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A Conditional Revenue Curse?

5 Jul 2016

One of the main obstacles to the sustainability of governments’ revenues in developing countries is the dependency on the rent generated by nonrenewable natural resources. Resource-rich countries have weak incentives to design and maintain efficient tax systems. I consider a theoretical model where the government of a resource-rich country, has to decide whether to undertake a costly investment in its ability to collect taxes and I incorporate progressive income tax. The model predicts that a resource-rich country has more incentives to invest in its ability to collect tax revenues, the more progressiveis the tax schedule because expected returns to that investment may be higher. I test this prediction, named the conditional revenue curse hypothesis, in a sample of 57 developing countries over the period 1981-2005. In order to deal with the endogeneity of natural resources, I construct a country-specific natural resource price index and use its growth rate as an instrument for natural resource rent windfalls. I find that an increase in resource rent windfalls of $1 reduces domestic tax revenues by $0.25. Moreover, at a progressivity level of 0.05 (a tax schedule such that an increase in gross income by 1% yields an increase in the average tax rate by 0.0005% point), an increase in resource rent windfalls of $1 reduces domestic tax revenues by only $0.14. Following a resource windfall, countries with a high level of progressivity collect more tax revenues than their counterparts with a low level of progressivity.
sustainable development government politics economics economy taxation tax revenue natural resources economic growth government policy investments progressive taxation renewable natural resources earnings tax revenue government budget fiscal capacity progressivity business finance endogeneity endogeneity (econometrics) economic rent progressive tax progressive instrumental variable
Pages
53
Published in
Ottawa, Ontario

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