Mr. Bahl, who received his doctorate in economics from the University of Kentucky, was an economist in the Fiscal Affairs Department of the Fund when this paper was prepared. He is now Associate Professor of Economics and Director of the Metropolitan and Regional Research Center in the Maxwell School at Syracuse University in New York State. He has written a number of articles on public finance.
The author is indebted to Richard Goode, Raja Chelliah, David Klein, and Mahla Ong for many helpful suggestions and comments.
This is the second in a series of papers originating from a study of taxation in developing countries undertaken by the Fund’s Fiscal Affairs Department. The first paper, “Trends in Taxation in Developing Countries,” by Raja J. Chelliah, appeared in the July 1971 issue of Staff Papers (pp. 254-331). It is planned to publish another paper by Mr. Bahl, “A Representative Tax System Approach to Measuring Tax Effort in Developing Countries,” in the next issue of Staff Papers.
Throughout this paper, the term “tax ratio” is used to describe the ratio of tax revenues (excluding social security taxes) to gross national product (GNP).
The first to use the statistical results of a tax ratio analysis for the purpose of making tax effort comparisons were Jørgen R. Lotz and Elliott R. Morss in “Measuring ‘Tax Effort’ in Developing Countries,” Staff Papers, Vol. XIV (1967), pp. 478-99.
Taxable capacity is defined in this paper as the tax ratio that would result if a country applied to its tax bases a set of “average” effective rates on those bases—these rates are computed as net regression coefficients for the sample of countries included here. The variable indicators of taxable capacity are proxy measures of tax bases.
Jeffrey G. Williamson, “Public Expenditure and Revenue: An International Comparison,” The Manchester School of Economic and Social Studies, Vol. XXIX (1961), pp. 43-56.
Sylvain Plasschaert, Taxable Capacity in Developing Countries, International Bank for Reconstruction and Development, Report No. EC-103 (mimeographed, Washington, 1962).
Harley H. Hinrichs, “The Changing Level of the Government Revenue Share,” Chapter 2 in A General Theory of Tax Structure Change During Economic Development (Harvard Law School, 1966), pp. 7-31.
Ibid., p. 19.
Richard S. Thorn, “The Evolution of Public Finances During Economic Development,” The Manchester School of Economic and Social Studies, Vol. XXXV (1967), pp. 19-53.
Steven J. Weiss, “Factors Affecting the Government Revenue Share in Less Developed Countries,” University of West Indies, Social and Economic Studies, Vol. 18 (1969), pp. 348-64.
Jørgen R. Lotz and Elliott R. Morss, “A Theory of Tax Level Determinants for Developing Countries,” Economic Development and Cultural Change, Vol. 18 (April 1970), pp. 328-41.
For example, if country A and country B have equal per capita incomes but A has a greater level of per capita “monetization,” it may follow that A has a smaller subsistence sector and therefore a greater taxable capacity.
Lotz and Morss, “Measuring ‘Tax Effort’ in Developing Countries” (cited in footnote 3).
Kilman Shin, “International Difference in Tax Ratio,” The Review of Economics and Statistics, Vol. LI (1969), pp. 213-20.
Computed as the percentage increase between 1950 and 1965.
Computed as an average of the increase in consumer prices over the preceding four years.
Shin, op. cit., p. 215.
United Nations Conference on Trade and Development, Objectives for the Mobilization of Domestic Resources—Mobilization of Resources for Development (mimeographed, TD/B/C. 3/75/Add. 1, February 23, 1970).
For a more detailed discussion, see Pietro Balestra and Marc Nerlove, “Pooling Cross Section and Time Series Data in the Estimation of a Dynamic Model: The Demand for Natural Gas,” Econometrica, Vol. 34 (1966), pp. 585-612.
Under certain conditions, another interpretation of the constant is possible. See Appendix II.
A multiplicative, double-log form was also tested on the data, but in no case did it give a significantly higher explained variance.
Lotz and Morss, “A Theory of Tax Level Determinants for Developing Countries” (cited in footnote 12).
Hereafter, the ratio of exports to GNP will be referred to as the export ratio, the ratio of imports to GNP as the import ratio, and the ratio of imports plus exports to GNP as the openness ratio.
