Taxation and Output Growth: Evidence from African Countries

There is considerable debate over the appropriate role for tax policy in developing economies. In one view, tax hikes reduce deficits and ease budgetary pressures, thereby encouraging long-term growth. An alternative view emphasizes the distortionary effects associated with increased taxation and the positive benefits of a carefully designed tax system. This paper tests these propositions by measuring the impact of government taxation and expenditure on aggregate output growth. A theoretical model is derived which shows that the impact of tax distortions on output growth is usually negative. The theoretical model is tested using a pooled cross-section time-series data set for 31 sub-Saharan African countries during 1965-73 and 1974-82. The regressions imply that the positive benefits of government investment during 1965-73 outweighed the distortionary effects of taxes necessary to finance them. By 1974-82, however, the marginal productivity of government investment had fallen; tax-financed public investment was predicted to have reduced output growth. The empirical results also imply that a revenue neutral shift from the import, corporate, and personal tax to a sales/excise (or consumption) tax will encourage output growth.