There are different impacts from the tax mix of progressive (e.g. corporate and personal income), proportional (e.g. property) and regressive (e.g. consumption, trade taxes) taxes. Quantitative analyses of high- and middle-income country data suggest that income taxes tend to be more harmful to growth, and that a shift towards generally less harmful consumption and property taxes (while keeping overall tax revenue unchanged) can modestly increase growth (McBride, 2012; Acosta-Ormaechea & Yoo 2012). McBride (2012) suggests that this may be because progressive taxation reduces the returns and therefore the incentives to work and invest, which in turn undermines growth. Most analyses fail to find similar clear trends in low-income countries (McBride, 2012; Acosta-Ormaechea & Yoo 2012) but a 2014 econometric analysis finds that a shift from trade and consumption taxes to personal income taxes, while keeping overall revenue unchanged, is also harmful to low-income country growth (McNabb & LeMay-Boucher, 2014). The same 2014 study finds no evidence, however, that a shift towards consumption taxes has been good for growth. The impact of taxation on growth is ultimately country-context-specific and mediated by the implementation of tax policy. An observational study of Latin American countries finds that personal income tax has not undermined growth, probably due to poor collection levels (Canavire-Bacarreza et al. 2013). The study also concludes that corporate income tax has a small negative effect on growth across all countries, and that reliance on consumption taxes has positive effects in most, but not all, countries.
The limited developing country evidence on company tax incentives (tax exemptions) does not find that they spur investment and growth, even though they can significantly reduce the overall tax collected (Curtis, 2014). Survey responses suggest they do not affect investors’ decisions, and nascent empirical analysis finds they have no effect on total investment or economic growth (ActionAid, 2013).
Key reading
McBride, William. (2012). What Is the Evidence on Taxes and Growth? (Special Report no. 207). Washington, D.C.: Tax Foundation.
This meta-review by a conservative US think-tank examined 26 studies on the relationship between taxation and growth. Of those studies, 23 find a negative effect of taxes on growth and the last 3 find no overall effect. Corporate income taxes appeared to be the most harmful, followed by personal income taxes, consumption taxes and property taxes. Most studies were of OECD members, although some larger studies also included developing countries. The paper cites one 1997 study of developing countries, which found that tax-financed spending reduces growth in high-income countries but increases growth in developing countries. This seems to be because in developing countries, financing government expenditure through tax is more growth-enhancing than financing expenditures through debt.
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Acosta Ormaechea, S. & Yoo, J. (2012). Tax Composition and Growth: A Broad Cross-Country Perspective (Working Paper 12/257). Washington, D.C.: IMF.
This econometric analysis looked at the relation between changes in tax composition and long-run economic growth using a dataset covering 69 countries with a wide range of income levels. The paper finds that for middle- and high-income countries, higher income taxes (personal income tax and social security contributions) seem to undermine growth, whereas higher consumption taxes (value-added and sales taxes) seem to improve growth. Corporation tax does not have a significant relationship with economic growth. In low-income countries there was no significant association between growth and any particular kind of tax, apart from trade taxes which seemed to worsen growth. The authors suggest that the lack of significant association between tax and growth in low-income countries is due to poorer quality tax administration and enforcement.
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Canavire-Bacarreza, G., Martinez-Vazquez, J., & Vulovic, V. (2013). Taxation and Economic Growth in Latin America (IDB Working Paper Series No. IDB-WP-431). Washington, D. C.: Inter-American Development Bank.
Using econometric analysis and modelling, this paper estimates the effects on growth of increases in the main taxes in Argentina, Brazil, Mexico, and Chile. The paper finds that personal income tax has not had any significant negative effects on economic growth in these middle- and high-income countries. This can be explained by the low collection levels in the region. For corporate income tax, the effects are inconsistent, with negative, positive or no effect on different countries. Use of consumption taxes has generally been a source of economic growth in Latin America. The authors conclude that reducing tax evasion and improving collection rates may boost economic growth in the region as a whole.
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ActionAid. (2013). Give us a break: How big companies are getting tax-free deals. London: ActionAid.
This literature review and advocacy paper explores the use of tax exemptions as ‘tax incentives’ for investment and economic growth in developing countries. The paper provides an overview of types of incentives, the growth in the use of incentives and proposals for ending tax breaks. Based on investor survey data and empirical evidence the paper concludes that these tax exemptions fail to act as incentives, can ‘crowd out’ local investors, and reduce revenue for public services.
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- Miller, S. M., & Russek, F. S. (1997). Fiscal structures and economic growth: international evidence. Economic Inquiry, 35(3), 603-613. See document online
- Curtis, M. (2014). Losing out: Sierra Leone’s massive revenue losses from tax incentives. London: ChristianAid. See document online
- McNabb, K. & LeMay-Boucher, P. (2014). Tax Structures, Economic Growth and Development (ICTD Working Paper 22). Brighton: Institute of Development Studies. See document online