Tax transition in developing countries: do value added tax and excises really work?

Abstract

This paper investigates the role of Value Added Tax (VAT) and excises in first wave tax transition (movement away from international trade taxes towards domestic revenue collection) of developing countries. Focusing on a sample of 96 developing countries over the period 1985–2013, we investigate whether the adoption of VAT enables developing countries to increase the likelihood of succeeding tax transition. Results indicate that having a VAT, allows developing countries to increase the probability of succeeding tax transition by 12%. We further investigate the extent to which VAT and excises offset trade tax revenue losses of trade liberalization in these countries. Our estimates reveal that VAT is offsetting by 52% trade tax revenue losses in developing countries with a U relationship, while this effect holds for excises duties with a U inverted relationship. The study also points out heterogeneities (while VAT-tax transition effect is robust to African and Asian countries, it seems not for Latin American countries), as well as asymmetries (the revenue collection of VAT and excises didn’t increase the period over which developing countries face an increase in trade tax). While enhancing tax administration fosters the transition process in these countries, the study however suggests taking with closer attention VAT and excises as powerful first wave tax transition tools in developing countries.