Impact of direct and indirect taxes on economic development: A comparison between developed and developing countries

Abstract

Taxes have extraordinary roles in any country’s economic development and policymaking. This study extends prior studies by investigating the impact of direct and indirect taxes on the economic development of 47 developed and 90 developing countries. All data about the variables involved in the study are accessed from the World Bank, covering from 2000 to 2020. Three equation models are developed to examine the impacts of tax structures on economic growth, which are gross domestic product per capita (GDPPC), foreign direct investment (FDI), and unemployment (UE). The study employed fixed effects (FE) and random effects (RE) of Generalized Least Square regression in testing the relationship between taxes structure (direct and indirect) and economic development (GDPPC, FDI, and UE). In addition, the cross-sectional dependence (CD) test is used to identify the presence of spatial dependence for FE and RE estimators. Overall, direct and indirect taxes have a significant negative relationship with economic development based on the GDPPC of developing countries. These results indicated that the tax structure in developing countries does not enhance the countries’ economic growth. By contrast, for developed countries, a significant positive relationship exists between direct taxes and economic development. Economics and Development; Economics; Public Finance

Keywords:

• Developed countries
• developing countries
• direct taxes
• economic development
• foreign direct investment
• indirect taxes
• unemployment rate

JEL Classification:

• Code: H2
• O1: O2

PUBLIC INTEREST STATEMENT

Taxes generate public revenues to finance investments in human capital and infrastructure and provide services for citizens and businesses. This study investigates the impact of taxes on economic development, covering the gross domestic product per capita (GDPPC), foreign direct investment (FDI), and unemployment (UE). The findings provide evidence that direct tax positively affects the economic development of developed countries but negatively affects the economic development of developing countries. Hence, the policymakers of developing countries are recommended to revisit the tax structures if they want to enhance the positive impact of taxes on their countries’ economic development. In doing so, the policymakers would be able to identify the best type of taxes that will be able to generate high revenues for the country to provide the best infrastructure and services to the citizens and businesses.

Acknowledgements

This work was supported by the Accounting Research Institute (ARI), HICoE, Universiti Teknologi (UiTM), Shah Alam, Malaysia under the Grant:600-RMC/ARI 5/3(012/2021).

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. Direct taxation refers as taxation imposed to an individual who is intended to be the final bearer of the tax payment.

2. Indirect taxation refers to taxation imposed to others than the individual who is intended to bear the final payment.

Additional information

Funding

This work was supported by the Accounting Research Institute (ARI), a Higher Institution Centre of Excellence, Ministry of Higher Education Malaysia [ARI-HICoE: 600-RMC/ARI 5/3].

Notes on contributors

Taufik Abd Hakim

Taufik Abd Hakim is a senior lecturer at Universiti Teknologi MARA (UiTM), Faculty of Business and Management. He holds a Doctor of Philosophy (PhD) in Business Management (Economics) from UiTM. His research interests include taxation, macroeconomics and panel data econometrics.

Abdul Aziz Karia

Abdul Aziz Karia is an Associate Fellow at Accounting Research Institute, HICoE, Universiti Teknologi MARA. He received his PhD in Economic Forecast from the Universiti Teknologi MARA. He actively participates in the policy paper and decision-making at the state level.

Jasmine David

Jasmine David began her career at Universiti Teknologi MARA in July 2005. She has a Ph.D. in accounting from the Victoria University of Wellington. She is actively engaged in research collaboration and networking with local, as well as international, universities and organizations.

Rainah Ginsad

Rainah Ginsad is a fellow at Accounting Research Institute, HICoE, Universiti Teknologi MARA. She holds a Doctor of Business Administration from Universiti Teknologi MARA (UiTM).

Norziana Lokman

Norziana Lokman is an Associate Professor and a Fellow at Accounting Research Institute, HICoE, Universiti Teknologi MARA. She has received her PhD in the field of Corporate Administration/Corporate Governance from the University of Southern Queensland. She has presented papers at various conferences and published articles in reputable scholarly journals.

Salwa Zolkafli

Salwa Zolkafli is a fellow at Accounting Research Institute, HICoE, Universiti Teknologi MARA. She holds a Doctor of Philosophy (Accounting) degree from Universiti Teknologi MARA (UiTM), with the title Factors and Challenges Influencing Money Laundering Investigation Outcome among the Law Enforcement Agencies in Malaysia.