Tax Structure in Developing Countries: Many Puzzles and a Possible Explanation

36 Pages Posted: 25 May 2005 Last revised: 2 Feb 2010

See all articles by Roger H. Gordon

Roger H. Gordon

University of California, San Diego (UCSD) - Department of Economics; Harvard University - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Wei Li

University of Virginia - Darden School of Business; Centre for Economic Policy Research (CEPR)

Date Written: April 2005

Abstract

Tax policies seen in developing countries are puzzling on many dimensions. To begin with, revenue/GDP is surprisingly small compared with that in developed economies. Taxes on labor income play a minor role. Taxes on consumption are important, but effective tax rates vary dramatically by firm, with many firms avoiding taxes entirely by operating through cash in the informal economy and others facing very high liabilities. Taxes on capital are an important source of revenue, as are tariffs and seignorage, all contrary to the theoretical literature.In this paper, we argue that all of these aspects of policy may be sensible responses if a government is able in practice to collect taxes only from those firms that make use of the financial sector. Through use of the financial sector, firms generate a paper trail, facilitating tax enforcement. The threat of disintermediation then limits how much can be collected in taxes. Taxes can most easily be collected from the firms most dependent on the financial sector, presumably capital-intensive firms. Given the resulting differential tax rates by sector, other policies would sensibly be used to offset these tax distortions. Tariff protection for capital-intensive firms is one. Inflation, imposing a tax on the cash economy is another.

Suggested Citation

Gordon, Roger H. and Li, Wei, Tax Structure in Developing Countries: Many Puzzles and a Possible Explanation (April 2005). NBER Working Paper No. w11267. Available at SSRN: https://ssrn.com/abstract=705587

Roger H. Gordon (Contact Author)

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
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858-534-4828 (Phone)
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Harvard University - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Wei Li

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
804-243-7691 (Phone)
804-243-7681 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/li.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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