Tax and price stability in selected African countries: A GARCH-MIDAS approach

Abstract

Motivated by the debate on how best to use tax as a policy tool to fill the huge development financing gap in African countries on the one hand, and achieve price stability objective on the other hand, this paper examines the role of different tax measures in the predictability of price stability in selected African countries using a GARCH-MIDAS framework. We find that taxes contribute significantly to inflation volatility, albeit with mixed outcomes. While the results show that raising income, profits and capital gains tax for most African countries heightens inflation volatility, except for Madagascar, we also find that overall tax revenue and customs and other import duties tax had no significant impact on inflation volatility in most of the countries. We also record out-of-sample forecast gains in accounting for tax in the prediction of inflation volatility. For policy, the paper underscored the need for country-specific tax policy designs and implementation strategies. These may include to expand the tax net and improve efficiency of tax collection and administration (for countries where a further increase in tax rate could heighten inflation volatility or in addition consider a marginal increase in tax rate if tax is not a key predictor of inflation). The general policy option is to diversify and stabilize non-tax revenue streams for consistent funding of essential public goods and services and developmental initiatives.