The Differential Impact of Democracy on Tax Revenues in Developing and Developed Countries

ABSTRACT

This paper investigates the extent to which democracy affects tax revenues in developing countries in comparison to developed countries across various categories of tax revenues. Based on a sample consisting of 30 developed and 29 developing countries for 2006–2013, the authors find that while democracy has a positive association with tax revenues in developed countries, the association is generally negative for developing countries compared to their counterparts. This study finds that the tax revenues most negatively affected by democracy in developing countries are corporate. The positive findings for developed countries support predictions of the compatibility perspective: that democracy results in economic growth. For developing countries, the relationship is either negative or weaker, matching the predictions of the conflict perspective that democracy results in various groups increasing rent-seeking activities from the state. These findings have implications for tax-related public policies.

KEYWORDS:

• Tax revenue
• democracy
• compatibility perspective
• the conflict perspective
• developing and developed countries

Notes

1. One exception is Profeta et al. (2013). They break the tax revenues into various categories, but their sample includes only developing countries. This study complements theirs by including both developing and developed countries and comparing the findings in various tax categories between these two types of countries.

2. Baskaran (2014) and Baskaran and Bigsten (2013) investigate whether taxation affects democracy. This paper argues that issue from a theoretical point of view; therefore, the direction of the relationship under investigation is more plausible (i.e., democracy is a determinant of tax revenues). Moreover, the direction of the relationship used in Baskaran (2014) and Baskaran and Bigsten (2013) goes against most of the research that investigates the association between democracy and taxation.

3. The EIU published the Democracy Index in 2006.

4. The EIU divides countries into four regimes using democracy scores: full democracy (scores of 8–10), flawed democracies (scores of 6–7.9), hybrid (scores of 4–5.9), and authoritarian (scores below 4). As this paper’s sample is small and for convenience of interpretation of results, the authors use only democracy score instead of dividing countries into these four regimes.

5. Profeta et al. (2013) use a democracy measure based on two variables: the political strength of democratic institutions and the protection of civil liberties.

6. For details about the construction of these indicators, see Democracy Index 2013: Democracy in Limbo, published by The Economist in 2014.

7. The data is available at www.systemicpeace.org/inscr/p4v2017.xls.