Essays on Tax Effort and Fiscal Balance: A Case of Selected African Economies

Abstract

Many African economies are confronting a persistent dual problem of lower tax revenues and a growing level of indebtedness. Infrastructure projects, for example, take a long time to complete and start generating revenues to repay the borrowed funds used to finance them. Because of such financial risk (i.e., a lack of long-term exchange hedge), financial institutions are often reluctant to finance such projects, despite the benefits they bring to society, making tax collection the most credible source of financing. So far, these problems have adversely affected development progress in the region and made these economies vulnerable to both exogenous and endogenous shocks, exacerbating slow growth and posing a threat of debt trap. This thesis explores the challenges of a narrow tax base and the influence of political factors and exposure to exogenous shocks on the budget balance in 25 selected African countries in three essays. The first essay examines tax effort in 25 selected African countries and its implications for economic development. It assesses the extent to which tax mobilisation is constrained by informality and economic complexity, limiting the ability of governments to leverage their full tax capacity for public expenditure. Additionally, the study compares tax effort across countries, providing insights into optimal tax structures for addressing budget deficits and managing debt. Using a panel data set from 2000 to 2021, tax effort and tax capacity were estimated using the stochastic frontier technique. Given data limitations and potential endogeneity concerns, the analysis was further validated using Ordinary Least Squares, panel Fixed Effects, and dynamic Generalized Method of Moments (GMM) for robustness. Key findings from the analysis indicate that the informal economy, coupled with agriculture, population size, voice accountability, and corruption control, negatively affect tax effort. Conversely, economic complexity, per capita gross domestic product, trade openness, remittances, foreign direct investment, and manufacturing contribute positively to tax revenue. These results underscore the critical role of reducing informality, strengthening governance, and advancing economic structural transformation to enhance revenue mobilisation in African economies. The study provides valuable insights into fiscal policy dynamics across the region and offers policy recommendations for improving tax efficiency and ensuring fiscal sustainability. The second essay provides an empirical analysis of the relations between election proximity, institutions and political regimes, and fiscal balance in 25 selected African countries, using unbalanced panel data for the period 2000 to 2021 and employing the dynamic panel data estimation technique (System and Difference-GMM techniques) for analysis. While accounting for endogeneity, cross-sectional dependence, instrument validity, and serial correlation problems in the panel data, the evidence supports the influence of election timing and regime type on budget deficits in these countries. The results indicate that, while xiii controlling for other indicators—such as economic growth, financial crisis, and institutional variables, all of which are statistically significant to the budget deficit—the proximity of the election cycle tends to increase budget deficits in these countries. The existence of the election-cycle shock to budget deficits suggests that there may be a need for robust fiscal prudence, especially during election years, or a need for the adoption of a strictly balanced budget rule that limits spending during the election cycle period. The third essay examines the change in fiscal balance in the context of the COVID-19 crisis. It analyses whether exogenous shocks stemming from the pandemic’s outbreak have any moderating effects on the budget balance determinants and whether these effects reinforce or dampen the initial effects of macroeconomic, demographic, and institutional setting variables on fiscal balance. The analysis used data from 25 African countries, and the Method of Moments Quantile regression and system GMM approaches. Various pandemic measures are employed to investigate this problem. The results show that the overall effect of the COVID-19 crisis has resulted in a disproportionate increase in the estimated impact of macroeconomic, demographic, and institutional quality determinants on the budget balance. The results suggest that the COVID-19 pandemic has had a reinforcing (dampening) effect on population expenditure (economic growth) variables on fiscal balance, both in the short term and the long term. These findings hold across different model specifications and datasets. The study also finds that containment measures, COVID-19-related deaths, economic market volatility, and the stringent index exert a long-term adverse effect on fiscal balance by increasing fiscal deficits across all quantiles. The effects of economic growth and population on the budget balance hold in both the long run and the short term, while the effect of the real interest rate is statistically significant only at the upper end of the distribution. Total expenditure as a percentage of gross domestic product is statistically significant only in the short term. Overall, the results suggest that efforts to broaden the tax base through reduction in levels of the informal sector, the infusion of technology into production, and other endowments in these countries are vital for increasing both revenue sources and broadening the tax base. At the same time, the political business cycle and fiscal balance results suggest that the continuous effort of institution building is necessary to strengthen the utilisation of available resources in addressing public social and economic problems. The exogenous shock to the economy caused by COVID-19 has had overreaching effects in various areas of the economy. The results suggest that, although the outbreak is one of its kind, it significantly impacts the fiscal balance. Thus, the results provide a learning opportunity in terms of how exogenous shocks impact budgetary planning should a similar outbreak occur in the future.