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Tax Structure and Government Spending: Does the Value-Added Tax Increase the Size of Government?

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  • Dongwon Lee
  • Dongil Kim
  • Thomas E. Borcherding

Abstract

This paper examines the claim that the adoption of a value-added tax (VAT) increases the size of government. Our analysis suggests that introducing the VAT, despite the fact that it is a relatively efficient tax in comparison to the income tax alternative, has little impact on government growth due to two factors: (1) the substitution of the VAT for other tax sources, and (2) the low price elasticity of demand for public goods. In contrast, demand-side changes may have a more significant impact on government size, thus reversing the direction of causality. Using a panel of 29 OECD countries over a period of 38 years (1970–2007), we confirm these hypotheses. Our findings imply that the demand for government spending markedly influences the tax structure of society. Using a broad concept of tax costs, introduction of a VAT increases social welfare because it reduces compliance costs, rent-seeking, and efficiency costs. Accordingly, increased usage of VATs during the 20th century should be understood as a collective choice to accommodate growing demands for public expenditure.

Suggested Citation

  • Dongwon Lee & Dongil Kim & Thomas E. Borcherding, 2013. "Tax Structure and Government Spending: Does the Value-Added Tax Increase the Size of Government?," National Tax Journal, National Tax Association;National Tax Journal, vol. 66(3), pages 541-570, September.
    • Handle: RePEc:ntj:journl:v:66:y:2013:i:3:p:541-570
    DOI: 10.17310/ntj.2013.3.02
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    2. Azmi, Anna & Sapiei, Noor Sharoja & Mustapha, Mohd Zulkhairi & Abdullah, Mazni, 2016. "SMEs' tax compliance costs and IT adoption: the case of a value-added tax," International Journal of Accounting Information Systems, Elsevier, vol. 23(C), pages 1-13.
    3. Ahmad Farhan Alshira’h & Moh’d Alsqour & Abdalwali Lutfi & Adi Alsyouf & Malek Alshirah, 2020. "A Socio-Economic Model of Sales Tax Compliance," Economies, MDPI, vol. 8(4), pages 1-15, October.
    4. Kaisa Alavuotunki & Jukka Pirttilä, 2015. "The consequences of the value-added tax on inequality," WIDER Working Paper Series 111, World Institute for Development Economic Research (UNU-WIDER).
    5. Dongwon Lee & Thomas E. Borcherding & Youngho Kang, 2014. "Public Spending and the Paradox of Supermajority Rule," Southern Economic Journal, John Wiley & Sons, vol. 80(3), pages 614-632, January.
    6. Kaisa Alavuotunki & Jukka Pirttilä, 2015. "The consequences of the value-added tax on inequality," WIDER Working Paper Series wp-2015-111, World Institute for Development Economic Research (UNU-WIDER).
    7. Gale, William G., 2020. "Raising Revenue with a Progressive Value-Added Tax," MPRA Paper 99197, University Library of Munich, Germany.
    8. Stanley L. Winer, 2016. "The Political Economy of Taxation: Power, Structure, Redistribution," Carleton Economic Papers 16-15, Carleton University, Department of Economics.
    9. Ahmad Farhan Alshira¡¯h & Hijattulah Abdul-Jabbar, 2019. "A Conceptual Model of Sales Tax Compliance among Jordanian SMEs and Its Implications for Future Research," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 11(5), pages 114-114, May.
    10. Alex Ufier, 2017. "The effect of VATs on government balance sheets," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 24(6), pages 1141-1173, December.

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