The relationship between taxes and growth is hardly an easy topic to resolve in a single blog. But the IMF has been saying some interesting things on this subject recently, not least in a paper I reviewed a couple of weeks ago, which had three notable findings:
- In middle- and high-income countries, there’s a negative association between economic growth and the share of personal income tax and social security contributions in the tax mix (and a positive one for value-added and sales taxes).
- The share of corporation tax in the overall mix doesn’t have a significant relationship with economic growth.
- The authors couldn’t find a significant association between growth and any particular kind of tax in low-income countries, apart from a negative one for trade taxes.
Now, via Mark Herkenrath, comes a note of an IMF conference “Taxation and Economic Growth in Latin America”. The note asserts that “Tax Policy Can Help Spur Economic Growth”, so the question, in the light of the evidence from the previous paper, is how?
This is a review of “Tax Composition and Growth: A Broad Cross-Country Perspective,” an IMF working paper by Santiago Acosta Ormaechea and Jia Yoo.
Here’s the assumption that I’m going to make in this post: it’s probably not too much of a stretch to say that the consensus among development practitioners is that economic growth in low-income countries is indispensable to development, but that the quality, as well as the quantity, of that growth matters. It follows from this that sometimes the most ‘pro-development’ policy change might be one that compromises on the quantity of growth in order to ensure that it’s good quality – for example that it happens in ways that benefit the poor and not just a small, wealthy section of the economy, and that it is sustainable. (I said ‘low-income’ countries, because some might argue that middle-income countries need to focus more on equality, and less on growth).
Anyone making recommendations about tax policy or administration, be it a campaigning NGO or the IMF, or indeed a government on the receiving end of this advice, needs to consider how the position they advocate will affect economic growth. But if my assumption above is correct, they need to do this in order to consider the balance between quality and quantity of growth, not just to evaluate a policy on how it affects the rate of growth.
With this in mind, I’ve been reading a new IMF paper which purports to be the most comprehensive empirical study of how different taxes affect economic growth. The paper focuses on the tax mix, that is the different sources from which income is raised, not the total tax that is raised as a share of national income. The logical use of this research for development practitioners in low-income countries is to answer the question “where should tax revenue come from in order to have the best (or least worst) impact on growth?”