Tax Productivity and Economic Development: A Quantitative Macroeconomic Analysis

Abstract

This paper examines the role of government capacity to collect taxes in driving economic development. We first draw on a new macro-historical database to document that tax collections relative to tax administration expenditures rise sharply with GDP per capita. We then interpret this finding in a neoclassical growth model with a tax administration sector in which labor inputs are required to raise tax revenues. Countries differ in their levels of tax productivity, capturing how effectively labor is used to raise taxes, as well as their levels of productivity in creating consumption and investment goods. Governments use tax revenues to provide public capital that complements private factors in production and to make transfers. Quantitatively, our model predicts that increases in tax productivity in low-income economies can raise GDP per capita substantially more than suggested by Hulten’s theorem.