Determinant of Tax Buoyancy: Empirical Evidence from Developing Countries

Transcription

1 Determinant of Tax Buoyancy: Empirical Evidence from Developing Countries Qazi Masood Ahmed Associate Professor, Institute of Business Administration, Karachi Tel: Sulaiman D. Mohammed Associate professor. Urdu University, Karachi Abstract The purpose of this paper is to find the determinant of tax buoyancy of developing countries. We have used 25 countries cross section data for the year 1998 to 2008 and used pooled least square method for result analysis. The result shows that import, manufacturing sector, services sector, monetization and budget deficit influence positively the tax buoyancy while growth in grants impact negatively on tax buoyancy. The growth of agriculture sector has insignificant impact on tax buoyancy in case of developing countries because they are not taxed or under taxe.. Keywords: Developing countries, Tax buoyancy JEL Classification Codes: O57, H29 I. Introduction The fiscal deficit is the core issue of most of the developing countries over the past several decades. The reason behind the large increase in fiscal imbalance is the rapid expansion in expenditure and low revenue collection. Recent endogenous growth model Romer (1986) have demonstrated that growth can be achieved by reducing fiscal imbalance, which can be achieved either by lowering expenditure or increase tax revenue. However, many developing countries have used option of reducing expenditure by reducing expenditures in case of health, education, and infrastructure, and other are rising tax revenue. International comparison of fiscal efforts of developing countries is researched several times. The famous studies in this area are Harley (1965); Lotz and Morss (1967); Raja (1971); Roy (1979); Dehnashwar Ghura (1998); Abhijit Sen Gupta (2007). Most of these studies used ordinary least square method (OLS) technique to find the determinants of total tax to GDP ratio and most common exogenous variables used by these studies were share of agriculture sector, share of industrial sector, share of foreign trade and per capital income. The other variables tested are monetization, level of education and urbanization in the estimation of tax potential of different developing countries. In the present study instead of exploring the determinants of tax to GDP ratio we attempt to explore the determinants of buoyancy of taxes i.e. the total tax, direct tax and indirect tax. The buoyancy of tax is defined as the total response of tax revenue in percentage term to a percentage change in GDP. The study would have been more useful if we find the determinants of elasticity instead of buoyancy. Buoyancy and elasticity both measure response of revenue to the change in income but there is a crucial difference as in the measure of elasticity we assume tax system remains unaltered - no 408

2 change in the tax laws, including the tax rates or bases. Thus the tax elasticity is a hypothetical construct and measure what tax revenue would have been if last year s laws continued to apply this year. But due to non availability of data and information of discretionary measure of each tax this is not convenient to measure elasticity of tax in case of panel analysis. Therefore, in this study we are using buoyancy rather than the elasticity of a tax as a dependent variable. After brief introduction the paper is structured as follow, In section 2 we describe the theoretical basis of model, section 3 gives research methodology and data source, section 4 provides result analysis and finally in section 5 gives conclusion and summary of the study. II. Theoretical Modeling and Hypothesis Exploring the determinants of buoyancy involves regressing the variable of tax buoyancy on the variables that serve as proxies for a country s tax handles the following equation is estimates. b= β + β ) + β ) + β ) + β ) + β 6 1 ser 2 manf ) + β 7 deficit 3 agr ) + β 8 grants ) + μ b = Buoyancy of the taxes (total tax, direct tax and indirect tax). manf ) is defined as the growth in manufacturing sector divided by growth of GDP. This variable will show the effects of growth in manufacturing sector on the tax revenue generating ability of developing countries. Increase in growth of manufacturing sector cause increase the revenue through sales tax, excise duty and corporate income tax etc. the expected sign of this variable is positive. agr ) will capture the impact of budget deficit on tax collection. Budget deficit is the key issue for most developing countries and due to high budget deficit their borrowing increases. Different international agencies like IMF (international monetary fund), World Bank and other lending agencies have imposed imp 5 Money is defined as the growth in agriculture sector divided by growth of GDP. The variable will capture the effects of growth in agriculture sector on tax revenue. In most of the developing countries the agriculture sector contribute significantly in GDP but due to strong agriculture lobbies the government face difficulties to impose tax on agriculture sector specially direct tax. So agriculture sector is used as tax evasion funnel for the income which is generated through other non agriculture sector. So the expected sign of this variable is ambiguous. imp/ g) is defined as growth in import sector divided by growth of GDP. The variables will capture the effects of growth in import sector on tax revenue. In most of under developing countries the contribution of import sector is very significant in collection of tax revenue through import duties, tariff etc. The expected sign of this variable is positive. In many developing countries the withholding income tax at the stage of import is also introduced. So growth in import sector not only increases indirect tax but also direct tax is well. Money/ g) is defined as growth in monetary sector (M2) divide by growth of GDP. The variable will capture the effect of growth in monetization on tax revenue collection. As increase in documentation of the economy will increase formal transaction activity and increase tax revenue collection. As a result the study assume that sign of this variable is positive. ser ) is defined as growth in service sector divide by growth of GDP. The variable will capture the effect of growth in service sector on tax revenue collection. In case of many of the developing countries the service sector comprises of informal sector. It is expected it will increase tax revenue but due to informal service sector degree of tax evasion is also high so growth in service sector impact not much on tax collection. The expected sign of this variable is ambiguous. g ) is defined as growth in budget deficit divide by growth of GDP. The variable ( deficit

