State Institutions and Tax Capacity: An Empirical Investigation of Causality
39 Pages Posted: 28 Aug 2019
Date Written: August 2019
Would better state institutions increase tax collection, or would higher tax collection help improve state institutions? In the absence of conclusive guidance from theory, this paper searches for an empirical answer to this question, using a panel dataset covering 110 non-resource-rich countries from 1996 to 2017. Employing a panel vector error correction model, the paper finds that tax capacity and state institutions cause and reinforce each other for a wide range of country groups. The bi-directional causality results suggest that developing tax capacity and building state institutions need to go hand in hand for best results, particularly in developing countries. Based on the impulse response analyses, the paper also finds that the causal effects in advanced economies are generally low in both directions, while in developing countries, both tax capacity and institutions shocks have larger positive impacts on institutions and tax capacity, respectively.
Keywords: Tax revenue, Tax exemptions, Tax administration, Tax reforms, Tax rates, Tax capacity, institutions, causality, GDP, state institution, weak institution, country group, government effectiveness
JEL Classification: H11, H26, O23, O55, C23, H2, E01, K34, H83, H71
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