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Working Paper

Working Paper 15

Institutional Quality, Economic Development and the Performance of VAT

Published on 1 February 2017

In this paper we test, empirically, to which extend the Value- Added Tax (VAT) is a relevant-policy option for developing countries aiming to improve upon their domestic resources mobilisation (DRM). First, we investigate the contribution of VAT to tax collection across developed and developing countries. We also compare the VAT experience of Sub-Saharan African (SSA) and other developing countries. Second, we examine the role of institutional quality in enhancing domestic tax mobilisation in the presence of VAT adoption. For these purposes, we employ a panel data model that takes into account the standard determinants of the tax-effort function as well as the institutional and geographical characteristics of countries.

Analysis of data from 149 countries over the 1970 – 2013 period indicates that VAT adoption improved tax-revenue collection in both developed and developing (SSA and non SSA) countries. Moreover, the marginal effect of VAT adoption is estimated to be strong for SSA and other developing countries as compared to their developed counterparts. The positive effect of VAT on tax collection in SSA is reassuring because some earlier studies were not able to identify an overall positive effect for the region. We show that analysis of data over the recent period is important to find a positive effect for SSA.

As regards the role of institutional quality, we find that tax-revenue collection is higher in countries with better institutional quality – even before VAT adoption. Interestingly, we show that the gain from adopting VAT is maximised in such countries. Given VAT is now adopted in almost all countries across the world, our findings suggest the need to promote reforms to improve the quality of institutions that facilitate tax collection in developing countries.

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Houssa, R., & Megersa, K. (2017). Institutional quality, economic development and the performance of VAT. Working paper (No. 0115). University of Namur, Department of Economics.

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