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Taxation, infrastructure, and firm performance in developing countries

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Abstract

This paper investigates the relationship between taxation and firm performance in developing countries. Combining firm-level data from the World Bank Enterprise Surveys and tax data from the Government Revenue Dataset, our results suggest that taxation benefits firm growth in developing countries, especially in lower-income countries. This positive contribution of domestic revenue to firm performance seems to channel through the financing of the public infrastructure vital to firms operating in these countries. We also provide evidence that this positive effect disappears when corruption is too pervasive, and when the source of tax revenue reduces government accountability.

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Notes

  1. Barro’s model considers that public finances are balanced.

  2. Version dated November 11, 2015.

  3. The questionnaire includes general questions on ownership, leadership, and production factors, as well as questions on infrastructure (e.g., access to power, water), performance (e.g., sales, exports, imports), and the business climate (market competitiveness, land ownership, crime, relationship with government, obstacles to business).

  4. In each survey, firm sales are measured in t, which is the last fiscal year before the survey year, and in t − 2, i.e., the three fiscal years before the survey year.

  5. Data for the GDP deflator and the exchange rate are retrieved from the World Development Indicators database.

  6. Note that INCOMEj,(t − 3,t − 5) captures the logarithm of per capita GDP in constant 2005 US dollars, but is not expressed in PPP. Estimates with INCOMEj,(t − 3,t − 5) in PPP lead to very similar results. Countries on the falling slope of the inverted-U-shaped relationship between taxation and firm growth with respect to the level of development are reported in Table S.A1 in the supplementary appendix, with both INCOMEj,(t − 3,t − 5) measures (non-PPP per capita GDP and PPP per capita GDP).

  7. Figures for non-developing countries must be considered carefully given the small number of developed economies in the subsample (9), and the few resulting observations at the country-year level (only 19).

  8. Chauvet and Ehrhart (2018) find that a 10% increase in aid would increase firm growth by 5–8%.

  9. Cf. Tables S.A2–S.A9 in the supplementary appendix.

  10. The methodology used to compute cyclically adjusted tax revenue is discussed in the supplementary appendix.

  11. Although the OLS coefficient is not significantly different from the one obtained with the TSLS estimate, since their confidence intervals overlap.

  12. See Table S.A13 in the supplementary appendix for a description of the additional covariates at country and firm levels.

  13. Except when GDP growth is entered, where the p value for the coefficient associated with TAXj,(t,t − 2) is now 0.12.

  14. Given that taxation may take some time to be transformed into infrastructure, we also examine the effect of taxation averaged over a longer time frame than in our baseline estimations, TAXj,(t,t − 5).

  15. Considering the full sample of developing countries and entering triple-interaction terms with income suggests that the positive effect of taxation on the growth of firms structurally more dependent on public utilities lessens as countries become more developed (i.e., as the provision of public goods improves). This implies that firms in industries that rely more intensively on public goods, such as electricity, tend to benefit more from higher overall taxation, especially when they operate in LICs/LMICs with a relatively poorer provision of public utilities.

  16. Indicating that corruption is perceived as being between a moderate (2) and major (3) obstacle to the current operations of the respondent’s establishment.

  17. Using these variables entails a slight reduction in the sample.

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Acknowledgements

We thank the editor and three anonymous reviewers for their constructive comments and helpful suggestions. We also wish to warmly thank Jérôme Héricourt, Silvia Marchesi, Oliver Morrissey, Andrea Presbitero, and Marc Raffinot for their most valuable comments. Lastly, we are grateful to participants from the ICTD and UNU-WIDER Workshop on “Taxation and Revenue Mobilization in Developing Countries”, the DIAL seminar and the EUDN PhD conference for their various comments on earlier versions of this paper.

Funding

The authors acknowledge financial support from UNU-WIDER. They declare that they have no relevant or material financial interests that relate to the research described in this paper.

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Authors and Affiliations

  1. IRD, Université Paris-Dauphine, PSL University, LEDa, DIAL, Paris, France

    Lisa Chauvet & Marin Ferry

  2. ERUDITE (EA 437), Université Gustave Eiffel, UPEC, 5 bd. Descartes – Champs/Marne, 77454, Marne-la-Vallée, France

    Marin Ferry

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  1. Lisa Chauvet
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Table 6 Study sample
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Chauvet, L., Ferry, M. Taxation, infrastructure, and firm performance in developing countries. Public Choice 187, 455–480 (2021). https://doi.org/10.1007/s11127-020-00788-4

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