (4)Growth and employment generation accelerated deficit financing while private investment decelerated it (5) There were long and short-run relationships among budget deficit, taxes, human capital investment and macroeconomic indicators with significant rate of adjustment of short-run disequilibrium. Study concluded that tax-financing of budget deficit was effective under Laffer curve effect. It was recommended, among others, that LDCs should enlarge their tax bases through inclusion, to finance budget deficit.

Tax-budget Deficit Relationships: Fiscalists’ Platform for Deficit Financing Policy

“…The a prior justification for the preferred used of common factor model was the application of Paiko's (2012) model which expresses a linear functional relationship among Yt, S1, S2, S3 and S4; where Yt is P1 (private investment), S1 is GM (government expenditure public sector borrowing from the commercial banking system), S2 is D B (budget deficit); S3 is XD (external debt stock); S4 is R T (interest rate). Okafor et al (2017) had also expressed a functional relationship among BDF, TGR, CIT, CED, PPT, VAT, REE, RHE, CEE, CHE, PIV, PCE, GDP and EMP where BDF is budget deficit finance; TGR is total government revenue; CIT is company income tax; CED is custom and exercise duties; PPT is petroleum profit tax; VAT is value-added tax; REE is recurrent education expenditure; CEE is capital education expenditure; CHE is capital health expenditure; PIV is private investment; PCE is private consumption expenditure; GDP is gross domestic product and EMP is employment. The present study has also adopted a model which expresses a functional relationship among BDF, TGR, CIT, CED, PPT, VAT, REE, RHE, CEE, CHE, PIV, PCE and GDP.…”