3 different conditionalities to reduce budget deficit. Due to these conditionalities the developing countries compelled to increase their tax revenue collection so expected sign of this variable is positive. grants ) is defined as growth in grants divide by growth of GDP. This variable will capture the impact of grants in tax collection. Increase in foreign resource inflow make government of developing countries relaxes and due to fear of any political reaction they don t take decisions for domestic resources mobilization. So the sign of this variable is expected to be negative. III. Methodology and Data Collection In this paper we have used panel (time series and cross sectional) data of 25 developing countries. The data was collected for 11 years from 1998 to 2008 converted in to log and used in the regression analysis. There are two steps in the methodology. In the first step we estimate buoyancy of each tax for each country. For this we regress following equation. logti = α 1 + α 2 loggdpi + ω Where; log T = log of tax (total tax or indirect tax or direct tax) log GDP= log of Gross domestic Product /output ω = Error term The direct tax includes income tax, corporate tax, wealth tax etc. while in indirect tax includes custom duties, excise duty, sales tax, etc, and total tax includes both direct and indirect taxes plus gratuity fund and other employer contribution. After calculating the buoyancy of tax in the second step we have used these tax buoyancies as dependent variable and pooled ordinary least square method has been used to find the determinants of buoyancy of each type of tax (direct, indirect and total tax). The data on each exogenous variable for 25 countries have been collected from WDI (World Development Indicator) and IFS (International Financial Statistics) for IMF (International Monetary Fund) various issue. The name of the countries and actual values of the buoyancies of each tax are given below Table

4 Table 1: shows Buoyancy of Tax Country Direct tax In direct tax Total tax Afghanistan Azerbaijan Bangladesh Bhutan Brazil Cameroon Chile China Cuba Egypt Ghana India Indonesia Iran, Islamic Rep Kazakhstan Kenya Libya Malaysia Mexico Nigeria Pakistan Papua New Guinea Sri Lanka Uganda Zimbabwe For each exogenous variable we compute growth rates and then divided by the GDP growth to make these variables standardized and used in the regression. IV. Result Analysis The results of study are given in Table 2 with brief description below. 411

5 Table 2: Method: Dependent Variable (tax buoyancy) Panel Least Square all independent variables are in log form. Independent variables Total Tax Direct Tax Indirect Tax constant (g imp/g ) (g agr/g ) (g manf/g ) (g ser/g ) (g M2/g ) (g grant/g ) (g deficit ) ( ) ( ) ( ) [ ] [ ] [ ] ** ** ( ) ( ) ( ) [ ] [ ] [ ] ( ) ( ) ( ) [ ] [ ] [ ] *** *** *** ( ) ( ) ( ) [ ] [ ] [ ] ** * ** ( ) ( ) ( ) [ ] [ ] [ ] *** *** *** ( ) ( ) ( ) [ ] [ ] [ ] *** *** *** ( ) ( ) ( ) [ ] [ ] [ ] ** *** ** ( ) ( ) ( ) [ ] [ ] [ ] Adjusted R Durbin-Watson stat F statistics *significant at 10% level ** significant at 5% level *** significant at 1% level / values in parenthesis is Standard error of coefficient Total Taxes The result in Table 2 shows growth in import and manufacturing sectors have positive and significant impact on tax buoyancy which shows with the increase in growth of import sector tax revenue collection increases through import duties, tariff, sales tax on import stage and withholding income tax at import stage. The growth in manufacturing sector increases tax collection by excise duties and corporations tax etc. The monetary growth is highly significant and positive sign which shows that increase in monetization (documentation) improves collection of tax. Agriculture growth coefficient is insignificant as in most of the developing countries the agriculture sector s income is exempted because of the strong political agricultural lobby. This is one of the important reasons for low tax buoyancy and hence low tax to GDP ratio in developing countries. Budget deficit is a key problem 412

