Abstract
Government continuously operates with revenues below expenditures and taxation is increasingly becoming a sensitive political and economic tool to be relied upon as an instrument for revenue generation and economic growth. This study seeks to examine the impact of tax policy and donor inflows on economic growth in Malawi from 1970 to 2010 using data envelope analysis (DEA) and transcendental logarithm (Translog). In doing the Translog, the study employed the Engle and Yoo three step estimation process. Data analyzed shows that consumption taxes have on average contributed 60.0% to total tax revenue while income taxes take up 40.0%. Tax burden has ranged from 11.0% in the 1970s to around 16.0% in 2010. Results of the study show that a 1.0% decrease in tax burden can raise economic growth by 0.8% in Malawi while a similar reduction in collection of taxes through expenditure can raise growth by 0.6%. Another finding is that economic growth rises by 0.3% for a 10.0% rise in foreign grants. The study therefore finds that reduction in tax burden is more potent in influencing economic growth than fine tuning the proportion in which income and consumption taxes are collected in Malawi. Furthermore, a complete reversal in donor funding will reduce economic growth by 3.0%.
Highlights
Until the early 1990s, literature on economic growth focused on modeling the economy with a long-run equilibrium where output is exogenously determined by technological progress
Theory suggests that higher taxes depress growth, empirics reveal no general evidence to support this across countries
Results from this study point to a need for reduction in tax burden in order to raise economic growth in Malawi
Summary
Until the early 1990s, literature on economic growth focused on modeling the economy with a long-run equilibrium where output is exogenously determined by technological progress. Because in this model, economic growth is assumed to be determined outside the system, the instruments of government policy have no permanent impact on the growth rate. Romer (1986) and Lucas (1988) hold a different view Reflected in their endogenous growth theories , they Argue that government policy for example, level of taxation and tax composition can affect economic growth. While the neoclassical and new growth theories agree on level effects of taxation, they differ on long-run growth effects
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