State Institutions and Tax Capacity: An Empirical Investigation of Causality

IMF Working Papers, August 16, 2019

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Canonical URL: State Institutions and Tax Capacity: An Empirical Investigation of Causality

Central question: Would better state institutions increase tax collection, or would higher tax collection help improve state institutions?
Sample: panel dataset covering 110 non-resource-rich countries from 1996 to 2017.
Methodology: panel vector error correction model; impulse response analyses also employed.

The paper finds that tax capacity and state institutions cause and reinforce each other for a wide range of country groups (bi-directional causality).
Developing tax capacity and building state institutions need to go hand in hand for best results, particularly in developing countries.
Impulse response results:
- In advanced economies, the causal effects are generally low in both directions.
- In developing countries, both tax capacity and institutions shocks have larger positive impacts on institutions and tax capacity, respectively.

Coordinate efforts to strengthen tax capacity and improve state institutions simultaneously, with particular emphasis on developing countries where interventions have larger positive effects.
Prioritize integrated reforms rather than isolated measures focused only on institutions or only on tax collection systems.