4.2 DETERMINANTS OF GOVERNMENT REVENUE
The various determinants of government revenues can be classified under such . . . Jl 1·
~
d 1· dJ.
16 Th . . 1 d . tcategones as statlstlca , qua Itatlve an po 1cy etermmants . e statlstlca etermman s are those that are quantitatively measurable. These are government expenditure, the level of public debt, degree of urbanisation, literacy rate, degree of openness etc. The qualitative variables include institutional and social determinants, the level of C()rruption, quality of tax administration, the resources allocated for this tax administration, size of penalties for non-compliance, incarne distribution, importance of the underground economy relative to the formai market, attitude of citizens toward the government, form of government etc. The policy determinants include the number and type of tax changes, the use of particular tax sources, the number of taxes in the country' s tax system
•
17, the lev el of tax rates 18, the use oftax incentives and tax expenditures in general19. More recently there are macroeconomie policies such as the exchange rate, import substitution, trade liberalisation, devaluation,
oe....-.---.. - -
-·; extemal debt, the rate of interest and inflation.
~ Lotz and Morss (1967, 1970) developed a model on tax determinants that has become a standard for future studies. They found that the tax share is positively related to both per capita incarne and the degree of openness (measured as exports plus imports over GDP). In their later work they introduced the degree of monetisation (measured in terms of per capita coins and notes), decentralisation and export concentration variables to the model to explain
15 Feldstein's summary of the position of the popular supply-siders (1986, p.27).
16 see V. Tanzi (1989 p.635) .
17 Sorne econornists are of the opinion that the higher the number of taxes used, the lower the lev el of taxation.
Others believe the opposite
18 This validates Laffer's Curve (the lower the tax rate the higher the subsequent tax receipts).
19 Promo ting activities through tax expenditure instead of direct subsidies might lower the lev el of taxation.
57 the variation in tax level. They found the degree of monetisation to be the most significant determinant.
'---~ 9)
attempted to extend the Lotz-Morss study by adding independent variables to the model: the ratio of agriculture to total incarne, the rate of growth of population, and the rate of growth of priees. For low-income countries, he found only the rate of priee increase and the rate of population growth to be significant, although, he provided little a priori explanation for these variables.~
Bahl's (1971) models are based on the findings that the tax ratio is a function of the agricultural share of GNP, the mining share, and the degree of openness of the economy.
Chelliah (1972) improved upon this- work by including non-export incarne per capita as an indicator of taxable surplus, the level of development and export share. He left out the
s'hare of agriculture. More recent IMF studies by Chelliah, Baas and Kelly (1975), Tait, Gratz
and Eichengreen (1979), and Tanzi (1987) estimated the Lotz-Morss and Bahl models using newer cross country data. The differences between these recent studies and the previous are that the per capita incarne variable enters the model in an inverse form which has a positive significant coefficient with direct tax share and a negative significant coefficient in the indirect tax share model. More so, the present studies include the share of foreign grants and loans in incarne,
Peter S. Helier (1973) showed that there is a positive relationship between non-debt revenue and GDP, government investment and government consumption, and a negative link with aid flows. Imports of the previous period were added as an additional instrument for predicting non-debt revenue since a large share of tax revenue is derived from imports. The study reveals that non-debt revenues . are very sensitive to the level of official loans particularly for Anglophone West African countries.
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58 Chowdhury and Mahabub (1988) studied the Bangladesh tax structure. In this study, they found that tax revenue is positively related to the level of development (Williamson, 1961 ), foreign aid, foreign trade and imports (Hinrichs, 1966) and all these variables are statistically significant.
Chhibber et. al (1989) conducted a study of inflation, pnce controls and fiscal adjustment in Zimbabwe. Revenue was divided into customs duty, export taxes and other government revenue. Customs revenue is specified as a function of import level, foreign priees, tariffs and the exchange rate and export taxes as a function of export levels, the
• 1 foreign priee for exports, the exchange rate and the export tax rate. Other government revenue is treated as a function of GNP. An adjustment coefficient is introduced to see if
· · revenue adjusts with a lag20. Government revenue is positively related to GDP and government revenue lagged one period.
Morande and Schmidt-Hebbel (1991) divided the tax revenue of Zimbabwe into three:
direct taxes, indirect taxes and custom duties. Their results show that direct taxes depend positively on GDP (a proxy for the tax base), inflation, the real exchange rate and the 1988 change in tax regime while the 1978-80 conflict and the 1982 change in tax regime were negatively related to the direct tax revenue. Indirect taxes are also positively related to GDP.
