The effects of economic freedom, regulatory quality and taxation on the level of per capita real income: a preliminary analysis for OECD nations and non-G8 OECD nations

Abstract

This study of the impact of economic freedom, regulatory quality and the relative burden of taxation on the level of per capita real income/GDP among OECD nations over the period 2003 to 2007 adopts a modified version of the overall economic freedom index computed by the Heritage Foundation (2013), one with the fiscal freedom and business freedom indices removed. This study then provides panel least squares fixed-effects estimates for five linear specifications/models. Each nation during this time frame can be regarded either as a nation per se or as a de facto ‘economic region’ within the OECD. The analysis first focuses upon all of the OECD nations and then, as a robustness test, subsequently focuses only on non-G8 OECD member nations. The estimations in this study all provide strong empirical support for the three central hypotheses proffered here, namely: (1) the higher the overall degree of economic freedom, the higher the per capita real income (GDP) level; (2) the higher the level of regulatory quality, the higher the level of per capita real income (GDP) and (3) the higher the overall tax burden, expressed as a per cent of GDP, the lower is the level of per capita real income (GDP).

Keywords:

• economic freedom
• regulation
• taxation
• per capita real income

JEL Classification:

• P10
• P16
• E60
• F43
• H61

Notes

¹ This emphasis on economic freedom and the per capita real income level is compatible, in principle, with that in Wiseman and Young (2011) for states within the US, and with certain other studies, including Islam (1996), Grubel (1997) and Nissan and Niroomand (2008).

² In 2010, four additional nations joined the OECD, raising membership from 30 to 34. Unfortunately, there are data limitations for the earlier portion of the study period for these nations, as well as for Iceland, so that this study deals with 29 OECD nations from 2003 through 2007.

³ In addition, this study investigates whether higher taxation reduces per capita real income and whether higher regulatory quality and greater political stability act to elevate per capita real income and thus act to create income differentials.

⁴ As explained below, TAXREVGDP is adopted in lieu of the Heritage Foundation (2013) economic freedom referred to as ‘fiscal freedom’.

⁵ As explained below, REGQUAL is adopted in lieu of the Heritage Foundation (2013) economic freedom referred to as ‘business freedom’.

⁶ In the Appendix, as a rudimentary robustness test, an alternative measure of economic freedom is considered, namely, that computed by Gwartney et al. (2012). The Gwartney et al. (2012) measure is not strictly comparable to the Heritage Foundation (2013) measure, especially given the ways in which the latter is modified in this study. Nevertheless, the results using this alternative data set provide strong empirical support for the principal findings in this study, that is, the findings regarding the three central hypotheses proffered here.

⁷ Related to the impact and nature of corruption, see the recent study by Goel and Nelson (2014).

⁸ Interestingly, it can be easily argued that the higher the value of TAXREVGDP, the greater the incentive to evade taxes (Cebula, 1997), which in turn can compromise tax revenue forecasts and actual tax revenues.

⁹ There is also a reason to believe that high taxation distorts human migration and the efficiency effects of migration and thereby reduces economic growth (Saltz, 1998; Cebula and Alexander, 2006; Damette and Fromentin, 2013), although such an issue is beyond the scope of this study.

¹⁰ The potential economic significance of regulation (good quality) is considered elsewhere in related studies (Clark et al., 2008; Yandle, 2013).

¹¹ HFFREEDOM is adopted as the symbol for the overall average level of economic freedom based on the Heritage Foundation (2013) indices. In subsequent estimations found in the Appendix of this study, an alternative measure of economic freedom based on Gwartney et al. (2012), GLHECONFREE, is substituted for HFFREEDOM.

¹² A complete data set for Iceland was unavailable, so that only 29 of the 30 member OECD nations over the study period could be studied over the period 2003 to 2007.

¹³ All of the estimations in this study adopt the White (1980) cross-section heteroscedasticity correction.

¹⁴ Interestingly, the mean per capita real GDP for the OECD nations without the G8-nations is $19 738 and the mean is $15 930.