Down The Ricardian Economics Rabbit Hole

The traditional role of the tax system is to bring in sufficient revenue to cover the growing public sector requirements. Common measures the capacity of the tax system to mobilize revenues are buoyancy and elasticity (Asher 1989). A desirable property of a tax system is that income elasticity and buoyancy should be equal to or higher than unity. Such property ensures that revenue growth keeps pace with that of Gross Domestic Product (GDP) without frequent discretionary changes. More important, it imparts build-in stability in the middle tax system, hence ensuring mitigation of cyclic variations in GDP over the space of the business cycle.

The study attempts to investigate the determinants of tax buoyancy, paying particular attention on the effect of monetization on tax buoyancy. The tax performance analysis aims at finding out whether there is a chance of increasing tax revenue in developing nations through the monetary policy. Taxation is an important instrument for attaining a proper pattern of income distribution, resource allocation, and economic stability, in order that the fruits of economic development are evenly distributed.

Tax systems should be adequately stable and buoyant in order to allow for a country to cover its increasing financial commitments as its gross domestic product (GDP) grows. If the tax revenue of a country is stable and buoyant, there is a high probability that its public expenditure needs will be adequately met over time. If GDP is growing more than tax revenues then it could be one policy indicator that the tax structure needs reform. The study of tax buoyancy is of much importance, for it is both a quality and quantity measure of tax performance. Tax buoyancy can also serve to summarize revenue growth over time, (Zolt, 2003:8). Finally, it shows the force of the tax system in the country when they’re subjected to certain environments for example when a certain sector is declining.

Ricardian Economics Continued

The manner in which different countries raise taxes differs as widely as do the amounts they raise. The pattern of taxes found in any country depends upon many factors such as its history, its economic structure, and the tax structures found in neighbouring countries (Bird and Zolt, 2003: 7). According to Zolt (2003:1), developing countries are no different: ideas, institutions, and interests play a pivotal role in shaping tax policy. Basing on this argument the study will be focusing on COMESA countries since they’re close to each other and belong to a community. Countries no longer have the luxury to design their tax systems in isolation.

The normative bent of the literature on tax policy is concerned with the questions of why a country develops a particular tax structure and why this tax structure differs among countries and changes in the process of economic growth. This strand of tax literature not only recognizes the importance of administrative constraints on tax policy, but as opposed to the normative literature places administrative factors at the forefront.

Further Discussions About Ricardian Economics

The ‘tax handle’ theory offers a sweeping historical explanation of tax structure change. It argues that low-income economies are obliged to collect revenue from easy-to-administer taxes (or tax handles), but that this administrative constraint lessens as countries develop and become able to choose ‘better’ taxes as determined by the normative objectives discussed above. Measures of tax handles typically include per trade taxes, capita income, and the number of people living in urban areas (Liebaman, 2003).

The optimal tax theory, the reigning normative approach to taxation combines the set of available taxes to the government, information on a country’s economic structure, and aims of tax policy to make recommendations on tax mix, structure and incidence (see Slemrod, 1990; Burgess and Stern, 1993). Optimal taxes are those that raise a desired amount of revenue with the lowest marginal efficient cost, with few distortions and that support the desired amount of wealth. While optimal tax theory tackles the trade off of different taxes, it doesn’t explain the structure of government revenues.

The Ricardian equivalence theory rests on the opinion that once the government borrows instead of levying taxes to finance budget deficit the current generation is under taxed, they’re rational and will realize that the loan will have to be repaid from income tax at some time in the future; debt finance is therefore for the adjournment of the tax burden which will fall on the future generation. The importance of this theory to tax performance is now questionable given the continuous borrowing done in developing nations and continuous budget deficit in the economies. The theory suggests discipline in the monetary sector and also effective borrowing which doesn’t affect generations to come.

Stotsky, J.G. And WoldeMariam, A. (1997),’ Tax Effort in Sub-Saharan Africa,’ IMF Working Paper, WP/97/107, September.

Wawire Nelson Were H. (2000),’ The Determinants of Tax Revenue in Kenya. ‘ Kenyatta University, Nairobi.

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