" As in the case of direct taxes, real exchange rate depreciation raises revenue. During the
1970/71-1975/76 period indirect tax revenue fell as compared to 1976/77-1980/81 years, while after 1980 revenue rose with the new tax regime, as reflected by the corresponding tax regime dummies. For custom duties the relevant tax base is imports, with a marginal tariff rate of about 10% for the period 1970/71-1981/82. Changes in the customs tax regime in 1982, 1983, and 1988 reflected by dummies CDR82, CDR83, and CDR88 raised revenues in
20 Introduced by Tanzi (1977) and empirically verified by Aghelvi and Khan (1978).
59 custom duties gradually above that 10% lev el.
V Growth researchers like Misra (1991) sought to explain tax determinants usmg variables such as per capita income, industrialisation, literacy rate, urbanisation, degree of monetisation etc. Their findings show that per capita incarne and industrialisation are the most important determinants of the growth of tax revenue in the Union Government of India.
Per capita income is the only significant determinant of income tax.
Klaus Schmidt-Hebbel (1993) identified the level of development, inflation and terms
of trade shocks as the determinants of long-term tax revenue. Four conclusions are reached.
Firstly, the level of incarne is the single most important determinant of tax revenue.
Secondly, inflation inhibits tax collection in all regions except Africa. Third, terms of trade shocks are more important in inhibiting tax collection in Africa than other regions and finally OECD countries can collect more taxes than developing countries after controlling for their higher level of development and lower inflation. The positive influence on tax of the level of development reflects the notion that both the will and the ability to tax increase with the level of development (Musgrave, 1959, 1969; Henrichs, 1966, 1989, Tanzi, 1991; Burgess and Stem, 1993).
v Kouassy and Bohoun (1993) attempted to find the determinants of fiscal deficits in Côte D'Ivoire and found that only the GDP variable is significant in explaining tax revenue. v This relation is consistent with the tax base effect of GDP (Ekpo and Ndebbio, 1990; Ariyo and Raheem, 1990; and Tanzi, 1989). The link between tax revenue and tax sensitivity and public investments is much unexpected. It suggests that an improvement in the use of public investments are more likely to bring about additional tax revenues than an increase in investments themselves (Blejer and Khan; 1984). Moreover, the negative link between tax revenue and the tax rate is also astonishing even though Laffer' s Law could be used to
A
60 explain this. The law argues on the basis that high tax rate will encourage smuggling and other forms oftax evasion and hence the reduction in tax revenue. For the determinants of the retums to public investment, only the receipts from corporations are significant and there is a negative relation between retums of public investments and the difference between the domestic priees and foreign priees applied by marketing boards and the quantities handled by the marketing boards.
~ Egwaikhide et. al. (1994) looked at the Nigerian expenence of exchange rate-J depreciatVn, budget deficit
~d
inflation. They divided government revenue into three:import duties, other government revenues and oil revenue. Import duty is specified as directly related to import levef that in tum is influenced by the exchange rate. Other government revenues are determined by nominal income and other government revenues lagged one
period. Both functions were estimated in log-linear form. Oil revenue is an exogenous ' variable. Government expenditure was also divided into two: debt service and other
J
government expenditure. They found a positive link between debt service and foreign interest rate. Other government expenditure is also directly related to real income, the magnitude of real government revenu/ d other government revenue lagged one period. Their result shows that, priee inflation would increase by an annual average of about 6% over the control solution and domestic money supply by almost 2%, thus, exchange rate depreciation can be inflationa, with a lag period of one year. Also real government expenditure
.
seemed to haveCV\.N-11'
grown faster than .revenues (8.11% as opposed to 4.83%), thus depreciation of the local currency might result in budget deficits. The increase in total government expenditure appears to have been fostered by growth in debt service payment, with depreciation of the exchange rate raising the stock in local currency. Perhaps it is through the monetization of the increased revenues from the exchange rate liberalization that the expansion in money base
'1
61 became enhanced, with rapid growth in money supply and inflation as sorne of the derivatives. The use of government revenue as a determinant of government expenditure is inspired by the debate in the literature. The debate is whether government revenue determines
government expenditure (Friedman, 1972; Buchanan and Wagner, 1977; Roberts, 1978;
Peacock and Wiseman, 1961, 1979; Marlow and Manage, 1987; Joulfaian and Mookerjee, 1990;); or government expenditure determines government revenue. Sorne of these studies were based on time series analysis and made use of the Granger test to show causality. The Barro thesis (1974) of expenditure causing revenue was confirmed by a study on the American economy by Anderson et. al. (1986).