The impact of macroeconomic policies on the level of taxation in developing countries: the case of Tanzania.

This study investigates the impact of macroeconomic policies on the level of taxation (tax revenue/GDP ratio) in developing countries, with Tanzania as a case study. The study's main hypothesis is that through various channels, macroeconomic policies, in particular, the exchange rate, import substitution, trade liberalisation, external debt, interest rate, public sector and wage policies, and inflation, impacted adversely on the level of tax revenue. Using an Error Correction Model (ECM) and Ordinary Least Squares (OLS) estimation technique, the above hypothesis is tested empirically for the 1967-91 period using Tanzanian data. At the aggregate tax level, empirical results indicate the following: first, macroeconomic policies are an important determinant of real tax revenue and the level of taxation in Tanzania. Second, the official real exchange rate has a negative impact on the level of taxation. Third, import substitution policies affect negatively the level of taxation. Fourth, real external debt leads to an increase in the level of taxation. That is, increases in real external debt stock and hence debt service payments induce more tax revenue collection, mainly through tax rate increases. Fifth, the impact of real parastatal profits on the level of taxation is negative. Sixth, the impact of real wage bill on level of taxation is positive, implying that wage bill requirements exert pressure on tax collection by inducing tax rate increases. Seventh, inflation has a negative influence on real tax revenue and level of taxation, mainly because some taxes are collected with delay. Eighth, the impact of real interest rate on the level of taxation is negative. Finally, economic performance as measured by real output change negatively affects the level of taxation. The study also singles out the complexity of the tax structure, tax evasion, and weaknesses in tax administration as other factors behind unsatisfactory tax revenue performance. Accordingly, based on the above findings, the study recommends for the need to 'rightly' conduct macroeconomic policies to minimise their imbalances and consequently their negative effects on output and tax revenue. It also suggests for the need to simplify the tax structure and strengthen tax administration by increasing enforcement and reducing tax revenue leakage and losses.