Tax Structures and Economic Growth: New Evidence from the Government Revenue Dataset

Abstract

This study uses the ICTD UNU-WIDER Government Revenue Dataset in order to challenge and extend existing findings on the relationship between tax structures and economic growth, in a panel of 100 countries. The results suggest that, broadly, revenue-neutral increases in income taxes are associated with lower long-run GDP growth and that revenue-neutral reductions in trade taxes have not always had positive effects. Crucially, many of the results presented differ according to income level, calling into question the validity of existing findings for developing countries and suggesting that policy advice on this issue in developing countries should be viewed through a more cautious lens. 1 The UN has ratified two official indicators for Goal 17.1 (Strengthen Domestic Resource Mobilization […] to improve domestic capacity for tax and other revenue collection): (i) total government revenue (% of GDP) and (ii) the proportion of domestic budget funded by domestic taxes. direction and significance of the coefficients on the tax variables can differ dramatically between income groups. Furthermore, some of the results do not stand up to robustness checks. These findings suggest that (i) there is no 'one size fits all' relationship between tax structure and growth and subsequently that (ii) caution should be applied when interpreting any policy advice given to low-income countries that is informed by findings from studies based only on high-income countries. Furthermore, the inherent shortcomings of the models estimated are acknowledged, and their implications discussed.The rest of this paper is organized as follows: Section 2 briefly reviews of the economic theory and empirical evidence linking taxation and growth. Section 3 introduces the data used and examines the trends in tax structures for the sample. The following section, Section 4, outlines the empirical approach, and the results of the PMG estimations are presented in Section 5. Section 6 considers some extensions and robustness checks. Section 7 discusses the limitations of the study, and Section 8 concludes. TAX AND GROWTH: IN THEORY 5There are clear arguments both for and against a higher tax ratio leading to higher GDP growth. On the one hand, higher taxes distort the incentives for individuals to supply more labour or for firms to produce more. On the other, higher taxes provide governments with the potential to invest in, for example, infrastructural improvements, education or R&D, all of which can increase the economy's productive capacity.Changes in the tax rate in the neoclassical growth model (e.g. Solow, 1956;Swan, 1956) can cause a shift only in the steady-state growth path, not its slope; the model does not allow for assessing the impact of fiscal policy on the long-run (steady-state) growth rate. However, the models of Barro (1990), King and Rebelo (1990) and Mendoza, Milesi-Ferretti and Asea (1997) are somewhat more appropriate; King and Rebelo (1990, 130) investigate the effect of an increase in the 'output tax rate applied equally to all sectora...

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