The impact of tax revenue on economic growth: time series evidence from Ethiopia

Abstract

Tax revenue is believed to provide developing countries with a stable and predictable fiscal environment to promote growth and to finance their social and physical infrastructural needs. However, the prior empirical results across different countries witness that the relationship between government tax revenue and economic growth can be negative, positive or neutral depending on countries economic exposure and stabilization policy experiences. Thus, this study examined the effect of tax revenue on economic growth of Ethiopia, from 1980 to 2018 by employing Autoregressive Distributed Lag (ARDL) approach. The enquiry also used Vector Error Correction Model (VECM) in order to observe how fast the co-integrated variables convergence in long-run and found expected negative sign. The stationarity properties of the data were detected using ADF and PP test statistics and the result confirms all the variables are stationary at level and first difference evidencing the effectiveness of ARDL model. The ARDL bound test result indicates that there is long run relationship between RGDP and independent variables. The empirical results are indication of long- and short-run positive impacts of government tax revenue on economic growth in Ethiopia. The result suggests that tax revenue exerted a positive and statistically significant effect on economic growth both in the long run and short-run implying that tax revenue enhances economic growth in Ethiopia. Furthermore, government expenditures on education and health as proxy of human capital and rate of inflation variables show a statistically significant and expected effect on real GDP in Ethiopia. Hence, the policy maker needs to give more effort to expand the tax base and should increase the efficiency of collection to stimulate overall economic growth in long and short run. JEL code: H2; O4; C22