Intercountry differences in official exchange rates—even if in equilibrium—at best measure variations in the purchasing power of a currency with respect to internationally traded goods and services rather than overall purchasing power. A high degree of incomparability may be introduced when per capita income in U. S. dollars is used in comparing countries at widely different levels of development. For a discussion of this problem and a suggested alternative index, see Wilfred Beckerman, International Comparisons of Real Incomes (Organization for Economic Cooperation and Development, Paris, 1966), Chapters I (pp. 7-10) and V (pp. 27-37).
However, to cite this as supporting evidence for using Ay as an independent variable, it must be argued that the agricultural share of income and of employment are related.
Irma Adelman and Cynthia Taft Morris, “A Factor Analysis of the Interrelationship Between Social and Political Variables and Per Capita Gross National Product,” The Quarterly Journal of Economics, Vol. LXXIX (1965), p. 562.
Jørgen R. Lotz and Elliott R. Morss, “The Tax Structure of Developing Countries, An Empirical Study” (unpublished, International Monetary Fund, January 21, 1969).
Another possibility for measuring the size of the subsistence sector is by constructing a variable to reflect intercountry variations in the degree of monetization. In an earlier study, Lotz and Morss used per capita coins and notes for this purpose. In this paper, the Lotz-Morss formulation is rejected on a priori grounds (see Section II, above) in favor of an expression, “money plus quasi-money as a percentage of GNP.” However, as may be seen from the coefficients in Table 1, there is no apparent relationship between this variable and any other dependent variable or between this variable and the tax ratio. Hence, it is not introduced again in this study.
Lotz and Morss, “The Tax Structure of Developing Countries, An Empirical Study” (cited in footnote 28).
Given this statement of hypotheses, all significance tests are one-tail. At the 0.05 level of significance, the critical t-value is 1.6779, whereas at the 0.01 level it is 2.4083. The conventions of describing the 0.05 level as significant and noting it with one asterisk, and the 0.01 level as highly significant and noting it with two asterisks, are adopted here.
The simple correlation between Ay and (Xy - Axy - Nxy) is -0.36, while that between Ny and (Xy - Nxy - Axy) is not significant.
when this equation was run, with the overall export ratio as the third independent variable, the results were not markedly different, i.e.,
When the export variable is specified to exclude agricultural and mining exports, a similar result is obtained, i.e.,
The lower explained variations compared with that of equation (13) indicate that the contribution of either measure of the foreign trade variable to explained variance was more than offset by the loss in degrees of freedom. The nonsignificance of the (Xy - Axy - Nxy) version of the export size variable is apparently due less to multicollinearity than to a nonsignificant relationship to the tax ratio.
Since the variables are already presented in terms of percentages of GNP, the net regression coefficients may be compared directly without problems of scale.
These are manufacturing, trade, government, other services, and construction.
No attempt is made here to relate the notion of the diminishing marginal utility of income to the concept of taxable capacity, since the question of intercountry tax burden differences is not analyzed in this paper. Such an analysis would require detailed consideration of intercountry tax shifting and would change the focus away from the taxable capacity of countries to the taxable capacity of individuals.
Lotz and Morss, “Measuring Tax Effort’ in Developing Countries” (cited in footnote 3).
The results are not strictly comparable, however, because the Lotz-Morss dependent variable included social security taxes, whereas the present dependent variable does not.
A Spearman rank correlation coefficient between the two series is 0.8704.
With appropriate adjustments for overlapping variables.
Such a formulation has been used by the Fiscal Affairs Department for deriving tax effort indices in developing countries.
The Spearman rank correlation coefficients are 0.9541 with the present study and 0.8918 with the Lotz-Morss equation.
The grouping of countries by region is shown in Table 4. It is apparent that this grouping is rather arbitrary, and that the results obtained may be affected if the countries are grouped in another way.
The significance test for the overall effect of region involves computing an F statistic on the ratio of the mean square among regions to the residual variance in the regression equation. The variation among the five intercepts (
where Ni = number of countries in the ith class and
The resulting F value of 4.98 is highly significant. See Daniel B. Suits, “Use of Dummy Variables in Regression Equations,” Journal of the American Statistical Association, Vol. 52 (1957), pp. 548-51.