6 most of developing countries and as the budget deficit increases the fiscal effort also increases for more collection of tax. In our study coefficient of budget deficit shows significant and positive sign which is according to economic intuition. Whereas the coefficient of grants is negative and significant which shows that increase in flow of foreign grants causes to reduce the fiscal effort for domestic resource mobilization. Coefficient of service sector is positive and significant unlike the previous study (Ahmed 1994). In the earlier study the insignificant impact of service sector in determination of tax buoyancy was because of underdeveloped financial sector. After 1990 s financial reforms and better tax administration caused improved tax collection through service sector in developing economy. Direct Tax The Table 2 shows the determinants of tax buoyancy of direct tax. This Table 2 shows that growth in manufacturing sector is positively impact of direct tax collection through corporate tax, income tax and pay roll taxes. The coefficient of growth in import is insignificant in this equation because growth of import affects only the indirect tax like tariff, import duties and sales tax however, in few countries withholding income tax is imposed on imports but the proportion is very small. The coefficient of growth in monetization shows positive and significant effect, which shows that as level of monetization increases causes to increase in documentation of transaction of the economy which can increase the collection of direct tax. The effect of growth in agriculture sector is insignificant on tax collection because most of the developing countries are agriculture based economies and to promote agriculture sector it is exempted from tax net. The coefficient of growth of grants is negative and shows highly significant which clearly indicate the flow of foreign grants reduces local resource mobilization and hence negatively impact on tax collection. Sign of coefficient of growth of service sector is positive and significant which indicate in most of developing countries banking and financial sector is now developing and dominating which causes significant impact on direct tax buoyancy. Coefficient of growth of Budget deficit is significant and positive sign which show that as budget deficit increases government of developing countries increase their fiscal efforts to reduce this budget deficit by direct tax. Indirect Tax The Table 2 shows the buoyancy of indirect tax is positively impacted by growth in manufacturing sector, growth in import and growth in monetization. Whereas the coefficient of agriculture is insignificant which suggest that in case of developing economy agriculture sector is not contributing to national exchequer. The impact of budget deficit is positive and of grant coefficient is negative on the government fiscal efforts. V. Conclusion The study attempts to search the determinant of tax buoyancy of 25 developing countries. Our study concluded that growth in import and manufacturing sector have positive impact on growth of tax collection. The effects of the other sector like agriculture is insignificant but unlike many of the past studies which found insignificant impact of service sector on tax buoyancy this study found positive and significant impact on tax buoyancy due to the development of service sector in 1990s. Increase monetary growth also influence positively on tax collection because increase in monetization cause documentation of transaction which improves tax buoyancy. Finally increase in budget deficit has positive influence on tax collection by demanding more resource mobilization from the governments however, at the same time the growth in grants inversely influences on tax collection because government in developing countries avoids unpopular steps of imposing taxes for domestic resource mobilization. 413

7 References [1] Abhijit Sen Gupta (2007), Determinenets of Tax Revenue Efforts in developing Countries, IMF Staff paper [2] Ahmed, Qazi Masood (1994) The determinant of tax buoyancy: an experience from the developing countries, Pakistan development review 33:4 page no [3] Alm, James, Jorge Martinez-Vazquez and Friedrich Schneider, 2004, Sizing the Problem of the Hard-to-Tax, in Taxing the Hard to Tax, ed. by Alm, Martinez-Vazquez, and S. Wallace. [4] Baltagi, B.H. (2001), Econometric Analysis of Panel Data, 2nd edition. John Wiley and Sons, Singapore. [5] Chelliah, Raja J., Hessel J. Baas, and Margaret R. Kelly, 1975, Tax Ratios and Tax Effort in Developing Countries, , Staff papers, International Monetary Fund, Vol. 22, pp [6] Dehnashwar Ghura (1998); Tax Revenues in Sub-Saharan Countries. IMF Staff Paper 98/135. [7] Eltony, M. Nagy, 2002, Determinants of Tax Efforts in Arab Countries, Arab Planning Institute Working Paper 207. [8] International monetary fund (IMF) Various issue of international financial statistics. [9] Leuthold, Jane H., 1991, Tax Shares in Developing Countries: A Panel Study, Journal of Development Economics, Vol. 35, pp [10] Lotz, J Challiah (1971) Trends in Taxation in developing countries (staff paper 14) [11] Piancastelli, Marcelo, 2001, "Measuring the Tax Effort of Developed and Developing Countries: Cross Country Panel Data Analysis, 1985/95," IPEA Working Paper No [12] Romer Paul, M Increasing returns and long-run growth. Journal of Political Economy 94(5): [13] Tanzi V. and Zee Howell H. (2000), Tax Policy for Emerging markets: Developing Countries, National Tax Journal, Vol. 53, No. 2 Jume, pp